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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 September 30, 2007

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 November 1, 2007
|Common Stock, par value $.01per share |  | 16,205,470                     



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##### Table of Contents

AVATECH SOLUTIONS, INC. AND SUBSIDIARIES

INDEX



|           |  |                                                                                                    |  |     
|---------- |  | -------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                    |  | Page
|PART I     |  | FINANCIAL INFORMATION                                                                              |  |     
|           |  |                                                                                                   
|ITEM 1.    |  | Financial Statements                                                                               |  |     
|           |  |                                                                                                   
|           |  | Consolidated Balance Sheets  September 30, 2007 (Unaudited) and June 30, 2007                     |  | 3   
|           |  |                                                                                                   
|           |  | Consolidated Statements of Operations  Three months ended September 30, 2007 and 2006 (Unaudited) |  | 5   
|           |  |                                                                                                   
|           |  | Consolidated Statement of Stockholders Equity  Three months Ended September 30, 2007 (Unaudited) |  | 6   
|           |  |                                                                                                   
|           |  | Consolidated Statements of Cash Flows  Three months ended September 30, 2007 and 2006 (Unaudited) |  | 7   
|           |  |                                                                                                   
|           |  | Notes to Consolidated Financial Statements (Unaudited)                                             |  | 8   
|           |  |                                                                                                   
|ITEM 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations              |  | 13  
|           |  |                                                                                                   
|ITEM 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                         |  | 18  
|           |  |                                                                                                   
|ITEM 4.    |  | Controls and Procedures                                                                            |  | 18  
|           |  |                                                                                                   
|PART II    |  | OTHER INFORMATION                                                                                  |  |     
|           |  |                                                                                                   
|ITEM 1A.   |  | Risk Factors                                                                                       |  | 19  
|           |  |                                                                                                   
|ITEM 6.    |  | Exhibits                                                                                           |  | 19  
|           |  |                                                                                                   
|SIGNATURES |  |                                                                                                    |  | 20  



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                     |  |                   |            |               |   |           
|-------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | ------------- | - | ----------
|                                                                                                                     |  | September 30,2007 |            | June 30, 2007
|                                                                                                                     |  | (unaudited)       |            |              
|Assets                                                                                                               |  |                   |            |               |   |           
|Current assets:                                                                                                      |  |                   |            |               |   |           
|Cash                                                                                                                 |  | $                 | 605,000    |               | $ | 1,688,000 
|Accounts receivable, less allowance of $202,000 as of September 30, 2007 and $188,000 as of June 30, 2007            |  |                   | 7,923,000  |               |   | 7,402,000 
|Other receivables                                                                                                    |  |                   | 490,000    |               |   | 492,000   
|Inventory                                                                                                            |  |                   | 918,000    |               |   | 902,000   
|Prepaid expenses and other current assets                                                                            |  |                   | 322,000    |               |   | 356,000   
|                                                                                                                     |  |                   |            |               |   |           
|Total current assets                                                                                                 |  |                   | 10,258,000 |               |   | 10,840,000
|                                                                                                                     |  |                  
|Property and equipment:                                                                                              |  |                   |            |               |   |           
|Computer software and equipment                                                                                      |  |                   | 3,019,000  |               |   | 2,907,000 
|Office furniture and equipment                                                                                       |  |                   | 1,212,000  |               |   | 1,212,000 
|Leasehold improvements                                                                                               |  |                   | 167,000    |               |   | 167,000   
|                                                                                                                     |  |                   |            |               |   |           
|                                                                                                                     |  |                   | 4,398,000  |               |   | 4,286,000 
|Less accumulated depreciation and amortization                                                                       |  |                   | 3,456,000  |               |   | 3,352,000 
|                                                                                                                     |  |                   |            |               |   |           
|                                                                                                                     |  |                   | 942,000    |               |   | 934,000   
|                                                                                                                     |  |                  
|Customer list, net of accumulated amortization of $454,000 as of September 30, 2007 and $387,000 as of June 30, 2007 |  |                   | 1,732,000  |               |   | 1,803,000 
|Goodwill                                                                                                             |  |                   | 5,968,000  |               |   | 5,888,000 
|Other assets                                                                                                         |  |                   | 99,000     |               |   | 109,000   
|                                                                                                                     |  |                   |            |               |   |           
|Total assets                                                                                                         |  | $                 | 18,999,000 |               | $ | 19,574,000
|                                                                                                                     |  |                   |            |               |   |           

See accompanying notes.



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)



|                                                                                                                                                                                                                                                                                                                            |  |                   |            |   |               |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                                                                                                                                                                                                                                                                            |  | September 30,2007 |            |   | June 30, 2007 |  
|                                                                                                                                                                                                                                                                                                                            |  | (unaudited)       |            |   |               |  
|Liabilities and stockholders equity                                                                                                                                                                                                                                                                                        |  |                   |            |   |               |   |            |  
|Current liabilities:                                                                                                                                                                                                                                                                                                        |  |                   |            |   |               |   |            |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                       |  | $                 | 6,093,000  |   |               | $ | 5,635,000  |  
|Accrued compensation and related benefits                                                                                                                                                                                                                                                                                   |  |                   | 1,110,000  |   |               |   | 1,461,000  |  
|Borrowings under line of credit                                                                                                                                                                                                                                                                                             |  |                   |           |   |               |   | 1,408,000  |  
|Note payable                                                                                                                                                                                                                                                                                                                |  |                   | 22,000     |   |               |   | 31,000     |  
|Deferred revenue                                                                                                                                                                                                                                                                                                            |  |                   | 1,053,000  |   |               |   | 1,094,000  |  
|Other current liabilities                                                                                                                                                                                                                                                                                                   |  |                   | 69,000     |   |               |   | 96,000     |  
|                                                                                                                                                                                                                                                                                                                            |  |                   |            |   |               |   |            |  
|Total current liabilities                                                                                                                                                                                                                                                                                                   |  |                   | 8,347,000  |   |               |   | 9,725,000  |  
|                                                                                                                                                                                                                                                                                                                            |  |                  
|Deferred tax liability                                                                                                                                                                                                                                                                                                      |  |                   | 80,000     |   |               |   |           |  
|                                                                                                                                                                                                                                                                                                                            |  |                  
|Series F Convertible Preferred Stock                                                                                                                                                                                                                                                                                        |  |                   | 3,629,000  |   |               |   | 3,629,000  |  
|                                                                                                                                                                                                                                                                                                                            |  |                  
|Stockholders equity:                                                                                                                                                                                                                                                                                                       |  |                   |            |   |               |   |            |  
|Convertible Preferred Stock, $0.01 par value; 1,300,537 shares authorized and 1,298,728 issued at September 30, 2007 and June 30,
2007; outstanding shares of 1,090,253 at September 30, 2007 and 1,106,929 at June 30, 2007 with an aggregate liquidation preference of $1,704,000 at September 30, 2007 and June 30, 2007 |  |                   | 11,000     |   |               |   | 11,000     |  
|Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 16,108,561 at September 30, 2007 and
15,482,036 at June 30, 2007.                                                                                                                                                             |  |                   | 161,000    |   |               |   | 155,000    |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                                  |  |                   | 12,934,000 |   |               |   | 12,706,000 |  
|Accumulated deficit                                                                                                                                                                                                                                                                                                         |  |                   | (6,163,000 | ) |               |   | (6,652,000 | )
|                                                                                                                                                                                                                                                                                                                            |  |                   |            |   |               |   |            |  
|Total stockholders equity                                                                                                                                                                                                                                                                                                  |  |                   | 6,943,000  |   |               |   | 6,220,000  |  
|                                                                                                                                                                                                                                                                                                                            |  |                   |            |   |               |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                                  |  | $                 | 18,999,000 |   |               | $ | 19,574,000 |  
|                                                                                                                                                                                                                                                                                                                            |  |                   |            |   |               |   |            |  

See accompanying notes.



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##### Table of Contents

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations



|                                                   |  |                                  |            |   |             |   |            |  
|-------------------------------------------------- |  | -------------------------------- | ---------- | - | ----------- | - | ---------- | -
|                                                   |  | Three Months Ended September 30, |           
|                                                   |  | 2007                             |            |   | 2006        |  
|                                                   |  | (unaudited)                      |            |   | (unaudited) |  
|Revenues:                                          |  |                                  |            |   |             |   |            |  
|Product sales                                      |  | $                                | 7,255,000  |   |             | $ | 7,254,000  |  
|Service revenue                                    |  |                                  | 2,823,000  |   |             |   | 2,619,000  |  
|Commission revenue                                 |  |                                  | 2,339,000  |   |             |   | 2,172,000  |  
|                                                   |  |                                  |            |   |             |   |            |  
|                                                   |  |                                  | 12,417,000 |   |             |   | 12,045,000 |  
|                                                   |  |                                  |            |   |             |   |            |  
|Cost of revenue:                                   |  |                                  |            |   |             |   |            |  
|Cost of product sales                              |  |                                  | 4,946,000  |   |             |   | 4,676,000  |  
|Cost of service revenue                            |  |                                  | 2,032,000  |   |             |   | 1,829,000  |  
|                                                   |  |                                  |            |   |             |   |            |  
|                                                   |  |                                  | 6,978,000  |   |             |   | 6,505,000  |  
|                                                   |  |                                  |            |   |             |   |            |  
|Gross margin                                       |  |                                  | 5,439,000  |   |             |   | 5,540,000  |  
|                                                   |  |                                  |            |   |             |   |            |  
|Other operating expenses:                          |  |                                  |            |   |             |   |            |  
|Selling, general and administrative                |  |                                  | 4,621,000  |   |             |   | 5,224,000  |  
|Depreciation and amortization                      |  |                                  | 175,000    |   |             |   | 171,000    |  
|                                                   |  |                                  |            |   |             |   |            |  
|                                                   |  |                                  | 4,796,000  |   |             |   | 5,395,000  |  
|                                                   |  |                                  |            |   |             |   |            |  
|Operating income                                   |  |                                  | 643,000    |   |             |   | 145,000    |  
|                                                   |  |                                  |            |   |             |   |            |  
|Other income (expense):                            |  |                                  |            |   |             |   |            |  
|Interest and other income                          |  |                                  | 26,000     |   |             |   | 12,000     |  
|Interest expense                                   |  |                                  | (13,000    | ) |             |   | (67,000    | )
|                                                   |  |                                  |            |   |             |   |            |  
|                                                   |  |                                  | 13,000     |   |             |   | (55,000    | )
|                                                   |  |                                  |            |   |             |   |            |  
|Income before income taxes                         |  |                                  | 656,000    |   |             |   | 90,000     |  
|Income tax expense                                 |  |                                  | 167,000    |   |             |   | 54,000     |  
|                                                   |  |                                  |            |   |             |   |            |  
|Net income                                         |  |                                  | 489,000    |   |             |   | 36,000     |  
|Preferred stock dividends                          |  |                                  | (42,000    | ) |             |   | (48,000    | )
|                                                   |  |                                  |            |   |             |   |            |  
|Net income (loss) available to common stockholders |  | $                                | 447,000    |   |             | $ | (12,000    | )
|                                                   |  |                                  |            |   |             |   |            |  
|Earnings per common share, basic                   |  | $                                | 0.03       |   |             | $ | 0.00       |  
|                                                   |  |                                  |            |   |             |   |            |  
|Earnings per common share, diluted                 |  | $                                | 0.02       |   |             | $ | 0.00       |  
|                                                   |  |                                  |            |   |             |   |            |  
|Shares used in computation - basic                 |  |                                  | 15,799,015 |   |             |   | 13,615,501 |  
|                                                   |  |                                  |            |   |             |   |            |  
|Shares used in computation - diluted               |  |                                  | 20,007,314 |   |             |   | 21,349,544 |  
|                                                   |  |                                  |            |   |             |   |            |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders Equity (Unaudited)



|                                                            |  |                  |   |              |           |        |                  |            |           |   |                            |  |   |                     |   |  |       |            |   |  |   |           |  
|----------------------------------------------------------- |  | ---------------- | - | ------------ | --------- | ------ | ---------------- | ---------- | --------- | - | -------------------------- |  | - | ------------------- | - |  | ----- | ---------- | - |  | - | --------- | -
|                                                            |  | Preferred Stock  |   | Common Stock |           |        |                  |            |           |   |                            |  |  
|                                                            |  | Number of Shares |   |              | Par Value |        | Number of Shares |            | Par Value |   | Additional Paid-In Capital |  |   | Accumulated Deficit |   |  | Total |           
|Balance at June 30, 2007                                    |  | 1,106,929        |   |              | $         | 11,000 |                  | 15,482,036 |           | $ | 155,000                    |  | $ | 12,706,000          |   |  | $     | (6,652,000 | ) |  | $ | 6,220,000 |  
|Issuance of common stock as compensation                    |  |                 |   |              |           |       |                  | 18,783     |           |   |                           |  |   | 16,000              |   |  |       |           |   |  |   | 16,000    |  
|Issuance of common stock upon the exercise of stock options |  |                 |   |              |           |       |                  | 507,924    |           |   | 5,000                      |  |   | 97,000              |   |  |       |           |   |  |   | 102,000   |  
|Issuance of common stock under Employee Stock Purchase Plan |  |                 |   |              |           |       |                  | 51,060     |           |   |                            |  |   | 50,000              |   |  |       |           |   |  |   | 50,000    |  
|Vesting of stock options issued to employees                |  |                 |   |              |           |       |                  |           |           |   |                           |  |   | 108,000             |   |  |       |            |   |  |   | 108,000   |  
|Conversion of preferred stock into common stock             |  | (16,676          | ) |              |           |       |                  | 48,758     |           |   | 1,000                      |  |   | (1,000              | ) |  |       |           |   |  |   |          |  
|Preferred stock dividends                                   |  |                 |   |              |           |       |                  |           |           |   |                           |  |   | (42,000             | ) |  |       |           |   |  |   | (42,000   | )
|Net income                                                  |  |                 |   |              |           |       |                  |           |           |   |                           |  |   |                    |   |  |       | 489,000    |   |  |   | 489,000   |  
|                                                            |  |                  |   |              |           |        |                  |            |           |   |                            |  |   |                     |   |  |       |            |   |  |   |           |  
|Balance at September 30, 2007                               |  | 1,090,253        |   |              | $         | 11,000 |                  | 16,108,561 |           | $ | 161,000                    |  | $ | 12,934,000          |   |  | $     | (6,163,000 | ) |  | $ | 6,943,000 |  
|                                                            |  |                  |   |              |           |        |                  |            |           |   |                            |  |   |                     |   |  |       |            |   |  |   |           |  

See accompanying notes.



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Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                            |  |                                  |            |   |             |   |             |  
|------------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ----------- | - | ----------- | -
|                                                                                            |  | Three Months Ended September 30, |           
|                                                                                            |  | 2007                             |            |   | 2006        |  
|                                                                                            |  | (unaudited)                      |            |   | (unaudited) |  
|Cash flows from operating activities                                                        |  |                                  |            |   |             |   |             |  
|Net income                                                                                  |  | $                                | 489,000    |   |             | $ | 36,000      |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                                  |            |   |             |   |             |  
|Provision for bad debts                                                                     |  |                                  | 26,000     |   |             |   | 29,000      |  
|Depreciation and amortization                                                               |  |                                  | 175,000    |   |             |   | 171,000     |  
|Non-cash stock compensation expense                                                         |  |                                  | 124,000    |   |             |   | 135,000     |  
|Changes in operating assets and liabilities:                                                |  |                                  |            |   |             |   |             |  
|Accounts and other receivables                                                              |  |                                  | (545,000   | ) |             |   | (828,000    | )
|Inventory                                                                                   |  |                                  | (16,000    | ) |             |   | (209,000    | )
|Prepaid expenses and other current assets                                                   |  |                                  | 34,000     |   |             |   | (49,000     | )
|Other assets                                                                                |  |                                  | 10,000     |   |             |   | (5,000      | )
|Accounts payable and accrued expenses                                                       |  |                                  | 458,000    |   |             |   | (1,127,000  | )
|Accrued compensation and related benefits                                                   |  |                                  | (351,000   | ) |             |   | 5,000       |  
|Deferred revenue                                                                            |  |                                  | (41,000    | ) |             |   | (102,000    | )
|Other current liabilities                                                                   |  |                                  | (27,000    | ) |             |   | 148,000     |  
|                                                                                            |  |                                  |            |   |             |   |             |  
|Net cash provided by (used in) operating activities                                         |  |                                  | 336,000    |   |             |   | (1,796,000  | )
|                                                                                            |  |                                  |            |   |             |   |             |  
|Cash flows from investing activities                                                        |  |                                  |            |   |             |   |             |  
|Purchase of property and equipment                                                          |  |                                  | (112,000   | ) |             |   | (95,000     | )
|Acquisition of customer list                                                                |  |                                  |           |   |             |   | (200,000    | )
|                                                                                            |  |                                  |            |   |             |   |             |  
|Net cash used in investing activities                                                       |  |                                  | (112,000   | ) |             |   | (295,000    | )
|                                                                                            |  |                                  |            |   |             |   |             |  
|Cash flows from financing activities                                                        |  |                                  |            |   |             |   |             |  
|Proceeds from borrowings under line of credit                                               |  |                                  | 795,000    |   |             |   | 15,376,000  |  
|Repayments of borrowings under line of credit                                               |  |                                  | (2,203,000 | ) |             |   | (13,414,000 | )
|Repayments of long-term debt                                                                |  |                                  | (9,000     | ) |             |   | (17,000     | )
|Proceeds from issuance of common stock to employees upon exercise of stock options          |  |                                  | 152,000    |   |             |   | 97,000      |  
|Payment of preferred stock dividends                                                        |  |                                  | (42,000    | ) |             |   | (48,000     | )
|Change in other long-term liabilities                                                       |  |                                  |           |   |             |   | (43,000     | )
|                                                                                            |  |                                  |            |   |             |   |             |  
|Net cash (used in) provided by financing activities                                         |  |                                  | (1,307,000 | ) |             |   | 1,951,000   |  
|                                                                                            |  |                                  |            |   |             |   |             |  
|Net change in cash and cash equivalents                                                     |  |                                  | (1,083,000 | ) |             |   | (140,000    | )
|Cash and cash equivalentsbeginning of period                                               |  |                                  | 1,688,000  |   |             |   | 581,000     |  
|                                                                                            |  |                                  |            |   |             |   |             |  
|Cash and cash equivalentsend of period                                                     |  | $                                | 605,000    |   |             | $ | 441,000     |  
|                                                                                            |  |                                  |            |   |             |   |             |  



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Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2007

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 audited financial statements and the notes thereto in the Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2007. Operating results for the
three months ended September 30, 2007 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.
The adoption of this Interpretation did not have any effect 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.



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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 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 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 $108,000 for the quarter ended
September 30, 2007, or less than $0.01 per basic and diluted share.

The Board of Directors may grant options under the Avatech Solutions, Inc. 2002
Stock Option Plan to purchase shares of the Companys common stock at an exercise price of not less than the fair market value of the common stock on the date of grant. The plan provides for the granting of either incentive or non-qualified
stock options to purchase an aggregate of up to 3,100,000 shares of common stock to eligible 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 months ended September 30, 2007 and 2006, the Company issued 18,783 and 9,559 shares, respectively, of fully vested common stock to members of the Board of Directors under the
Companys Restricted Stock Award Plan, with an aggregate market value of $16,000 and $18,000, respectively. For the three months ended September 30, 2007 and 2006, total stock compensation expense charged against income for these plans was
$124,000 and $135,000, 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 for the other periods presented:



|                                               |  |                                  |           |   |      |   |           |  
|---------------------------------------------- |  | -------------------------------- | --------- | - | ---- | - | --------- | -
|                                               |  | Three months ended September 30, |          
|                                               |  | 2007                             |           |   | 2006 |  
|Average risk-free interest rate                |  |                                  | 4.18      | % |      |   | 4.64      | %
|Dividend yield                                 |  |                                  | 0         | % |      |   | 0         | %
|Expected term                                  |  |                                  | 6.6 years |   |      |   | 6.0 years |  
|Average expected volatility                    |  |                                  | 0.96      |   |      |   | 1.06      |  
|Weighted average fair value of granted options |  | $                                | 0.70      |   |      | $ | 1.45      |  



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

A summary of stock option
activity during the three months ended September 30, 2007 and related information is included in the table below:



|                                            |  |           |   |  |                                |      |                           |   |        
|------------------------------------------- |  | --------- | - |  | ------------------------------ | ---- | ------------------------- | - | -------
|                                            |  | Options   |   |  | Weighted-AverageExercise Price |      | Aggregate Intrinsic Value
|Outstanding at July 1, 2007                 |  | 1,625,301 |   |  | $                              | 0.93 |                           |   |        
|Granted                                     |  | 247,000   |   |  |                                | 0.95 |                           |   |        
|Exercised                                   |  | (527,924  | ) |  |                                | 0.22 |                           |   |        
|Forfeited                                   |  | (21,767   | ) |  |                                | 1.73 |                           |   |        
|                                            |  |           |   |  |                                |      |                           |   |        
|Outstanding at September 30, 2007           |  | 1,322,610 |   |  | $                              | 1.20 |                           | $ | 337,000
|                                            |  |           |   |  |                                |      |                           |   |        
|Exercisable at September 30, 2007           |  | 940,777   |   |  | $                              | 1.16 |                           | $ | 320,000
|                                            |  |           |   |  |                                |      |                           |   |        
|Weighted-average remaining contractual life |  | 7.6 Years |   |  |                                |      |                           |   |        
|                                            |  |           |   |  |                                |      |                           |   |        

The weighted average grant date fair value of options granted during the quarter ended September 30, 2007 was
$0.70 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 September 30, 2007 ranged from $0.17 to $63.33 as
follows



|                        |              |                     |           |                                                        |   |                                                                    |  |                     |  |                                                        |  |                                                                    |      |  |          
|----------------------- | ------------ | ------------------- | --------- | ------------------------------------------------------ | - | ------------------------------------------------------------------ |  | ------------------- |  | ------------------------------------------------------ |  | ------------------------------------------------------------------ | ---- |  | ---------
|Range ofExercise Prices |              | Options Outstanding |           | Weighted Average Exercise Prices of OptionsOutstanding |   | Weighted Average Remaining Contractual Life of Options Outstanding |  | Options Exercisable |  | Weighted Average Exercise Prices of OptionsExercisable |  | Weighted Average Remaining Contractual Life of Options Exercisable
|$                       | 0.17  0.34  |                     | 116,153   |                                                        | $ | 0.29                                                               |  | 6.2 years           |  | 116,153                                                |  | $                                                                  | 0.29 |  | 6.2 years
|                        | 0.35  0.91  |                     | 721,000   |                                                        |   | 0.73                                                               |  | 7.9 years           |  | 583,583                                                |  |                                                                    | 0.69 |  | 7.3 years
|                        | 1.05  63.33 |                     | 485,457   |                                                        |   | 2.09                                                               |  | 8.5 years           |  | 241,041                                                |  |                                                                    | 2.72 |  | 8.1 years
|                        |              |                     |           |                                                        |   |                                                                    |  |                     |  |                                                        |  |                                                                    |      |  |          
|                        |              |                     | 1,322,610 |                                                        |   |                                                                    |  |                     |  | 940,777                                                |  |                                                                    |      |  |          
|                        |              |                     |           |                                                        |   |                                                                    |  |                     |  |                                                        |  |                                                                    |      |  |          

Assuming that no additional share-based payments are granted after September 30, 2007, unamortized stock
compensation expense of $384,000 will be recognized in the statement of operations over a weighted average period of 2.3 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 and will decrease as the Companys aggregate net worth increases. The
interest rate ranges from the banks prime rate plus two percent to a low of the prime rate prime rate plus 0.25% when the Companys net worth exceeds $4,000,000 at the end of a fiscal quarter. Based on the Companys current net
worth, the interest rate for the quarter ended September 30, 2007 was the banks prime rate plus one-half percent ( 1/2%), or 8.25%. The loan will expire on December 31, 2008 and is secured by all of the Companys assets, except inventory. The Company expects to renew the line of credit prior to its expiration.



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

5. Note Payable

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $22,000 as of September 30, 2007. Such debt is classified as a current liability because it is due within one year.

6. Income Taxes

Income tax expense during the three
months ended September 30, 2007 includes both federal and state income taxes, after adjusting for available net operating loss carry-forwards from prior years. Income tax expense during the three months ended September 30, 2006 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 has a net operating loss carry-forward which will be used to offset some of its taxable income
during fiscal year 2008. A portion of the federal net operating loss carry-forward is subject to an annual limit under Section 382 of the Internal Revenue Code. 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 by dividing net earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share include the potential
dilution that would occur from common shares issuable upon the exercise of outstanding stock options and warrants and the conversion of the Companys preferred stock. As of September 30, 2007, 9,914,991 shares of common stock were issuable
upon the conversion or exercise of options, warrants and preferred stock. For the three months ended September 30, 2007, there were 4,911,559 common stock equivalents excluded from the computation of diluted earnings per share because their
effect would have been antidilutive.

The following summarizes the computations of basic and diluted earnings per common share for the three months ended
September 30, 2007 and 2006:



|                                                   |  |                                  |            |   |      |   |            |  
|-------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                   |  | Three Months Ended September 30, |           
|                                                   |  | 2007                             |            |   | 2006 |  
|Numerator for basic earnings per share:            |  |                                  |            |   |      |   |            |  
|Net income                                         |  | $                                | 489,000    |   |      | $ | 36,000     |  
|Less: preferred stock dividends                    |  |                                  | (42,000    | ) |      |   | (48,000    | )
|                                                   |  |                                  |            |   |      |   |            |  
|Net income (loss) available to common stockholders |  | $                                | 447,000    |   |      | $ | (12,000    | )
|                                                   |  |                                  |            |   |      |   |            |  
|Denominator:                                       |  |                                  |            |   |      |   |            |  
|Weighted average shares outstandingbasic          |  |                                  | 15,799,015 |   |      |   | 13,615,501 |  
|Assumed conversion of preferred stock              |  |                                  | 3,783,321  |   |      |   | 6,192,709  |  
|Effect of outstanding stock options                |  |                                  | 235,821    |   |      |   | 1,150,329  |  
|Effect of outstanding stock warrants               |  |                                  | 189,157    |   |      |   | 391,005    |  
|                                                   |  |                                  |            |   |      |   |            |  
|Weighted average shares outstandingfully diluted  |  |                                  | 20,007,314 |   |      |   | 21,349,544 |  
|                                                   |  |                                  |            |   |      |   |            |  
|Earnings per common sharebasic                    |  | $                                | 0.03       |   |      | $ | 0.00       |  
|                                                   |  |                                  |            |   |      |   |            |  
|Earnings per common sharediluted                  |  | $                                | 0.02       |   |      | $ | 0.00       |  
|                                                   |  |                                  |            |   |      |   |            |  

8. Liquidity and Capital Resources

The Companys improved cash position has allowed it to pay off in full the borrowing under lines of credit and all but one outstanding loan as of September 30, 2007. This improvement in cash position is a
result of



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cash flows from operations, collections on accounts receivable, and proceeds from the issuance of stock to employees upon the exercise of stock options and
proceeds from the issuance of stock upon the exercise of warrants. As of September 30, 2007, the Company had working capital of $1,911,000 and its stockholders equity was $6,943,000. 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.



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

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

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

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

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



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



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



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

This strategy was designed to match the Companys product and service offerings more precisely with the needs of its
customers.

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



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



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



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



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

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

The Company also offers Autodesks subscription programs, which entitle subscribers to receive software upgrades, web support and eLearning lessons directly from Autodesk. Because subscribers do not participate
in the delivery of these subscription products or the web support and eLearning lesson benefits, Avatech records the gross profit from the sale of Autodesk software subscriptions as commission revenue. Approximately 92% of the Companys total
product revenue is related to the resale of Autodesk products.

Service Revenue- Avatech provides services in the form of training,
consulting services, software development, and technical support to its customers. Avatech employs a technical staff of approximately 98 personnel associated with these types of services.

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

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.



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Three Months Ended September 30, 2007 Compared to the Three Months Ended September 30, 2006

The following tables set forth a comparison of the Companys results of operations for the three-month period ended September 30, 2007 to the
three-month period ended September 30, 2006. The amounts are derived from selected items reflected in the Companys unaudited Consolidated Statements of Operations included elsewhere in this report. The three months financial results are
not necessarily indicative of future results.

Revenues



|                   |  |                                  |            |      |   |            |  |     |  
|------------------ |  | -------------------------------- | ---------- | ---- | - | ---------- |  | --- | -
|                   |  | Three Months Ended September 30, |           
|                   |  | 2007                             |            | 2006 |   | % increase | 
|Revenues:          |  |                                  |            |      |   |            |  |     |  
|Product sales      |  | $                                | 7,255,000  |      | $ | 7,254,000  |  | 0.1 | %
|Service revenue    |  |                                  | 2,823,000  |      |   | 2,619,000  |  | 7.8 | %
|Commission revenue |  |                                  | 2,339,000  |      |   | 2,172,000  |  | 7.7 | %
|                   |  |                                  |            |      |   |            |  |     |  
|Total revenues     |  | $                                | 12,417,000 |      | $ | 12,045,000 |  | 3.1 | %
|                   |  |                                  |            |      |   |            |  |     |  

Revenues. Total revenues for the three months ended September 30, 2007 increased
$372,000 or 3.1% when compared to the same period in the prior fiscal year.

Product sales were virtually flat when compared to the same
period in the prior fiscal year. Product sales showed no growth due to customers transitioning from buying new upgraded software to subscription contracts which provide access to all product upgrades during the subscription period, and are
classified as commission revenue on the Companys income statement. The Companys product sales were also negatively impacted by an economic slowdown, particularly in the construction industry.

Service revenue showed continued growth, consistent with the Companys operating plan, increasing by $204,000, or 7.8%, for the three months ended
September 30, 2007 when compared to the same period in the prior fiscal year. The continued growth in services business is the result of continued emphasis to sell services offerings to new customers and existing customers and the market driven
need for additional services associated with upgrading to higher end vertical and 3D software products.

Commission revenue increased by
7.7%, or $167,000, for the three months ended September 30, 2007 when compared to the same period in the prior fiscal year, the result of more customers transitioning to subscription contracts as described above.

Cost of Revenues and Gross Margin



|                        |  |                                  |           |      |   |            |  |      |  
|----------------------- |  | -------------------------------- | --------- | ---- | - | ---------- |  | ---- | -
|                        |  | Three Months Ended September 30, |          
|                        |  | 2007                             |           | 2006 |   | % increase | 
|Cost of revenue:        |  |                                  |           |      |   |            |  |      |  
|Cost of product sales   |  | $                                | 4,946,000 |      | $ | 4,676,000  |  | 5.8  | %
|Cost of service revenue |  |                                  | 2,032,000 |      |   | 1,829,000  |  | 11.1 | %
|                        |  |                                  |           |      |   |            |  |      |  
|Total cost of revenue   |  | $                                | 6,978,000 |      | $ | 6,505,000  |  | 7.3  | %
|                        |  |                                  |           |      |   |            |  |      |  
|Gross margin            |  | $                                | 5,439,000 |      | $ | 5,540,000  |  |      |  
|                        |  |                                  |           |      |   |            |  |      |  

Cost of revenue. The total cost of revenue increased $473,000, or 7.3%, for the three
months ended September 30, 2007 when compared to the same period in the prior fiscal year.

Cost of product sales increased 5.8% while
product sales increased only 0.1% during the three months ended September 30, 2007 as compared with the same period the prior fiscal year. Product costs increased at a higher rate than product revenues due to changes in costs and incentive
plans made by its principal supplier, Autodesk. The Company continues to refocus its sales programs and strategies and has made progress in increasing its gross margin levels.



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##### Table of Contents

Cost of service revenue increased $203,000, or 11.1%, for the three months ended September 30, 2007
when compared to the same period in the prior fiscal year, while service revenues increased $204,000 or 7.8%. Cost of service revenue as a percentage of related revenue increased from 69.8% to 72.0% during the three months ended September 30,
2007 when compared to the same period in the prior fiscal year. The higher cost of service revenue resulted from lowered productivity of the services personnel during the current fiscal quarter. The Company is taking steps to address this
productivity dip and expects the gross margins in its Services business to rise in future quarters.

Gross margin. For the
previously-stated reasons, the Companys gross margin percentage decreased to 43.8% for the three months ended September 30, 2007 as compared to 46.0% for the same period in the prior fiscal year.

Other Operating Expenses



|                                    |  |                                  |           |      |   |            |  |       |   
|----------------------------------- |  | -------------------------------- | --------- | ---- | - | ---------- |  | ----- | --
|                                    |  | Three Months Ended September 30, |          
|                                    |  | 2007                             |           | 2006 |   | % increase | 
|Other operating expenses:           |  |                                  |           |      |   |            |  |       |   
|Selling, general and administrative |  | $                                | 4,621,000 |      | $ | 5,224,000  |  | (11.5 | )%
|Depreciation and amortization       |  |                                  | 175,000   |      |   | 171,000    |  | 2.3   | % 
|                                    |  |                                  |           |      |   |            |  |       |   
|Total other operating expenses      |  | $                                | 4,796,000 |      | $ | 5,395,000  |  | (11.1 | )%
|                                    |  |                                  |           |      |   |            |  |       |   

Selling, General and Administrative Expense. Selling, general and administrative expenses
decreased $603,000, or 11.5%, for the three months ended September 30, 2007 when compared to the same period in the prior fiscal year. Selling, general and administrative expense as a percent of total revenues was 37.2% for the three months
ended September 30, 2007, down from 43.4% for the same period in the prior fiscal year. The decrease in selling, general and administrative expenses are the result of cost-cutting initiatives which occurred during the fourth quarter of fiscal
year 2007 including a reduction in executive and senior management positions, two office closings, and elimination of non-critical positions.

Depreciation and Amortization. Depreciation and amortization expenses increased $4,000, or 2.3%, for the three months ended September 30, 2007 when compared to the same period in the prior fiscal year as a result of purchases of
fixed assets.

Other Income (Expense)



|                             |  |                                  |         |   |      |   |         |            |  |        |   
|---------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---------- |  | ------ | --
|                             |  | Three Months Ended September 30, |        
|                             |  | 2007                             |         |   | 2006 |   |         | % increase | 
|Other income (expense):      |  |                                  |         |   |      |   |         |            |  |        |   
|Interest and other income    |  |                                  | 26,000  |   |      |   | 12,000  |            |  | 116.7  | % 
|Interest expense             |  |                                  | (13,000 | ) |      |   | (67,000 | )          |  | (80.6  | )%
|                             |  |                                  |         |   |      |   |         |            |  |        |   
|Total other income (expense) |  | $                                | 13,000  |   |      | $ | (55,000 | )          |  | (123.6 | )%
|                             |  |                                  |         |   |      |   |         |            |  |        |   

Other Income (Expense). The Company earned $13,000 in other income during the three months
ended September 30, 2007 compared to $55,000 in other expense during the same period in the prior fiscal year. The Companys positive cash flow in recent quarters has allowed it to maintain an interest-bearing cash balance and minimal use
of its line of credit during the three months ended September 30, 2007. During the same period in the prior fiscal year, the Company borrowed heavier against its line of credit, and earned substantially less interest due to its lower average
cash balances.

Income Tax Expense



|                   |  |                                  |         |      |   |            |  |       |  
|------------------ |  | -------------------------------- | ------- | ---- | - | ---------- |  | ----- | -
|                   |  | Three Months Ended September 30, |        
|                   |  | 2007                             |         | 2006 |   | % increase | 
|Income tax expense |  | $                                | 167,000 |      | $ | 54,000     |  | 209.3 | %
|                   |  |                                  |         |      |   |            |  |       |  



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##### Table of Contents

Income Tax Expense. The Company recorded a tax provision of $167,000 during the three months ended
September 30, 2007, a 209.3% increase over the $54,000 recorded for the same period in the prior fiscal year, the result of increased income before income taxes. During fiscal year 2007, the Companys net income was fully offset by federal
net operating losses, and the Companys tax provision was for federal alternative minimum tax as well as state and local income taxes.

The Company has approximately $1.8 million of federal net operating loss carry-forward available for fiscal year 2008 and beyond, however $1.3 million of the carry-forward is subject to a $91,000 annual limitation under Internal Revenue
Code Section 382. Due to this annual limitation, the Company expects that its net income will exceed its available net operating loss carry-forward in fiscal year 2008.

Additionally, the Company has deferred tax assets which are fully offset by a valuation allowance due to the uncertainty that such assets will be
realized. 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.

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 94% 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 three months ended September 30, 2007 were approximately $112,000 compared to $95,000 for the same period in 2006.

For the three months ended September, 2007, net cash provided by operating activities was $336,000, an improvement of $2,132,000 over the same period in 2006. The major difference between the periods included a
$453,000 improvement in net income, and an increase in accounts payable and accrued expenses of $458,000 for the three months ended September 30, 2007 compared with a decrease of $1,127,000 during the same period in 2006. The accounts payable
grew due to increased available vendor credit lines as well as decreased accrued vendor incentives, which offset accounts payable.

For the
three months ended September 30, 2007, the Company used $1,307,000 of cash in financing activities compared with receiving cash of $1,951,000 for the same period in 2006. The difference in cash flows from financing activities resulted from
paying off the revolving line of credit during the three months ended September 30, 2007 versus obtaining net borrowings of $1,962,000 on its line of credit during the same period in 2006.

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 September 30, 2007 was the banks prime rate plus
one-half percent ( 1/2%), or 8.25%. The loan was renewed through December 31, 2008 and is secured by all of
the Companys assets, except inventory.



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The Company did not have an outstanding line of credit balance as of September 30, 2007. Total
borrowings from the bank under this line of credit were approximately $1.4 million as of September 30, 2006.

The Company had working
capital of $1,911,000 as of September 30, 2007. As a result of its profitable operations, 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 line of credit.

Because the Company is one of the largest resellers of Autodesk software and
because Autodesk has continued to state its intention to continue to strengthen its relationships with its resellers, the Company expects to continue to be a leading seller of Autodesk software at margins sufficient to grow its business and improve
its financial results. The Company 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 September 30, 2007:



|                                         |  |       |           |                 |   |             |  |             |           |  |   |        
|---------------------------------------- |  | ----- | --------- | --------------- | - | ----------- |  | ----------- | --------- |  | - | -------
|                                         |  | Total |           | Less than 1year |   | 1  3 years |  | 3  5 years
|Contractual Obligations                  |  |       |           |                 |   |             |  |             |           |  |   |        
|Operating leases                         |  | $     | 3,743,000 |                 | $ | 1,308,000   |  | $           | 1,757,000 |  | $ | 678,000
|Current portion of long-term obligations |  |       | 22,000    |                 |   | 22,000      |  |             |          |  |   |       
|Capital lease obligations                |  |       | 7,000     |                 |   | 7,000       |  |             |          |  |   |       
|Interest on fixed rate obligations       |  |       | 1,000     |                 |   | 1,000       |  |             |          |  |   |       
|                                         |  |       |           |                 |   |             |  |             |           |  |   |        
|Total obligations                        |  | $     | 3,773,000 |                 | $ | 1,338,000   |  | $           | 1,757,000 |  | $ | 678,000
|                                         |  |       |           |                 |   |             |  |             |           |  |   |        



|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 September 30, 2007, there was no outstanding debt on the variable rate line of credit. The Company may, however, borrow
against this line of credit in future periods for normal, recurring business transactions. Assuming previous levels 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 change by less than $15,000 in future reporting periods. 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



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constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, 2007 was carried out under the supervision and with the participation of management, including the CEO and the CFO. Based on
that evaluation, management, including the CEO and the CFO, has concluded that the Companys disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the 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, 2007. Management does not believe that any material
changes in these risk factors have occurred since the filing of the Form 10-K.



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

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



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SIGNATURES

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



|                        |  |                         |  |                                                                                                  
|----------------------- |  | ----------------------- |  | -------------------------------------------------------------------------------------------------
|                        |  | AVATECH SOLUTIONS, INC.
|                        |  |                        
|Date: November 14, 2007 |  | By                      |  | /s/ George M. Davis                                                                              
|                        |  |                         |  | George M. Davis                                                                                  
|                        |  |                         |  | President and Chief Executive Officer                                                            
|                        |  |                        
|Date: November 14, 2007 |  | By                      |  | /s/ Lawrence Rychlak                                                                             
|                        |  |                         |  | Lawrence Rychlak                                                                                 
|                        |  |                         |  | Executive Vice President and Chief Financial Officer (Principal financial and accounting officer)



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EXHIBIT INDEX



|        |  |                                                                                                                                                                                                                                                                                                                                                                         
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                                                                                                                                             
|3.1     |  | Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                                             
|        | 
|3.2     |  | First Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                          
|        | 
|3.3     |  | Reverse Split Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                                                                                                                                                        
|        | 
|3.4     |  | Amendment of PlanetCADs Certificate of Incorporation to change the name of PlanetCAD, Inc. to Avatech Solutions, Inc. (incorporated by reference to our Registration Statement on form S-4
filed on May 30, 2002, File No. 333-89386)                                                                                                                                  
|        | 
|3.5     |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)                                                                                                                                                                        
|        | 
|3.6     |  | 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)                                                                                                                                                                     
|        | 
|3.7     |  | 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)                                                                                                                                                         
|        | 
|3.8     |  | 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 4.3 hereto)                                                                                                                                                                                                                            
|        | 
|3.10    |  | 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)
|        | 
|3.11    |  | By-Laws (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)                                                                                                                                                                                                                                           
|        | 
|4.1     |  | Form of Purchase Agreement for Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No.
001-31265)                                                                                                                                                                                    
|        | 
|4.2     |  | Warrants to purchase up to 51,828 shares of common stock issued by Avatech to W. James Hindman dated April 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on
July 19, 2004, File No. 333-114230)                                                                                                                                   
|        | 
|4.3     |  | Warrants to purchase up to 38,878 shares of common stock issued by Avatech Solutions, Inc. to W. James Hindman, dated July 1, 2005 (incorporated by reference to our Annual Report on Form 10-K,
filed on November 14, 2005, File No. 001-31265)                                                                                                                        
|        | 
|4.4     |  | Warrant to purchase up to 100,000 shares of common stock issued by Avatech to W. James Hindman, dated October 22, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on
November 14, 2005, File No 001-31265)                                                                                                                                  
|        | 
|4.5     |  | 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)                                                                                                                                                                                                       



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|      |  |                                                                                                                                                                                                                                                        
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.6   |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                      
|      | 
|4.7   |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                           
|      | 
|4.8   |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                         
|      | 
|4.9   |  | Form of Common Stock Purchase Warrants issued to Sigma Opportunity Fund LLC and Pacific Asset Partners (incorporated by reference to our Registration Statement on Form S-1, filed on June 22,
2006, File No. 333-134862)                              
|      | 
|4.10  |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)                                                                                                           
|      | 
|4.11  |  | Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                                      
|      | 
|4.12  |  | Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                                                        
|      | 
|4.13  |  | Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)                                                                                                   
|      | 
|10.1  |  | 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)                                            
|      | 
|10.2  |  | Avatech Solutions, Inc. 2002 Stock Option Plan (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)                                                                                         
|      | 
|10.3  |  | Avatech Solutions, Inc. Restricted Stock Award Plan, as amended (incorporated by reference to our Registration Statement on form S-8, filed on February 10, 2006, File No.
333-131721)                                                                 
|      | 
|10.4  |  | Avatech Solutions, Inc. Employee Stock Purchase Plan (incorporated by reference to our Definitive Proxy Statement on form 14A, filed on May 7, 2004, File No. 001-31265)                                                                               
|      | 
|10.5  |  | Amended and Restated Employment Agreement between George Davis and Avatech Solutions, Inc. dated September 12, 2007 (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K,
filed on September 18, 2007)                         
|      | 
|10.6  |  | Employment Agreement by and between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated July 1, 2003 (incorporated by reference to our Annual Report on form 10-K, filed on
October 3, 2003, File No. 001-31265)                                
|      | 
|10.7  |  | Separation and Retirement Agreement between Donald R. Scotty Walsh and Avatech Solutions, Inc. dated August 22, 2007 (incorporated by reference to Exhibit 10.1 of our Current Report
on Form 8-K, filed on August 27, 2007)                         
|      | 
|10.8  |  | Employment Agreement by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. dated as of June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on
July 19, 2004, File No. 333-114230)                 
|      | 
|10.9  |  | Separation Agreement dated February 28, 2007 by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. (incorporated by reference to Exhibit 10.1 of our Form 8-K filed on March 2,
2007)                                                  
|      | 
|10.10 |  | 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)               
|      | 
|10.11 |  | 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)



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|      |  |                                                                                                                                                                                                                                                                                                                                  
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.12 |  | 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)                                                                                      
|      | 
|10.13 |  | 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)                                                                                               
|      | 
|10.14 |  | 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)                                                                             
|      | 
|10.15 |  | 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)                                                                                                       
|      | 
|10.16 |  | 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)                                                                                                                                             
|      | 
|10.17 |  | 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)                                                                                           
|      | 
|10.18 |  | 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)                                                         
|      | 
|10.19 |  | 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)                                                                    
|      | 
|10.20 |  | 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)
|      | 
|31.1  |  | Rule 15d-14(a) Certification of Chief Executive Officer (filed herewith)                                                                                                                                                                                                                                                         
|      | 
|31.2  |  | Rule 15d-14(a) Certification of Chief Financial Officer (filed herewith)                                                                                                                                                                                                                                                         
|      | 
|32.1  |  | Section 1350 Certifications (furnished herewith)                                                                                                                                                                                                                                                                                 



23