-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, E6Z/vELz636GrJzN1mZ7zQVAs2ns3oKjdXGxstX9rQRpx9s36jaN7rO+Kph0T8vg VpG9j/gag9CYI0xive7D9A== 0000916641-03-000743.txt : 20030326 0000916641-03-000743.hdr.sgml : 20030325 20030326134326 ACCESSION NUMBER: 0000916641-03-000743 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 20030326 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVATECH SOLUTIONS INC CENTRAL INDEX KEY: 0000852437 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 841035353 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-104035 FILM NUMBER: 03617766 BUSINESS ADDRESS: STREET 1: 11403 CRONHILL DRIVE STREET 2: SUITE A CITY: OWING MILLS STATE: MD ZIP: 21117 BUSINESS PHONE: 4109026900 MAIL ADDRESS: STREET 1: 11403 CRONHILL DRIVE STREET 2: SUITE A CITY: OWING MILLS STATE: MD ZIP: 21117 FORMER COMPANY: FORMER CONFORMED NAME: SPATIAL TECHNOLOGY INC DATE OF NAME CHANGE: 19960708 FORMER COMPANY: FORMER CONFORMED NAME: PLANETCAD INC DATE OF NAME CHANGE: 20001117 S-1 1 ds1.txt AVATECH SOLUTIONS, INC. FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 26, 2003 REGISTRATION NO. 333-______ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 AVATECH SOLUTIONS, INC. (Exact name of registrant as specified in its charter) DELAWARE 7372 84-1035353 (State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer of Incorporation or Classification Code Number) Identification No.) Organization) 11403A Cronhill Drive Owings Mills, Maryland 21117 (410) 902-6900 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) DONALD ("SCOTTY") WALSH CHIEF EXECUTIVE OFFICER 11403A CRONHILL DRIVE OWINGS MILLS, MARYLAND 21117 (410) 902-6900 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) COPY TO: Christopher Olander Neuberger, Quinn, Gielen, Rubin & Gibber, P.A. One South Street 27th Floor Baltimore, Maryland 21202 APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [X] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [ ] CALCULATION OF REGISTRATION FEE
TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM SECURITIES TO BE AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF REGISTERED REGISTERED (1) COMMON SHARE (2) PRICE (3) REGISTRATION FEE common stock, $0.01 par 2,320,247 1.25 2,900,308 $ 234.63 value per share
(1) 1,120,247 shares are being offered for resale by selling shareholders of the registrant, 1,000,000 shares are issuable in merger and acquisition transactions in which registrant may engage in the future, and 200,000 shares are issuable under registrant's Restricted Stock Award Plan. (2) Estimated solely for purposes of calculating the registration fee under Rule 457(c) and (g) under the Securities Act of 1933. The proposed maximum offering price per share is based on the last sale price of $1.25 per share of registrant's common stock reported on the OTC Bulletin Board on March 17, 2003. (3) Of this amount, $1,400,308 relates to shares that may be offered for resale by selling shareholders of the registrant, $1,250,000 relates to shares that may be issued by the registrant in connection with merger and acquisition transactions, and $250,000 relates to shares that registrant may issue under its Restricted Stock Award Plan. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. SUBJECT TO COMPLETION, DATED MARCH 26, 2003. PROSPECTUS AVATECH SOLUTIONS, INC. 2,320,247 SHARES OF COMMON STOCK Up to 1,120,247 shares of common stock covered by this Prospectus are being offered for sale by selling stockholders of Avatech, from time to time, at market prices prevailing at the time of the sale, at fixed prices in privately negotiated transactions, or otherwise. We are registering these shares to satisfy registration rights of the selling stockholders. We will receive none of the proceeds of the sale of these shares. The selling stockholders will receive all sale proceeds. This Prospectus also covers up to 1,000,000 shares of our common stock that we may issue to shareholders of companies we acquire, by merger or otherwise, in the future, in privately negotiated transactions. Although part of the consideration in these transactions may consist of cash, we contemplate that the consideration received by the sellers of acquired companies will consist primarily of shares of our common stock. We will provide the specific terms of these transactions in supplements to this Prospectus. Up to 200,000 shares of Common Stock covered by this Prospectus may be issued under our Restricted Stock Award Plan. You should read this Prospectus and any supplement carefully before you invest. Our common stock is traded on the OTC Bulletin Board under the symbol "AVSO.OB." The last sale price on March 17, 2003 was $1.25 per share. Investing in our securities involves risks. See "risk factors" beginning on page 2 to read about factors you should consider before buying shares of our common stock. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The Date of this Prospectus is ____________, 2003 TABLE OF CONTENTS Prospectus Summary.....................................................................................1 Risk Factors...........................................................................................2 A Warning About Forward-Looking Statements.............................................................7 Market Price and Dividend Information..................................................................7 Use of Proceeds........................................................................................8 Selling Stockholders...................................................................................9 Selected Financial and Other Data......................................................................9 Management's Discussion and Analysis of Financial Condition and Results of Operations.................11 Changes in and Disagreements with Avatech's Accountants...............................................23 Business..............................................................................................24 Background.......................................................................................24 General..........................................................................................25 Markets..........................................................................................26 Solutions and Products...........................................................................27 Sales and Marketing..............................................................................28 Customers........................................................................................29 Competition......................................................................................29 Intellectual Property............................................................................30 Employees........................................................................................30 Properties.......................................................................................30 Legal Proceedings.....................................................................................31 Management............................................................................................31 Directors and Executive Officers.................................................................31 Executive Compensation...........................................................................33 Certain Relationships and Related Transactions...................................................34 Security Ownership of Certain Beneficial Owners and Management........................................35 Plan of Distribution..................................................................................36 Description of Securities.............................................................................37 Summary of Avatech Solutions, Inc. Restricted Stock Award Plan........................................39 Tax Treatment of Shares Awarded under the Avatech Solutions, Inc. Restricted Stock Award Plan.........40 Disclosure of Commission Position on Indemnification for Securities Act Liabilities...................41 Legal Matters.........................................................................................41 Experts...............................................................................................41 Where You Can Find More Information...................................................................41 What Information You Should Rely On...................................................................43 Index to Financial Statements .....................................................................F - 1 Annex A: Avatech Solutions, Inc. Restricted Stock Award Plan......................................A - 1
- i - PROSPECTUS SUMMARY This summary highlights selected information from this Prospectus and may not contain all of the information that is important to you. To understand the terms of the securities we are offering, you should carefully read this document with any attached Prospectus supplement. You should also read the documents to which we have referred you in "Where You Can Find More Information" below for additional information about our company and our financial statements. Our Business Avatech Solutions is a leading provider of design automation and quality assurance solutions for the manufacturing, building design, civil engineering, and GIS markets. Headquartered at 11403A Cronhill Drive, Owings Mills, Maryland 21117, we specialize in software development, technical support, training and consulting aimed at improving design and documentation efficiencies and the seamless integration of workflow processes. These technology solutions enable our customers to enhance productivity, profitability, and competitive position. We are one of the largest Autodesk software integrators worldwide and a leading provider of engineering document management solutions. We are the developer of the award-winning PrescientQA(TM) quality assurance software and cycle time reduction products for the manufacturing supply chain. We sell this product line predominantly to the manufacturing industry with special focus on the computer-aided design (CAD), manufacturing (CAM) and engineering (CAE) markets. We have embarked on a revised growth strategy which focuses on expanding our people resources, product offerings, and geographic "footprint." We will increase our efforts to attract and employ highly qualified professionals throughout our organization, including salespeople, applications engineers, and software developers. Our portfolio of products and services will expand to include new relationships with other software manufacturers, additional service offerings, and continued development of new proprietary software products to support our planned entry into the product lifecycle management (PLM) market. This diversification strategy is intended to match our product and service offerings more precisely with the needs of our customers. We have reached agreement in principal with Unigraphics Solutions, Inc. ("UGS") a wholly-owned subsidiary of Electronic Data Systems Corporation ("EDS"), and one of the largest manufactures of PLM software solutions. We expect to enter into a strategic relationship in which we will work together with EDS to promote PLM solutions through our national sales and marketing force. We contemplate entering into an EDS PLM Certified Reseller Agreement in the Spring of 2003. We will support geographic expansion by targeted mergers and acquisitions, the opening of new locations, and expanded international product distribution relationships. Risk Factors Purchasers of our common stock should consider carefully, in addition to the other information contain in or incorporated by reference into this Prospectus or any supplement, the risk factors set forth in the Risk Factors section beginning on page 2. Use of Proceeds We will not receive any proceeds from the sale of our common stock under this Prospectus by the selling stockholders identified under "Selling Stockholders" or from the issuance of shares under our Restricted Stock Award Plan. We will not receive cash proceeds from the issuance of shares to stockholders of companies we acquire by merger or otherwise, but will instead receive all of the capital stock or all of the assets of those companies in connection with acquisition and merger transactions. - 1 - Plan of Distribution The selling stockholders will sell shares covered by this Prospectus in open-market transactions effectuated on the OTC Bulletin Board or in privately negotiated transactions. Shares issued to stockholders of companies we acquire, by merger or otherwise, will be issued in private, negotiated merger or other form of acquisition transaction. We will issue shares under our Restricted Stock Award Plan directly to participating individuals. RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS, TOGETHER WITH THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS, BEFORE DETERMINING WHETHER OR NOT TO INVEST IN SHARES OF OUR COMMON STOCK. We have a history of significant losses, expect to incur additional losses and may never achieve profitability. In five fiscal years of operation, we have reported a net profit only in the fiscal year ending June 30, 2001. We expect to incur net losses for the foreseeable future because our expected operating and marketing expenses will increase as we attempt to grow our business. With increased expenses, we will need to generate significant additional revenue to achieve profitability. As a result, we may never become profitable. Even if we do achieve profitability in any period, we may not be able to sustain or increase profitability on a quarterly or an annual basis. Increased costs resulting from our merger with PlanetCAD have reduced working capital and will continue to place strains on our liquidity in future periods. We have experienced a decline in working capital resulting from unexpectedly high costs incurred to complete the merger with PlanetCAD, in most cases, professional and printing costs substantially in excess of original estimates. The result has been a reduction in the amount of working capital that we have to fund current operations. Unless we raise additional capital or negotiate successfully with various service providers in the merger transaction to reduce fees and charges claimed by them, we will continue to experience working capital deficits that could have a materially adverse effect on our operations in future periods. We have a limited operating history, which makes it difficult to evaluate our business and prospects. We began operations in 1997, with the merger of four founding companies. Since that time, we have acquired seven additional companies, all of which haven been operating together for less than four years. Management has been working to successfully integrate these businesses and their disparate operations, employees and management structures and personnel. These activities may adversely impact our business, financial condition and results of operations and may also delay the integration of companies to be acquired in the future. The limited history and continuing evolution of our operations makes it difficult to evaluate our business and prospects. Our prospects must be considered in light of the risks, uncertainties, expenses, and difficulties frequently encountered by companies in their early stages of development. If we fail to address these risks and uncertainties, we may be unable to grow our business, increase our revenue, or become profitable. Our cycle time reduction business line may never be successful. Our products and services to reduce cycle time for supply chain manufacturers are new and unproven and may never be successful. The success of this line of products and services, acquired as a result of our merger with PlanetCAD, depends on a number of factors. These factors include: . competition from other supply chain management software developers; . the size of information technology budgets for the purchase of our enterprise software solutions and services; - 2 - . confidence in our long-term strength as a service provider; . our ability to introduce and sell products such as SCS-Envoy to supply chain manufacturers of our existing customers; . our ability to differentiate the product SCS-Envoy from those of our competitors; and . our ability to continue to differentiate and support our PrescientQA line of products. Failure of PLM software products and services to gain general market acceptance would damage our business since we expect to devote substantial resources to the implementation of a diversification strategy involving PLM software products. Although we believe that PLM software products and services represent a substantial new growth market, because of the way PLM radically enhances manufacturers' ability to bring quality products to market and enhance and manage them throughout their active lifecycle, there can be no assurance that PLM will gain widespread acceptance in the manufacturing sector or that, if it does, we will have the resources, financial and otherwise, to capitalize on the growing PLM market due to limited financial resources, competition, and other factors. Our PLM reseller relationship with Electronic Data Corporation, if consummated, will require us to devote resources to market and sell a product that may not generate substantial revenue. We have entered into a letter of understanding with EDS that contemplates that we will become a certified reseller of EDS' PLM products and we intend to dedicate personnel and other resources to marketing and selling these products. If PLM products generally, or EDS' PLM products specifically, do not gain acceptance in the manufacturing sector, we may not generate sufficient revenues to offset our costs. Our inability to compete with competitors with superior resources may cause our revenues and stock price to decline significantly. The markets for our products and services are highly competitive, rapidly changing, and subject to constant technological innovation. Participants in these markets face constant pressure to accelerate the release of new products, enhance existing products, introduce new product features, and reduce prices. Most of our competitors or potential competitors have significantly greater financial, managerial, technical, and marketing resources than we do. Accordingly, we may be unable to compete effectively in our markets and as a result, our revenues and stock price may decline significantly. Our products may contain undetected errors that could harm our sales and revenue and result in increased operating expenses and liabilities. Our business depends on complex computer software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when new versions are released. Although we conduct extensive testing, we may not discover software defects that affect new or current products and services or enhancements until after they are deployed. If we market products and services that contain errors or that do not function properly, we may experience negative publicity, loss of or delay in market acceptance, or claims against us by customers, any of which could harm our current and future sales or result in expenses and liabilities that could reduce our operating results and adversely affect our financial condition and the market for our common stock. In the past, we have discovered software errors in some new products and enhancements after their introduction, and we may find errors in current or future new products or releases after commencement of commercial use. - 3 - Our inability to efficiently complete or integrate recent acquisitions or future strategic acquisitions, may divert management resources away from business operations and cause greater expenses and decreased revenues and sales. We may find it necessary or desirable to acquire additional complementary businesses, products or technologies. Integrating product acquisitions and completing any future acquisitions could cause significant diversions of management time and resources. Managing acquired businesses entails numerous operational and financial risks. These risks include difficulty in assimilating acquired operations, diversion of management's attention, and the potential loss of key employees or customers of acquired operations. We may not be able to effectively integrate any such acquisitions, and our failure to do so could result in significant expenses and lost revenue. If we are unable to protect our proprietary rights, our ability to compete will suffer. Our proprietary technologies are important to our success and ability to compete in our cycle time reduction line of business. We rely, to some extent, on trade secret and copyright laws to protect certain proprietary technologies, but our efforts may be inadequate to protect these proprietary rights. Further, effective trade secret and copyright protection may not be available in all foreign countries. The unauthorized misappropriation of our technology could have a material adverse effect on our ability to compete. In addition, if we were to resort to legal proceedings to enforce our proprietary rights, the proceedings could be burdensome and expensive and could involve a high degree of risk. We may inadvertently infringe on third party proprietary rights, which could result in costly litigation, reduced sales and revenue and a decline in the price of our stock. We also may be subject to claims alleging that we have infringed third party proprietary rights. Litigating such claims, whether meritorious or not, is costly. The expenditure of such costs, and the accompanying diversion of management time to such litigation, may cause a decrease in attention to sales and product development and a corresponding decrease in revenue. These claims might require us to enter into royalty or license agreements with terms unfavorable to us. If we were found to have infringed upon the proprietary rights of third parties, we could be required to pay damages, cease sales of the infringing products, or redesign or discontinue such products, any of which could materially reduce our sales and revenue and cause a decline in the market price for our common stock. Our certificate of incorporation, bylaws, and anti-takeover protections could delay or prevent an acquisition or sale of Avatech and thus, prevent the stockholders from receiving any potential benefit from an offer to acquire Avatech. Our charter and bylaws, resulting from our merger with PlanetCAD, as well as the General Corporation Law of the State of Delaware, may deter, discourage, or make more difficult a change in control, even if such a change in control would benefit our stockholders. As a result, stockholders may be unable to receive any economic or other benefit contained in any proposal. In particular, the board of directors may issue preferred stock having such designations, rights, and preferences as they determine; only stockholders owning not less than two-thirds of the outstanding shares may call special meetings of stockholders; advance notice is required for presentation of new business and nominations of directors at meetings of stockholders; and our bylaws may be amended only by the board of directors or by the holders of two-thirds of the outstanding voting stock. In addition, under our stockholder rights plan, in general, if a person or group acquires more than 15% of the outstanding shares of common stock, all of our other stockholders would have the right to purchase securities from us at a discount to such securities' fair market value, thus causing substantial dilution to the holdings of that acquiring person or group. Finally, under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of our capital stock until the holder has held the stock for three years unless, among other possibilities, the board of directors approves the transaction. - 4 - The high volatility of our stock price could materially and adversely affect the price of our stock. The market price of our common stock has been highly volatile and is likely to continue to be volatile. Factors affecting our stock price may include: . fluctuations in sales or operating results; . announcements of technological innovations or new software standards by us or our competitors; . published reports of securities analysts; . developments in patent or other proprietary rights; . changes in our relationships with development partners and other strategic alliance partners; and . general market conditions, especially regarding the general performance of comparable technology stocks. Many of these factors are beyond our control. These factors may materially adversely affect the market price of our common stock, regardless of our operating performance. General economic conditions may reduce our net revenues and harm our business. As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. Because of the recent slowdown in the U.S. economy, many customers are delaying or reducing technology purchases. The impact of this slowdown is difficult to predict, but it may result in reductions in sales of our products and services, longer sales cycles, slower adoption of new technologies, and increased price competition. In addition, weakness in the end-user market could negatively affect the cash flow of our customers, who could in turn delay paying their obligations to us, which would increase our credit risk exposure. Any of these events would likely harm our business, results of operations, and financial condition. Our operating results fluctuate from quarter to quarter, making our future revenues and operating results difficult to predict. Our quarterly operating results have fluctuated in the past and are likely to do so in the future. Some of the factors that could cause our operating results to fluctuate include, among other things, the timing of the introduction of new products or delays in product releases by our major software vendors such as Autodesk, changes in marketing or operating expenses, changes in a major software vendor's pricing or product mix, changes in compensation practices, the timing of large solution sales or implementation, and general economic conditions. Additionally, our operating expenses are based in part on our expectations for future revenues and are relatively fixed in the short term. Accordingly, any revenue shortfall below expectations could have an immediate and significant adverse effect on our profitability. If we are unable to raise additional capital on favorable terms, our ability to fund growth and otherwise operate our business will be significantly limited. We need to raise additional capital to fund operating losses, develop and enhance our services and products, fund expansion, respond to competitive pressures, or acquire complementary businesses or technologies. We may not be able to raise additional financing on favorable terms, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and the securities issued may have rights, preferences, or privileges senior to those of our common stock. If we cannot raise adequate funds on acceptable terms, our ability to fund growth, take advantage of business opportunities, develop or enhance services or products, or otherwise respond to competitive pressures will be significantly limited. Insufficient funds may require us to scale-back or eliminate some or all of our plans for growth. - 5 - Competition in the design software market may reduce our net revenues and profits. The software industry has limited barriers to entry, and the availability of desktop computers with continually expanding capacity at progressively lower prices contributes to the ease of competitive market entry. The design software market in particular is fairly mature and characterized by vigorous competition in each of the vertical markets in which we compete, both by entry of competitors with innovative technologies and by consolidation of companies with complementary products and technologies. In addition, some of our competitors have greater financial, technical, sales and marketing, and other resources. Furthermore, the availability of third-party application software is a competitive factor within the computer aided design market. Because of these and other factors, competitive conditions in the industry are likely to intensify in the future. Increased competition could result in price reductions, reduced net revenues and profit margins, and loss of market share, any of which would likely harm our business. Our reliance on the sale of a single software vendor's products could decrease our revenues and our profitability. We derive over 90% of our net revenues from the sale and integration of Autodesk products and from providing upgrades to those products. As such, if sales of Autodesk products and upgrades decrease, our revenues will decrease, which will adversely affect our profitability. If our relationship with Autodesk is not renewed each year, our revenues would significantly decrease and such decrease would jeopardize our viability. Our continued growth and future success are largely dependent upon maintaining our relationship with Autodesk. While our current relationship with Autodesk is amicable, there can be no assurance that this relationship will continue. Under the terms of the Autodesk Channel Partner Agreement, this relationship must be renewed each year. Since over 90% of our revenues are attributable to the resale of Autodesk products, Autodesk's failure to renew its relationship with us would significantly decrease our sales, revenues and overall financial condition, which would jeopardize our viability. Our current Channel Partner Agreement with Autodesk has expired and we have not yet finalized a new one. Our Channel Partner Agreement with Autodesk expired on January 31, 2003. We are seeking to amend a number of its terms prior to entering into a new agreement. Although we continue to operate under the expired agreement on a de facto basis and believe our dominance in Autodesk's distribution channel does not create any significant possibility of Autodesk not providing us with products for resale, it is possible that Autodesk could refuse to supply products to us or do so on unfavorable terms. Any acquisition we make could disrupt our business and harm our financial condition and operations. In an effort to effectively compete in the design automation solutions market where increasing competition and industry consolidation prevail, we may acquire complementary businesses in the future. In the event of any future acquisitions, we could: . issue additional stock that would dilute our current shareholders' percentage ownership; . incur debt and assume liabilities; . incur amortization expenses related to goodwill and other intangible assets; or . incur large and immediate write-offs. - 6 - We may not be able to successfully expand through strategic acquisitions, which could decrease our profitability. A key element of our strategy is to pursue strategic acquisitions that either expand or complement our business, in order to increase revenues. We may not be able to identify additional attractive acquisition candidates on terms favorable to us or in a timely manner. We may require additional debt or equity financing for future acquisitions, which may not be available on terms favorable to us, if at all. Moreover, we may not be able to successfully integrate any acquired businesses into our business or to operate any acquired businesses profitably. Each of these factors may contribute to our inability to successfully expand through strategic acquisitions, which could ultimately result in increased costs without a corresponding increase in revenues, which would result in decreased profitability. Our future success depends upon our ability to hire key personnel. Our operations are dependent upon the efforts of senior management and highly skilled employees. We will likely also be dependent on the senior management of companies that may be acquired in the future. The loss of key employees or the inability to recruit new employees would negatively impact our business. In addition, we may experience increased compensation costs to attract and retain skilled personnel. Recipients of Common Stock under our Restricted Stock Award Plan will recognize taxable income for Federal income tax purposes on each "vesting date" under their restricted stock grant. Recipients of restricted stock under our Restricted Stock Award Plan will be deemed to have received income as to "vested shares" equal to the sum obtained by multiplying the fair market value of our common stock on the vesting date by the number of vested shares, and will be required to pay income taxes on that amount. Alternatively, recipients can make an election under Section 83(b) of the Internal Revenue Code of 1986, as amended, in which case, as to vested as well as unvested shares, recipients will be taxed on the fair market value of all shares received as of the date of issuance. A WARNING ABOUT FORWARD-LOOKING STATEMENTS We have made forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) in this document and in documents that are incorporated by reference in this document that are subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of our operations. Also, statements including words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," or similar expressions are forward-looking statements. Purchasers of shares offered hereby should note that many factors, some of which are discussed elsewhere in this document and in the documents incorporated by reference in this document, could affect our future financial results and could cause actual results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements in this Prospectus include, among others, the factors set forth under the caption "Risk Factors," general economic, business and market conditions, changes in laws, and increased competitive pressure in the CAD, CAM, CAE, GIS, customer management, and product support industries. MARKET PRICE AND DIVIDEND INFORMATION MARKET PRICE DATA Prior to our merger with PlanetCAD, PlanetCAD's common stock was listed on the American Stock Exchange under the symbol "PCD". Since the date of the merger, our common stock has been trading on the OTC Bulletin Board under the symbol "AVSO.OB". The following table indicates the high and low sales prices per share, rounded to the nearest whole cent, reported by the American Stock Exchange, for the periods indicated prior to - 7 - November 20, 2002 and as available through the OTC market for the periods indicated since that date. The OTC quotations represent prices between dealers and do not reflect the retailer markups, markdowns or commissions, and may not represent actual transactions. All prices shown have been restated to reflect the one-for-twenty reverse stock split that occured on October 22, 2002, and the high and low prices shown for the period from November 20, 2002 through March 7, 2003 are for the period after the reverse stock split. PERIOD HIGH LOW - ------------------------------------------------------------------------------- 2000 First Quarter...................................... $ 240.00* $ 77.60* Second Quarter..................................... 160.00* 62.60* Third Quarter...................................... 88.80* 35.00* Fourth Quarter..................................... 65.00* 10.00* 2001 First Quarter...................................... $ 27.60* $ 6.00* Second Quarter..................................... 15.00* 8.00* Third Quarter...................................... 11.00* 3.00* Fourth Quarter..................................... 4.80* 2.00* 2002 First Quarter...................................... $ 4.40* $ 3.40* Second Quarter..................................... 8.60* 3.40* Third Quarter...................................... 8.60* 4.80* Period from November 20, 2002 through March 7, 2003 OTC Bulletin Board................................ $ 1.95 $ 0.25 * These figures have been multiplied by twenty to adjust for the 1 for 20 reverse stock split occurring on October 22, 2002. RECENT CLOSING PRICES On March 17, 2003, the closing price for our common stock on the OTC Bulletin Board, as reported by the Reuters, was $1.25. DIVIDEND INFORMATION We have never paid any cash dividends on our common stock and we anticipate that we will continue to retain any earnings for the foreseeable future for use in the expansion and operation of our business. NUMBER OF STOCKHOLDERS As of January 31, 2003, there were 219 holders of record of our common stock. USE OF PROCEEDS Proceeds from the sale of shares owned by the Selling Stockholders will be received by such stockholders and we will receive none of those proceeds. We will receive no proceeds from the issuance of shares under our Restricted Stock Award Plan. - 8 - In exchange for the issuance of shares of our common stock to the shareholders or owners of companies we acquire, by merger or otherwise, we expect to receive all of the issued and outstanding shares of capital stock of those companies, or all or substantially all, of their assets, business, and properties. SELLING STOCKHOLDERS The following shows the name, address, and number of shares of our common stock owned by the Selling Stockholders who may sell shares covered by this Prospectus: Name and Address Number of Shares ---------------- ---------------- Capstone Ventures SBIC, L.P. 30,497 3000 Sand Hill Road Building 1, Suite 290 Menlo Park, CA 94025 The Roser Partnershp III, SBIC, L.P. 26,141 1105 Spruce Street Boulder, CO 80302 J.F. Shea Co., Inc. as Nominee 20,041 2000-25 655 Brea Canyon Road Walnut, CA 91789 Cypress Growth Fund III, L.P. 17,427 300 Sand Hill Road Building 1, Suite 140 Menlo Park, CA 94025 Dassault Systems Corp. 17,427 9 Quai Marcel Dassault 9/150 Suresnes France Dolphin Offshore Partners, L.P. 8,714 129 E. 17th Street New York, NY 10003 TOTALS 120,247 ---------------- In addition, purchasers of our Series C Convertible Preferred Stock shall have the right to resell shares of common stock acquired upon conversion of their shares of Preferred Stock under this Prospectus. Information regarding their names addresses, and share ownership, will be set forth in a supplement to this Prospectus. SELECTED FINANCIAL AND OTHER DATA The following selected historical consolidated financial data is derived from our audited financial statements as of and for the five years ended June 30, 2002. The financial data for the six-month periods ended December 31, 2002 and 2001 are derived from unaudited financial statements. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, that we consider necessary for a fair presentation of the financial position and the results of operations for these periods. Operating results for the six months ended December 31, 2002 are not necessarily indicative of the results that may be expected for the entire year ending June - 9 - 30, 2003. The following consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and related notes included elsewhere in this Registration Statement.
Six Months Ended Years ended December 31, June 30, --------------------------- ------------------------------------------ STATEMENT OF OPERATIONS DATA: 2002 2001 2002 2001 2000 --------------------------- ------------------------------------------ Revenue: Product sales $ 6,904,130 $ 9,895,458 $ 18,486,676 $ 20,490,029 $ 22,436,739 Service revenues 3,313,859 2,908,982 6,482,160 6,049,275 7,519,169 Commission revenue 2,082,770 2,319,198 4,843,751 4,332,174 3,199,443 ------------ ------------ ------------ ------------ ------------ Total revenue 12,300,759 15,123,638 29,812,587 30,871,478 33,155,351 Cost of revenue: Cost of product sales 4,581,813 6,582,974 12,464,965 14,249,470 16,228,849 Cost of service revenue 2,075,573 1,826,517 3,773,041 3,813,635 4,664,518 ------------ ------------ ------------ ------------ ------------ Total cost of revenue 6,657,386 8,409,491 16,238,006 18,063,105 20,893,367 Gross margin 5,643,373 6,714,147 13,574,581 12,808,373 12,261,984 Other expenses: Selling, general and administrative 6,282,221 6,377,576 12,806,324 11,519,199 12,919,902 Depreciation and amortization 313,642 331,872 589,306 694,503 692,180 Impairment loss -- -- 285,374 -- -- Acquired in-process research and development 282,000 -- -- -- -- ------------ ------------ ------------ ------------ ------------ Total other expenses 6,877,863 6,709,448 13,681,004 12,213,702 13,612,082 ------------ ------------ ------------ ------------ ------------ Income/(loss) from operations (1,234,490) 4,699 (106,423) 594,671 (1,350,098) Other income/(expense) ------------ ------------ ------------ ------------ ------------ Gain on the extinguishment of debt 1,960,646 -- -- -- -- Interest and other income/ (expense) 24,737 71,181 61,510 61,488 (61,819) Minority interest (17,891) -- -- -- -- Interest expense (157,655) (252,612) (487,582) (553,823) (641,320) ------------ ------------ ------------ ------------ ------------ 1,809,837 (181,431) (426,072) (492,335) (703,139) ------------ ------------ ------------ ------------ ------------ Income (loss) before income taxes 575,347 (176,732) (532,495) 102,336 (2,053,237) Income tax expense (benefit) 403,000 22,843 (285,000) 13,000 -- ------------ ------------ ------------ ------------ ------------ Net income (loss) $ 172,347 $ (199,575) $ (247,495) $ 89,336 $ (2,053,237) ============ ============ ============ ============ ============ Earnings (loss) per common share - basic and diluted $ 0.07 $ (0.09) $ (0.11) $ 0.04 $ (0.91) ============ ============ ============ ============ ============ Weighted average number of common shares outstanding - basic and diluted 2,390,790 2,220,670 2,224,993 2,220,856 2,251,402 ============ ============ ============ ============ ============ Years ended June 30, --------------------------- STATEMENT OF OPERATIONS DATA: 1999 1998 --------------------------- Revenue: Product sales $ 26,668,743 $ 23,968,375 Service revenues 6,871,010 5,936,998 Commission revenue 3,432,413 1,981,224 ------------ ------------ Total revenue 36,972,166 31,886,597 Cost of revenue: Cost of product sales 19,664,861 17,426,413 Cost of service revenue 4,980,225 3,315,193 ------------ ------------ Total cost of revenue 24,645,086 20,741,606 Gross margin 12,327,080 11,144,991 Other expenses: Selling, general and administrative 12,940,965 10,688,583 Depreciation and amortization 736,196 586,646 Impairment loss -- -- Acquired in-process research and development -- -- ------------ ------------ Total other expenses 13,677,161 11,275,229 ------------ ------------ Income/(loss) from operations (1,350,081) (130,238) Other income/(expense) ------------ ------------ Gain on the extinguishment of debt -- -- Interest and other income/ (expense) (18,703) 31,996 Minority interest -- -- Interest expense (484,932) (234,318) (503,635) (202,322) ------------ ------------ Income (loss) before income taxes (1,853,716) (332,560) Income tax expense (benefit) -- 22,049 ------------ ------------ Net income (loss) $ (1,853,716) $ (354,609) ============ ============ Earnings (loss) per common share - basic and diluted $ (0.83) $ (0.17) ============ ============ Weighted average number of common shares outstanding - basic and diluted 2,236,711 2,028,981 ============ ============
- 10 -
As of June 30, As of ------------------------------------------------------------------------ BALANCE SHEET DATA: December 31, 2002 2002 2001 2000 1999 1998 ----------------- ------------------------------------------------------------------------ (unaudited) Cash and cash equivalents $ 541,855 $ 222,562 $ 309,621 $ 423,307 $ 1,198,675 $ 900,461 Working capital (3,296,830) (1,615,747) (3,927,450) (1,257,780) 157,394 (959,977) Total assets 7,863,149 7,108,413 8,377,015 7,920,247 9,827,994 8,648,728 Total debt 2,182,590 5,980,013 6,480,880 5,750,883 6,492,239 3,205,274 Total stockholders' deficiency (2,280,515) (3,737,862) (3,424,838) (3,427,041) (1,609,640) (132,431)
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 OF AVATECH SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS PROXY STATEMENT/PROSPECTUS. Certain statements set forth below constitute "forward-looking statements." Such forward-looking statements involve known and unknown risk, uncertainties, and other factors including, but not limited to, those discussed in the annual and quarterly reports, that may cause Avatech's actual results, performance, or achievements to be materially different from any future results, performance, or achievements implied by such forward-looking statements. Given these uncertainties, investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. Avatech disclaims any obligation to update information contained in any forward-looking statement. OVERVIEW Avatech Solutions is a leading provider of design automation and quality assurance solutions for the manufacturing, building design, civil engineering, and GIS markets. The company specializes in software development, technical support, training, and consulting aimed at improving design and documentation efficiencies and the seamless integration of workflow processes. These technology solutions enable Avatech's 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. Additionally, Avatech is the developer of the award-winning PrescientQA(TM) quality assurance software and cycle time reduction products for the manufacturing supply chain. This product line is sold predominantly to the manufacturing industry with special focus on the computer-aided design (CAD), manufacturing (CAM) and engineering (CAE) markets. Avatech has embarked on a revised growth strategy which focuses on expanding its people, resources, product offerings, and geographic "footprint." The company plans to increase its efforts to attract and employ highly qualified professionals throughout the organization, including salespeople, applications engineers, and software developers. The company's portfolio of products and services will expand to include new relationships with other software manufacturers, additional service offerings, and continued development of new proprietary software products to support its planned entry into the product lifecycle management (PLM) market. Geographic expansion will be supported by targeted mergers and acquisitions, the opening of new locations, and expanded international product distribution relationships. This diversification strategy is intended to match Avatech's product and service offerings more precisely with the needs of its customers. PRODUCT SALES Avatech product sales are primarily the resale of packaged design software programs that are installed on a user workstation, on a local area network server, or in a hosted environment. The programs perform and support a wide variety of functions related to design, modeling, drafting, mapping, rendering, and facilities management tasks. Avatech is the largest domestic reseller of design software developed by Autodesk, one of the world's leading design software and digital content companies for building design and land development, manufacturing, utilities, - 11 - telecommunications, wireless data services, and digital media. Approximately 90% of Avatech's total product revenues are related to Autodesk products. Product sales also include hardware that Avatech may purchase for the convenience of its customers. During fiscal 1999, Avatech made a strategic decision to de-emphasize the resale of hardware products as the future profit margins for these offerings were deteriorating. Product hardware sales do not represent a significant percentage of total revenues for Avatech in any of the periods presented. As a result of the merger with PlanetCAD, Avatech offers proprietary software products through its distribution channel. Avatech's enterprise software products include PrescientQA(TM) and the new SCS|Envoy(TM) supply chain solution software. PrescientQA(TM) is quality assurance software that detects, assesses, corrects, and even prevents product development problems caused by modeling practices that are inaccurate, incomplete, inconsistent, or all three. These problems, generally undetected, account for approximately 45% of the engineering change orders in a typical organization. Prescient technology is the only quality assurance solution that works across multiple CAD systems, including CATIA(R), Pro/Engineer(R), Unigraphics(R), and Autodesk Inventor(R), with a single reporting and configuration system. SERVICE REVENUE Avatech provides services in the form of training, technical support, and professional services. Product and process education classes are offered at Avatech's training facilities or directly at a customer site. Avatech's class instructors are application engineers who have formal training or industry experience in the course content. Technical support services are provided primarily through Avatech's telephone support center located in Omaha, Nebraska. Through its staff of full time consultants, Avatech provides assistance to customers making inquiries concerning software products that it sells. Professional services are project-focused offerings that are fulfilled primarily with Avatech's own application engineers and programmers and can include software customization, data migration, computer aided design standards consulting, workflow analysis, and implementation assistance for complex software products. COMMISSION REVENUE Avatech generates commission revenue from the resale of Autodesk software to certain customers designated as major Autodesk accounts. Autodesk considers certain customers to be major accounts based on specified criteria, primarily sales volume. Avatech is responsible for managing and reselling product to certain of these accounts; however, the software product is shipped directly from Autodesk to the customer. Avatech has received commissions ranging from 17% to 26% on the product sales price depending upon the product type and volume. Commission revenues are recognized upon shipment of the product from Autodesk to the customer. COST OF PRODUCT SALES Cost of product sales consists of Avatech's cost of purchasing the products from the software suppliers or hardware manufacturers. Additionally, the associated shipping and handling costs are included in cost of product sales. COST OF SERVICE REVENUE Cost of service revenue includes the direct costs associated with the implementation of software and hardware solutions as well as training, support services, and professional services. These costs consist primarily of compensation, benefits, travel, and the costs of third-party contractors engaged by Avatech. Cost of service revenue does not include an allocation of overhead costs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense consists primarily of compensation and other expenses associated with management, finance, human resources, and information systems. Additionally, advertising and - 12 - public relations expense as well as expenses for facilities such as rent and utilities are included in selling, general and administrative expense. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense represents the period costs associated with Avatech's investment in property and equipment and amortizable intangible assets. Property and equipment consists principally of computer equipment, software, furniture and fixtures, and leasehold improvements. Depreciation and amortization expense is computed using the straight-line method. Additionally, Avatech leases all of its facilities and depreciates leasehold improvements over the lesser of the lease term or the useful life of the asset. Goodwill is the excess of the purchase price paid over the value of the identifiable net assets acquired in purchase business combinations and was being amortized over the expected period of benefit primarily 15 years. As of July 1, 2002, Avatech no longer amortizes this goodwill, but rather makes annual assessments of impairment. The Company amortizes acquired intangible assets with definite lives over their estimated useful life. These assets consist principally of non-complete arrangements and technology acquired in the acquisition of PlanetCAD, which are amortized over useful lives ranging from 4 to 6 years. INTEREST EXPENSE Interest expense consists primarily of interest on Avatech's revolving line-of-credit and subordinated debt, which it incurred to fund operations over the past three years. CRITICAL ACCOUNTING POLICIES General. Avatech's consolidated financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. Critical accounting policies and estimates that impact the consolidated financial statements are those that relate to software revenue recognition, estimates of bad debts, and estimates of the recoverability of goodwill. A summary of the significant accounting policies can be found in the Notes to the Consolidated Financial Statements. Presented below is a description of the accounting policies that Avatech believes are most critical to understanding the consolidated financial statements. Software Revenue Recognition. Avatech derives most of its revenue from the resale of packaged software programs. Product sales also include hardware that may be purchased for the convenience of customers. Historically, Avatech has not experienced significant customer returns. Avatech also earns service revenue from training and other professional services for the products that are sold. These services are not essential to the functionality of the software. Additionally, Avatech offers annual support contracts to its customers for the software products that it sells. Maintenance and support services are also sold under hourly billing arrangements. Revenue from software arrangements is recognized in accordance with the provisions of Statement of Position No. 97-2, Software Revenue Recognition, as amended by SOP No 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Prior to recognizing any revenue under these arrangements, (1) persuasive evidence of an arrangement must exist, (2) delivery of the software or service must have occurred, (3) all fees must be assessed as fixed or determinable and (4) all fees must be probable of collection. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the fee charged for services rendered and products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. Avatech's customer arrangements can involve the sale of two or more elements. When this occurs, revenue is allocated to each element based on the relative fair value of each element. Avatech limits the assessment of fair value to the price that is charged when the element is sold separately. All of the elements included in the multiple element arrangements have been analyzed, which may include products that are resold, training and other professional services, and support services. Avatech has determined that sufficient evidence of the fair value based - 13 - on these separate sales exists to allocate revenue to the specified elements. Training and other professional services revenue is recognized as services are delivered and support revenue is recognized ratably over the respective contract term. All unrecognized fees that have been billed are included in deferred revenue. Bad Debts. Avatech maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to pay for products and services that are sold or for disputes that affect its ability to fully collect its accounts receivable. Avatech estimates this allowance by reviewing the status of past-due accounts and recording general reserves based on historical bad debt expense. Avatech's actual experience has not varied significantly from its estimates. However, if the financial condition of Avatech's customers were to deteriorate, resulting in their inability to pay for products or services, Avatech may need to record additional allowances in future periods. To mitigate this risk, Avatech performs ongoing credit evaluations of its customers. Recoverability of Goodwill. Avatech has remaining goodwill of $0.9 million at December 31, 2002. As of July 1, 2002, Avatech adopted Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets ("Statement 142"). Under the new rules, goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the Statement. Accordingly, the Company no longer amortizes this goodwill, but rather makes annual assessments of impairments. During the second quarter of fiscal 2003, the Company completed phase one of the transitional impairment tests required by Statement 142, which indicated that goodwill associated with one of its reporting units was impaired. The Company will complete phase two of the transitional impairment tests before the end of fiscal year 2003 at which time any impairment charge for the goodwill will be recorded as of July 1, 2002. The Company expects that an impairment charge of approximately $400,000 to $600,000 will be recorded when its transitional impairment tests are complete. In the future, the Company will be making impairment tests during the fourth quarter of each year. In making these assessments, Avatech must make subjective judgments regarding estimated future cash flows and other factors to determine the fair value of the reporting units of its business that are associated with its remaining goodwill. It is possible that these judgments may change over time as market conditions or strategies change, and these changes may cause Avatech to record additional impairment charges to adjust goodwill to its estimated fair value. EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS As of July 1, 2002, the Company adopted Financial Accounting Standards Board Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement 144"). Statement 144 supersedes and serves to clarify and further define the provisions of Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and provides a single accounting model for long-lived assets to be disposed of. Statement 144 does not apply to goodwill and other intangible assets that are not amortized, and retains the Company's current policy to recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted future cash flows and to measure the impairment loss as the difference between the carrying amount and the fair value of the asset. In April 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (Statement 145). Among other changes, Statement 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and classified as an extraordinary item, net of the related tax effect. Statement 145 provides that gains and losses from extinguishment of debt should be classified as extraordinary items only if they are unusual or infrequent or they otherwise meet the criteria for classification as an extraordinary item, and observes that debt extinguishment transactions would seldom, if ever, result in extraordinary item classification of the resulting gains and losses. Avatech adopted Statement 145 effective July 1, 2002. In August 2002, the Company reported a $2.0 million gain from the early extinguishment of certain debt. In July 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 146, Accounting for Costs Associated with Exit or Disposal Activities (Statement 146). Statement 146 - 14 - supersedes EITF Issue No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Statement 146 requires that costs associated with an exit or disposal plan be recognized when incurred rather than at the date of a commitment to an exit or disposal plan. Statement 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002, and early adoption is encouraged. Avatech does not expect that the adoption of Statement 146 will have a material effect on its reported results of operations and financial position. RESULTS OF OPERATIONS SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001 REVENUES Total revenues for the six months ended December 31, 2002 decreased $2.8 million, or 18.7%, to $12.3 million, compared to $15.1 million for the same period in 2001. Overall, the gross margin percentage increased to 45.9% in the six months ended December 31, 2002, compared to 44.4% in the same period in 2001. For the six months ended December 31, 2002, revenues from product sales and commissions decreased, while revenues from service increased. The decrease in revenues from product sales and commissions was due to weak economic conditions as well as timing of product upgrade cycles. The increase in revenues from service was a result of a realigned sales organization and a renewed focus by Avatech as a full solution, service provider for its customers. Although price changes occurred throughout the period, they did not have a material effect on fluctuations in revenues. Improved management over the sales organization has enhanced sales forecasting to better exploit product sales and service opportunities to larger customers, which attributed to an increase in service revenues. Product sales for the six months ended December 31, 2002 decreased $3.0 million, or 30.2%, to $6.9 million, compared to $9.9 million in the same period in 2001. The fluctuation in product sales is primarily attributed to weak economic conditions causing customers to defer purchasing software products as well as timing of product upgrade cycles. Sales of hardware products also declined in this period albeit this only represented $149,000 or 5.0% of the total decrease in product sales. The remaining decrease in product sales is attributable to a decline in sales volume on software product sales. Software products sold represented 97.4% and 96.7% of total product sales for the six months ending December 31, 2002 and 2001, respectively. Also, the sale of software developed by Autodesk, Inc. represented 89.3% and 94.7% of total software sales for the six months ending December 31, 2002 and 2001, respectively. Service revenue for the six months ended December 31, 2002 increased $0.4 million, or 13.8%, to $3.3 million, compared to $2.9 million in the same period in 2001. The increase in service revenue is a result of an increase in professional and technical support service contracts of $0.5 million or 48.5%, partially offset by a decline in training of $120,000, or 6.6%, attributable to the decline in software sales. All of Avatech's professional, technical support and training services have received additional sales focus as Avatech transitions to a full solution, service provider of software and services for its customers. Commission revenue for the six months ended December 31, 2002 decreased $0.2 million, or 10.2%, to $2.1 million, compared to $2.3 million in the same period in 2001. The decrease in commission revenues resulted from weak economic conditions causing major account customers to defer purchasing software products as well as the timing of product upgrade cycles. COST OF REVENUES AND EXPENSES COSTS OF REVENUE Cost of product sales for the six months ended December 31, 2002 decreased $2.0 million, or 30.4.%, to $4.6 million, compared to $6.6 million for the same period in 2001. Cost of product sales as a percentage of related revenue for the six months ended December 31, 2002 remained relatively consistent at 66.4% compared to 66.5% in the same period in 2001. - 15 - Cost of service revenue for the six months ended December 31, 2002 increased $0.3 million, or 13.6%, to $2.1 million compared to $1.8 million for the same period in 2001. Cost of service revenue as a percentage of related revenue for the six months ended December 31, 2002 decreased slightly to 62.6% from 62.8% in the same period in 2001. The modest decrease in cost of service revenue as a percentage of revenue is primarily attributable to more effective management and improved cost controls over the delivery of these services. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense for the six months ended December 31, 2002 decreased $0.1 million, or 1.5%, to $6.3 million, compared to $6.4 million for the same period in 2001. Selling, general and administrative expense as a percent of total revenues was 51.1% during the six months ended December 31, 2002, and 42.2% during the same period in 2001. The increase in selling, general and administrative expense as a percent of total revenues is attributable to the fixed cost required to support a nationwide network of 22 offices and the added expenses associated with the operation of PlanetCAD after the merger on November 19, 2002. DEPRECIATION AND AMORTIZATION Depreciation and amortization expense for the six months ended December 31, 2002 decreased $18,000 or 5.4%, to $314,000, compared to $332,000 for the same period in 2001. Depreciation and amortization expense of property and equipment increased as a result of the merger with PlanetCAD. The increase was offset by amortization expense of $48,000 on unamortized goodwill that was recorded for the six months ended December 31, 2001. On July 1, 2002, the Company adopted Statement 142 and no longer amortizes goodwill. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT In connection with the acquisition of PlanetCAD in November 2002, the Company allocated $282,000 of the purchase price to in-process research and development projects. This allocation represents the estimated fair value based on discounted cash flows related to the incomplete research and development projects. At the time of acquisition, the progress of these technologies had not yet reached technological feasibility and the technologies had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date. OTHER INCOME (EXPENSE) Other income for the six months ended December 31, 2002 increased $2.0 million to $1.8 million, compared to $(0.2) million for the same period in 2001. The significant increase in other income is attributable to a gain recorded for the extinguishment of debt. In January 1999, Avatech borrowed $3.0 million from a junior lender. In August 2002, Avatech executed an agreement to extinguish the debt for a cash payment of $1.0 million resulting in a $2.0 million gain on the extinguishment of debt. INCOME TAXES Income tax expense for the six months ended December 31, 2002 was $0.4. In August 2002, the Company realized a $1.96 million taxable gain from the extinguishment of certain debt, which resulted in a net deferred tax asset of $0.4 million being recorded at June 30, 2002. During the six months ended December 31, 2002, the Company recorded deferred income tax expense of $0.4 million related to the estimated reduction in deferred tax assets in 2003. This increase in deferred income tax expense coupled with certain state tax expense resulted in the additional income tax expense for the six months ended December 31, 2002. - 16 - YEARS ENDED JUNE 30, 2002, 2001 AND 2000 The following table sets forth the percentages of total revenues represented by selected items reflected in our audited Consolidated Statements of Operations included elsewhere in this registration statement. The year-to-year comparisons of financial results are not necessarily indicative of future results. YEARS ENDED JUNE 30, ----------------------- 2002 2001 2000 ----- ----- ----- Revenue: Product sales 62.0% 66.4% 67.7% Service revenues 21.7% 19.6% 22.7% Commission revenue 16.3% 14.0% 9.6% ----- ----- ----- Total revenue 100.0% 100.0% 100.0% Cost of revenue: Cost of product sales 41.8% 46.2% 48.9% Cost of service revenue 12.7% 12.3% 14.1% ----- ----- ----- Total cost of revenue 54.5% 58.5% 63.0% ----- ----- ----- Gross margin 45.5% 41.5% 37.0% Other expenses: Selling, general and administrative 43.0% 37.3% 39.0% Depreciation and amortization 2.1% 2.3% 2.1% Impairment Loss 0.8% -- -- ----- ----- ----- Total other expenses 45.9% 39.6% 41.1% Income/(loss) from operations (0.4)% 1.9% (4.1)% Other income/(expense): Interest and other income/(expense) 0.2% 0.2% (0.2)% Interest expense (1.6)% (1.8)% (1.9)% ----- ----- ----- (1.4)% (1.6)% (2.1)% Income before income taxes (1.8)% 0.3% (6.2)% Income tax expense (benefit) (1.0)% 0.0% 0.0% ----- ----- ----- Net income (loss) (0.8)% 0.3% (6.2)% ===== ===== ===== YEAR ENDED JUNE 30, 2002 COMPARED TO YEAR ENDED JUNE 30, 2001 REVENUES Total revenues for the year ended June 30, 2002 decreased $1.1 million, or 3.4%, to $29.8 million, compared to $30.9 million for the same period in 2001. Overall, the gross margin percentage increased to 45.5% in the year ended June 30, 2002, compared to 41.5% in the same period in 2001. For the year ended June 30, 2002, revenues in two of three categories--service revenue and commission revenue--increased as a result of a realigned sales organization and a renewed focus by Avatech as a full solution, service provider for its customers. Although price changes occurred throughout the period, they did not have a material effect on fluctuations in revenues. Avatech realigned its sales organization in September 2000 and has improved sales forecasting to better exploit sales opportunities on high margin software products as well as sales to major accounts, which attributed to an increase in commission revenues. - 17 - Product sales for the year ended June 30, 2002 decreased $2.0 million, or 9.8%, to $18.5 million, compared to $20.5 million in the same period in 2001. The fluctuation in product sales is attributed to a decrease in sales volume of software sold through the Company's customer base. In June 2001, Autodesk announced the release of an upgrade to it most popular version of Computer Aided Design ("CAD") software. Maintenance support on the former version of CAD software was phased out in January 2002, which resulted in most major customers purchasing the software upgrades in 2002. The software sales growth was completely offset by enhanced efforts to sell more Autodesk major accounts, thereby increasing commission revenue but reducing product sales, as well as a significant decline in the resale of hardware products. As Autodesk major account sales increased, the level of focus on other end product sales then diminished and resulted in a $1.6 million or 7.8% decrease in related revenues. Additionally, hardware sales decreased by $436,000, or 46.3% in the period of 2002. The Company has de-emphasized the resale of hardware products to its customers. Service revenue for the year ended June 30, 2002 increased $433,000, or 7.2%, to $6.5 million, compared to $6.0 million in the same period in 2001. The increase in service revenue is a direct result of an increase in the number of training and professional services sold through the Company's expanded customer base during 2002, which resulted in approximately $250,000 in additional revenue. Avatech's training and technical support services have received additional sales focus as Avatech transitions to a full solution, service provider of software and services for its customers. Commission revenue for the year ended June 30, 2002 increased $512,000, or 11.8%, to $4.8 million, compared to $4.3 million in the same period in 2001. The increase in commission revenues resulted from Avatech's realigned sales organization, which has improved sales to major accounts that provide for commission revenue. COST OF REVENUES AND EXPENSES COSTS OF REVENUE Cost of product sales for the year ended June 30, 2002 decreased $1.8 million, or 12.5%, to $12.5 million, compared to $14.2 million for the same period in 2001. Cost of product sales as a percentage of related revenue for the year ended June 30, 2002 decreased to 67.4% from 69.5% in the same period in 2001. The decrease in cost of product sales as a percentage of related revenues is attributed to an increase in sales of high margin software products. Cost of service revenue for the year ended June 30, 2002 decreased $41,000, or 1.1%, to $3.8 million compared to $3.8 million for the same period in 2001. Cost of service revenue as a percentage of related revenue for the year ended June 30, 2002 decreased to 58.2% from 63.0% in the same period in 2001. The decrease in cost of service revenue as a percentage of revenues is attributed to enhanced efforts to sell higher margin training and professional services rather than lower margin installations of hardware products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense for the year ended June 30, 2002 increased $1.3 million, or 11.2%, to $12.8 million, compared to $11.5 million for the same period in 2001. Selling, general and administrative expense as a percent of total revenues was 43.0% during the year ended June 30, 2002, and 37.3% during the same period in 2001. The increase in selling, general and administrative expense is attributable to the expansion of Avatech's sales force and technical support staff in its existing locations, as well as the costs associated with opening three new offices in Chicago, IL, St. Paul, MN, and Tampa, FL, during the third and fourth quarters of 2001. Avatech's sales force and support staff increased by approximately 15 employees in 2002 resulting in an approximate $1.0 million increase in selling, general and administrative expense. New facilities costs attributed to a $50,000 increase in selling, general and administrative expense during the same period. - 18 - DEPRECIATION AND AMORTIZATION Depreciation and amortization expense for the year ended June 30, 2002 decreased $105,000 or 15.1%, to $589,000, compared to $695,000 for the same period in 2001. Depreciation and amortization expense of property and equipment decreased as a result of capital expenditures for computer equipment and software made in 1999 becoming fully depreciated in 2001. GOODWILL IMPAIRMENT For the year ended June 30, 2002, Avatech recorded an impairment charge for the write down of unamortized goodwill to its net realizable value. The impairment charge was recorded in the third quarter of 2002 upon the recognition of an impairment indicator. During the period, Avatech evaluated goodwill for its past business combinations by comparing its best estimate of undiscounted future cash flows with the carrying value of goodwill. As the carrying value of goodwill exceeded the estimate of undiscounted future cash flows for one of these acquired companies, a discounted cash flow analysis was performed which attributed to the goodwill impairment charge of $283,000 or the amount by which the carrying value exceeded the fair value of the unamortized goodwill balance at that time. OTHER INCOME (EXPENSE) Other expense for the year ended June 30, 2002 decreased $66,000, or 13.5%, to $426,000, compared to $492,0000 for the same period in 2001. The reduction in other expense in 2002 is primarily attributable to a reduction in interest expense resulting from a decrease in the variable interest rate associated with the revolving line-of-credit. INCOME TAX BENEFIT In 2002, Avatech recorded an income tax benefit of $285,000. This benefit includes current income tax expense of $88,000 for state income taxes and a deferred tax benefit of $373,000. The deferred tax benefit of $373,000 is the result of a change in the estimate of the amount of net operating loss carryforwards that will likely be used to reduce 2003 income taxes. This estimate was revised principally because Avatech recorded a $1.96 million gain from the extinguishment of certain debt in August 2002, which will increase 2003 taxable income. YEAR ENDED JUNE 30, 2001 COMPARED TO YEAR ENDED JUNE 30, 2000 REVENUES Total revenues for the year ended June 30, 2001 decreased $2.3 million, or 6.9%, to $30.9 million compared to $33.2 million in the same period in 2000. For the year ended June 30, 2001, revenues in two of the three categories--product sales and service revenue--decreased as a result of the general economic slowdown experienced in the forth quarter of fiscal 2000 as well as the culmination of the Y2K technology spending. Additionally, the sales cycle for Autodesk's most popular CAD software product concluded in February 2000, which contributed to the overall decline in product sales for fiscal 2001. While revenues declined for the year ended June 2001, the gross margin percentage increased to 41.5% in 2001 from 37.0% in 2000 principally due to Avatech's strategic decision to discontinue reselling the low margin hardware products and focus on selling higher margin software products on both a direct and agency basis. Product sales for the year ended June 30, 2001 decreased $1.9 million, or 8.7%, to $20.5 million, compared to $22.4 million in the same period in 2000. The decrease in product sales is attributed to the culmination of the Y2K technology spending and the conclusion of the sales cycle for Autodesk's most popular CAD software product in February 2000. Additionally, Avatech made a strategic decision to discontinue reselling the low margin hardware products and focus on selling higher margin software products. As a result, Avatech experienced a $1.9 million, or 66.8%, decline in hardware sales. - 19 - Service revenue for the year ended June 30, 2001 decreased $1.5 million, or 19.5%, to $6.0 million, compared to $7.5 million in the same period in 2000. The decrease in service revenue is primarily attributed to a $829,000, or 17.5%, reduction in training service revenue in 2001. The decline is service revenue is a result of limited resources available to focus on selling training services. During fiscal 2000, Avatech experienced exceptional results from training services due to intense promotional efforts and sales force focus. These efforts were not sustained in 2001 due to the implementation of certain cost containment measures. Additionally, support services revenue for the year ended June 30, 2001 decreased $348,000, or 18.9%, due to changes associated with the strategic decision to discontinue selling hardware. Commission revenues for the year ended June 30, 2001 increased $1.1 million, or 35.4%, to $4.3 million compared to $3.2 million in the same period in 2000. The entire increase in commission revenue during 2001 resulted from the integration of past business combinations, which provided Avatech with the national network to service and sell to major accounts. COST OF REVENUE AND EXPENSES COST OF REVENUE Cost of product sales for the year ended June 30, 2001 decreased $2.0 million, or 12.2%, to $14.2 million compared to $16.2 million for the same period in 2000. Cost of product sales as a percentage of related revenue decreased to 69.5% in 2001 from 72.3% in 2000. The decrease in cost of product sales as a percentage of revenues is attributable to the application of earn-backs and other rebates received from Autodesk as a result of Avatech achieving its sales quotas in fiscal 2001. These earn-backs and rebates are offset against cost of product sales in the period in which they are earned. Cost of service revenue for the year ended June 30, 2001 decreased $851,000, or 18.2%, to $3.8 million compared to $4.7 million for the same period in 2000. Cost of service revenue as a percentage of related revenue remained relatively constant at 63.0% in 2001 in comparison to 62.0% in 2000. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense for the year ended June 30, 2001 decreased $1.4 million, or 10.8%, to $11.5 million, compared to $12.9 million for the same period in 2000. Selling, general and administrative expense as a percent of total revenues was 37.3% in 2001 compared to 39.0% in 2000. The reduction in selling, general and administrative expense in 2001 is attributable to an expense reduction program that was implemented in the fourth quarter of 2000. The expense reduction program coupled with a 6.9% decrease in total revenues attributed to the favorable decline in the ratio of selling, general and administrative expenses to revenues for the year ended June 30, 2001 in comparison to the year ended June 30, 2000. DEPRECIATION AND AMORTIZATION Depreciation and amortization expense for the year ended June 30, 2001 increased $3,000, or 0.3%, to $695,000 compared to $692,000 for the same period in 2000. Depreciation and amortization expense for 2001 remained consistent with 2000 as few additions to property and equipment were needed. OTHER INCOME (EXPENSE) Other expense for the year ended June 30, 2001 decreased $211,000, or 30.0%, to $492,000 compared to $703,000 for the same period in 2000. The reduction in other expense is primarily attributable to a decrease in interest expense of 13.6% or $87,000 in 2001. The reduction in interest expense is a result of refinancing of Avatech's revolving line-of-credit to provide for a lower interest rate. - 20 - LIQUIDITY AND CAPITAL RESOURCES Historically, Avatech has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations and borrowings under short-term and long-term debt arrangements. Avatech had a deficiency of working capital of $3.3 million at December 31, 2002. Current liabilities include $1.4 million of borrowings under a line-of-credit from a senior lender as well as $248,000 of subordinated notes and a $500,000 note payable to a related party. In October 2000, Avatech entered into a $4.0 million revolving line-of-credit agreement with a senior lender that was to expire in October 2003, but was payable within 60 days of demand. Borrowings under the line-of-credit bore interest at the senior lender's prime rate plus 1.5%. The amount of outstanding borrowings was limited to 75% of eligible accounts receivable. Avatech expects to enter into a new revolving line of credit agreement with another senior lender and terminate the old line of credit arrangement in March 2003. The terms of this new credit facility are essentially the same as the old one, except that the maximum borrowings under the line of credit are $2.5 million and the rate of interest on outstanding amounts is the senior lender's prime rate, plus 2%, with a minimum of 7.5%. In January 1999, Avatech borrowed $3.0 million from a junior lender. In August 2002, Avatech executed an agreement to extinguish the debt for a cash payment of $1.0 million and compliance with certain non-financial covenants. Avatech borrowed $500,000 from each of PlanetCAD and James Hindman, an Avatech director, to make the cash payment. On November 19, 2002 the merger with PlanetCAD was completed and the loan from PlanetCAD eliminated, as Avatech became a subsidiary of PlanetCAD. Mr. Hindman's loan matures on July 1, 2003. The loan bears simple interest at a rate of 15.0% on outstanding principal balance of the loan and is subordinate to Avatech's senior lender. Avatech also had outstanding $1.8 million of 10% subordinated notes. The notes were to mature on July 1, 2003 and interest was payable quarterly until maturity or prepayment. On November 19, 2002 with the completion of the merger with PlanetCAD, subordinated noteholders owning an aggregate of $1.5 million of subordinated notes exchanged their notes for preferred stock. As a result of these exchanges, Avatech's liabilities at November 19, 2002 have been reduced by $1,525,000, and interest expense is expected to be reduced by $152,500 per year. For the six months ended December 31, 2002 Avatech used $0.1 million of cash in its operations. For the comparable six-month period in 2001, Avatech generated $0.9 million of cash from its operations. Cash flow from operations before working capital changes was a deficit of $0.8 million for the six months ended December 31, 2002. Avatech's operating assets and liabilities consist primarily of accounts receivable, accounts payable, and inventory. Changes in these balances are affected by the timing of sales and investments in inventory based on expected customer demand. Inventory levels are minimized through arrangements with suppliers to ship products with an average delivery period of two days and centralized inventory management. For the six-month period ended December 31, 2002, cash flows from operations was positively affected by decreases in accounts receivable of $0.4 million. Accounts receivable, net of allowance for doubtful accounts, decreased approximately 15.4% for the period ended December 31, 2002. Day sales outstanding (DSO's) in receivables increased to 70 days as of December 31, 2002 from 49 days as of December 31, 2001. The increase in DSO's is attributable to the weak economic conditions, and the merger with PlanetCAD, which had DSO's of 95 days as of December 31, 2002. The decrease in the accounts receivable balance is primarily attributable to lower sales in December 2002 due economic weakness and the timing of product upgrade cycles. The Company's customary collection terms range from 30 to 60 days for all of its customers. Avatech's investment activities consist principally of investments in computer and office equipment. Avatech acquired $76,000 of fixed assets during the six months ended December 31, 2002. Avatech has no outstanding purchase commitments at December 31, 2002, and expects total fixed asset purchases in 2003 to be less than $0.4 million. As described more fully above, Avatech's financing activities in all periods have consisted principally of borrowings and repayments under its lines of credit. Net borrowings under lines of credit were $11,000 for the six months ended December 31, 2002. At January 31, 2003, Avatech had additional borrowing availability under its line of credit of $0.6 million. - 21 - As of March 10, 2003, Avatech and PlanetCAD had unpaid expenses due to professional firms totaling approximately $550,000 that were incurred in connection with the merger completed on November 19, 2002. Management believes that these fees are excessive and plans to vigorously negotiate the amounts due and related payment terms with all of the service providers. It is believed that the Company will be successful in negotiating reduced fees and extended payment terms. Because of the demand provisions of the line-of-credit and the lending agreement and uncertainties surrounding the Avatech's ability to obtain the needed cash, there would be substantial doubt about the ability of Avatech to continue as a going concern if the lenders exercise their demand rights under the agreement. Although management cannot control the actions of these lenders, it believes that they will not demand repayment of outstanding borrowings in the next 12 months. One of the Company's directors has expressed his intention of lending the Company, up to $500,000, to fund any needed working capital deficiencies. Based on an evaluation of the likely cash generated from operations in the near term, available capital resources and the timing of cash payments to vendors, management believes that it has sufficient sources of working capital to fund its operations in the normal course of business through at least June 30, 2003. The Company has engaged an investment banking firm to assist in obtaining long-term financing. Additionally, the Company plans to raise between $1.0 million to $2.0 million of short term financing on acceptable terms by June 30, 2003. Below is a summary of the Company's contractual obligations and commitments at December 31, 2002:
PAYMENTS DUE BY PERIOD --------------------------------------------------------------------------------- Total 2003 2004 2005 2006 Thereafter --------------------------------------------------------------------------------- Contractual Obligations Long-term debt $ 748,388 $ -- $ 748,388 $ -- $ -- $ -- Operating leases 2,715,122 1,040,785 643,170 386,361 329,885 314,921 --------------------------------------------------------------------------------- Total obligations $ 3,463,510 $ 1,040,785 $ 1,391,558 $ 386,361 $ 329,885 $ 314,921 =================================================================================
FINANCING ARRANGEMENTS WITH CIT Under the CIT Revolving Line of Credit Agreement, Avatech obtained a 3-year revolving line of credit with the CIT Group/Business Credit, Inc. ("CIT") in an amount up to $4,000,000. In consideration for granting the line of credit, Avatech granted to CIT a warrant to purchase up to 16,213 shares of its voting common stock at an exercise price of $.01 per share. The warrant expires on October 25, 2003. Avatech also granted CIT certain registration and other rights (including but not limited to drag-along rights and tag-along rights) pursuant to that certain Warrantholders Rights Agreement of the same date. QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly financial information for each of the eight quarters in the two years ended June 30, 2002. Management believes that this information has been prepared on the same basis as the audited consolidated financial statements appearing elsewhere in this Prospectus and, in managements opinion, this information includes all adjustments, consisting only of normal recurring adjustments, necessary to fairly present the unaudited quarterly operating results when read in conjunction with the audited consolidated financial statements of the Company and the notes thereto appearing elsewhere in this Prospectus. These operating results are not necessarily indiciative of results for any future period. - 22 -
Three Months Ended -------------------------------------------------------- Sept. 30, Dec. 31, Mar. 31, Jun. 30, 2000 2000 2001 2001 -------------------------------------------------------- Revenues $ 7,537,928 $ 7,487,901 $ 8,007,077 $ 7,838,572 Cost of sales 4,705,999 4,505,066 4,713,387 4,138,653 Gross margin 2,831,929 2,982,835 3,293,690 3,699,919 Operating income (179,088) 177,468 353,272 243,019 Net income $ (304,989) $ 48,277 $ 234,113 $ 111,935 ======================================================== Earnings (loss) per share - basic and diluted $ (0.14) $ 0.02 $ 0.11 $ 0.05 ======================================================== Shares used in computation 2,193,902 2,233,778 2,227,754 2,227,388 ======================================================== Three Months Ended ------------------------------------------------------- Sept. 30, Dec. 31, Mar. 31, Jun. 30, 2001 2001 2002 2002 ------------------------------------------------------- Revenues $ 7,529,009 $ 7,594,629 $ 8,102,625 $ 6,586,324 Cost of sales 4,295,779 4,113,712 4,318,174 3,510,341 Gross margin 3,233,230 3,480,917 3,784,451 3,075,983 Operating income (271,266) 275,965 (74,667) (36,455) Net income $ 37,890 $ 161,685 $ (192,190) $ (254,880) ======================================================= Earnings (loss) per share - basic and $ 0.02 $ 0.07 $ (0.09) $ (0.11) diluted ======================================================= Shares used in 2,226,677 2,223,595 2,221,973 2,220,670 computation ======================================================
The Company's operating results may vary significantly from quarter to quarter due to a variety of factors. One such significant factor is the potential fluctuation in revenues due to seasonality of the business. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Avatech is exposed to market risk from changes in interest rates associated with its variable rate line-of-credit facility. At December 31, 2002, approximately 65.7% of its outstanding debt bears interest at variable rates. Accordingly, Avatech's earnings and cash flow are affected by changes in interest rates. Assuming the current level of borrowings at variable rates and a 100 basis point change in the 2002 average interest rate under these borrowings, it is estimated that Avatech's 2002 interest expense and net income would change by less than $20,000. In the event of an adverse change in interest rates, management would likely take actions to further mitigate its exposure. However, due to the uncertainty of the actions that would be taken and their possible effects, the analysis assumes no such actions. Further the analysis does not consider the effects of the change in the level of overall economic activity that could exist in such an environment. CHANGES IN AND DISAGREEMENTS WITH AVATECH'S ACCOUNTANTS In May 2002, the management of Avatech Solutions, Inc. engaged Ernst & Young LLP as their independent auditors for the year ended June 30, 2002 in anticipation of our becoming a public registrant. Our board of directors ratified this engagement of Ernst & Young LLP effective May 28, 2002. During the 2002 fiscal year and through the date of this report, there were no disagreements with Ernst & Young on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedures which, if not resolved, would have caused them to make reference to the subject matter in connection with their report on our consolidated financial statements for such year. Ernst & Young LLP's report on our financial statements for the past year did not contain an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles. Additionally, there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K. Walpert & Wolpoff, LLP had been engaged to audit our consolidated financial statements for the fiscal years ended June 30, 2001 and 2000. During these two fiscal years and through the date of this report, there were no disagreements with Walpert & Wolpoff on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedures which, if not resolved, would have caused them to make reference to the subject matter in connection with their report on our consolidated financial statements for such years. Neither of Walpert & Wolpoff, LLP's reports on our financial statements for either of the past two years contained an adverse - 23 - opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles. Additionally, there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K. KPMG, LLP had been engaged to audit the financial statements of PlanetCAD, Inc, which merged with us effective November 19, 2002, for the years ended December 31, 2001 and 2000. During these two fiscal years and through the date of this report, there were no disagreements with KPMG on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedures which, if not resolved, would have caused them to make reference to the subject matter in connection with their report on PlanetCAD's financial statements for such years. Neither of KPMG's reports on PlanetCAD, Inc's financial statements for either of the past two years contained an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles. Additionally, there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K. BUSINESS BACKGROUND Avatech was formed as a Delaware corporation on September 9, 1996. On June 20, 1997, CADWORKS, Inc., a company conducting its operations principally in Texas providing design automation software, training, technical support and professional services to corporations, was merged into Avatech, with such merger being accounted for as a recapitalization. On June 30, 1997, Premier Design Systems, Inc., a company with similar operations principally in Maryland, was merged with a wholly-owned subsidiary of Avatech in a business combination accounted for as a pooling-of-interests. All outstanding common stock of CADWORKS, Inc. was exchanged for 593,525 shares of voting common stock of Avatech. All outstanding common stock of Premier Design Systems, Inc. was exchanged for 665,575 shares of our voting common stock. During fiscal years 1998 through 1999, we consummated business combinations with nine companies that provided design automation software, training, technical support, and professional services to corporations, government agencies, and educational institutions throughout the United States. Seven of the business combinations were each consummated by the exchange of all of the outstanding shares of voting common stock of the acquired company for shares of our voting common stock and were accounted for as pooling-of-interests. Two of these business combinations were accounted for as purchases. Our executive offices are located at 11403 Cronhill Drive, Suite A, Owings Mills, Maryland 21117, and our telephone number is (410) 902-6900. INDUSTRY BACKGROUND Today's increasingly competitive business environment has forced many companies in diverse industries to increase efficiencies while improving flexibility and responsiveness to changing market conditions. In addition to facing higher competitive standards with respect to product quality, variety and price, businesses also recognize the need to shorten lead times, adjust production for frequent changes in customer requirements, and quote more accurate and reliable delivery dates. Furthermore, a company's trading network may span multiple continents, requiring suppliers in one part of the world to collaborate with a plant in another. These forces are prompting companies to collaborate with technology transparency, across a broad range of suppliers and customers to improve efficiencies within multi-enterprise value chains and market places. The development and proliferation of communications, desktop automation, and software applications, including applications for specific industry focuses such as AEC, Mechanical Design, GIS, and Facilities Management are accelerating many companies' efforts to increase efficiencies by enabling a platform-independent communications network. This platform independence and demand for interoperability has prompted demand for a dynamic, open, and integrated environment among customers, suppliers, and designers. In response to these evolving market forces, many companies are seeking business solutions that include re-engineering their business process to reduce manufacturing cycle times, shifting from mass production to order-driven manufacturing, - 24 - increasing the use of outsourcing, and sharing information more readily with vendors and customers over the Internet. GENERAL We are a leading provider of design automation and quality assurance solutions for the manufacturing, building design, civil engineering, and GIS markets. We specialize in software development, technical support, training, and consulting aimed at improving design and documentation efficiencies and the seamless integration of workflow processes. Our sales are to corporations, government agencies, and educational institutions worldwide. Our product sales are primarily the resale of packaged design software programs that are installed on a user workstation, on a local area network server, or in a hosted environment. The programs perform and support a wide variety of functions related to design, modeling, drafting, mapping, rendering, and facilities management tasks. We are one of the largest domestic commercial reseller of design software developed by Autodesk, Inc. (Autodesk), one of the world's leading design software and digital content companies for the building design and land development, manufacturing, utilities, telecommunications, and media and entertainment industries. We differentiate ourselves from traditional product resellers through the wide range of value-added services we can provide as part of an overall business solutions engagement. Our services are structured around three areas: training, technical support, and professional services--and are often bundled with the associated software products that support them. Education classes are offered through Our 30 training classroom facilities or directly at a customer site, and include basic through advanced product training and customized company-specific training curriculum. Our instructors are application engineers and product specialists who have formal training or industry experience in the course content. Technical support services are provided primarily through our telephone support center located in Omaha, Nebraska. Through our staff of full time consultants, we provide assistance to customers with questions or issues concerning the suite of software products we resell, and those associated with the professional services engagements we perform. Professional services include project-focused offerings that are fulfilled primarily with our own application engineers and programmers and include software customization, data migration, computer aided design standards consulting, workflow analysis, and implementation assistance for complex software products. Our strategic focus is in responding to our customers' requests for interoperability and product lifecycle management solutions that address broader, enterprise-wide initiatives. More than 90% of our total revenue arises from the resale of Autodesk's software, and the delivery of related services from the sales of these products. We are required to enter into annual channel partner agreements with Autodesk and other software developers that we represent. These agreements grant us authorization to sell certain software products to certain customers in certain geographic areas of the United States. There are no clauses in these agreements that limit or restrict the services that we can offer to customers. We have a national sales and service delivery network of approximately 180 personnel operating out of 21 business offices across the country. Our sales database has over 180,000 point-of-contact names collected over a 15-year time span, and an active customer list of approximately 20,000 firms, and federal, state and local agencies. We own, market, and support cycle time reduction software solutions that integrate engineering processes and data for the manufacturing supply chain. We operate predominantly in the manufacturing industry with special focus on the computer-aided design (CAD), manufacturing (CAM) and engineering (CAE) markets. These software tools and applications enhance the value of engineering data in the manufacturing design and procurement supply chain by enabling cycle time reduction. During the traditional manufacturing process, if the supply chain manufacturer receives a product's specifications and design electronically, important data may be lost if the supply chain manufacturer does not use the same software application as used by the data originator. In that event, a sample manufactured product is provided to the end-user or OEM for approval or modification. If the sample does not meet the end-user's or OEM's specifications, it must be modified by the supply chain manufacturer and sent again for approval or modification. This process is often repeated several times and is costly. "Cycle time" is a term used to describe the cycle of trial-and-error iterations it takes for the supply chain manufacturer to produce an end product satisfactory to the end-user or OEM. Our cycle time reduction solutions enhance engineering processes and reduce product time-to-market by addressing product data quality, communication, and downstream - 25 - data interoperability. These include, but are not limited to, computer-aided design, data translation and data movement and data tracking solutions that enable communication of engineering data with varying formats and precision, and data quality assurance tools that improve design quality and reduce or even eliminate iterations from electronic design to the finished product meeting the electronic design standards. The technology and products we acquired in our merger with PlanetCAD are based on JAVA, which is a cross-platform, highly-scalable, and internet-enabled development software programming platform. These JAVA-based technologies and products enable efficient engineering information exchange and integration for professional manufacturing and design engineers worldwide. Engineers and managers can benefit from lower costs of production and accelerated introduction of products to market. Our enterprise software products include PrescientQA(TM) and our new SCS|Envoy(TM) supply chain solution software. PrescientQA(TM) is quality assurance software that detects, assesses, corrects, and even prevents product development problems caused by modeling practices that are inaccurate, incomplete, inconsistent, or all three. These problems, generally undetected, account for approximately 45% of the engineering change orders in a typical organization. Prescient technology is the only quality assurance solution that works across multiple CAD systems, including CATIA(R), Pro/Engineer(R), Unigraphics(R), and Autodesk Inventor(R), with a single reporting and configuration system. SCS|Envoy is a new line of solutions for automating the distribution of disparate data and enabling secure, rapid, and automated communication of product data throughout the supply chain, resulting in more productive and efficient manufacturing operations. In addition, we offer professional services that help implement a transparent integration of cycle time reduction solutions with existing manufacturing systems in corporate product design and production processes. We believe that PLM software and services represents a significant opportunity for future growth. Our relationship with EDS, which we expect to result in the execution of a Certified Reseller Agreement in the Spring of 2003, will not only provide us with a new potentially significant new product line, but will also permit us to expand our higher margin services business and significantly increase the average size of sales transactions. PLM software significantly enhances manufacturing efficiencies and permits manufacturers to manage products through their active lifecycles. MARKETS The AEC market is comprised of design services focused on the construction of large physical assets such as buildings, roads, factories, utility companies, and commercial infrastructure projects. Architects, builders, and civil engineers use design automation systems to create detailed three dimensional construction drawings, material specifications, and maintenance records. Digital files are created and shared by multiple architects, engineers, and suppliers of services and raw materials throughout the construction schedule and subsequent operations of the asset. The Mechanical Design and Manufacturing market is primarily focused on the design, tooling, assembly, and testing of instruments, electronic devices, machines, mechanical devices, and power-driven equipment. Inventors, engineers, technicians, and designers use design automation software as basic tools in the overall form, fit and function, creation, and refinement of the product or item. Given the physical and electronic complexity of most items invented today, software and services are critical to achieving tight production schedules and cost targets. EDM systems provide methodical and organized processes involved with the storage, retrieval, management, and versioning of design files, drawings and related documents such as customer correspondence, inventory lists, digital images, and other items. These products are based on a client/server architecture, and are scalable from a departmental solution to a division level infrastructure system. GIS software permits users to link together disparate data files (maps, aerial photos, tax records, marketing data, etc.) and provide the user with a unified image and knowledge base of a specific geographic location or building location. This software can also be used to develop emergency exit and disaster rescue plans by providing - 26 - detailed information about employee locations, communication information, distances to the closest stairwells, and elevators, fire hose connection points, etc. New technology based on powerful desktop computer hardware has enabled software developers to offer products that are easier to use and less expensive than the previous applications, thus expanding the volume of purchases, installation, and level of usage from the traditional civil engineering, utilities, public works, and transportation logistics markets and into the emergency services and Homeland Security segments. Facilities Management applications enable facility managers and physical plant staff to efficiently operate and utilize all aspects of a facility's operational systems (heating, cooling, power, communications, security, etc.) including its internal and external space and infrastructure. When integrated with Internet browsers, GIS, and document management tools, users are able to have substantial knowledge about their buildings, their neighborhoods, and their documents, which leads to better effectiveness and cost containment. As a result of our merger with PlanetCAD, we develop, market, and support cycle time reduction software solutions that integrate engineering processes and data for the manufacturing supply chain. We operate predominantly in the manufacturing industry with special focus on the computer-aided design (CAD), manufacturing (CAM), and engineering (CAE) markets. We provide software tools and applications that enhance the value of engineering data in the manufacturing design and procurement supply chain by enabling cycle time reduction. During the traditional manufacturing process, if the supply chain manufacturer receives a product's specifications and design electronically, important data may be lost if the supply chain manufacturer does not use the same software application used by the data originator. In that event, a sample manufactured product is provided to the end-user or OEM for approval or modification. If the sample does not meet the end-user's or OEM's specifications, it must be modified by the supply chain manufacturer and sent again for approval or modification. This process is often repeated several times and is costly. "Cycle time" is a term used to describe the cycle of trial-and-error iterations it takes for the supply chain manufacturer to produce an end product satisfactory to the end-user or OEM. Our cycle time reduction solutions enhance engineering processes and reduce product time-to-market by addressing product data quality, communication, and downstream data interoperability. This includes, but is not limited to, computer-aided design, data translation, and data movement and tracking that enables communication of engineering data with varying formats and precision and data quality assurance tools that improve design quality and reduce or even eliminate iterations from electronic design to the finished product meeting the electronic design standards. Product Lifecycle Management (PLM) software solutions are expected to be a significant new tool for manufacturers in multiple vertical industries over the next decade. According to AMR Research, the PLM software market was $2 billion in 2001 and will grow to nearly $8 billion by 2006. We believe that our newly created relationship with Unigraphics, a subsidiary of EDS, pursuant to which we expect to become an EDS Certified Reseller, will provide us with important product diversity consistent with our new strategy of increased investment in people, diversification of product and service offerings, and a targeted merger and acquisition program to expand our geographic footprint. SOLUTIONS AND PRODUCTS As a design automation company, we sell software packages developed by third party software developers. We provide a variety of services to assist our customers in maximizing the benefits from these software applications. These services include training, technical support, and professional services. Our product sales are primarily composed of packaged software programs that are installed on a user workstation, on a local area network server, or in a hosted environment. The programs perform and support a wide variety of functions related to design, drafting, manufacturing, workflow automation, and document management activities. Product offerings include a full range of design automation software packages from the industry leader, Autodesk, and workflow and document management software from Cyco, Inc. Training Services. We have a curriculum of over 30 different subjects offered at our 30 training facilities, and through mobile labs that we can send to a customer site. Our employees serve as class instructors and have formal training or successful industry experience in the topics they are teaching. All instructors must take and pass - 27 - annual subject-matter exams required by Autodesk and other software providers to retain their product-based teaching certifications. We also provide training services that are highly tailored to meet the needs of a particular customer, including company-specific operational topics, customized product usage, and other general technology or process training. Technical Support Services. We provide end-user and corporate technical support services through our National Support Center (NSC) located in Omaha, Nebraska. A staff of full-time product and technology consultants assists customers calling with questions about product features, functions, usability issues, and configurations--as well as from our professional services engagements. The NSC offers services through multiple access levels including prepaid services, actual elapsed time, and annual support contracts. Customers can communicate with the NSC through e-mail, telephone, and fax channels. Standard NSC support services are offered on a 12-hour by 5-day basis, with premium pricing for extended coverage hours. Professional Services. Professional Services are project-focused offerings that include software customization, data migration, computer aided design standards consulting, supplemental staffing for design work, drawing digitization, symbol library development, and GIS database development. We also provide technology interoperability, engineering collaboration, and workflow improvement solutions with design automation and manufacturing organizations. CHANNEL SALES AGREEMENT WITH AUTODESK, OUR LARGEST VENDOR, PROPOSED RESELLER AGREEMENT WITH EDS. Our revenues are primarily derived from the resale of vendor software products and services. These resales are made pursuant to channel sales agreements whereby we are granted authority to purchase and resell the vendor products and services. Under these agreements, we either resell software directly to our customers or act as a sales agent for various vendors and receive commissions for our sales efforts. We entered into an Authorized Channel Partner Agreement with Autodesk, Inc. whereby Autodesk appointed us as a non-exclusive partner to market, distribute, and support Autodesk software products. Collectively with our subsidiaries, we must achieve a yearly minimum revenue in the amount of $300,000 from the sale of Autodesk's software products in order to be eligible to purchase such products directly from Autodesk. This Agreement expired on January 31, 2003, and we are in the process of negotiating modifications to the standard Channel Partner Agreement with Autodesk. We have reached an agreement principal with EDS whereby we will become a Certified Reseller of EDS' PLM software solution. The terms of this Agreement have not yet been finalized. SALES AND MARKETING Our merger and acquisition growth strategy, coupled with post merger marketing efforts, has provided us with a sales database of over 180,000 point-of-contact names and an active customer base of 18,000 organizations. We sell software products and solutions services through a direct sales organization consisting of sales representatives, many with engineering degrees and industry experience, and pre-sales technical consultants. Many of our customers were successfully transitioned from acquired companies, as dedicated sales representatives worked diligently to retain their customer relationships. We utilize a customer relationship system (CRM) to manage customer communications that is deployed at all offices via a wide-area network. We also use a sophisticated electronic marketing system for permission-based, automated, one to one marketing communications and regular electronic publications. The features include automatic customized e-mail messages to prospects with interest in our products and services and automated lead distribution directly to the sales force. In addition, we have a comprehensive and scaleable website, which supports secure transactions and serves streaming media demonstrations and technical tips on a 24x7 on-demand basis. - 28 - CUSTOMERS We market our products to private companies, public corporations, government agencies, and educational institutions throughout the United States. In fiscal year 2002, the revenues generated by our top 10 customers represented approximately 5% of total revenues. We have a national sales and service delivery network that is comprised of 20 business offices and 30 training classrooms across the country. Our customers include: AOL Time Warner Communications AT&T Baltimore Gas & Electric Baseland Bechtel Becton Dickenson Bell Atlantic Bouck & Lee Engineers Caterpillar Champion Industries City of Baltimore City of Roseville, CA Colorado Springs Utilities Consumers Energy Dewberry & Davis Ford Motor Company General Electric General Mills Goodyear Hellmuth, Obata & Kassabaum, Inc. Honeywell INTEL JCPenney John Deere Johnson & Johnson Kimley-Horn & Associates Lucent Technologies MBNA Media One Michigan Department of Transportation Naptheon NASA National Park Service Nestle Nolte Engineering Norfolk Naval Air Station Oceana Naval Base Ozark Aircraft Pacific Bell Parker Hannifan Parsons Brinckerhoff Quade &Douglas, Inc. Pioneer Hybrid Qwest Communications Rockwell Royal Caribbean International RTKL Associates Sacramento Regional Transit SBC Siemens Siemens Medical Systems Texaco Texas Instruments The Sports Authority Trane Union Pacific URS Greiner US Bureau of Land Management Verizon
COMPETITION We compete in the design automation channel, a market historically composed of small niche, regionally focused companies. Since we began operations in 1997, the Autodesk reseller channel has changed radically. The number of Autodesk channel participants has declined significantly from approximately 400 at the time of our formation to approximately 200 currently. The many new products and their increased complexity have made it very difficult for small companies to compete. The vast majority of smaller resellers lack the technical talent, financial resources, and business management skills to transition from the old, single-application product model to one offering complete solutions. While several, small, reseller competitors exist in the various geographic territories where we conduct business, we have a competitive advantage in terms of geographic reach, comprehensive training and support and the provision of other products and services. We are the largest commercial Autodesk reseller in the United States. Two national competitors that could be compared to us in scale, size, geographical reach and target markets for the resale of Autodesk products; INCAT International, Inc. (INCAT) and RAND A Technology Corporation (RAND). INCAT is a systems integrator for design automation products. They have 30 offices in nine countries with worldwide headquarters in the United Kingdom. They have 15 offices in the United States. They have approximately 800 employees worldwide with approximately 65 percent in consulting, design engineering and technical support. While INCAT is larger than Avatech, we estimate that the Autodesk portion of its business is less than one-fourth as large as our Autodesk business. RAND is the largest computer-aided design and engineering technology company worldwide. However, we estimate that its Autodesk related business is less than fifty percent as large as ours. It operates in 104 offices located - 29 - in 27 countries with headquarters in Canada. It has 38 offices in the United States. As of December 31, 2001, it reported having over 1,200 employees worldwide. INTELLECTUAL PROPERTY We regard our technology and other proprietary rights as essential to our business. While we rely on copyright, trade secret, confidentiality procedures, contract provisions, and trademark law to protect our technology and intellectual property, we believe that the technological skills of our employees and reliable service maintenance are also critical to establishing and maintaining an intellectual property leadership position. We own a number of federal trademarks, including "AVATECH SOLUTIONS," "AVANEWS," and "PRESCIENT QA," and have no trademark applications pending. We have no patents or patent applications pending. We acquired a number of other trademarks as a result of our merger with PlanetCAD. We have entered into confidentiality agreements with our employees, consultants and corporate partners and intend to control access to, and distribution of our products, documentation and other proprietary information. EMPLOYEES As of December 31, 2002, we had approximately 170 full time employees located in 22 offices throughout the United States. Many of our current employees formerly were employees of the companies that we acquired. Approximately 43 are located in Maryland where we have our corporate headquarters, as well as two sales and training locations. Maryland is also the location of our centralized accounting, order processing, and marketing functions. Approximately 62 of our total work force is engaged in sales and marketing activities, and approximately 60 employees are engaged in service fulfillment. Our future success depends in significant part upon the continued services of our key sales, technical, and senior management personnel and our ability to attract and retain highly qualified sales, technical and managerial personnel. None of our employees are represented by collective bargaining agreements, and we have never experienced a work stoppage. We believe our employee relations are good. PROPERTIES Our corporate offices are located in Owings Mills, Maryland where we lease approximately 3,000 square feet of office space, pursuant to a lease that expires June 30, 2003. These facilities house our executive and primary administrative offices as well as accounting, order processing operations, IT, and marketing. We also lease office space at the following locations: LOCATION SQUARE FOOTAGE TERM -------- -------------- -------------- California--Roseville................. 2,877 06/30/2003 Colorado--Englewood................... 7,250 03/31/2005 Colorado--Boulder..................... 3,720 11/1/2007 Connecticut--Milford.................. 5,342 Month to month Florida--Sarasota..................... 2,500 7/31/2003 Florida--Tampa........................ 2,290 12/31/2003 Iowa--Cedar Rapids.................... 2,525 05/31/2003 Iowa--Clive........................... 4,310 04/30/2004 Maryland--Owings Mills................ 10,010 05/31/2004 Maryland--Rockville................... 2,616 04/01/2003 Michigan--Ann Arbor................... 5,543 02/28/2003 Minnesota--St. Paul................... 2,782 09/30/2002 Nebraska--Omaha....................... 7,150 Month to month New Jersey--East Brunswick............ 2,000 03/31/2003 New York--Liverpool................... 2,105 05/14/2003 Texas--Austin......................... 2,125 10/31/2004 Texas--Irving......................... 10,522 12/31/2002 Virginia--Richmond.................... 2,250 03/31/2006 Virginia--Virginia Beach.............. 5,000 12/31/2002 - 30 - Not listed are leases for space that has been vacated where the sublessee's payments to us defray, in whole or in substantial part, our lease payment obligations. The commercial real estate market is volatile and unpredictable in terms of available space, rental fees, and occupancy rates and preferred locations. We cannot be certain that additional space will be available when we require it, or that it will be affordable or in a preferred location LEGAL PROCEEDINGS We are not currently a party to any material legal proceeding. MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS Set forth below is information, as of December 31, 2002, with respect to the individuals who serve as our directors and executive officers. For additional information concerning each of these directors and executive officers, see "Security Ownership of Certain Beneficial Owners and Management" and "Executive Compensation." NAME AGE POSITION - --------------------- ------ ------------------------------------ W. James Hindman 67 Chairman of the Board Henry D. Felton 60 Vice Chairman of the Board Donald "Scotty" Walsh 66 Chief Executive Officer and Director Eugene J. Fischer 56 Director James A. Fanella 44 Director John W. Sasser 54 Director Gary Rever 50 Chief Financial Officer V. Joel Nicholson 60 Executive Vice President Debra Keith 51 Senior Vice President Scott Fischer 44 Executive Vice President There are no family relationships among any of our directors or executive officers. W. JAMES HINDMAN. Mr. Hindman has been a member of the Board of Directors of Avatech since its inception in 1997. Previously, Mr. Hindman founded Youth Services International, Inc. and served as its Chairman of the Board and Chief Executive Officer from 1991 to 1997. In addition, Mr. Hindman is the founder of Jiffy Lube International, Inc. and served as its Chairman of the Board and Chief Executive Officer from 1980 to 1989. In addition, from 1976 to 1980, Mr. Hindman was the Head Football Coach at Western Maryland College, his alma mater. From 1967 to 1979, Mr. Hindman was involved as the founder and President of W.J. Hindman & Associates, Inc., a real-estate development, health care and consulting company that owned and operated 18 nursing home facilities throughout Maryland, Iowa, Illinois and Nebraska. He has served as a member of the boards of directors of Morningside College and the Baltimore Symphony Orchestra. HENRY D. FELTON. Mr. Felton has been with Avatech since its inception in 1997 and has served as Chairman of the Board and Chief Executive Officer since that time. He is the former Co-Founder, President and Chief Operating Officer of Youth Services International, Inc. Previously, Mr. Felton was Executive Vice President of Maryland National Bank and a Management Committee member. DONALD R. WALSH. Before joining Avatech as its CEO in December, 2002, Mr. Walsh was the Executive Vice President of Business & Network Systems Sales for InterVoice-Brite, Inc., a global leader in the call - 31 - automation industry, a position he held since August 1999. From July 1997 until the 1999 merger of Brite Voice Systems, Inc. with InterVoice, Inc., Mr. Walsh served as the Executive Vice President of Worldwide Sales for the Brite Voice Systems. Before joining Brite Voice Systems, Mr. Walsh served as President of PSC Information Services, a division of a Philadelphia suburban corporation that provides data processing products and services. Mr. Walsh's experience also includes 23 years of experience with IBM. EUGENE J. FISCHER. Mr. Fischer was a director of PlanetCAD from March 2000 until its merger with Avatech, and currently serves as a director of Avatech and a member of its Executive, Audit, and Compensation Committees. Mr. Fischer co-founded Capstone Management LLC, a venture capital firm, in July 1995, and is an executive officer in Capstone's affiliated entities. His investment experience includes Internet, software, health care service and other technology-enabled service companies. Mr. Fischer holds a B.S. from the University of Minnesota and an M.S. from the University of California, Davis. JOHN W. SASSER. Mr. Sasser is presently self-employed and has been so since July of 1991. From 1987 to July of 1991, Mr. Sasser was the President of American Oil Change Corporation, a Jiffy Lube franchisee. Mr. Sasser also served as the President of the Jiffy Lube Association of Franchisees from 1989 until July of 1991. Previously, Mr. Sasser was the Senior Vice President and Chief Financial Officer of Jiffy Lube International from 1984 to 1987. He currently serves as a member of the boards of directors of the Cloisters Children's Museum and Port Discovery, two children's museums in Baltimore, Maryland. JAMES A. FANELLA. Mr. Fanella served as a director of PlanetCAD from October 2001 until its merger with Avatech, and currently serves as a director of Avatech and a member of its Audit and Compensation Committees. Mr. Fanella recently served as Senior Vice President, Enterprise Solutions, at Yahoo!, a position he held since August 2001. From September 2000 until July 2001, Mr. Fanella served as a group president and general manager of global services at CommerceOne. From November 1999 until September 2000, he served as a group president of AppNet, Inc., which was acquired by Commerce One. From 1994 until October 1999, Mr. Fanella was a managing principal at the Unisys Corporation. GARY REVER. Mr. Rever joined Avatech in August 2000 as Senior Vice President and Chief Financial Officer. He was formerly the President of Mason-Dixon Services, LLC, a bank holding company subsidiary that provided operational and IT services to affiliate companies from 1998 to 2000. Prior, he has served as the Chief Financial Officer of Bank of Maryland Corporation and Vice President of MNC Affiliates from 1981 to 1998. Mr. Rever is a Certified Public Accountant and earned his BA in Economics at the University of Maryland. V. JOEL NICHOLSON. Mr. Nicholson has been with Avatech since its inception in 1997 and has served as a director and Executive Vice President since that time. Prior to joining Avatech, Mr. Nicholson served as President of Evergreen National Development, Inc., a start-up corporation that provided services to client companies considering mergers, acquisitions, and other growth options. Formerly, Mr. Nicholson was the Senior Vice President of Youth Services International, Inc., responsible for mergers and acquisitions. During his military career, he held various high level positions. SCOTT FISCHER. Mr. Fischer joined Avatech in April 2002 as Senior Vice President, Professional Services and currently serves as our Executive Vice President--Operations. Prior to going to Avatech, Mr. Fischer was a principal in TenX Capital Partners from June of 2001 to April of 2002. Prior, he was Vice President and General Manager--Americas for Wireless Knowledge, a start-up wireless technology provider from January through May of 2001. From June of 1999 through January of 2001, Mr. Fischer was a Senior Vice President of AppNet, then Commerce One, which acquired it. Mr. Fischer was Vice President--Sales and Marketing, General Manager, of triSpan Internet Business Solutions, of Conshohocken, Pennsylvania from August 1998 until June of 1999, when the company was sold. From October 1997 to August 1998, Mr. Fischer was the President of NDC Group, a consulting company in Alexandria, Virginia. Mr. Fischer began his career with Anderson Consulting (Accenture) where he worked until September 1997. DEBRA KEITH. Ms. Keith joined Avatech in July of 1998 as a Sales Manager and became Senior Vice President of Sales and Marketing in April 2002. Prior to joining Avatech, Ms. Keith was the Sales Development Manager for Autodesk, Inc. from December of 1994 through July of 1998. From 1979 until 1994, Ms. Keith held - 32 - various management positions in Auto-trol Technology Corporation of Denver, Colorado, including Business Unit Manager (1992 to 1994) and Senior Account Manager (1987 to 1992). EXECUTIVE COMPENSATION The following table presents information concerning all compensation earned during the three most recent fiscal years ended June 30 by our immediately past Chief Executive Officer and four other most highly compensated executive officers whose combined salary and bonus exceeded $100,000 for services rendered during the fiscal years. These executive officers are referred to as the "Named Executive Officers." The compensation set forth in the table below does not include medical, group life or other benefits that are available to all of our salaried employees, and perquisites and other benefits, securities, or property that do not exceed the lesser of $50,000 or 10% of the person's salary and bonus shown in the table. SUMMARY COMPENSATION TABLE
SECURITIES NAME AND PRINCIPAL SALARY BONUS UNDERLYING ALL OTHER POSITION YEAR ($) ($) OPTIONS (#) COMPENSATION ($) - ---------------------------------------- ------ ---------- ------ ----------- ---------------- Henry Felton Vice Chairman, Former Chief Executive Officer 2002 $ 6,079 $ -- 12,674 $ -- 2001 6,121 -- 12,613 -- 2000 5,765 -- 18,959 -- Gary Rever, Senior Vice President, Chief Financial Officer 2002 114,696 -- -- -- 2001 77,000 7,000 22,320 -- 2000 -- -- -- -- Joel Nicholson, Executive Vice President 2002 127,176 -- -- -- 2001 109,596 -- -- -- 2000 103,596 -- -- -- Debra Keith Senior Vice President, Sales & Marketing 2002 110,051 10,895 5,580 -- 2001 84,167 25,000 3,720 -- 2000 80,000 25,000 670
OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth information with respect to stock options granted to each of the Named Executive Officers during 2002. We granted options to purchase up to a total of 138,812 shares to employees during the year. The table's percentage column shows how much of that total went to the Named Executive Officers.
Number of Shares Percent of Total Underlying Options Options Granted to Exercise Price Granted in 2002 Employees (%) ($ / Share) Expiration Date ------------------ ------------------ -------------- --------------- Henry Felton 12,674 9.1% $ 11.42 June 2012 Joel Nicholson -- -- -- -- Debra Keith 5,580 4.0% $ 11.42 November 2011 Gary Rever -- -- -- --
- 33 - OPTION EXERCISES IN LAST FISCAL YEAR The following table sets forth the number of shares the Named Executive Officers purchased in connection with option exercises during the 2002 fiscal year and the value they realized on those exercises.
Number of Securities Underlying Unexercised Options at Fiscal Year-End Shares Acquired on -------------------------------------- Name Exercise Value Realized Exercisable Unexercisable ------------------ -------------- ------------- --------------- Henry Felton -- -- 44,246 -- Joel Nicholson. -- -- -- -- Debra Keith -- -- 3,918 8,283 Gary Rever -- -- 7,440 14,880
EMPLOYMENT CONTRACTS, CHANGE-IN-CONTROL AND INDEMNIFICATION ARRANGEMENTS The executive officers serve at the discretion of our board of directors. However, two of our executives, Donald "Scotty" Walsh and Gary Rever (CFO), have signed employment agreements with severance provisions that provide for specific cash compensatory arrangements to these employees in the event of a change in control. The agreements for Messrs. Walsh and Rever provide that if the executive's employment is terminated or substantially modified as a result of a change in control, then the executive will receive a severance payment equal to 12 and 18 months' base salary, respectively, then in effect and full accelerated vesting of all unvested stock options. Mr. Felton and Mr. Nicholson are parties to severance agreements with us which entitle them, upon a change of control or termination of employment without cause, to 18 months' severance pay. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS W. James Hindman currently owns approximately 2.68% of our outstanding common stock and is the Chairman of our Board of Directors. Mr. Hindman loaned us $500,000 in August 2002. The $500,000 loan bears simple interest at a rate of 15% per year with interest to be paid quarterly. The loan must be repaid on July 1, 2003. Avatech began in 1996 and grew by acquiring corporations through merger. Our stock was given to the owners of these founding companies in exchange for the stock of the founding companies. The owners of these founding companies became our controlling stockholders. After the PlanetCAD merger, these founding stockholders, as a group, own approximately 32.6% of our outstanding stock. Henry D. Felton is currently the Vice Chairman and our immediate past CEO. Mr. Felton owns approximately 6.6% of our outstanding stock and holds, as of July 31, 2002, stock options and warrants to purchase up to approximately 1.72% of our stock. As our chief executive officer, Mr. Felton was issued stock options to purchase our common stock in lieu of cash compensation. Thus, Mr. Felton received an option each month to purchase 1,061 shares of Avatech common stock. Each option he received is fully vested and has an exercise price of $11.42 per share. Pursuant to a written lease dated June 30, 1998, Frank Willson is a member of Saltwater, L.L.C., the landlord of an office building in Virginia Beach, Virginia in which we are a tenant. We pay $6,527.27 per month under the lease that runs until December 31, 2003. Mr. Willson owns approximately 9.31% of our outstanding stock. Management has verbally agreed to enter into a written agreement with certain stockholders of Avatech giving the right to those stockholders to participate (through the selling of owned shares) in underwritten public offerings. The stockholders to be given these rights are our founding stockholders who were considered to be affiliates of Avatech prior to the merger with PlanetCAD on November 19, 2002. Specifically, the Avatech stockholders to be given the participation rights are Frank Willson, Jean and Brice Schaeffer, Greg Blackwell and Keith Carter. Each of Mr. Willson, Ms. Schaeffer, Mr. Blackwell and Mr. Carter were, until November 2002, members of our Board of Directors. Mr. Willson, the Schaeffers, Mr. Blackwell and Mr. Carter own approximately - 34 - 9.31%, 8.27%, 7.17% and 4.21% of the outstanding shares of Avatech common stock, respectively. The participation rights will be available on a pro-rata basis with any other stockholder who may have similar rights, and they will be subject at all times to the combined company's sale of securities in the applicable underwritten offering. In addition to their right to have shares included in underwritten public offerings, resales of shares owned by these individuals are covered by this Prospectus. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the ownership of our common stock by (i) each of our current directors, (ii) each of our executive officers named in the summary compensation table found on page 34, (iii) all of such officers and directors as a group, and (iv) all those known us to be beneficial owners of more than five percent of our common stock as of December 31, 2002. For the purposes of this table, ownership figures are based on reported ownership of Avatech securities as of December 31, 2002. Beneficial Ownership/1/ ------------------------------------ Name and Address of Beneficial Owner Number of Shares Percent of Shares - ------------------------------------ ---------------- ----------------- James A. Fanella/2/ 750 * 23 Wescott Drive South Barrington, Il 60010 Eugene J. Fischer/3/ 75,598 2.55 245 Laning Drive Woodside, CA 94062 John W. Sasser/4/ 372 * 1820 Circle Road Baltimore, MD 21204 W. James Hindman/5/ 85,372 2.88 2322 Nicodemus Road Westminster, MD 21157 V. Joel Nicholson/6/ 157,312 5.30 745 N. MacEwen Drive Osprey, FLA 34229 Henry D. Felton/7/ 249,577 8.41 13001 Dover Road Reisterstown, MD 21136 -- -- Gary Rever/8/ 14,880 * 2204 Eastlake Road Timonium, MD 21093 Debra Keith/9/ 7,241 * 1811 Kendall Court Keller, TX 76248 Donald Walsh/10/ 1,860 * 3 Boxwood Lane Lutherville, MD 21093 - ---------- - 35 - * Less than one percent. 1. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of Avatech common stock subject to options and warrants currently exercisable within 60 days of December 31, 2002 are deemed outstanding for purposes of computing the percentage of the person or entity holding such securities but are not deemed outstanding for purposes of computing the percentage of any other person or entity. Except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. 2. Includes 750 shares subject to stock options that are exercisable within 60 days of December 31, 2002. 3. Includes 1,377 shares subject to stock options that are exercisable within 60 days of December 31, 2002, 39,343 shares held of record by Capstone Ventures SBIC, L.P. (including 30,497 shares underlying convertible preferred stock), and 19,630 shares of common stock issuable upon exercise of outstanding warrants held by Capstone. Mr. Fischer is the president of the general partner of Capstone. Mr. Fischer shares voting and dispositive power with respect to the shares held by Capstone with Barbera L. Santry. 4. Includes 372 shares of common stock subject to a warrant that is exercisable within 60 days of December 31, 2002. 5. Mr. Hindman serves as Chairman of the Board of Avatech. Includes 2,604 shares subject to stock options that are exercisable within 60 days of December 31, 2002, 1,488 warrants to purchase common stock held by Mr. Hindman's spouse, 1,860 warrants to purchase common stock held by Mr. Hindman, and 10,952 shares held by Hindman and Associates. Mr. Hindman's adult children beneficially own 154,287 shares of Avatech. Mr. Hindman disclaims beneficial ownership of the shares owned by his adult children. 6. Mr. Nicholson serves as an Executive Vice President of Avatech. Includes 2,188 shares owned by Mr. Nicholson's spouse. 7. Mr. Felton serves as the Vice Chairman of the Board of Avatech. Includes 49,019 shares subject to stock options that are exercisable within 60 days of December 31, 2002, 2,604 warrants to purchase common stock held by Mr. Felton's spouse, and 1,860 warrants to purchase common stock owned by Mr. Felton. 8. Mr. Rever serves as Chief Financial Officer of Avatech. Includes 14,880 shares subject to stock options that are exercisable within 60 days of December 31, 2002. 9. Mrs. Keith serves as Senior Vice President, Sales and Marketing of Avatech. Includes 7,241 shares subject to stock options are exercisable within 60 days of December 31, 2002. 10. Mr. Walsh serves as Chief Executive Officer of Avatech. Includes 1,860 shares subject to stock options that are exercisable within 60 days of December 31, 2002. PLAN OF DISTRIBUTION This Prospectus covers: 1. Resales of shares by certain holders of our common stock, who acquired their shares upon conversion of PlanetCAD's Series B Convertible Preferred Stock at the time of our merger with PlanetCAD in November 2002. These holders were granted registration rights pursuant to which we were contractually obligated to register their shares for resale within 120 days after the closing of the merger. 2. Resales of shares of our common stock acquired upon conversion of our Series C Convertible Preferred Stock, which is convertible at any time after 120 days from the date of issuance thereof. 3. The initial issuance of shares to shareholders of companies we acquire by merger or otherwise who are issued shares in exchange for all of the issued and outstanding shares of such companies, - 36 - or in exchange for all or substantially all of the assets of such companies. Material terms of any such acquisition transactions will be disclosed in Supplements to this Prospectus prior to the issuance of such shares. 4. The initial issuance of shares to key management employees, consultants, officers, and directors under our Restricted Stock Award Plan in exchange for past or future services to us. The Restricted Stock Award Plan is provided as Annex A to this Prospectus. Resales of shares effectuated pursuant to this Prospectus may occur from time to time at market prices prevailing at the time of sale, at fixed prices, or in privately negotiated transactions. We will not receive any of the proceeds from the sale of such shares. DESCRIPTION OF SECURITIES The following is a summary of the material information relating to our common stock based on our certificate of incorporation and bylaws and the applicable provisions of the Delaware General Corporation Law. For information on how to obtain copies of our certificate of incorporation and bylaws, see "Where You Can Find More Information." As of the date of Prospectus, we have the authority to issue an aggregate of 25,000,000 shares of capital stock, consisting of 22,500,000 shares of common stock, par value $0.01 per share, and 2,500,000 shares of preferred stock issuable from time to time by the board of directors in one or more classes or series. As of January 31, 2003, there were 2,965,958 shares of our common stock outstanding, no shares of Series A Junior Participating Preferred Stock outstanding, no shares of Series B Convertible Preferred Stock outstanding and 34,585 shares of Series C Convertible Preferred Stock outstanding. COMMON STOCK Dividends. The holders of common stock are entitled to dividends when and as declared by the board of directors from funds legally available to pay such dividends. Voting Rights. Each holder of Avatech's common and preferred stock is entitled to attend all special and annual meetings of the stockholders of Avatech, and to vote upon any matter, including, without limitation, the election of directors, properly brought for consideration before the stockholders. The holders of common stock are entitled to one vote for each share held of record. No Preemptive or Conversion Rights. Holders of Avatech common stock have no preemptive rights and no rights to convert their common stock into any other securities. Liquidation Rights. In the event of a liquidation, dissolution or winding up of Avatech, the holders of Avatech common stock and the holders of any class or series of stock entitled to participate with such holders, will be entitled to participate in the distribution of any assets of Avatech remaining after Avatech has paid all of its debts and liabilities and after Avatech has paid, or set aside for payment, to the holders an amount equal to the purchase price for, and any accrued and unpaid dividends on, to any future class or series of stock with a liquidation preference over the common stock the preferential amount to which they are entitled. AVATECH PREFERRED STOCK Avatech's board of directors has designated three classes of preferred stock: the Series A Junior Participating Preferred Stock, the Series B Convertible Preferred Stock, and the Series C Convertible Preferred Stock. In addition, the board of directors has the authority to designate additional classes or series of preferred stock in the future with rights that may adversely affect the rights of the holders of Avatech common stock. - 37 - LIMITATION OF LIABILITY AND INDEMNIFICATION Limitations of Liability. Delaware law authorizes corporations to limit or eliminate the personal liability of directors to corporations and their stockholders for monetary damages for breach of the fiduciary duty of care. Although Delaware law does not change the duty of care, it enables corporations to limit available relief to equitable remedies such as injunction or rescission. Avatech's certificate of incorporation limits the liability of directors to Avatech or its stockholders to the fullest extent permitted under Delaware law. Specifically, directors of Avatech are not personally liable for monetary damages to Avatech or its stockholders for breaches of the their fiduciary duties, except for liability for acts or omissions not in good faith or involving intentional misconduct, for knowing violations of the law, for any transaction from which the director or executive officer derived an improper personal benefit, or for authorizing the payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. Indemnification. Avatech has entered into indemnification agreements with each of its directors and executive officers that require Avatech to indemnify each such person to the fullest extent authorized or permitted by Avatech's certificate of incorporation and Delaware law against expenses, judgments, fines, settlements and other amounts actually and responsibly incurred (including expenses of a derivative action) in connection with any proceeding, whether actual or threatened, to which they may be made a party by reason of the fact that they are or were acting as a director, officer, employee, or other agent of Avatech or any of its affiliated enterprises. Delaware law permits this indemnification, provided the person acted in good faith and in a manner reasonably believed to be in or not opposed to the best interest of Avatech and, with respect to any criminal proceeding, had no reasonable cause to believe his or her conduct was unlawful. The indemnification agreements also set forth certain procedures that will apply in the event of a claim for indemnification thereunder. In addition, Avatech maintains director and officer liability insurance which, subject to certain exceptions and limitations, insures directors and officers for any alleged breach of duty, neglect, error, misstatement, misleading statement, omission, or act in their respective capacities as directors and officers of Avatech. CERTAIN PROVISIONS RELATING TO A CHANGE OF CONTROL Provisions Related To The Election Of Directors And Stockholder Action. Avatech's certificate of incorporation requires the affirmative vote of two-thirds of the stockholders to remove a director from the board of directors without cause. The certificate of incorporation also provides that all board vacancies are to be filled by the remaining directors, unless the remaining directors approve a stockholder vote to fill a vacancy. Avatech's bylaws prohibit less than two-thirds of Avatech's stockholders from calling a special meeting, whether for the purpose of replacing directors or for any other purpose. As a result, once elected, Avatech directors may not be removed from office without cause until the next annual meeting of the stockholders. Therefore, a third party interested in taking control of Avatech quickly will not be able to do so unless the third party acquires two-thirds or more of Avatech's voting securities at the time of the acquisition. In addition, Avatech's certificate of incorporation and bylaws prohibit stockholders from taking action by written consent in lieu of a meeting. Stockholder Rights Plan. In March 2002, Avatech's board of directors adopted a stockholders rights plan. The plan is designed to deter a takeover of Avatech on terms other than those approved by the Avatech's board of directors. The plan causes substantial dilution to a person or group that attempts to acquire Avatech on terms that are not approved by the Avatech board of directors. Under the plan, each Avatech stockholder as of March 21, 2002 received a right that entitles that stockholder to purchase one one-thousandth of a share of Avatech's Series A Junior Participating Preferred Stock for each share of common stock held. Generally, the rights become exercisable only if a person or group acquires or obtains the rights to acquire 15% or more of Avatech's outstanding common stock, or if a tender or exchange offer is commenced, the completion of which would result in a person owning more than 15% of Avatech's outstanding common stock. The rights, however, are not exercisable if a person who acquires more than 15% of Avatech's outstanding common stock offers to purchase all of Avatech's outstanding shares of common stock and Avatech's board of directors determines by a two-thirds vote that such offer is fair to and otherwise in the best interests of Avatech and its stockholders. If the rights become exercisable, the rights of the person who acquires more than 15% of Avatech's common stock become null and void. All other stockholders will be entitled to purchase stock of Avatech, or the stock of any company that has acquired Avatech, having a value twice that of the exercise price of the rights. For - 38 - example, at a purchase price of $5.00 per right, each right would entitle its holder to purchase $10.00 worth of stock of Avatech or the company that has acquired Avatech for $5.00. The rights will expire March 8, 2012, and are redeemable for $0.0001 per right at the approval of Avatech's board of directors. It is highly probable that our Board of Directors will redeem the rights and terminate the Plan, although as of the date of this Prospectus, it has not done so. Certain Statutory Provisions. Avatech is subject to the provisions of Section 203 of the Delaware General Corporation Law. In general, this provision prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless: . prior to such date, the corporation's board of directors approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; . upon consummation of the transaction that resulted in such person becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding, shares owned by certain directors or certain employee stock plans; and . on or after the date the stockholder became an interested stockholder, the business combination is approved by the corporation's board of directors and authorized by the affirmative vote, and not by written consent, of at least two-thirds of the outstanding voting stock of the corporation excluding that owned by the interested stockholder. A "business combination" includes a merger, asset sale, or other transaction resulting in a financial benefit to the interested stockholder. An "interested stockholder" is a person, other than the corporation and any direct or indirect wholly-owned subsidiary of the corporation, who together with the affiliates and associates, owns or, as an affiliate or associate, within three years prior, did own 15% or more of the corporation's outstanding voting stock. Section 203 expressly exempts from the requirements described above any business combination by a corporation with an interested stockholder who becomes an interested stockholder in a transaction approved by the corporation's board of directors. SUMMARY OF AVATECH SOLUTIONS, INC. RESTRICTED STOCK AWARD PLAN The Avatech Solutions, Inc. Restricted Stock Award Plan is designed to allow us to attract and retain the services of key management employees, consultants, officers and directors essential to our long-term growth and financial success. The restricted stock awards will play a significant role in our efforts to remain competitive in the market for talented individuals, and we believe that these awards will allow us to attract and retain highly qualified individuals in positions vital to our success. The following is a summary of the material terms of the Restricted Stock Award Plan, which is attached to this prospectus as Annex A and is incorporated herein by reference. We urge you to read the Restricted Stock Award Plan carefully as it is a legal document that governs the plan. Administration. Our board of directors as a whole or a committee of the board of directors made up of two non-employee directors have the authority to make awards restricted stock and set the terms on which grants of stock become vested. Share Reserve. Initially, 200,000 shares of common stock are reserved for issuance under the terms of the Restricted Stock Award Plan. - 39 - The shares of common stock issuable under the Restricted Stock Award Plan may be drawn from shares of our authorized but unissued common stock or from shares of our common stock which we acquire, including shares purchased on the open market. Shares of unvested stock that are forfeited or otherwise reacquired by us may be reissued under the Plan. Eligibility. Employees, and consultants of Avatech or one of its subsidiaries are eligible to receive stock awards under the Plan if they are already shareholders or hold options to purchase shares of our common stock. Officers and directors are also eligible to receive stock awards without regard to whether they are already own our stock. Restricted Stock Awards. The board of directors (or committee) will have the complete discretion to determine which eligible individuals will receive stock awards, the time or times when those awards are made, the number of shares awarded, and the conditions on vesting of the shares. However, awards will be made only in recognition of past or future services to Avatech. The shares will generally vest in more than one installment after either the recipient's continued service to us for a specific term of years or the recipient's achievement of specific, predetermined performance goals. Generally, unvested shares may not be transferred by the recipient before they become vested and will be held in escrow by us. Unvested shares may be exchanged or surrendered in a tender offer, merger, split, or other reorganization and will not be subject to restrictions under the Plan in the hands of such a recipient; however, any consideration received in such an exchange will continue to be subject to the original vesting restrictions. Valuation. As long as our stock is listed on the OTC Bulletin Board, the fair market value of our common stock under the Restricted Stock Award Plan will be deemed to be the last closing price of our common stock on the OTC Bulletin Board as of the close of business on the last business day prior to the date on which the shares are to be valued. TAX TREATMENT OF SHARES AWARDED UNDER THE AVATECH SOLUTIONS, INC. RESTRICTED STOCK AWARD PLAN Under section 83(a) of the Internal Revenue Code of 1986, as amended, shares of stock granted to a person in connection with their performance of services to the issuer but subject to a "substantial risk of forfeiture" are not subject to income taxation until risk of forfeiture lapses. Under the regulations promulgated by the Department of the Treasury under section 83(a), stock is subject to a "substantial risk of forfeiture" if a recipient's continued rights in the shares are conditioned on the future performance of substantial services to the issuer or the completion of any other condition related to the purpose for the initial grant of shares, and if there is a substantial possibility that the conditions will not be satisfied. The Shares awarded under the Restricted Stock Award Plan will generally be subject to a "substantial risk of forfeiture" while they are unvested. Ordinarily, a recipient of unvested shares under the Restricted Stock Award Plan will not pay income tax on the value of the shares until the shares become vested. The recipient will then have a basis in the shares equal to the value of the shares on the day they vest and are taxed. When the recipient subsequently sells the shares, any gain or loss will be treated as a capital gain or loss. If a recipient sells unvested shares despite the transfer restrictions, he or she must pay taxes on the larger of the sale price or the fair market value of the shares on the day they are sold. A person who receives unvested shares of stock in connection with services performed for the issuer may make an election under section 83(b) of the Internal Revenue Code of 1986, as amended, to be taxed on the value of the shares in the year in which the shares are received rather than when the shares vest. The election must be made within thirty days of the award of stock and is generally irrevocable. If the recipient of shares makes this "83(b) election," he or she will pay ordinary income tax on the value of the shares when they are received and will have a basis in the stock equal to the value of the shares when they are issued. If the shares vest and the recipient sells the shares, any gain or loss on the transaction will be a capital gain or loss. However, if the recipient forfeits the shares, he or she may not claim a loss, even though he or she paid taxes on the shares when they were received. - 40 - When the value of the shares is taxed, the shares will be treated as salary if the recipient is an employee of Avatech and otherwise will be treated as shares received in exchange for services. If necessary, we may withhold taxes from the recipient at the time the shares are taxed. DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, the registrant has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is therefore unenforceable. LEGAL MATTERS Certain legal matters will be passed upon for Avatech by Neuberger, Quinn, Gielen, Rubin & Gibber, P.A., Baltimore, Maryland. EXPERTS The consolidated financial statements and schedule of Avatech Solutions, Inc. and subsidiaries at June 30, 2002 and for the year then ended, included in this registration statement, have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. The consolidated financial statements and schedule of Avatech Solutions, Inc. and subsidiaries as of June 30, 2001 and 2000, and for each of the two years in the period ended June 30, 2001, included in this registration statement have been audited by Walpert and Wolpoff, LLP, independent auditors, as stated in their report appearing herein, and upon the authority of such firm as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION We file annual, quarterly and special reports, proxy statements and other information with the SEC. You may read and copy any reports, statements or other information we file at the SEC's public reference rooms at the following locations: Public Reference Section Northeast Regional Office Midwest Regional Office 450 Fifth Street, N.W. 233 Broadway Northwestern Atrium Center Washington, D.C. 20549 New York, NY 10279 500 West Madison Street, Suite 1400 Chicago, IL 60661
Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. Our SEC filings are also available to the public from commercial document retrieval services and at the website maintained by the SEC at www.sec.gov. We filed a registration statement on Form S-1 to register with the SEC the common stock to be issued or sold hereunder. This Prospectus is a part of our registration statement. As allowed by SEC rules, this Prospectus does not contain all the information you can find in our registration statement or the exhibits to the our registration statement. You may obtain copies of the registration statement in the manner described above. - 41 - The SEC allows us to "incorporate by reference" information into this Prospectus, which means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is deemed to be part of this Prospectus, except for any information superseded by information contained directly in this Prospectus. This Prospectus incorporates by reference the documents set forth below that we have previously filed with the SEC. These documents have been supplied to you along with this Prospectus. These documents contain important information about us and our financial condition:
PLANETCAD SEC FILINGS (FILE NO. 0-288-42) DATE FILED FILE NO. Annual Report on Form 10-KSB for the year ended December 31, 2001 April 11, 2002 001-31265 Amendment No. 1 to Annual Report on Form 10-KSB for the year ended December 31, 2001 April 30, 2002 001-31265 Amendment No. 2 to Annual Report on Form 10-KSB for the year ended December 31, 2001 July 17, 2002 001-31265 Amendment No. 3 to Annual Report on Form 10-KSB for the year ended December 31, 2001 August 21, 2002 001-31265 Quarterly Report on Form 10-QSB for the quarter ended March 31, 2002 May 15, 2002 001-31265 Amendment No. 1 to Quarterly Report on Form 10-QSB for the quarter ended March 31, 2002 August 21, 2002 001-31265 Quarterly Report on Form 10-QSB for the quarter ended June 30, August 14, 2002 001-31265 2002 Quarterly Report on Form 10-QSB for the quarter ended November 14, 2002 001-31265 September 30, 2002 Quarterly Report on Form 10-QSB for the quarter ended December February 14, 2003 001-31265 31, 2002 Current Report on Form 8-K January 25, 2002 001-28842 Current Report on Form 8-K March 11, 2002 001-31265 Current Report on Form 8-K May 2, 2002 001-31265 Current Report on Form 8-K May 28, 2002 001-31265 Current Report on Form 8-K August 14, 2002 001-31265 Current Report on Form 8-K August 21, 2002 001-31265 Current Report on Form 8-K November 20, 2002 001-31265 Current Report on Form 8-K December 4, 2002 001-31265 Current Report on Form 8-K January 31, 2003 001-31265 Current Report on Form 8-K February 19, 2003 001-31265 Current Report on Form 8-K March 4, 2003 001-31265
DOCUMENTS INCORPORATED BY REFERENCE ARE AVAILABLE FROM US WITHOUT CHARGE, EXCLUDING ALL EXHIBITS UNLESS WE HAVE SPECIFICALLY INCORPORATED BY REFERENCE AN EXHIBIT IN THIS PROXY STATEMENT/PROSPECTUS. STOCKHOLDERS MAY OBTAIN DOCUMENTS INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT/PROSPECTUS BY REQUESTING THEM IN WRITING OR BY TELEPHONE FROM US AT THE FOLLOWING ADDRESS: AVATECH SOLUTIONS, INC. 11403 A CRONHILL DRIVE OWINGS MILLS, MARYLAND 21117 You may also obtain information from our website: www.avat.com. - 42 - WHAT INFORMATION YOU SHOULD RELY ON NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION THAT DIFFERS FROM, OR ADDS TO, THE INFORMATION DISCUSSED IN THIS PROSPECTUS.THEREFORE, IF ANYONE GIVES YOU DIFFERENT OR ADDITIONAL INFORMATION, YOU SHOULD NOT RELY ON IT. THIS DOCUMENT IS DATED MARCH 26, 2003. THE INFORMATION CONTAINED IN THIS PROSPECTUS SPEAKS ONLY AS OF ITS DATE UNLESS THE INFORMATION SPECIFICALLY INDICATES THAT ANOTHER DATE APPLIES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO EXCHANGE OR SELL, OR A SOLICITATION OF AN OFFER TO EXCHANGE OR PURCHASE, SHARES OF AVETECH COMMON STOCK OR TO ASK FOR PROXIES, TO OR FROM ANY PERSON TO WHOM IT IS UNLAWFUL TO DIRECT THESE ACTIVITIES. - 43 - INDEX TO FINANCIAL STATEMENTS Reports of Independent Auditors............................................F - 2 Audited Financial Statements Consolidated Balance Sheets.............................................F - 4 Consolidated Statements of Operations...................................F - 5 Consolidated Statements of Stockholders' Deficiency.....................F - 6 Consolidated Statements of Cash Flows...................................F - 7 Notes to Consolidated Financial Statements.................................F - 8 F - 1 REPORTS OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Avatech Solutions, Inc. We have audited the accompanying consolidated balance sheet of Avatech Solutions, Inc. and subsidiaries as of June 30, 2002, and the related consolidated statements of operations, stockholders' deficiency and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. Since the date of completion of our audit of the accompanying financial statements and initial issuance of our report thereon dated September 3, 2002, the Company, as discussed in Note 14, has experienced a decline in working capital resulting principally from costs incurred to complete the acquisition of PlanetCAD, Inc. Note 14 describes management's plans to address this liquidity issue. In our opinion, the 2002 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avatech Solutions, Inc. and subsidiaries at June 30, 2002 and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Baltimore, Maryland September 3, 2002 (except Note 3 and 14, as to which the date is March 10, 2003) F - 2 To the Board of Directors and Stockholders Avatech Solutions, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of Avatech Solutions, Inc. and Subsidiaries as of June 30, 2001 and 2000, and the related consolidated statements of operations, stockholders' deficiency, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avatech Solutions, Inc. and Subsidiaries as of June 30, 2001 and 2000, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Since the date of completion of our audit of the accompanying financial statements and initial issuance of our report thereon dated October 3, 2001, the Company, as discussed in Note 14, has experienced a decline in working capital resulting principally from costs incurred to complete the acquisition of PlanetCAD, Inc. Note 14 describes management's plans to address this liquidity issue. WALPERT & WOLPOFF, LLP Baltimore, Maryland October 3, 2001 (except for Note 3 and 14, as to which the date is March 10, 2003) F - 3 AVATECH SOLUTIONS, INC. AND SUBSIDIARIES AUDITED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS
June 30, December 31, ---------------------------- 2001 2002 2002 -------------------------------------------- (Restated - Note 3) (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 309,621 $ 222,562 $ 541,855 Accounts receivable, less allowance of $212,000 in 2001, $111,897 in 2002 and $258,569 at December 31, 2002 5,123,773 4,108,372 3,855,186 Inventory 462,660 356,013 305,394 Deferred income taxes - 373,000 - Prepaid expenses 232,202 113,469 559,331 Other current assets 150,209 - 60,068 -------------------------------------------- Total current assets 6,278,465 5,173,416 5,321,834 Property and equipment: Computer software and equipment 2,381,422 2,664,168 2,935,045 Office furniture and equipment 799,526 778,037 768,034 Leasehold improvements 191,908 198,002 308,143 -------------------------------------------- 3,372,856 3,640,207 4,011,222 Less accumulated depreciation and amortization 2,461,630 2,889,000 3,128,037 -------------------------------------------- 911,226 751,207 883,185 Goodwill 1,108,920 752,920 878,378 Other intangible assets, net of accumulated amortization of $22,889 - - 663,111 Other assets 78,404 430,870 116,641 -------------------------------------------- Total assets $ 8,377,015 $ 7,108,413 $ 7,863,149 ============================================ LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities: Accounts payable and accrued expenses $ 4,021,062 $ 3,655,902 $ 5,047,345 Accrued compensation and related benefits 293,780 223,919 278,225 Borrowings under line-of-credit 1,916,912 1,422,901 1,434,202 Note payable to related party - - 500,000 Current portion of long-term debt 2,968,030 500,000 248,388 Deferred revenue 794,916 650,511 940,498 Other current liabilities 211,215 335,930 170,006 -------------------------------------------- Total current liabilities 10,205,915 6,789,163 8,618,664 Long-term debt (including $775,000 payable to related parties) 1,595,938 4,057,112 - Commitments and contingencies - - - Minority interest - - 1,525,000 Stockholders' deficiency: Common stock, $0.01 par value; 22,500,000 shares authorized; issued and outstanding shares of 2,227,392, 2,220,670, and 2,965,958, respectively 22,274 22,207 29,660 Additional paid-in capital 1,764,438 1,698,976 2,976,523 Accumulated deficit (5,211,550) (5,459,045) (5,286,698) -------------------------------------------- Total stockholders' deficiency (3,424,838) (3,737,862) (2,280,515) -------------------------------------------- Total liabilities and stockholders' deficiency $ 8,377,015 $ 7,108,413 $ 7,863,149 ============================================
See Accompanying Notes. F - 4 AVATECH SOLUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended June 30, Six Months Ended December 31 ---------------------------------------------------------------------------- 2000 2001 2002 2001 2002 ---------------------------------------------------------------------------- (Unaudited) Revenue: Product sales $ 22,436,739 $ 20,490,029 $ 18,486,676 $ 9,895,458 $ 6,904,130 Service revenue 7,519,169 6,049,275 6,482,160 2,908,982 3,313,859 Commission revenue 3,199,443 4,332,174 4,843,751 2,319,198 2,082,770 ---------------------------------------------------------------------------- 33,155,351 30,871,478 29,812,587 15,123,638 12,300,759 Cost of revenue: Cost of product sales 16,228,849 14,249,470 12,464,965 6,582,974 4,581,813 Cost of service revenue 4,664,518 3,813,635 3,773,041 1,826,517 2,075,573 ---------------------------------------------------------------------------- 20,893,367 18,063,105 16,238,006 8,409,491 6,657,386 Gross margin 12,261,984 12,808,373 13,574,581 6,714,147 5,643,373 Other expenses: Selling, general and administrative 12,919,902 11,519,199 12,806,324 6,377,576 6,282,221 Depreciation and amortization 692,180 694,503 589,306 331,872 313,642 Impairment loss - - 285,374 - - Acquired in-process research and development - - - - 282,000 ---------------------------------------------------------------------------- 13,612,082 12,213,702 13,681,004 6,709,448 6,877,863 ---------------------------------------------------------------------------- Income (loss) from operations (1,350,098) 594,671 (106,423) 4,699 (1,234,490) Other income (expense): Gain on the extinguishment of debt - - - - 1,960,646 Interest and other income (expense) (61,819) 61,488 61,510 71,181 24,737 Minority interest - - - - (17,891) Interest expense (641,320) (553,823) (487,582) (252,612) (157,655) ---------------------------------------------------------------------------- (703,139) (492,335) (426,072) (181,431) 1,809,837 ---------------------------------------------------------------------------- Income (loss) before income taxes (2,053,237) 102,336 (532,495) (176,732) 575,347 Income tax expense (benefit) - 13,000 (285,000) 22,843 403,000 ---------------------------------------------------------------------------- Net income (loss) $ (2,053,237) $ 89,336 $ (247,495) $ (199,575) $ 172,347 ============================================================================ Earning (loss) per common share - basic and diluted $ (0.91) $ 0.04 $ (0.11) $ (0.09) $ 0.07 ============================================================================ Shares used in computation 2,251,402 2,220,856 2,224,993 2,220,670 2,390,790 ============================================================================
See Accompanying Notes. F - 5 AVATECH SOLUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY YEARS ENDED JUNE 30, 2002, 2001, 2000 AND SIX MONTHS ENDED DECEMBER 31, 2002
Common Stock Number of Additional Accumulated Shares Par Value Paid-In Capital Deficit Total --------------------------------------------------------------------------------------- (Restated -Note 3) Balance at July 1, 1999 2,217,005 $ 22,169 $ 1,615,840 $ (3,247,649) $ (1,609,640) Issuance of common stock for cash 37,966 380 410,245 - 410,625 Issuance of common stock in connection with the 1998 Employee Stock Purchase Plan 6,967 70 67,839 - 67,909 Purchase of common stock from former employees (25,143) (251) (242,447) - (242,698) Net loss for fiscal year 2000 - - - (2,053,237) (2,053,237) --------------------------------------------------------------------------------------- Balance at June 30, 2000 2,236,795 22,368 1,851,477 (5,300,886) (3,427,041) Issuance of common stock for cash 2,288 23 26,225 - 26,248 Purchase of common stock from former employees (11,691) (117) (113,264) - (113,381) Net income for fiscal year 2001 - - - 89,336 89,336 --------------------------------------------------------------------------------------- Balance at June 30, 2001 2,227,392 22,274 1,764,438 (5,211,550) (3,424,838) Purchase of common stock from current and former employees (6,722) (67) (65,462) - (65,529) Net loss for fiscal year 2002 - - - (247,495) (247,495) --------------------------------------------------------------------------------------- Balance at June 30, 2002 2,220,670 22,207 1,698,976 (5,459,045) (3,737,862) Issuance of shares of common stock to purchase PlanetCAD, Inc. (Unaudited) 745,288 7,453 1,277,547 - 1,285,000 Net income for the six months ended December 31, 2002 (Unaudited) - - - 172,347 172,347 --------------------------------------------------------------------------------------- Balance at December 31, 2002 (Unaudited) 2,965,958 $ 29,660 $ 2,976,523 $ (5,286,698) $ (2,280,515) =======================================================================================
See Accompanying Notes. F - 6 AVATECH SOLUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended Year Ended June 30, December 31 ---------------------------------------------------------------------------- 2000 2001 2002 2001 2002 ---------------------------------------------------------------------------- (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (2,053,237) $ 89,336 $ (247,495) $ (199,575) $ 172,347 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Provision for bad debts 55,367 73,893 75,542 8,375 44,565 Gain on extinguishment of debt - - - - (1,960,646) Depreciation and amortization 692,180 694,503 612,918 331,871 313,642 Deferred income taxes 23,802 - (373,000) - 373,000 Impairment loss - - 285,374 - - Gain on available-for-sale securities (2,205) - - - - Write-off of in-process research and development - - - - 282,000 Loss (gain) on disposal of property and equipment 17,420 1,420 7,575 - (3,532) Amortization of debt discount charged to interest expense 3,838 2,694 3,844 - - Other - - - - 1,920 Changes in operating assets and liabilities: Accounts receivable (1,869) (1,027,531) 893,017 1,085,715 363,623 Inventory 385,182 (7,065) 106,647 23,390 50,619 Prepaid expenses and other current assets 437,728 96,987 190,804 216,433 (394,748) Accounts payable and accrued expenses 272,247 (295,547) (240,179) (463,514) 742,899 Accrued compensation and related benefits 23,451 (23,439) (69,862) (21,225) (16,988) Deferred revenue 213,915 14,144 (144,405) (102,626) 60,661 Other current liabilities 141,401 29,410 (4,058) (14,383) (165,924) ---------------------------------------------------------------------------- Net cash provided by (used in) operating activities 209,220 (351,195) 1,096,722 864,461 (136,562) CASH FLOWS FROM INVESTING ACTIVITIES Cash (paid) received in merger, net of acquisition costs - - (302,228) - 343,445 Purchase of property and equipment (535,161) (394,060) (258,944) (98,647) (75,811) Proceeds from sale of property and equipment 4,436 6,343 10,584 - 3,532 Proceeds from sale of available-for-sale securities 16,807 - - - - ---------------------------------------------------------------------------- Net cash provided by (used in) investing activities (513,918) (387,717) (550,588) (98,647) 271,166 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings under line-of-credit 31,870,180 30,977,721 31,166,171 15,805,605 13,618,320 Repayments of borrowings under line-of-credit (32,571,042) (30,244,758) (31,660,182) (16,449,288) (13,607,019) Proceeds from issuance of long-term debt 137,269 - - - 1,175,000 Repayments of long-term debt (188,894) (6,810) - (8,184) (1,000,000) Proceeds from issuance of common stock 478,534 26,248 - - - Repurchase of common stock (242,698) (113,381) (65,529) - - Change in other assets related to financing costs 45,891 (13,794) (73,653) - (1,612) ---------------------------------------------------------------------------- Net cash provided by (used in) financing activities (470,760) 625,226 (633,193) (651,867) 184,689 ---------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (775,458) (113,686) (87,059) 113,947 319,293 Cash and cash equivalents--beginning of period 1,198,765 423,307 309,621 309,621 222,562 ---------------------------------------------------------------------------- Cash and cash equivalents--end of period $ 423,307 $ 309,621 $ 222,562 $ 423,568 $ 541,855 ============================================================================
See Accompanying Notes. F - 7 AVATECH SOLUTIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business and Basis of Presentation. Avatech Solutions, Inc. provides design automation software, hardware, training, technical support and professional services to corporations, government agencies and educational institutions throughout the United States. The consolidated financial statements include the accounts of Avatech Solutions, Inc. and its subsidiaries (collectively, the "Company"). One of the Company's subsidiaries has issued and outstanding preferred stock, which is accounted for as minority interest. All intercompany accounts and transactions have been eliminated in consolidation. Unaudited Interim Financial Information. All interim financial information as of December 31, 2002 and for the six month periods ended December 2001 and 2002 is unaudited and has been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Article 10 of Regulation S-X. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation of such periods. The operating results for any interim period are not necessarily indicative of results for any future period. Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents. The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Inventory. Inventory, consisting of computer software and hardware, is stated at the lower of first-in, first-out cost, or market. Property and Equipment. Property and equipment is stated at cost. Depreciation for computer software and equipment and office furniture and equipment is provided for by the straight-line method over estimated useful lives ranging from three to seven years. Leasehold improvements are depreciated over the lesser of the lease term or the useful life of the asset using the straight-line method. Impairment of Long-Lived Assets Excluding Goodwill. Long-lived assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, the Company evaluates recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. Assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the assets are impaired, the impairment recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. Goodwill. Goodwill is the excess of the purchase price paid over the fair value of the identifiable net assets acquired in purchase business combinations. Prior to July 1, 2002, goodwill was amortized on a straight-line basis over 15 years. Commencing July 1, 2002, goodwill is not amortized but is tested annually for impairment at the reporting unit level. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The implied fair value of goodwill is the amount determined by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the F - 8 reporting unit. If the recorded value of goodwill exceeds its implied value, an impairment charge is recorded for the excess. (See also Note 1, Recent Accounting Pronouncements). Stock Options Granted to Employees. The Company uses the intrinsic value method to account for its employee and director stock option plans. Under the intrinsic value method, compensation expense is calculated as the difference between the fair value of the underlying common stock and the exercise price of the option at the date of grant for fixed stock option awards. Any resulting compensation expense is recognized pro rata over the vesting period. The Company discloses in Note 8 the pro forma effects on net income if the Company had elected the fair value method of accounting for stock options. Revenue Recognition and Accounts Receivable. The Company generates revenue from three sources, the resale of prepackaged software products, professional services and commissions. Software products are frequently sold in an arrangement that includes implementation services or maintenance services. Maintenance services are limited to help desk support and training. The Company allocates the total arrangement fee among each element based on vendor-specific objective evidence of the relative fair value of each of the elements. The Company limits its assessment of fair value of each element to the price charged when the same element is sold separately. Revenues for software product sales are recognized as revenue when four criteria are met. These four criteria are (i) a signed purchase order has been obtained (ii) delivery of the software has occurred (iii) the fee is fixed or determinable and (iv) the fee is probable of collection. Software product sales billed and not recognized as revenue are included in deferred revenue. The Company generally does not require collateral. The Company provides a 30-day return policy to its customers. The Company has historically not experienced significant returns, and accordingly, allowances for returned products are not recorded. Revenues from maintenance services are recognized ratably over the contractual service period. Revenues from implementation and training services are recognized as the services are provided. Advance payments for these services are deferred and recognized in the periods when the services are performed. The Company also receives commissions from vendors for transactions in which the Company does not take title to the product or have responsibility for the delivery of the services, has no risk of loss for collection, and has acted as an agent or broker. These commissions are recorded as revenue when earned. Cost of Product Sales. Cost of product sales includes the costs of purchasing software and hardware from suppliers and the associated shipping and handling costs. Cost of Service Revenue. Cost of service revenue consists primarily of direct employee compensation and related benefits, the cost of subcontracted services and direct expenses billable to customers. Cost of service revenue does not include an allocation of overhead costs. Warranty Costs. The Company does not provide for warranty costs for its products as such costs are incurred by the manufacturer of the products. Advertising Costs. Costs incurred for producing and communicating advertisements are expensed as incurred and included in selling, general and administrative expenses in the accompanying statements of operations. Advertising expenses approximated $399,000, $412,000 and $549,000 for years ended June 30, 2000, 2001 and 2002, respectively. Business Segment Reporting. The Company's operating segments are established based on geographical areas managed by location managers and for which discrete financial information is prepared and reviewed by the Company's chief operating decision maker. These segments are aggregated for segment reporting purposes into one reporting segment because the operating segments have similar economic characteristics and generate revenues from sales of similar products and services to similar types of customers. Income Taxes. The Company uses the liability method to account for income taxes. Income tax expense includes income taxes currently payable and deferred taxes arising from temporary differences between financial F - 9 reporting and income tax bases of assets and liabilities. Deferred income taxes are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Concentration of Credit Risk. The Company maintains cash in bank accounts, which at times, may exceed federally insured limits. The Company has not experienced any losses on these accounts. Earnings (Loss) Per Share of Common Stock. Basic earnings (loss) per common share is computed as net income (loss) divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share include the potential dilution that would occur from common shares issuable upon the exercise of outstanding stock options and warrants. Basic and diluted earnings (loss) per common share are equal for all years presented because the assumed exercise of options and warrants is antidilutive. Recent Accounting Pronouncements Goodwill and Other Intangible Assets. As of July 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("Statement 142"). Under the new rules, goodwill and other intangible assets deemed to have indefinite lives are no longer amortized, but are subject to annual impairment tests in accordance with the Statement. Other intangible assets with finite lives will continue to be amortized over their useful lives. The goodwill amortization expense and net income (loss) of the Company for the three years ended June 30, 2002 and the six months ended December 31, 2001 and 2002 are as follows:
Six Months Ended Year Ended June 30, December 31 -------------------------------------------------------------------------------- 2000 2001 2002 2001 2002 -------------------------------------------------------------------------------- (Unaudited) Reported net income $ (2,053,237) $ 89,336 $ (247,495) $ (199,575) $ 172,347 Goodwill amortization, net of income taxes 89,000 87,297 73,000 48,434 - -------------------------------------------------------------------------------- Adjusted net income (loss) $ (1,964,237) $ 176,633 $ (174,495) $ (151,141) $ 172,347 ================================================================================ Earnings per common share, basic: Reported net income (loss) $ (0.91) $ 0.04 $ (0.11) $ (0.09) $ 0.07 Goodwill amortization, net of income taxes 0.04 0.04 0.03 0.02 - -------------------------------------------------------------------------------- Adjusted net income $ (0.87) $ 0.08 $ (0.08) $ (0.07) $ 0.07 ================================================================================
During the second quarter of fiscal year 2003, the Company completed phase one of the transitional impairment test under Statement 142. Based on the results of this test, management believes that the Company is likely to have an impairment charge for one of its reporting units, which will approximate $400,000 to $600,000. The Company will complete phase two of the transitional impairment test before the end of fiscal year 2003, at which time it will record the impairment charge as of July 1, 2002. There were no changes in the carrying amount of goodwill for the six-months ended December 31, 2002. Accounting for the Impairment or Disposal of Long-Lived Assets. As of July 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement 144"). Statement 144 supersedes and serves to clarify and further define the provisions of Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and provides a single accounting model for long-lived assets to be disposed of. F - 10 Statement 144 does not apply to goodwill and other intangible assets that are not amortized, and retains the Company's current policy to recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted future cash flows and to measure the impairment loss as the difference between the carrying amount and the fair value of the asset. Reporting Extraordinary Items. In April 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (Statement 145). Among other changes, Statement 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and classified as an extraordinary item, net of the related tax effect. Statement 145 provides that gains and losses from extinguishment of debt should be classified as extraordinary items only if they are unusual or infrequent or they otherwise meet the criteria for classification as an extraordinary item, and observes that debt extinguishment transactions would seldom, if ever, result in extraordinary item classification of the resulting gains and losses. The Company adopted Statement 145 in July 2002, and reports as other expenses (income) any losses or gains that it incurs upon the extinguishment of debt. Accounting for Costs Associated with Exit or Disposal Activities. In July 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (Statement 146). Statement 146 supersedes EITF Issue No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Statement 146 requires that costs associated with an exit or disposal plan be recognized when incurred rather than at the date of a commitment to an exit or disposal plan. Statement 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002, with early application encouraged. The adoption of Statement 146 is not expected to have a significant effect on the Company's results of operations and financial position. 2. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION The Company paid interest of approximately $629,000, $553,000 and $416,000 in 2000, 2001 and 2002, respectively. Additionally, interest of $210,000 and $136,000 was paid for the six months ended December 31, 2001 and 2002, respectively. 3. RESTATEMENT As discussed in Note 13, the Company entered into a merger with PlanetCAD Inc. on November 19, 2002 whereby Avatech stockholders received three shares of PlanetCAD for each share of PlanetCAD outstanding on the closing date. On November 19, 2002, PlanetCAD Inc. changed its name to Avatech Solutions, Inc. and assumed the June 30th year-end of Avatach. The merger constitutes a reverse acquisition purchase in which Avatech is treated as the acquiror of PlanetCAD for financial accounting purposes. As a result, the historical capital stock of the Company has been retroactively restated to present as common stock the equivalent number of shares received in the merger and to give effect to the change in par value of the common stock received in the merger. All share and per share data included in the consolidated financial statements have been restated to reflect this transaction. 4. IMPAIRMENT LOSS In fiscal year 2002, the Company determined that the goodwill and other long-lived assets of one of its subsidiaries were likely impaired due to recurring operating losses and changes in the estimates of the future estimated cash flows from these operations over the remaining amortization period. The Company determined that the carrying value of these assets exceeded their estimated fair values by $285,374 and recorded an impairment loss in that amount. The fair value of the long-lived assets was determined using discounted cash flows over the remaining estimated useful life of the assets. Of the recorded impairment loss of $285,374, $283,000 related to goodwill and the remainder related to fixed assets. F - 11 5. BORROWINGS UNDER LINE-OF-CREDIT The Company has entered into a revolving line-of-credit agreement with a financial institution which expires October 30, 2003, but is payable within 60 days of demand by the lender. The credit extended under this financing agreement is limited to the lesser of $4.0 million or 75% of the Company's aggregate outstanding eligible accounts receivable. The balance outstanding under this line-of-credit was $1.4 million at December 31, 2002. Borrowings under this line-of-credit bear interest at the prime rate plus 1.5% and are secured by the assets of the Company. In addition, the bank has the right to restrict any prepayment of other indebtedness by the Company. Because the interest rate adjusts with changes in the prime rate, the estimated fair value of the borrowings under the line of credit is equal to the carrying amount. 6. LONG-TERM DEBT, WARRANTS AND GAIN ON THE EXTINGUISHMENT OF DEBT At June 30, 2002, the Company was obligated to one of its suppliers under a note agreement in the amount of $2.96 million, bearing interest at 6.5% per annum. The note required interest only payments through September 30, 2001, with subsequent quarterly payments of principal and interest of $621,311 until maturity in December 2002. The Company was in default of specified financial covenants at June 30, 2001, and the note was therefore classified as current at that date. In August 2002, the Company entered into an agreement to extinguish the outstanding $2.96 million debt for a cash payment of $1.0 million and compliance with certain non-financial covenants. The Company obtained the $1.0 million due the lender from borrowings from a director and shareholder and from PlanetCAD Inc., each in the amount of $500,000. These borrowings totaling $1.0 million bear interest at 15% per annum. The loan from the director and shareholder matures on July 1, 2003 and is recorded as a note payable to related party in the accompanying balance sheet at December 31, 2002. The loan from PlanetCAD was due at the earlier of (i) the date on which Avatech became unable or refused to complete the merger, or (ii) July 1, 2003. Accordingly, this note was eliminated in consolidation when the Company completed its merger with PlanetCAD on November 19, 2002. The gain on the extinguishment of the debt of $1.96 million was recorded in August 2002 upon the settlement of the $2.96 million note for cash of $1.0 million and compliance with certain non-financial covenants. As of November 2002, the Company had issued approximately $1.8 million of 10% subordinated notes. These notes bear simple interest at the rate of 10% per annum until all principal and accrued and unpaid interest has been paid. Interest only is payable quarterly until maturity. The notes are fully subordinated to the payment of senior indebtedness (line-of-credit) of the Company. In connection with the merger with PlanetCAD, Inc., approximately $1.5 million of subordinated notes were converted into 610,000 shares of preferred stock in a subsidiary of the Company on November 19, 2002. (See Note 7). As of December 31, 2002, the Company has outstanding warrants to purchase 25,668 shares of common stock issued in connection with the 10% subordinated notes that are exercisable for $15.46 per share and expire five years after their date of issuance. Warrants for the purchase of 23,436 shares and 372 shares of common stock will expire in 2003 and 2004, respectively. The remaining 1,860 stock purchase warrants will expire in 2007. The number of shares or exercise price will be adjusted in the event of any stock dividend, stock splits, or recapitalization of the Company. The warrants issued in conjunction with the 10% subordinated notes were valued at $19,840, an estimate based on a valuation using the Black-Scholes Pricing Model, a generally accepted warrant valuation methodology. The estimated value of the warrants was recorded as additional paid-in capital and the notes have been recorded net of a discount of $19,840. The estimated fair value of the options was based on the Black-Scholes Pricing Model. The valuation assumptions used included an expected life of five years; an expected price volatility of 0.10; no dividend yield; risk-free interest rate of 5.5%; and the stock price at the date of grant of $11.42. At December 31, 2002, the balance outstanding under the 10% subordinated notes was $248,388. F - 12 7. MINORITY INTEREST The Company has issued Series A Convertible Preferred Stock in one of its subsidiaries. The Preferred Stock accrues dividends at a rate of 10% per annum on the principal value. Dividends may be paid each quarter from available cash of the subsidiary beginning October 1, 2002. The dividends of the subsidiary's preferred stock is recorded as minority interest in the consolidated statement of operations. All accrued but unpaid dividends shall be paid in cash at or before a liquidation event as defined in the preferred stock agreement. Each share of preferred stock shall automatically convert into 1.1 shares of Avatech Solutions, Inc. upon the earlier of (i) 24 months from the issuance of the preferred stock or (ii) immediately preceding a liquidation event. On all matters submitted to the stockholders of the Company, the shares of Preferred Stock will vote together as a single class with the share of common stock on a one share, one vote basis. The preferred stock is presented as minority interest in the accompanying balance sheet at December 31, 2002. 8. EMPLOYEE STOCK PLANS Effective April 2, 1998, the Company adopted the Avatech Solutions, Inc. 1998 Stock Option Plan. Effective January 1, 2000, the Company adopted the Avatech Solutions, Inc. 2000 Stock Option Plan. Both plans are administered by the Board of Directors and provide for the granting of either qualified or non-qualified stock options to purchase an aggregate of up to 279,000 shares of common stock to eligible employees, officers, and directors of the Company. The options granted under this plan vest in three equal installments on the anniversary date of the grant over a three year period. A summary of stock option activity and related information is included in the table below:
Year Ended June 30, 2000 2001 2002 ------------------------------------------------------------------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------------------------------------------------------------------------------ Outstanding at beginning of year 63,880 $ 11.42 102,040 $ 11.42 148,497 $ 11.42 Granted 64,892 11.42 65,604 11.42 157,364 11.42 Exercised - - - - - - Forfeited (26,732) 11.42 (19,147) 11.42 (47,211) 11.42 ------------------------------------------------------------------------------ Outstanding at end of year 102,040 $ 11.42 148,497 $ 11.42 258,650 $ 11.42 ============================================================================== Exercisable at end of year 35,526 $ 11.42 69,374 $ 11.42 140,761 $ 11.42 ============================================================================== Weighted-average fair value of options granted during the year $ 3.17 $ 2.55 $ 1.77 ========== ========== ========== Weighted-average remaining contractual life 9.2 Years 8.8 Years 8.7 Years ========== ========== ==========
Pro Forma Information
Year Ended June 30, ----------------------------------------------- 2000 2001 2002 ----------------------------------------------- Net income (loss)--historical $ (2,053,237) $ 89,336 $ (247,495) Net (loss) income--pro forma $ (2,163,510) $ (99,456) $ (363,857) Basic and diluted net income (loss) per common share--historical $ (0.91) $ 0.04 $ (0.11) Basic and diluted net (loss) per common share--pro forma $ (0.96) $ (0.04) $ (0.16)
F - 13 For the three years ended June 30, 2002, required pro forma net income (loss) and income (loss) per share information assuming that stock options were recorded at their fair value at the grant date was determined using the minimum value method. 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. In determining the estimated fair value of granted stock options under the minimum value method, the risk-free interest rate was assumed to be 5.5%, 5.21%, and 4.48% in 2000, 2001 and 2002, respectively, the dividend yield was estimated to be 0% and the expected life of granted options was assumed to be five years. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the minimum value method and other methods of estimating fair value do not necessarily provide a single measure of the fair value of its employee stock options. Effective May 1, 1998, the Company adopted the 1998 Employee Stock Purchase Plan for all employees meeting certain eligibility requirements. Under the Plan, employees may purchase shares of the Company's common stock, subject to certain limitations, at 85% of its market value as determined by the Board of Directors. Purchases are limited to 10% of an employee's eligible compensation. A total of 55,800 shares are available for sale to employees under this Plan. The Board of Directors authorized the suspension of this Plan in March 2000. During 2000, the Company sold approximately 6,997 shares to employees under this Plan. The Plan does not contain a provision requiring the Company to repurchase shares from terminated employees. However, the Company elected to purchase 11,742 shares for $113,381 in 2001 and 6,751 shares for $65,529 in 2002 from former employees. At June 30, 2002, the Company has reserved 302,808 shares of common stock for future issuance upon the exercise of any stock options granted under the 1998 and 2000 Stock Option Plans and upon the exercise of outstanding warrants. 9. INCOME TAXES Significant components of the Company's deferred tax assets and liabilities are as follows: June 30, ----------------------------- 2001 2002 ----------------------------- Deferred tax assets: Net operating loss carryforward $ 1,688,082 $ 1,860,991 Allowance for doubtful accounts 81,974 43,214 Accrued vacation pay 1,822 - Book over tax depreciation 76,571 77,341 ----------------------------- Total deferred tax assets 1,848,449 1,981,546 Valuation allowance for deferred tax assets (1,848,449) (1,608,546) ----------------------------- Net deferred tax assets $ - $ 373,000 ============================= As of June 30, 2001, the Company recorded a valuation allowance equal to its deferred tax assets due to the inability to conclude that it was more likely than not that those assets would be realized from future taxable income. In August 2002, as described more fully in Note 6, the Company realized a $1.96 million taxable gain from the extinguishment of certain debt. This gain provided significant evidence of the likelihood of taxable income in fiscal year 2003, and the Company therefore at June 30, 2002 recorded a valuation allowance of $1.6 million that resulted in net deferred tax assets of $373,000, or the amount that management estimated was likely to be realizable from taxable income in 2003. The ultimate amount of the net operating loss carryforward used to reduce 2003 taxable income may ultimately differ from the amount estimated, and it is reasonably possible that the difference may be material. F - 14 The Company's provision for income taxes resulted in effective tax rates that varied from the statutory federal income tax rate of 34%, as summarized in the table below.
Year Ended June 30, 2000 2001 2002 ------------------------------------------------ Expected federal income tax expense (benefit) at 34% $ (698,100) $ 30,374 $ (181,048) Expenses not deductible for income tax purposes 47,419 26,879 153,566 State income taxes, net of federal benefit (94,860) 8,580 (24,601) Change in valuation allowance for deferred taxes 735,900 (54,441) (239,903) Other 9,641 1,608 6,986 ------------------------------------------------ $ - $ 13,000 $ (285,000) ================================================
At June 30, 2002, the Company has net operating loss carryforwards totaling approximately $4,800,000, which will begin to expire in 2012. Certain net operating loss carryforwards at June 30, 2002, are related to subsidiaries of the Company, and are available only to offset future taxable income of those subsidiaries. During the six months ended December 31, 2002, the Company recorded deferred income tax expense of $373,000 related to the estimated reduction in deferred tax assets in fiscal 2003. This increase in deferred income tax expense coupled with certain state income tax expense resulted in the additional income tax expense for the six months ended December 31, 2002. The Company estimates that its total income tax expense in fiscal year 2003 will approximate $425,000. 10. COMMITMENTS AND CONTINGENCIES Operating Leases. The Company leases certain office space and equipment under noncancellable operating lease agreements that expire in various years through 2006, and generally do not contain significant renewal options. The Company also leases one office location from an entity controlled by a stockholder under a noncancellable operating lease, which expires in 2003. Future minimum payments under all noncancellable operating leases with initial terms of one year or more consisted of the following at June 30, 2002: Related Year ended June 30 Party Other Total ------------------------------------------ 2003 $ 42,552 $ 821,490 $ 864,042 2004 - 469,621 469,621 2005 - 115,934 115,934 2006 - 25,515 25,515 ------------------------------------------ Total minimum lease payments $ 42,552 $ 1,432,560 $ 1,475,112 ========================================== 2000 2001 2002 ------------------------------------------ Office space $ 1,009,056 $ 1,066,818 $ 1,162,344 Equipment 99,915 69,132 40,361 ------------------------------------------ $ 1,108,971 $ 1,135,950 $ 1,202,705 ========================================== Rent expense for the years ended June 30, 2000, 2001 and 2002 included amounts paid to related parties of approximately $82,000, $83,000 and $85,000, respectively. Agreements with Executives. The Company has entered into agreements with three executives that provide for payments of eighteen months of salary and immediate vesting of all stock options not previously vested upon termination of the executive or change in control of the Company, as defined. At December 31, 2002, the total contingency was approximately $500,000. F - 15 Litigation. On May 21, 2002, a former employee filed a lawsuit against the Company alleging breach of employment contract in connection with the former employee's dismissal. The lawsuit alleges damages in the amount of $187,500. This lawsuit was settled for an agreed upon cash payment. 11. EMPLOYEE BENEFIT AND INCENTIVE COMPENSATION PLANS Effective January 1, 1998, the Company adopted the Avatech Solutions, Inc. 401(k) Retirement Savings Plan and Trust (the "Plan"). The Plan is a defined contribution plan, which covers substantially all employees of the Company, or its wholly-owned subsidiaries, who have attained age 21 and have completed 6 months of service. Participants may elect to contribute from 1% to 15% of eligible annual compensation to the Plan. Maximum salary deferrals are currently $10,000 per year. The Company will match 25% of the participant salary deferrals up to 6% of a participant's compensation for all participants employed on the last day of the Plan year. The Company may also make discretionary profit-sharing contributions to the Plan for all participants who are employed on the last day of the Plan year. The total amount recorded by the Company as expense during the years ended June 30, 2000, 2001 and 2002, was approximately $86,000, $79,000 and $62,000, respectively. The Company did not contribute to the plans for the six months ended December 31, 2001 and 2002, respectively. 12. SIGNIFICANT SUPPLIER Approximately 80%, 87% and 92% of the Company's purchases for the years ended June 30, 2000, 2001 and 2002, respectively, were from one vendor and approximately 85% and 81% of accounts payable at June 30, 2001 and 2002, respectively, were due to this vendor. The Company's purchases for the six months ended December 31, 2002 were 95% from this same vendor and approximately 60.0% of accounts payable at December 31, 2002 were due to this vendor. 13. BUSINESS COMBINATION - MERGER WITH PLANETCAD, INC. (UNAUDITED) On November 19, 2002, the Company consummated a merger with PlanetCAD Inc., whereby shareholders of the Company exchanged their shares of the Company's common stock for common stock of PlanetCAD. Upon completion of the merger, the shareholders of the Company owned 75% of the outstanding common stock of PlanetCAD. PlanetCAD develops, markets, and supports cycle time reduction software solutions that integrate engineering processes and data for the manufacturing supply chain. In connection with the merger, options and warrants to purchase the common stock of the Company were converted into options and warrants to acquire common stock of the post-merger entity based on the merger exchange ratio. For accounting purposes, the Company was deemed to have acquired PlanetCAD, as its shareholders own a majority of the outstanding common stock of the surviving entity. Upon the completion of the merger, the Company has 2,965,958 shares of outstanding common stock, 2,220,670 of which were issued to shareholders of Avatech upon the closing date. The results of operations of PlanetCAD are included in the accompanying statements of operations since November 1, 2002 or the effective date of the merger. The purchase method of accounting was used to record the acquisition, and the cost of acquiring PlanetCAD of $2.2 million, including estimated acquisition costs of $1.0 million, was assigned to acquired assets and liabilities based on their estimated fair value, as determined by an independent appraisal. The Company has not finalized the allocation process as management continues to negotiate with service providers over certain merger costs. Accordingly, the allocation of the purchase price is preliminary, however; management believes that the final purchase price will not vary significantly from the preliminary allocation included in the accompanying consolidated financial statements. The purchase price allocation to acquired assets and liabilities at the acquisition date is summarized below: F - 16 ASSETS Cash $ 995,000 Accounts receivable 155,000 Prepaid expenses and other current assets 611,000 Property and equipment 337,000 Acquired technology and other amortizable intangible assets 686,000 Goodwill 120,000 -------------- Total assets 2,904,000 -------------- LIABILITIES Accounts payable and accrued expenses 720,000 Deferred revenue 229,000 -------------- Total liabilities 949,000 -------------- Cost of net assets acquired, excluding acquired in-process research and development assets of $282,000 $ 1,955,000 ============== The value allocated to projects identified as in-process research and development of PlanetCAD products was charged to expense immediately following the completion of the merger. This write-off was necessary because the acquired in-process research and development had not yet reached technological feasibility and has no future alternative uses, and the related products under development may not achieve commercial viability. The value of acquired technology was determined by taking into account risks related to the characteristics and applications of the developed technology, existing and future markets and assessments of the stage of the developed technology's life cycle. This analysis resulted in a valuation for developed technology that had reached technological feasibility and therefore was capitalized. The developed technology and other intangible assets are being amortized on a straight-line basis over 4 to 6 years. The following summarizes the unaudited pro forma statements of operations information for the years ended June 30, 2001 and 2002 and the six months ended December 31, 2001 and 2002, assuming that the acquisition was completed on July 1, 2001. The in-process research and development charge is excluded from the pro forma statements of operations information because the charge is non-recurring. The results are not necessarily indicative of what would have occurred had this transaction been consummated as of the beginning of the period nor of future operations:
Year ended June 30 Six Months Ended December 31 ----------------------------------------------------------------- 2001 2002 2001 2002 ----------------------------------------------------------------- Revenue $ 33,396,903 $ 31,580,291 $ 16,210,638 $ 12,708,132 Net loss $ (14,130,629) $ (8,210,294) $ (5,368,575) $ (1,466,778) Loss per common share, basic and diluted $ (4.87) $ (2.80) $ (1.86) $ (0.51)
14. LIQUIDITY AND CAPITAL RESOURCES As discussed more fully in Note 13, in November 2002, the Company completed the acquisition of PlanetCAD, Inc. In connection with the acquisition, the Company incurred approximately $1.0 million of merger costs, and PlanetCAD incurred approximately $1.3 million of merger costs. These costs have reduced the amount of working capital that the Company has available for its operations. Management is currently negotiating with service providers to reduce the amounts billed and extend the terms for payment of unpaid obligations related to the merger. One of the Company's directors has expressed their intention of lending the Company up to $500,000 to fund any needed working capital deficiencies. Based on an evaluation of the likely cash generated from operations in the near term, available capital resources and the timing of cash payments to vendors, management believes that it has sufficient sources of working capital to fund its operations in the normal course of business through at least June 30, 2003. The Company has engaged an investment banking firm to assist in obtaining long-term financing. Additionally, the Company plans to raise between $1.0 million to $2.0 million of short term financing on acceptable terms by June 30, 2003. F - 17 ANNEX A: AVATECH SOLUTIONS, INC. RESTRICTED STOCK AWARD PLAN Section 1. Purpose. The Avatech Solutions, Inc. Restricted Stock Award Plan (the "Plan") is intended to provide incentives which will attract and retain highly competent persons as officers, directors, key employees and consultants of Avatech Solutions, Inc. (the "Company") and its present or future subsidiaries ("Subsidiaries"), by providing them with opportunities to acquire common stock of the Company, par value par value $0.01 per share ("Common Stock") pursuant to terms and restrictions contained in this Plan and in an agreement with the Company (an "Award"). Section 2. Administration. The Board of Directors ("Board") of the Company shall supervise and administer the Plan. 2.1. The Board will resolve any questions of interpretation of the Plan or of any Awards, and such determination shall be final and binding upon all persons. 2.2. A Committee of the Board of Directors comprised solely of two non-employee directors (within the meaning of Rule 16b-3 under the Exchange Act of 1934, 17 C.F.R. Section 240.16b-3(b)(3)) (the "Committee") shall have any or all of the powers and discretions vested in the Board under the Plan, except the power to amend or terminate the Plan. Any determination of the Committee under the Plan may be made without notice or meeting of the Committee, by a writing signed by a majority of the Committee members. Section 3. Awards. "Award Shares" are shares of Common Stock transferred to Participants (as defined in 3.2.3) pursuant to an Award in exchange for past or future service to the Company or its Subsidiaries without other payment therefor. 3.1. Governing Agreements. Each Award will be governed by an "Award," which may contain any provision the Board determines appropriate, including without limitation, provisions for the forfeiture of and restrictions on the sale, resale or other disposition of shares acquired under any Award, provisions giving the Company the right to repurchase shares acquired under any Award, provisions to comply with federal and state securities laws, or understandings or conditions as to the Participant's employment, in addition to those specifically provided for under the Plan. 3.2. Nontransferability. Except as provided below or as explicitly provided in the Award, a Participant may not transfer Common Stock represented by an Award that is subject to forfeiture, redemption or other restriction on resale imposed by its governing Award ("Unvested Shares"). 3.2.1. Unvested Shares (i) may be tendered in response to a tender offer for a request or invitation to tenders of greater than 50 percent of the outstanding Common Stock of the Company or (ii) may be surrendered in a merger, consolidation or share exchange involving the Company; provided, in each case, that the securities or other consideration (including any cash) received in exchange for the Unvested Shares will be subject to the restrictions and conditions on the Unvested Shares set forth in the Award. In the event of and immediately upon receipt by a third party of Unvested Shares by any person or entity other than the Company pursuant to a transaction under this Section 3.2, the Unvested Shares will no longer be subject to restrictions on transfer, sale, assignment, etc. imposed by this Plan or any Award. 3.2.2. In the event of any change in the outstanding Common Stock resulting from a subdivision or consolidation of shares, whether through reorganization, recapitalization, share split, reverse share split, share distribution or combination of shares or the payment of a share dividend, the Unvested Shares shall be treated in the same manner in any such transaction as other Common Stock. Any Common Stock or other securities received by the Grantee with respect to the Unvested Shares in any such transaction shall be subject to the restrictions and conditions set forth in this Award. 3.2.3. In the event that Unvested Shares are transferred by will or the laws of descent and distribution, any payments shall be made only to the executor or administrator of the estate of the A - 1 deceased Participant or the person or persons to whom the deceased Participant's rights under the Award shall pass by will or the laws of descent and distribution and only to the extent, if any, that the deceased Participant was entitled at the date of the Participant's death. Section 4. Participants. The Board, in its sole discretion, will designate "Participants" to receive Award Shares. Notwithstanding this authority, the Board may designate as Participants only natural persons who: 4.1. are employees, officers, directors, or consultants of the Company or one of its Subsidiaries and immediately prior to receiving the designated Award, are owners of common stock or options to purchase common stock of the Company; or 4.2. are officers or directors of the Company regardless of ownership of any common stock or options to purchase common stock of the Company. Award Shares may be granted under this Plan to persons who have previously received Award Shares or other benefits under this or other plans of the Company. Section 5. Shares Reserved Under the Plan. There is hereby reserved for issuance as Award Shares under the Plan an aggregate of 200,000 shares of Common Stock, which may be authorized but unissued or treasury shares. 5.1. Reissue of Shares. Any shares of Common Stock subject an Award may thereafter be subject to a new Award under the Plan if the shares of Common Stock are issued under an Award and are subsequently reacquired by the Company pursuant to the terms of the Award. 5.2. Adjustment Provisions. If the Company at any time changes the number of issued shares of Common Stock without new consideration to the Company (by stock dividend, stock split, or a similar transaction), the total number of shares reserved for issuance under the Plan and the number of shares covered by each outstanding Award shall be adjusted so that the value of each such Award shall not be changed. Awards may contain provisions for their continuation or for other equitable adjustments after changes in the Common Stock resulting from reorganization, sale, merger, consolidation or similar occurrences. Section 6. Valuation. The fair market value of the Award Shares on any given day will be: 6.1. if the Common Stock is listed on a national securities exchange, the mean between the highest and lowest sale prices reported as having occurred on the primary exchange with which the Stock is listed and traded on the date prior to such date, or, if there is no such sale on that date, then on the last preceding date on which such a sale was reported; 6.2. if the Common Stock is not listed on any national securities exchange but is quoted in the National Market System of the National Association of Securities Dealers Automated Quotation System on a last sale basis, the average between the high bid price and low ask price reported on the date prior to such date, or, if there is no such sale on that date, then on the last preceding date on which a sale was reported; 6.3. if the common stock is listed on the OTC Bulletin Board, the last closing price of the common stock of the Company on the OTC Bulletin Board as of the close of business on the last business day prior to the date on which the shares are to be valued. 6.4. if the Common Stock is not listed on a national securities exchange nor quoted in the National Market System of the National Association of Securities Dealers Automated Quotation System on a last sale basis, nor listed on the OTC Bulletin Board, the most recent price at which shares of the Company's common stock traded in any recognized securities market. A - 2 6.5. if the Common Stock is not listed on a national securities exchange nor quoted in the National Market System of the National Association of Securities Dealers Automated Quotation System on a last sale basis, nor listed on the OTC Bulletin Board, nor traded in any recognized securities market, the amount determined by the Board to be the fair market value based upon a good faith attempt to value the Stock accurately and computed in accordance with applicable regulations of the Internal Revenue Service; or 6.6. in the event of a transaction pursuant to judicial order, state law, or a vote of the majority of the Company's shareholders which results in receipt of value by the shareholders in exchange for their shares of common stock, that same amount received by the shareholders. Section 7. No Employment Agreement. Neither this Plan nor any Award are, nor should either be construed to embody or contain, an agreement or promise of future employment of the Participant by the Company or its Subsidiaries. A Participant's right, if any, to continue to serve the Company or its Subsidiaries as an officer, employee or otherwise, shall not be enlarged or otherwise affected by the Plan. Section 8. Duration, Amendment and Termination. 8.1. The Board may not grant Award Shares more than ten years after the date on which the Plan is adopted by the Board; provided, however, that the terms and conditions of any Award may thereafter be amended or modified by mutual agreement between the Company and the Participant or such other persons as may then have an interest in the Award. 8.2. The Board, pursuant to a mutual agreement between the affected Participant and the Company, may grant Award Shares under the Plan or any future plan of the Company in substitution and in exchange for, and in cancellation of, any previously-granted Award Shares. 8.3. The Board may amend the Plan from time to time or terminate the Plan at any time. However, no action authorized by this paragraph shall reduce the amount of any existing Award or change the terms and conditions thereof without the Participant's consent. No amendment of the Plan shall, require the approval of the stockholders of the Company, except to the extent required by law, regulation or stock exchange requirements. A - 3 [Back Cover] UNTIL _____, ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION OT THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13: OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION: The following table sets forth the fees and expenses, other than any underwriting discounts and commissions incurred by us in connection with the issue and distribution of the common stock being registered. Items marked with asterisks (*) are estimated fees as of the date of this filing. Item Cost - ---- Accounting Fees $15,000* Costs of Printing $5,000* Legal Fees $40,000 Registration Fees $234.63 Federal Taxes $0 State Taxes and Fees $0 Trustees' and Transfer Agents' Fees $0 Expenses Borne by Security Holder $0 Premium on Indemnification Policy $0 ITEM 14: INDEMNIFICATION OF DIRECTORS AND OFFICERS Under Delaware General Corporation Law, a corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee, or agent of the corporation or is or was serving at the request of the corporation as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorney's fees), judgments, fines, and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit, or proceeding if the person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful. Although Delaware General Corporation Law permits a corporation to indemnify any person referred to above against expenses (including attorney fees) that are actually and reasonably incurred by such person ("Expenses"), in connection with the defense or settlement of an action by or in the right of the corporation, provided that such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the corporation's best interests, if such person has been judged liable to the corporation, indemnification for such expenses is only permitted to the extent that the Court of Chancery, or the court in which the action or suit was brought, determines that, despite the adjudication of liability, such person is entitled to indemnity for such Expenses as the Court of Chancery, or such other court, deems proper. The determination, with respect to a person who is a director of officer at the time of such determination, as to whether a person seeking indemnification has met the required standard of conduct is to be made (i) by a majority vote of the directors who are not parties to such action, suit, or proceeding, even though less than a quorum, or (ii) by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or (iii) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (iv) by the stockholders. II - 1 Delaware General Corporation Law also provides that to the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in the defense of any action, suit, or proceeding covered by the statute, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. In addition, Delaware General Corporation Law provides for the general authorization of advancements of a director's or officer's litigation expenses, subject to an undertaking by such person to repay any such advancement if such person is ultimately found not to have been entitled to reimbursement for such expenses and that indemnification and advancement of expenses provided by the statute shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. Avatech's Restated certificate of incorporation provides that Avatech shall indemnify its directors, officers, employees, and agents to the fullest extent permitted by Delaware General Corporation Law. Avatech also is authorized to secure insurance on behalf of any person it is required or permitted to indemnify. Pursuant to this provision, Avatech maintains liability insurance for the benefit of its directors and officers. ITEM 15: RECENT SALE OF UNREGISTERED SECURITIES
Terms of Number Exemption Exercise of Purchase from (for Use of Date Title/Class Shares Name of Purchaser Price Registration options) Proceeds - ---- ----------- ------ ------------------------------ -------- ------------ -------- --------------- 2/22/03 Series C Preferred 15,000 Dennis Oldorff Trustee for 25,350 4(2) N/A Working Capital Stock Dennis Oldorff Revocable Trust 2/22/03 Series C Preferred 14,792 Richard D. & Marlyce Larsen 25,000 4(2) N/A Working Capital Stock 2/22/03 Series C Preferred 14,792 Gary Jones 25,000 4(2) N/A Working Capital Stock
ITEM 16: EXHIBITS AND FINANCIAL SCHEDULES (a) EXHIBITS
EXHIBIT PAGE NO./ NO. EXHIBIT DESCRIPTION (REFERENCE) 2.1 Agreement and Plan of Merger (S) 3.1 Restated Certificate of Incorporation (SB) 3.2 First Amendment to Restated Certificate of Incorporation (SB) 3.3 Reverse Split Amendment to Restated Certificate of Incorporation (S) 3.4 Amendment of PlanetCAD's Certificate of Incorporation to change the name of PlanetCAD Inc. to Avatech Solutions, Inc. (S) 3.5 Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock (A) 3.6 Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock (K1) 3.7 By-Laws (SB) 5.1 Opinion of Neuberger, Quinn, Gielen, Rubin & Gibber, P.A. regarding the legality of the shares E - 1 of common stock being registered 10.01 Autodesk Authorized Channel Partner Agreement by and among Avatech Solutions, Inc. and (S) Autodesk, Inc. effective as of February 1, 1997 and as later amended on February 1, 2002 10.02 Bentley Reseller Agreement by and among Avatech Solutions, Inc. and Bentley Systems, (S, T) Incorporated dated June 11, 2001 and as later amended on March 15, 2002
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EXHIBIT PAGE NO./ NO. EXHIBIT DESCRIPTION (REFERENCE) 10.03 CIT Revolving Line of Credit Agreement by and among CIT Group/Business Credit, Inc. and Avatech (S) Solutions, Inc. and its subsidiaries dated October 25, 2000, in the amount up to $4,000,000 10.04 Warrant to purchase up to 16,213 shares of Common Stock issued by Avatech to CIT Group/Business (S) Credit, Inc. dated October 25, 2000 10.05 Warrantholders Rights Agreement by and among CIT Group/Business Credit, Inc. and Avatech (S) Solutions, Inc. and its subsidiaries dated October 25, 2000 10.06 Autodesk Loan Agreement by and among Autodesk, Inc. and Avatech Solutions, Inc. and its (SA2) subsidiaries dated January 25, 1999 10.07 Autodesk Subordination Agreement by and among Autodesk, Inc., Avatech Solutions, Inc. and its (S) subsidiaries, and CIT Group/Business Credit, Inc., dated October 25, 2000 10.08 Master Lease Agreement by and between Allstate Leasing, Inc. and Avatech Solutions, Inc. dated (S) July 17, 2001 10.09 Form of 10% Subordinated Note with attached Warrant issued by Avatech Solutions, Inc. to (S) certain note holders in connection with Avatech Solutions, Inc.'s 1998 $2,600,000 Subordinated Debt Offering 10.10 Avatech Solutions Subsidiary, Inc. 1998 Stock Option Plan (S) 10.11 Avatech Solutions Subsidiary, Inc. 2000 Stock Option Plan (S) 10.12 2002 Stock Option Plan (S) 10.13 Restricted Stock Award Plan (included in Annex A) A-1 10.14 Avatech Solutions, Inc. Stockholders' Agreement by and among Avatech Solutions, Inc. and (S) certain stockholders of Avatech Solutions, Inc. who acquired shares of Avatech Solutions, Inc. common stock under Avatech Solutions, Inc.'s terminated employee stock purchase plan 10.15 Severance Agreement dated February 26, 1998, and made effective January 1, 1998, by and between (S) Avatech Solutions, Inc. and Henry D. Felton 10.16 Severance Agreement dated February 27, 1998, and made effective January 1, 1998, by and between (S) Avatech Solutions, Inc. and V. Joel Nicholson 10.17 Letter Agreement dated July 25, 2000, by and between Avatech Solutions, Inc. and A. Gary Rever (S) 10.18 Settlement Agreement between Autodesk and Avatech Solutions, Inc. dated August 14, 2002 (SA3) 10.19 Senior Subordinated Promissory Note, principal amount $500,000.00, issued by Avatech Solutions, (SA2) Inc. in favor of PlanetCAD Inc 10.20 Senior Subordinated Promissory Note, principal amount $500,000.00, issued by Avatech Solutions, (SA2) Inc. in favor of W. James Hindman
II - 3
EXHIBIT PAGE NO./ NO. EXHIBIT DESCRIPTION (REFERENCE) 10.21 Subordination Agreement by and among PlanetCAD Inc., Avatech Solutions, Inc., Technical (K2) Learningware Company, Inc. and CIT Group/Business Credit, Inc. dated August 14, 2002 10.22 Subordination Agreement by and among W. James Hindman, Avatech Solutions, Inc., Technical (SA2) Learningware Company, Inc. and CIT Group/Business Credit, Inc. dated August 13, 2002 10.23 Change in Control Agreement between PlanetCAD and David Hushbeck dated November 2001, as amended (SA3) 10.24 Change in Control Agreement between PlanetCAD and Joy Godesiabois dated November 2001, as (SA3) amended 10.25 Employment Agreement by and between Donald R. "Scotty" Walsh and Avatech Solutions, Inc. dated E - 3 December 2, 2002 15.1 Letters regarding unaudited interim financial information (included with financial statement II - 5 schedules) 21.1 Subsidiaries of the Registrant E - 8 23.1 Consent of Ernst & Young LLP E - 9 23.2 Consent of Walpert and Wolpoff, LLP E - 10 23.3 Consent of Neuberger, Quinn, Gielen, Rubin & Gibber, P.A. (included in Exhibit 5.1) E - 1 24.1 Power of attorney (included on signature page) II - 8 99.1 Current Report on Form 8-K filed on January 31, 2002 (K3)
- ---------- A Incorporated by reference to the Registrant's Registration Statement on Form 8-A, filed on March 11, 2002. K1 Incorporated by reference to the Registrant's Current Report on Form 8-K, filed on May 28, 2002. K2 Incorporated by reference to the Registrant's Current Report on Form 8-K, filed on August 21, 2002. K3 Incorporated by reference to the Registrant's Current Report on Form 8-K, filed on January 31, 2003. S Incorporated by reference to the Registrant's form S-4 filed on May 30, 2002. SA2 Incorporated by reference to the Registrant's amended form S-4 filed on September 13, 2002. SA3 Incorporated by reference to the Registrant's amended form S-4 filed on September 27, 2002. SB Incorporated by reference to the Registrant's registration statement on form SB-2 filed on November 21, 2000. T Terminated. II - 4 (b) FINANCIAL STATEMENT SCHEDULES Schedule II Valuation and Qualifying Accounts REPORTS OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES The Board of Directors and Stockholders Avatech Solutions, Inc. We have audited the consolidated financial statements of Avatech Solutions, Inc. as of June 30, 2002 and for the year then ended, and have issued our report thereon dated September 3, 2002 (except Note 3 and 14, as to which the date is March 10, 2003) (included elsewhere in this Registration Statement). Our audit also included the 2002 amounts included in the financial statement schedule responsive to Item 21(b) of this Registration Statement. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, the 2002 amounts in the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Baltimore, Maryland September 3, 2002 The Board of Directors and Stockholders Avatech Solutions, Inc. We have audited the consolidated financial statements of Avatech Solutions, Inc. as of June 30, 2001 and 2000 and for the years then ended, and have issued our report thereon dated October 3, 2001 (except Note 3 and 14, as to which the date is March 10, 2003) (included elsewhere in this Registration Statement). Our audit also included the 2001 and 2000 amounts included in the financial statement schedule responsive to Item 21(b) of this Registration Statement. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, the 2001 and 2000 amounts in the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ Walpert & Wolpoff, LLP Baltimore, Maryland October 3, 2001 II - 5 Avatech Solutions, Inc. and Subsidiaries Valuation and qualifying accounts
Additions --------- Charged to Balance at Charged to other beginning costs and accounts Deductions Balance at Description of period expenses - describe - describe end of period Year Ended June 30, 2002: Deducted from assets accounts: Allowance for doubtful accounts: ........ $ 212,000 $ 76,000 $ - $ (176,000)/1/ $ 112,000 Year Ended June 30, 2001: Deducted from assets accounts: Allowance for doubtful accounts: ........ $ 282,000 $ 7,000 $ - $ (77,000)/1/ $ 212,000 Year Ended June 30, 2000: Deducted from assets accounts: Allowance for doubtful accounts: ........ $ 83,000 $ 289,000 $ - $ (90,000)/1/ $ 282,000
/1/ Uncollectible accounts written off, net of recoveries. ITEM 17: UNDERTAKINGS The undersigned registrant hereby undertakes: 1. To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: a. To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; b. To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in the volume of securities offered (if the total dollar value of the securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. c. To include any material information with respect to any plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; 2. That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 3. To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold t the termination of the offering. 4. The undersigned registrant hereby undertakes to deliver or cause to be delibered with the prospectus, to each person to whom the prospectus is sent or given, the latest annual report to security holders that is incorporated by reference in the prospectus and furnished pursuant to and meeting the requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of 1934; and where interim financial information required to be presented by Article 3 of Regulation S-X are not set forth in the prospectus, to deliver, or cause to be delivered to II - 6 each person to whom the prospectus in sent or given, the latest quarterly report that is specifically incorporated by reference in the prospectus to provide such interim financial information. SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Owings Mills, State of Maryland on March 26, 2003. AVATECH SOLUTIONS, INC. By: /s/ Donald R. Walsh --------------------------------- Donald R. "Scotty" Walsh Chief Executive Officer II - 7 POWER OF ATTORNEY Each person whose signature appears below hereby constitutes and appoints Donald R. "Scotty" Walsh and Gary Rever as his attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, from such person and in each person's name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, or any registration statement relating to this registration statement under Rule 462 of the Securities Act and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement on Form S-1 has been signed on March 26, 2003 by the following persons in the capacities indicated:
Name Title Date - ---- ----- ---- /s/ Donald Walsh Chief Executive Officer and Director March 26, 2003 - ------------------------------------- Donald "Scotty" Walsh /s/ Gary Rever Chief Financial Officer March 26, 2003 - ------------------------------------- Gary Rever /s/ W. James Hindman Chairman of the Board March 26, 2003 - ------------------------------------- W. James Hindman /s/ Hank Felton Vice Chairman of the Board March 26, 2003 - ------------------------------------- Hank Felton /s/ Eugene J. Fischer Director March 26, 2003 - ------------------------------------- Eugene J. Fischer /s/ James A. Fanella Director March 26, 2003 - ------------------------------------- James A. Fanella /s/ John W. Sasser Director March 26, 2003 - ------------------------------------- John W. Sasser
II - 8 EX-5.1 3 dex51.txt OPINION OF NEUBERGER, QUINN, GIELEN, RUBIN & GIBBER, P.A. EXHIBIT 5.1 Board of Directors Avatech Solutions, Inc. 11403A Cronhill Drive Owings Mills, Maryland 21117 Gentlemen: We are acting as counsel to Avatech Solutions, Inc., a Delaware corporation (the "Company"), in connection with its registration statement on Form S-1, as amended (the "Registration Statement"), filed with the Securities and Exchange Commission in connection with the registration under the Securities Act of 1933, as amended, of shares ("Shares") of the Company's common stock, par value $0.01 per share. Some of the Shares are being registered to satisfy the registration rights of certain Avatech stockholders and will be offered for sale by selling stockholders of Avatech, from time to time, at market prices prevailing at the time of the sale, at fixed prices, or in privately negotiated transactions or otherwise (the "Resale Shares"). Some Shares may be issued to shareholders of companies that Avatech acquires, by merger or otherwise, in the future, in privately negotiated transactions (the "Merger Shares"). Some Shares may be issued to holders of Series C Convertible Preferred Stock of the Company upon conversion of such shares of Convertible Preferred Stock, (the "Conversion Shares") and other Shares may be issued to officers of, directors of, employees of or consultants to the Company pursuant to the Company's Restricted Stock Award Plan (the "Award Shares"). This opinion letter is furnished to you at your request to enable you to fulfill the requirements of Item 601(b)(5) of Regulation S-K, 17 C.F.R. ss. 229.601(b)(5), in connection with the Registration Statement. For purposes of this opinion letter, we have examined copies of the following documents: 1. An executed copy of the Registration Statement. 2. The Restated Certificate of Incorporation of the Company, with amendments thereto, as certified by the Secretary of the Company on the date hereof as being complete, accurate and in effect. 3. The Bylaws of the Company, as certified by the Secretary of the Company on the date hereof as being complete, accurate and in effect. In our examination of the aforesaid documents, we have assumed the genuineness of all signatures, the legal capacity of all natural persons, the accuracy and completeness of all documents submitted to us, the authenticity of all original documents, and the conformity to authentic original documents of all documents submitted to us as copies (including telecopies). As to all questions of fact material to this opinion that have not been independently established, we have relied upon certificates or comparable documents of officers and representatives of the Company. This opinion letter is based as to matters of law solely on the General Corporation Law of the State of Delaware, as amended. We express no opinion herein as to any other laws, statutes, ordinances, rules or regulations. Based upon, subject to and limited by the foregoing, we are of the opinion that, following the effectiveness of the Registration Statement and the issuance of the Merger Shares, the Conversion Shares and the Award Shares, the Merger Shares, Conversion Shares and Award Shares will be validly issued, fully paid and nonassessable. This opinion letter has been prepared for your use in connection with the Registration Statement and speaks as of the date hereof. We assume no obligation to advise you of any changes in the foregoing subsequent to the delivery of this opinion letter. E - 1 We hereby consent to the filing of this opinion letter as Exhibit 5.1 to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the prospectus constituting a part of the Registration Statement. In giving this consent, we do not thereby admit that we are an "expert" within the meaning of the Securities Act of 1933, as amended. Very truly yours, Neuberger, Quinn, Gielen, Rubin & Gibber, P.A. By: /s/ Neuberger, Quinn, Gielen, Rubin & Gibber, P.A. -------------------------------------------------- Baltimore, Maryland March 17, 2003 E - 2 EX-10.25 4 dex1025.txt EMPLOYMENT AGREEMENT BETWEEN DONALD R. WALSH AND AVATECH SOLUTIONS, INC. EXHIBIT 10.25 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is made and entered into as of December 2, 2002 by and between Donald R Walsh (the "Executive") and Avatech Solutions, Inc., a Delaware corporation ("Avatech"). EXPLANATORY STATEMENT Avatech desires to employ Executive, and Executive desires to enter into employment with Avatech, as Avatech's Chief Executive Officer, and to perform services for Avatech on the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the Explanatory Statement, which is incorporated by reference herein, the mutual covenants, agreements, representations and warranties herein set forth, and other good and valuable consideration, the adequacy and sufficiency of which is hereby acknowledged, the parties hereto do hereby agree as follows: 1. Employment and Duties. From and after December 2, 2002 (the "Commencement Date"), Avatech shall employ Executive as the Chief Executive Officer of Avatech. Executive shall perform such duties as may be assigned to him from time to time by the Board of Directors of Avatech, and shall report directly to the Board of Directors. Executive shall use his best efforts on a full time basis (at least 40 hours per week) in the performance of his duties on behalf of Avatech. 2. Compensation and Benefits. 2.1. Salary. Executive's base annual salary ("Base Salary") shall be two hundred thousand dollars ($200,000), payable in accordance with Avatech's customary payroll policies in force at the time of payment. 2.2. Incentive Compensation and Bonuses. Prior to the end of each of Avatech's fiscal years, its management will recommend to the Compensation Committee of the Board of Directors whether to pay to Executive additional compensation, and the Compensation Committee shall determine if additional compensation shall be paid to Executive, and if so, in what amounts. Such a determination by the Compensation Committee shall be made in conjunction with its consideration of an overall incentive compensation plan for senior management of Avatech. The Compensation Committee may pay to Executive any or all of the following: incentive compensation based on Executive's achievement of specific goals or objectives developed by the Compensation Committee; a bonus based upon outstanding performance by the Executive; and additional options to purchase Avatech's Common Stock under its Incentive Stock Option plan or otherwise. 2.3. Annual Review. Commencing with the beginning of the fiscal year of Avatech beginning July 1, 2003, and on each July 1 thereafter, the Board shall conduct an annual performance review of Executive and, at that time, consider increases in Executive's base compensation. 2.4. Stock Options. Avatech shall immediately grant to Executive options to purchase 50,000 shares of Avatech's Common Stock under Avatech's Incentive Stock Option Plan, with such terms and conditions as are customarily contained in option agreements entered into by Avatech. The options shall have a term of 10 years, shall automatically convert to nonqualified options upon any cessation of employment with Avatech by Executive (unless such cessation is the result of a Termination for Cause, as described in Section 4.2 hereof, in which case all vested and unvested options shall cease, terminate and be null and void), and shall have an exercise price equal to the mean between the bid and asked prices of Avatech's Common Stock on the OTC Bulletin Board at the close of trading on December 2, 2002. One third of the options shall vest on each July 1 of 2003, 2004 and 2005. 2.5. Benefits. Executive shall be entitled to participate in Avatech's standard benefits provided to other management level employees of Avatech, as established or modified by Avatech from time to E - 3 time, including but not limited to life insurance, health insurance, and dental insurance, to the extent not provided to Executive from another business or corporation. 2.6. Vacation. Executive shall be entitled to four calendar weeks of vacation during each fiscal year of Avatech, which vacation weeks shall not accrue if they are not used. 2.7. Business Expenses. Pursuant to Avatech's customary policies in force at the time of payment, Executive shall be promptly reimbursed, against presentation of vouchers or receipts, for all authorized expenses properly incurred by him in the performance of his duties hereunder. 2.8. Moving and Relocation Costs. Avatech shall reimburse Executive, or pay directly to the moving and storage company handling same, the actual charges incurred to move Executive's furniture, personal items, and vehicles to the Baltimore, Maryland area from Executive's current home, plus reasonable and necessary closing costs associated with Executive's purchase of a new home in the Baltimore, Maryland area. 3. Term and Termination. 3.1. Term. This Agreement shall have a term beginning on the Commencement Date and ending on the date of a Termination for Cause (as defined in Section 3.2) or the date of a Termination Other than for Cause (as defined and described in Section 3.3), whichever shall first occur. 3.2. Termination for Cause. Executive shall be entitled to payment of his Base Salary earned, accrued bonus earned (if any), and benefits existing at the time of termination of his employment if such termination is a Termination for Cause. "Termination for Cause" means one or more of. (a) voluntary termination of employment by Executive for any reason; (b) death of Executive; (c) Executive having been unable to render services required of him hereunder for a consecutive period of six months or for any period in the aggregate of six months in any twelve month period because of a serious and continuing health impairment, which impairment will most likely result in Executive's continued inability to render the services required of him hereunder; (d) Executive"s misappropriation of corporate funds; (e) Executive's conviction of a felony; (f) Executive's conviction of any crime involving theft, dishonesty, or moral turpitude; (g) Executive's failure to devote substantially his full business time and attention to Avatech as provided in Section 1 hereof; (h) Executive's willful violation of directions of the Board of Directors of Avatech which are consistent with Executive's duties as Chief Executive Officer; (i) falsification of any material representation made by Executive to Avatech; (j) verifiable evidence that Executive has engaged in sexual harassment of a nature that could give rise to liability on the part of Avatech; and (k) the commission by Executive of a material breach of the terms of this Agreement. 3.3. Termination Other Than for Cause. If Executive's employment with Avatech is terminated and such termination is not a Termination for Cause, Executive shall be entitled to payment of his Base Salary and other benefits existing at the time of such termination for a period of twelve months thereafter, with all such payments to be made periodically pursuant to Avatech's policies in force at the time of payment, provided, however, that Avatech shall not be obligated to continue any benefit if the plan or policy under which such benefit is provided limits the provision of the benefit to full-time employees of Avatech, or if the validity of the plan or policy would be adversely impacted by the continuation of the benefit. 3.4. Change in Control. If, upon a Change in Control, Executive is either terminated or elects to resign, such termination shall be treated as a termination under Section 3.3. As used in this Agreement, "Change in Control" shall mean (a) a dissolution or liquidation of Avatech; (b) a merger of consolidation in which Avatech is not the surviving corporation or the party to the merger or consolidation whose shareholders do not own 50% or more of the voting stock of the resulting corporation; or (c) the acquisition of more than 50% of the outstanding voting stock of Avatech by any person, or group of persons acting in concert, in a single transaction or series of transactions. E - 4 4. Confidential Information 4.1. Definition of Confidential Information. For purposes of this Agreement, the term "Confidential Information" means that secret, proprietary information of Avatech not otherwise publicly disclosed (whether or not discovered or developed by Executive) and known by Executive as a consequence of Executive's employment with Avatech or as a consequence of Executive's position as a director of Avatech. Without limiting the generality of the foregoing, such proprietary information shall include information not generally known in the industry or related industries which concerns customer lists; computer programs and routines; the identity of specialized consultants and contractors and confidential information developed by them for Avatech; operating and other cost data, including information regarding salaries and benefits of employees; cost and pricing data; acquisition, expansion, marketing, financial, strategic, and other business plans; Avatech manuals, files, records, memoranda, plans, drawings and designs, specifications and computer programs and records; and all information that is a "trade secret" as defined in the Uniform Trade Secrets Act. 4.2. Confidential Information. During Executive's employment with Avatech, Executive shall have access to and become familiar with Confidential Information of Avatech. Executive acknowledges that such Confidential Information is owned and shall continue to be owned solely by Avatech. During the term of Executive's employment with Avatech and after termination of such employment for any reason, Executive shall not use or divulge Confidential Information to any person or entity other than Avatech, or persons to whom Avatech has given its written consent, unless such information has become publicly available and is not longer Confidential Information. 4.3. Return of Documents. Upon termination of Executive's employment with Avatech for any reason, all procedural manuals, guides, specifications, plans, drawings, designs, records, lists, notebooks, software, diskettes, customer lists, pricing documentation and other property which is or contains Confidential Information, including all copies thereof, in the possession or control of Executive, whether prepared by Executive or others, shall be forthwith delivered by Executive to Avatech. 5. Covenants Not to Compete 5.1. Restrictive Covenant. Avatech and Executive agree and acknowledge that Avatech has legitimate business interests to support the restrictive covenants set forth hereinafter, including, but not limited to, trade secrets, Confidential Information that otherwise does not qualify as trade secrets, and Executive's substantial relationships with prospective or existing customers. Executive covenants and agrees that during Executive's employment with Avatech and for a period of one year following Executive's cessation of employment for any reason, Executive shall not in any manner start or join any business which, as of or after the date of this Agreement, enters into a line of business or is engaged in a line of business that is a line of business conducted by Avatech. This Section 5.1 shall prevent Executive, directly or indirectly, on Executive's own behalf or as an executive, officer, employee, agent, director, partner, consultant, lender, or advisor, from forming, owning, joining, controlling, financing, or otherwise participating in the ownership or management of or being otherwise affiliated with any person or entity engaged in the type of business prohibited by this Section. Executive shall not permit any person or entity (other than Avatech) of which Executive is a shareholder, partner or director, or in which Executive has an ownership interest, to engage in any type of business prohibited by this Section. Notwithstanding any other provision herein to the contrary, the parties agree that Executive may invest Executive's personal, private assets as a passive investor in not more than one percent of the total outstanding shares of any publicly traded company engaged in a competing business, so long as Executive does not participate in the management or operations of such company. 5.2. Solicitation of Employees. During the one-year period following Executive's cessation of employment for any reason, Executive shall not, without the prior written approval of the Chairman of the Board of Directors of Avatech, directly or indirectly solicit, raid, entice, or induce any person who is, or was at any time within six months prior to such cessation, an employee of Avatech, to become employed by any other person, firm, or corporation in any business which is in any manner in competition with Avatech. Furthermore, E - 5 Executive shall inform Avatech in writing if any other person employed by Avatech contacts Executive for the purpose of seeking employment during such one year period. 5.3. New Developments. Executive agrees that, with respect to his work for Avatech, any developments made by Executive or under Executive's direction in connection with the work of Avatech shall be the sole and absolute property of Avatech, and that any and all copyrights, patent rights, and other proprietary rights therein shall belong to Avatech. Executive shall cooperate with Avatech and execute any documents prepared by Avatech to secure or protect any such rights. 6. Representations of Executive. Executive hereby represents and warrants that he has the unrestricted right to accept employment with Avatech on the terms and conditions set forth herein and to execute and perform this Agreement without being in conflict with any other agreement, obligation or understanding with any third party. Executive represents that he is not bound by any agreement or by any other existing or previous business relationship which conflicts with, or may conflict with, the performance of his obligations hereunder, or prevent the full performance of his duties and obligations hereunder. 7. Notices. Any notice permitted or required to be given under this Agreement shall be sufficient if in writing and delivered personally or by certified mail, return receipt requested, if to Executive, to Mr. Donald R Walsh at his residence address as reflected in Avatech's payroll records, and if to Avatech, to the attention of Mr. W. James Hindman, at Avatech's principal corporate office address. A party may change his or its address for receipt of notices by complying with this Section. 8. Entire Agreement. This Agreement contains the entire understanding of the parties in respect of its subject matter and supersedes all prior agreements and understandings between the parties with respect to such subject matter. 9. Amendment; Waiver. This Agreement may not be amended, supplemented, canceled or discharged except by a written instrument executed by the party affected thereby. No failure to exercise, and no delay in exercising, any right, power or privilege hereunder shall operate as a waiver thereof. No waiver of any breach of any provision of this Agreement shall be deemed to be a waiver of any preceding or succeeding breach of the same or any other provision. 10. Binding Effect; Assignment. The rights and obligations set forth in this Agreement shall bind and inure to the benefit of any successor of Avatech by reorganization, merger or consolidation, or any assignee of all or substantially all of Avatech's business and properties. Executive's rights or obligations hereunder may not be assigned by Executive, except that upon Executive's death, all rights to compensation hereunder shall pass to Executive's executor or administrator. 11. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect the meaning or interpretation of this Agreement. 12. Governing Law; Interpretation. This Agreement shall be construed in accordance with, and governed by, the laws of the State of Maryland and, to the extent it involves any United States statute, by the laws of the United States. 13. Further Assurances. Each of the parties agrees to execute, acknowledge, deliver and perform, or caused to be executed, acknowledged, delivered and performed, at any time and from time to time, all such further acts, documents, transfers, conveyances, or assurances as may be necessary or appropriate to carry out the provisions or intent of this Agreement. 14. Severability. If any one or more of the terms, provisions, covenants, or restriction contained in this Agreement shall be determined by a court of competent jurisdiction to be invalid, void, or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. E - 6 IN WITNESS WHEREOF, the parties hereto have entered into this Agreement as of the day and year first above written. AVATECH SOLUTIONS, INC. By: /s/ Henry Felton -------------------------------------- Vice Chairman /s/ Donald R. Walsh ----------------------------------------- Donald R. Walsh E - 7 EX-21.1 5 dex211.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 Subsidiaries of the Registrant. The consolidated financial data presented with this Registration Statement includes Avatech Solutions, Inc., a holding company, and the following wholly-owned (direct or indirect) subsidiaries: AVATECH SOLUTIONS SUBSIDIARY, INC. TECHNICAL LEARNINGWARE COMPANY, INC E - 8 EX-23.1 6 dex231.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated September 3, 2002 (except Note 3 and Note 14, as to which the date is March 10, 2003) in the Registration Statement (Form S-1 No. 333-_______) and related Prospectus of Avatech Solutions, Inc. and subsidiaries for the registration of 2,320,247 shares of its common stock. /s/ Ernst & Young LLP Baltimore, Maryland March 21, 2003 E - 9 EX-23.2 7 dex232.txt CONSENT OF WALPERT AND WOLPOFF, LLP EXHIBIT 23.2 Consent of Walpert and Wolpoff, LLP We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated October 3, 2001 (except Note 3 and Note 14, as to which the date is March 10, 2003) in the Registration Statement (Form S-1 No. 333-_______) and related Prospectus of Avatech Solutions, Inc. and subsidiaries for the registration of 2,320,247 shares of its common stock. /s/ Walpert & Wolpoff, LLP Baltimore, Maryland March 21, 2003 E - 10 -----END PRIVACY-ENHANCED MESSAGE-----