10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

OR

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

Commission file number: 001-31265

Avatech Solutions, Inc.

(Exact Name of Registrant as Specified in its Charter)

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

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

(410) 581 - 8080

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.

Class	Outstanding at October 31, 2005
Common Stock, par value $.01 per share	11,077,959

AVATECH SOLUTIONS, INC. AND SUBSIDIARIES

INDEX

		Page
PART I	FINANCIAL INFORMATION
ITEM 1.	Consolidated Financial Statements
	Consolidated Balance Sheets – September 30, 2005 (Unaudited) and June 30, 2005	3
	Consolidated Statements of Operations – Three months ended September 30, 2005 and 2004 (Unaudited)	5
	Consolidated Statement of Stockholders’ Deficit – Three months ended September 30, 2005 (Unaudited)	6
	Consolidated Statements of Cash Flows – Three months ended September 30, 2005 and 2004 (Unaudited)	7
	Notes to Consolidated Financial Statements (Unaudited)	8
ITEM 2.	Management’s Discussion and Analysis of Results of Operations and Financial Condition	14
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	18
ITEM 4.	Controls and Procedures	19
PART II	OTHER INFORMATION
ITEM 6.	Exhibits	20
SIGNATURES

2

PART I. FINANCIAL INFORMATION

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets

	September 30, 2005		June 30, 2005
	(unaudited)		(audited)
Assets
Current assets:
Cash and cash equivalents	$	154,000	$	295,000
Accounts receivable, less allowance of $149,000 at June 30, 2005 and September 30, 2005		5,183,000		5,808,000
Other receivables		154,000		189,000
Inventory		377,000		531,000
Prepaid expenses and other		227,000		227,000
Total current assets		6,095,000		7,050,000
Property and equipment:
Computer software and equipment		2,690,000		2,720,000
Office furniture and equipment		932,000		910,000
Leasehold improvements		275,000		278,000
		3,897,000		3,908,000
Less accumulated depreciation and amortization		3,220,000		3,215,000
		677,000		693,000
Customer list, net of accumulated amortization of $17,000 at June 30, 2005 and $34,000 at September 30, 2005		245,000		262,000
Goodwill		52,000		52,000
Other assets		138,000		162,000
Total assets	$	7,207,000	$	8,219,000

See accompanying notes.

3

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)

	September 30, 2005			June 30, 2005
	(unaudited)			(audited)
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable and accrued expenses	$	3,178,000		$	3,379,000
Accrued compensation and related benefits		415,000			401,000
Borrowings under lines-of-credit		1,145,000			3,198,000
Current portion of long-term debt		415,000			605,000
Note payable to related party		902,000			—
Deferred revenue		617,000			572,000
Other current liabilities		555,000			441,000
Total current liabilities		7,227,000			8,596,000
Long-term debt		1,062,000			1,163,000
Note payable to related party		—			902,000
Other long-term liabilities		218,000			260,000
Commitments and contingencies		—			—
Stockholders’ deficit:
Series D Convertible Preferred Stock, $0.01 par value; 1,297,537 shares authorized, issued and outstanding at June 30, 2005 and September 30, 2005		13,000			13,000
Series E Convertible Preferred Stock, $0.01 par value; 3,000 shares authorized; no shares issued and outstanding at June 30, 2005 and 1,191 shares issued and outstanding at September 30, 2005		—			—
Common stock, $0.01 par value; 80,000,000 shares authorized; 10,868,330 and 10,908,914 shares issued and outstanding at June 30, 2005 and September 30, 2005, respectively		109,000			109,000
Additional paid-in capital		6,673,000			5,476,000
Accumulated deficit		(8,095,000	)		(8,300,000	)
Total stockholders’ deficit		(1,300,000	)		(2,702,000	)
Total liabilities and stockholders’ deficit	$	7,207,000		$	8,219,000

See accompanying notes.

4

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations

	Three Months Ended September 30,
	2005			2004
	(unaudited)			(unaudited)
Revenues:
Product sales	$	6,210,000		$	4,479,000
Service revenue		1,863,000			1,305,000
Commission revenue		1,154,000			968,000
		9,227,000			6,752,000
Cost of revenue:
Cost of product sales		3,819,000			3,120,000
Cost of service revenue		1,227,000			970,000
		5,046,000			4,090,000
Gross margin		4,181,000			2,662,000
Other operating expenses:
Selling, general and administrative		3,729,000			3,277,000
Depreciation and amortization		93,000			61,000
		3,822,000			3,338,000
Operating income (loss)		359,000			(676,000	)
Other income (expense):
Minority interest		—			(38,000	)
Interest and other income		5,000			12,000
Interest expense		(139,000	)		(103,000	)
		(134,000	)		(129,000	)
Income (loss) before income taxes		225,000			(805,000	)
Income tax expense		20,000			8,000
Net income (loss)		205,000			(813,000	)
Preferred stock dividends		(39,000	)		(20,000	)
Net income (loss) available to common stockholders	$	166,000		$	(833,000	)
Earnings (loss) per common share, basic	$	0.02		$	(0.09	)
Earnings (loss) per common share, diluted	$	0.01		$	(0.09	)
Shares used in computation - basic		10,884,969			9,599,659
Shares used in computation - diluted		14,242,185			9,599,659

See accompanying notes.

5

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Deficit (Unaudited)

	Series D Preferred Stock			Series E Preferred Stock			Common Stock			Additional Paid-In Capital			Accumulated Deficit			Total
	Number of Shares	Par Value		Number of Shares	Par Value		Number of Shares	Par Value
Balance at July 1, 2005	1,297,537	$	13,000	—	$	—	10,868,330	$	109,000	$	5,476,000		$	(8,300,000	)	$	(2,702,000	)
Issuance of common stock as compensation							40,584				20,000						20,000
Issuance of stock options as compensation											25,000						25,000
Issuance of Series E Convertible Preferred Stock and common stock purchase warrants				1,191							1,191,000						1,191,000
Preferred stock dividends											(39,000	)					(39,000	)
Net income for the three months ended September 30, 2005														205,000			205,000
Balance at September 30, 2005	1,297,537	$	13,000	1,191	$	—	10,908,914	$	109,000	$	6,673,000		$	(8,095,000	)	$	(1,300,000	)

See accompanying notes.

6

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

	Three Months Ended September 30,
	2005			2004
	(unaudited)
Cash flows from operating activities
Net income (loss)	$	205,000		$	(813,000	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Provision for (recovery of) bad debts		(4,000	)		9,000
Depreciation and amortization		93,000			61,000
Non-cash stock compensation expense		45,000			16,000
Amortization of debt discount charged to interest expense		1,000			6,000
Amortization of financing costs charged to interest expense		—			5,000
Changes in operating assets and liabilities:
Accounts and other receivables		660,000			604,000
Inventory		154,000			(92,000	)
Prepaid expenses and other current assets		—			18,000
Other assets		24,000			(91,000	)
Accounts payable and accrued expenses		(221,000	)		(594,000	)
Accrued compensation and related benefits		14,000			(90,000	)
Deferred revenue		45,000			66,000
Other current liabilities		114,000			54,000
Net cash provided by (used in) operating activities		1,130,000			(841,000	)
Cash flows from investing activities
Purchase of property and equipment		(53,000	)		(49,000	)
Net cash used in investing activities		(53,000	)		(49,000	)
Cash flows from financing activities
Proceeds from borrowings under line-of-credit		11,888,000			9,687,000
Repayments of borrowings under line-of-credit		(13,942,000	)		(9,194,000	)
Repayments of long-term debt		(274,000	)		(26,000	)
Proceeds from sale of preferred stock		1,191,000			—
Proceeds from sale of common stock to employees		—			27,000
Payment of preferred stock dividends		(39,000	)		(20,000	)
Change in other long-term liabilities		(42,000	)		(35,000	)
Net cash provided by (used in) financing activities		(1,218,000	)		439,000
Net change in cash and cash equivalents		(141,000	)		(451,000	)
Cash and cash equivalents - beginning of period		295,000			690,000
Cash and cash equivalents - end of period	$	154,000		$	239,000

See accompanying notes.

7

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2005

1. Basis of Presentation

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect all adjustments (consisting of normal recurring accruals), which are, in management’s opinion, necessary to present a fair statement of results of the interim periods presented. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005. Operating results for the three months ended September 30, 2005 are not necessarily indicative of results for any future period.

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

2. Employee Stock Compensation Plans

During the first quarter ended September 30, 2005 the Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment” (Statement 123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company accounted for stock-based compensation plans and the employee stock purchase plan in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations and provided the required pro forma disclosures of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation”. On July 1, 2005, the Company elected to adopt the modified-prospective-transition method as provided by Statement 123R. Under this transition method, compensation cost recognized during fiscal 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant-date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of Statement 123R. The effect of adopting Statement 123R in the first quarter of fiscal 2006 was a decrease to net income of $25,000, or less than $0.01 per basic and diluted earnings per share. Results for prior periods have not been restated.

The Board of Directors may grant options under four stock option plans to purchase shares of the Company’s common stock at a price not less than the fair market value of the common stock at the grant date. The Avatech Solutions, Inc. 2000 Stock Option Plan and the Avatech Solutions, Inc. 2002 Stock Option Plan are the only plans with significant stock option awards available for grant. All plans provide for the granting of either qualified or non-qualified stock options to purchase an aggregate of up to 4,955,000 shares of common stock to eligible employees, officers, and directors of the Company. The exercise price of each stock option equals 100% of the market price of the Company’s stock on the date of grant and generally has a maximum term of 10 years. Options generally vest ratably over three or four years, depending on the specific grant award. For the three months ended September 30, 2005, the Company also issued 40,584 shares of fully vested common stock to members of the Board of Directors with an aggregate market value of $20,000. For the three month periods ended September 30, 2005 and 2004, total stock compensation expense charged against income (loss) for these plans was $45,000 and $15,000, respectively.

8

The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of Statement 123R to stock-based employee compensation for the three months ended September 30, 2004:

Net loss, as reported	$	(813,000	)
Add: Stock-based compensation cost included in net loss, net of taxes		15,000
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of taxes		(70,000	)
Pro forma net loss		(868,000	)
Preferred stock dividends		(20,000	)
Pro forma net loss attributable to common stockholders	$	(888,000	)
Net loss attributable to common stockholders:
Basic - as reported	$	(0.09	)
Diluted - as reported	$	(0.09	)
Basic - pro forma	$	(0.09	)
Diluted - pro forma	$	(0.09	)

For the purpose of estimating the grant-date fair value of stock options as required by Statement 123R, the Company used a Black-Scholes-Merton option-pricing formula and is amortizing the value of the options to expense over the options’ vesting periods ratably.

To determine the pro forma data as required by Statement 123, the Company used stock option pricing models to measure the fair value of stock options as of the date of grant. For all stock options granted prior to November 19, 2002, the date the Company’s common stock became publicly traded and had a readily determinable market value, the Company used the minimum value method to calculate pro forma stock compensation expense. The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option. For all stock options grated after this date, the Company used the Black-Scholes-Merton option pricing model.

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

	Three months ended September 30,
	2005			2004
Average risk-free interest rate		3.87	%		3.28	%
Dividend yield		0	%		0	%
Expected term		5.7 years			5 years
Average expected volatility		1.45			2.58
Weighted average fair value of granted options	$	0.56		$	0.52

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

9

A summary of stock option activity during the three months ended September 30, 2005 and related information is included in the table below:

	Options		Weighted- Average Exercise Price		Aggregate Intrinsic Value
Outstanding at July 1, 2005	1,738,941		$	0.60
Granted	225,000			0.60
Forfeited	(43,006	)		0.36
Outstanding at September 30, 2005	1,920,935		$	0.63	$	896,000
Exercisable at September 30, 2005	1,273,541		$	0.70	$	506,000
Weighted-average remaining contractual life	7.9 Years

The weighted average grant date fair value of options granted during the first quarter of fiscal year 2006 was $0.56 per share. All options granted have an exercise price equal to the fair value of the Company’s common stock on the date of grant. Exercise prices for options outstanding as of September 30, 2005 ranged from $0.17 to $63.33 as follows:

Range of Exercise Prices	Options Outstanding	Weighted Average Exercise Prices of Options Outstanding		Weighted Average Remaining Contractual Life of Options Outstanding	Options Exercisable	Weighted Average Exercise Prices of Options Exercisable		Weighted Average Remaining Contractual Life of Options Exercisable
$ 0.17 - 0.34	711,398	$	0.19	6.8 years	573,781	$	0.20	6.5 years
0.35 – 0.91	1,173,000		0.61	8.8 years	666,830		0.62	8.6 years
1.17 – 63.33	36,537		10.10	5.5 years	32,930		11.08	5.4 years
	1,920,935				1,273,541

Assuming that no additional share-based payments are granted after September 30, 2005, unamortized stock compensation expense of $272,000 will be recognized in the statement of operations over a weighted average period of 1.8 years.

3. Borrowings Under Lines-of-Credit

The Company maintains a $3.0 million line of credit with a bank payable within 60 days of demand and expiring in September 2006. Outstanding borrowings are limited to 85% of the Company’s aggregate outstanding eligible accounts receivable, bear interest at the greater of 7.5% or the prime rate plus 2.0% (8.75% at September 30, 2005) 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.

On October 28, 2004, a wholly-owned subsidiary entered into a loan agreement with the bank to provide for a $700,000 revolving credit facility expiring on October 28, 2005. Borrowings under this credit facility bear interest at the greater of 7.5% or the prime rate plus 2.0% (8.75% at September 30, 2005) and are secured by the assets of the Company and the guarantee of the Chairman of the Board of Directors. The Company renewed this facility for sixty days and expects to replace it and the $3.0 million line of credit with a new $5.0 million credit line prior to December 31, 2005.

The aggregate outstanding borrowings from the bank under the $3.0 million line and the $700,000 line were $3,198,000 and $1,145,000 at June 30, 2005 and September 30, 2005, respectively.

10

4. Long-Term Debt

Loans From Software Vendor

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

The terms of the loan agreement provided for a loan of $1,500,000 with repayment of principal plus interest at 6% per annum in thirty-five equal quarterly installments commencing in January 2005. In July 2005 the Company made the decision to discontinue its relationship with the vendor and restructured the loan. The new terms of the loan provide for quarterly principal payments of approximately $91,000 plus interest at an annual rate of 6%. These quarterly payments began in July 2005 and will continue until July 1, 2007 when the final payment of approximately $727,000 is due. The balance of this loan was $1,456,000 and $1,365,000 at June 30, 2005 and September 30, 2005, respectively.

Note Payable To Related Party

On July 1, 2005, the Company extended the maturity date of a $902,000 subordinated note to a director and shareholder to July 1, 2006. The note accrues interest at 12% per annum, with quarterly interest payments due commencing October 1, 2005. In consideration for the extension of the loan’s maturity, the Company issued warrants to purchase 38,878 shares of common stock for $0.60 per share expiring on June 1, 2010. Using the Black-Scholes option pricing model, these warrants were valued at $23,000.

Other Long-Term Debt

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $112,000 as of September 30, 2005.

5. Income Taxes

Income tax expense relates to the recordation of a federal alternative minimum tax provision as a result of the Company’s profitable results. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes for the foreseeable future.

6. Earnings (Loss) Per Share

Basic earnings (loss) per common share is computed as net earnings (loss) available to common stockholders divided by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per common share include the potential dilution that would occur from common shares issuable upon the exercise of outstanding stock options and warrants and the conversion of preferred stocks. Basic and diluted loss per common share are equal for the three months ended September 30, 2004 because the assumed exercise of options and warrants and the conversion of preferred stocks is antidilutive. As of September 30, 2005, 7,094,870 shares of common stock were issuable upon the conversion or exercise of options, warrants and preferred stock.

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

	Three Months Ended September 30,
	2005			2004
Numerator:
Net income (loss)	$	205,000		$	(813,000	)
Less: preferred stock dividends		(39,000	)		(20,000	)
Net income (loss) available to common stockholders	$	166,000		$	(833,000	)
Denominator:
Weighted average shares outstanding - basic		10,884,969			9,599,659
Assumed conversion of preferred stock		2,597,236			—
Effect of outstanding stock options		652,551			—
Effect of outstanding stock warrants		107,429			—
		14,242,185			9,599,659
Earnings (loss) per common share, basic	$	0.02		$	(0.09	)
Earnings (loss) per common share, diluted	$	0.01		$	(0.09	)

11

7. Issuance of Preferred Stock

In July 2005 the Company issued 1,191 shares of Series E Convertible Preferred Stock which raised $1,191,000 for working capital purposes. In connection with this issuance, the Company granted 366,475 warrants to purchase its common stock at an exercise price of $0.65 per share, expiring on July 29, 2008. The Series E shares have the following terms:

Redemption Feature

The preferred stock is redeemable in the event that the Company is engaged in a business combination that is approved by the Board of Directors and subsequently submitted and approved by a vote of the Company’s shareholders. Any director who holds shares of Series E is not eligible to vote on the proposed business combination. The redemption price is $0.65 per share (upon conversion) plus an amount equal to all declared and unpaid dividends accrued on such shares since the original issue date.

Voting Rights

Each holder of the preferred stock shall vote together with all other classes and series of stock of the Company as a single class on all actions. Each share shall entitle the holder to one vote per share of common stock into which the preferred stock is then convertible on each such action.

Dividend Rate

The holders of the Series E are entitled to receive cumulative dividends at a rate of 10.0% per annum when and as declared by the Board of Directors. Dividends are paid quarterly to preferred shareholders.

Conversion Feature

The preferred stock is convertible at any time beginning 120 days after the original issuance date at the option of the holder and automatically converts into common stock if the common stock trades for more than $2.25 per share for 60 consecutive trading days.

Each share of preferred stock is convertible into shares of common stock by multiplying the appropriate conversion rate in effect by the number of shares of preferred stock being converted. Currently, the conversion rate is 1,538.5 shares of common stock for each share of Series E; however, this rate may be adjusted due to stock splits, dividends, and other events defined in the stock purchase agreement.

Liquidation Preference

In the event of a liquidation, dissolution or winding up of the Company, the holders of Series E are entitled to receive for each share, prior and in preference to any distribution of any of the assets or surplus funds to the holders of common stock, an amount equal to $0.65 per share (upon conversion) plus all accumulated but unpaid dividends. If upon the occurrence of such event, the

12

assets and funds thus distributed among the holders are insufficient to permit the payment of the preferential amount, then the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the preferred stockholders.

8. Liquidity and Capital Resources

The Company incurred significant operating losses in past years that depleted its capital resources. However, operating results have improved and the Company reported net income of $1,934,000 for the year ended June 30, 2005 and $205,000 for the quarter ended September 30, 2005. In July 2005, the Company raised cash of $1,191,000 through an offering of 1,191 shares of Series E Convertible Preferred Stock with the proceeds utilized for working capital purposes.

In addition, the Company is in the process of securing additional financing by obtaining an increased credit limit under a line of credit from a new bank.

Based on the cash generated from the sale of the Series E Convertible Preferred Stock in July 2005, the projected availability from the Company’s lines of credit and an evaluation of likely cash to be generated from operations in the near term and other available capital resources, management believes that it has sufficient sources of working capital to fund its operations in the normal course of business for the next twelve months.

13

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

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

Overview

Avatech Solutions is a leader in design and engineering technology solutions with expertise in CAD software, data management, facilities management and process optimization for the manufacturing, engineering, building design and facilities management industries. Avatech specializes in software resale, integration, standards development and deployment, education and technical support, aimed at improving design and documentation efficiencies and the seamless integration of workflow processes. The Company’s sales are to corporations, government agencies, and educational institutions throughout the United States.

The Company’s product sales may be somewhat cyclic, and increase when the developer of a specific software product offers a new version, promotions or discontinues support of an older product. As is common among software resellers, the Company purchases products from its suppliers with a combination of cash and credit. Avatech does not usually carry significant inventory, and generally places an order with the supplier only after receiving a firm commitment from its customer and, except in unusual situations, does not allow its customers to return merchandise.

Product Sales. Product sales consist of the sale of prepackaged software to customers in the United States. Sales are focused on three major product categories and associated value-added services- design automation, facilities management and data management.

Service Revenue. Avatech offers training courses in over thirty different subjects related to various software solutions offered at nineteen training facilities and through mobile labs that it can send to a customer site or other off-site facilities. Training is led employees who serve as class instructors and have formal training or successful industry experience in the topics they teach. The Company also provides 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. As part of the training offering, the Company has developed and deployed an Internet based assessment tool that allows its clients to test their employees’ knowledge and ability to use the software tools.

Commission Revenue. The Company generates commission revenue from the resale of Autodesk software to various customers, a number of which Autodesk considers “major accounts.” Autodesk designates these customers as major accounts based on specific criteria, primarily sales volume, and typically gives these customers volume discounts. The Company is responsible for managing and reselling Autodesk products to a number of these major account customers; however, software products are shipped directly from Autodesk to the customers. Avatech receives commissions upon shipment of the products from Autodesk to the customer based on the product sales price.

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

14

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

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

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

Interest Expense. Interest expense consists primarily of interest on a revolving line-of-credit, a note payable to a member of the Board of Directors and a loan from a vendor.

Three Months Ended September 30, 2005 Compared to the Three Months Ended September 30, 2004

The following tables set forth a comparison of the three month period ended September 30, 2005 to the three month period ended September 30, 2004. The amounts are derived from selected items reflected in our unaudited Consolidated Statements of Operations included elsewhere in this report. The three months financial results are not necessarily indicative of future results.

Revenues

	Three Months Ended September 30,
	2005		2004		%
Revenues:
Product sales	$	6,210,000	$	4,479,000	38.6	%
Service revenue		1,863,000		1,305,000	42.8	%
Commission revenue		1,154,000		968,000	19.2	%
Total revenues	$	9,227,000	$	6,752,000	36.7	%

Revenues. The Company realized significant revenue growth over the same period in the prior fiscal year. Total revenues increased $2,475,000, or 36.7%, between periods and all three categories of revenues showed large increases.

Product sales increased to $6,210,000 for the quarter, an increase of $1,731,000 from the quarter ended September 30, 2004, or 38.6%. The increase is due to continued economic improvement in the Company’s market, aggressive promotional campaigns initiated by Autodesk resulting in an increased demand for their products and improved execution and performance of the Company. During fiscal 2005, the Company acquired the operations of Comtrex Corporation, an authorized Autodesk reseller with offices in Greensboro, Charlotte, and Morrisville, North Carolina thereby increasing its geographic reach and increasing its sales volume. The increase in product sales attributable to this acquisition for the quarter ended September 30, 2005 was approximately $550,000.

Service revenues increased $558,000, or 42.8%, for the three months ended September 30, 2005 as compared to the same period in the prior fiscal year. The Company continued its strategy of investing in its services business by adding personnel and expanding its training, support and consulting capabilities. This strategy resulted in the large growth in its services revenues for the period and as the Company continues to invest in this area it expects continued growth in its services revenues.

15

Commission revenues increased $186,000 or 19.2% for the three months ended September 30, 2005, compared to the same period in the prior fiscal year. The increase in commission revenues was a result of a significant industry-wide increase in sales volume and a continued focus by the Company to increase this category of business.

Cost of Revenues and Gross Margin

	Three Months Ended September 30,
	2005		2004		%
Cost of revenue:
Cost of product sales	$	3,819,000	$	3,120,000	22.4	%
Cost of service revenue		1,227,000		970,000	26.5	%
Total cost of revenue	$	5,046,000	$	4,090,000	23.4	%
Gross margin	$	4,181,000	$	2,662,000

Costs of revenue. Total cost of revenue increased $956,000, or 23.4%, for the three months ended September 30, 2005 as compared to the same period in the prior fiscal year.

Cost of product sales increased $699,000, or 22.4%, due to the increase in product revenues. However, the cost of product sales as a percentage of related revenue for the three months ended September 30, 2005 was 61.5%, compared to 69.7% in the same period in 2004. The primary reason for the lower cost of product sales was that the Company realized greater incentives from Autodesk as a result of its higher sales during the period and those incentives are accounted for as a reduction in cost of product sales.

Cost of service revenue increased $257,000, or 26.5%, for the three months ended September 30, 2005 compared to the same period in the prior fiscal year. However, cost of service revenue as a percentage of related revenue for the three months ended September 30, 2005 decreased to 65.9% from 74.3% in the same period in the prior fiscal year. This decrease was due to a more effective utilization of the Company’s services personnel resulting in a significant increase in billable time without a proportional increase in personnel costs.

Gross margin. Overall, as a result of the increased sales incentives earned from Autodesk and the higher utilization of services personnel, the gross margin percentage increased significantly from 39.4% for the three months ended September 30, 2004 to 45.3% for the same period in the current fiscal year.

Other Operating Expenses

	Three Months Ended September 30,
	2005		2004		%
Other operating expenses:
Selling, general and administrative	$	3,729,000	$	3,277,000	13.8	%
Depreciation and amortization		93,000		61,000	52.4	%
Total other operating expenses	$	3,822,000	$	3,338,000	14.5	%

Selling, General and Administrative Expense. Selling, general and administrative expenses increased $452,000, or 13.8%, for the three months ended September 30, 2005 compared to the same period in the prior fiscal year due to higher salary expense and sales commissions due to new sales personnel hired in the past twelve months. Selling, general and administrative expense as a percent of total revenues was 40.4% for the three months ended September 30, 2005 down significantly from 48.5% for the same period in the prior fiscal year. The percentage decrease is due to the Company’s continued cost containment efforts coupled with the growth in revenues.

Depreciation and Amortization. Depreciation and amortization expenses increased $32,000, or 52.4%, for the three months ended September 30, 2005 compared to the same period in the prior fiscal year. These expenses increased due to the Company’s investment in upgrading its information technology infrastructure, purchases of new, upgraded computers for several of the Company’s training centers as well as for new personnel that were brought on during the last twelve months and the amortization of the customer list, recorded as a result of the Company’s purchase of Comtrex Corporation in April 2005.

16

Other income (expense)

	Three Months Ended September 30,
	2005			2004			%
Other income (expense):
Minority interest	$	—		$	(38,000	)	100.0	%
Interest and other income		5,000			12,000		(58.3	)%
Interest expense		(139,000	)		(103,000	)	35.0	%
Total other income (expense)	$	(134,000	)	$	(129,000	)	3.9	%

Other Income (Expense). Other income (expense) increased $5,000, or 3.9%, for the three months ended September 30, 2005 compared to the same period in the prior fiscal year. The minority interest expense in the prior period represents dividends paid on shares of preferred stock issued by a subsidiary and those shares were converted into common stock last fiscal year. Interest expense increased as a result of higher interest rates on the Company’s lines of credit as well as the amortization of financing costs incurred in the prior fiscal year.

Income tax expense

	Three Months Ended September 30,
	2005		2004		%
Income tax expense	$	20,000	$	8,000	250.0	%

Income Tax Expense. Income tax expense increased $12,000 for the three months ended September 30, 2005 compared to the same period in the prior fiscal year. The increase in tax expense relates to the recordation of a federal alternative minimum tax provision as a result of the Company’s profitable results. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes for the foreseeable future.

Liquidity and Capital Resources

Historically, the Company has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations, borrowings under short-term and long-term debt arrangements, and sales of preferred stock.

The Company’s operating assets and liabilities consist primarily of accounts receivable, inventory and accounts payable. Changes in these balances are affected principally by the timing of sales and investments in inventory based on expected customer demand. The Company minimizes inventory levels through arrangements with suppliers to ship products with an average delivery period of two days and centralized inventory management. The Company purchases approximately 90% of its product from one principal supplier which provides $3.0 million of available credit to finance those purchases.

The Company’s investing activities consist principally of investments in computer and office equipment. Capital expenditures for the quarter ended September 30, 2005 were approximately $53,000, compared to $49,000 for the same period in 2004.

The Company maintains a $3.0 million line of credit with a bank payable within 60 days of demand and expiring in September 2006. Outstanding borrowings are limited to 85% of the Company’s aggregate outstanding eligible accounts receivable, bear interest at the greater of 7.5%, or the prime rate plus 2.0% (8.75% at September 30, 2005) 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.

On October 28, 2004, a wholly-owned subsidiary entered into a loan agreement with the bank to provide for a $700,000 revolving credit facility expiring on October 28, 2005. Borrowings under this

17

credit facility bear interest at the greater of 7.5%, or the prime rate plus 2.0% (8.75% at June 30, 2005) and are secured by the assets of the Company and the guarantee of the Chairman of the Board of Directors. The Company renewed this facility for sixty days and expects to replace it and the $3.0 million line of credit with a new $5.0 million credit line during its second fiscal quarter ending December 31, 2005.

On July 1, 2005, the Company extended the maturity date of a $902,000 subordinated note to a director and shareholder to July 1, 2006 and is shown in current liabilities in the accompanying consolidated balance sheet. The note accrues interest at 12% per annum, with quarterly interest payments due commencing October 1, 2005.

The total borrowings from the bank under the $3.0 million line and the $700,000 line were approximately $3.2 million and $1.1 million as of June 30, 2005 and September 30, 2005, respectively.

In July 2005, the Company raised cash of $1,191,000 through an offering of 1,191 shares of Series E Convertible Preferred Stock.

Outstanding debt totaled approximately $3.5 million at September 30, 2005, and the Company had a deficiency of working capital of approximately $1.1 million. The working capital deficit was in large part caused by the classification of the lines of credit as current liabilities due to their demand provisions. Despite the existence of the 60-day demand provision on these lines-of-credit, the Company does not believe it is likely that the bank will exercise the demand provisions of the agreements. In addition, the Company fully expects to have a new financing arrangement with another lender by the end of calendar year 2005 that would extend the maturity of the current lines of credit and provide for an increased borrowing limit. The Company’s working capital needs have stabilized, and management believes the Company’s near-term needs can be met from its available cash resources, cash flows from operations and its lines of credit.

Since Avatech is one of the largest resellers of Autodesk software and since Autodesk has continued to state its intention to continue to strengthen its relationships with its resellers, the Company fully expects to continue to be a leading seller of Autodesk software at margins sufficient to grow its business and improve its financial results. The Company’s Channel Partner Agreement with Autodesk expires on February 1^st of each year, but Autodesk has indicated its intention to renew the Agreement on February 1, 2006. In addition, the Company continues to diversify its revenues by increasing its service revenues and the sale of non-Autodesk software.

Below is a summary of the Company’s contractual obligations and commitments at September 30, 2005:

	Total		Less than 1 year		1 – 3 years		3 – 5 years		More than 5 years
Contractual Obligations
Lines of credit	$	1,145,000	$	1,145,000	$	—	$	—	$	—
Long-term obligations		1,477,000		415,000		1,062,000		—		—
Interest on fixed rate obligations		234,000		182,000		52,000		—		—
Operating leases		4,401,000		1,268,000		1,924,000		895,000		314,000
Note payable to related party and capital lease obligations		1,090,000		998,000		92,000		—		—
Total obligations	$	8,347,000	$	4,008,000	$	3,130,000	$	895,000	$	314,000

Adoption of Recent Accounting Pronouncement

During the first quarter ended September 30, 2005 the Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment” (Statement 123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company accounted for stock-based compensation plans and the employee stock purchase plan in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations and provided the required pro forma disclosures of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation”. On July 1, 2005, the Company elected to adopt the modified-prospective-transition method as provided by Statement 123R. Under this transition method, compensation cost recognized during fiscal 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant-date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005 based on the grant-date fair value estimated in accordance with the provisions of Statement 123R. Results for prior periods have not been restated. For the purpose of estimating the grant-date fair value of stock options as required by Statement 123R, the Company used a Black-Scholes-Merton option-pricing formula and is amortizing the value of the options to expense over the options vesting periods. For the three month period ended September 30, 2005, stock compensation expense charged against income was $25,000 based on the Black-Scholes-Merton option pricing methodology. Assuming the Company used this methodology and recognized stock compensation expense in its statement of operations for the three month period ended September 30, 2004, stock compensation expense charged against the loss would have approximated $70,000.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk from changes in interest rates associated with its variable rate lines-of-credit. At September 30, 2005, 33% of the outstanding debt bears interest at variable rates. Accordingly, the Company’s earnings and cash flow are affected by changes in interest rates. Assuming the current level of borrowings at variable rates and assuming a 100 basis point change in the average interest rate under these borrowings, the Company estimates that its interest expense and net income would have changed by less than $5,000 for the quarter ended September 30, 2005. In the event of an adverse

18

change in interest rates, management would likely take actions to further mitigate this exposure. However, due to the uncertainty of the actions that would be taken and their possible effects, the analysis assumes no such actions. Further, the analysis does not consider the effects of the change in the level of overall economic activity that could exist in such an environment.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains a system of disclosure controls and procedures that is designed to provide reasonable assurance that information, which is required to be disclosed by the Company in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and is accumulated and communicated to management in a timely manner. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated this system of disclosure controls and procedures as of the end of the period covered by this quarterly report, and believe that the system is effective. There have been no changes in our internal control over financial reporting during the most recent quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

19

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS

Exhibit No.	Description of Exhibit
10.1	Form of Promissory Note, principal amount $902,168.80, issued by Avatech Solutions, Inc. in favor of W. James Hindman dated July 1, 2005 *
10.2	Warrants to purchase up to 38,878 shares of common stock issued by Avatech to W. James Hindman dated July 1, 2005 *
10.3	Amendment to the Avatech Solutions, Inc. Restricted Stock Award Plan dated August 23, 2005*
31.1	Rule 15d-14(a) Certification of Chief Executive Officer *
31.2	Rule 15d-14(a) Certification of Chief Financial Officer *
32.1	Section 1350 Certifications *

* Filed herewith

20

SIGNATURES

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

	AVATECH SOLUTIONS, INC. AND SUBSIDIARIES
Date: November 14, 2005	By	/s/ Donald R. “Scotty” Walsh
		Donald R. “Scotty” Walsh
		Chief Executive Officer
Date: November 14, 2005	By	/s/ Lawrence Rychlak
		Lawrence Rychlak
		Vice President and Chief Financial Officer
		(Principal financial and accounting officer)

EX-10.1

Exhibit 10.1

SENIOR SUBORDINATED PROMISSORY NOTE

$902,168.80

July 1, 2005

Owings Mills, Maryland

FOR VALUE RECEIVED, Avatech Solutions, Inc., a Delaware corporation (“Borrower”), hereby unconditionally promises to pay to the order of W. James Hindman, a Maryland resident (“Lender”), in lawful money of the United States of America and in immediately available funds, the principal sum of $902,168.80 and any unpaid accrued interest thereon, as set forth below.

The following is a statement of the rights of Lender under this Senior Subordinated Promissory Note (this “Note”) and the conditions to which this Note is subject, and to which Lender, by the acceptance of this Note, agrees:

1. Principal Repayment. This Note shall mature, and the entire unpaid principal balance of this Note, together with all accrued and unpaid interest, late charges and other fees hereon, shall be due and payable on July 1, 2006 (the “Maturity Date”), if not paid earlier as hereinafter provided. At any time upon prior written notice to Lender, the Borrower may prepay without penalty, in whole or in part, the principal sum, plus accrued interest to the date of payment, of this Note.

2. Interest Rate. Borrower further promises to pay interest on the unpaid principal balance of this Note, which interest shall accrue at a simple rate of 12% per annum beginning on the date hereof. Quarterly interest payments shall be paid to Lender on or before each of October 1, 2005; and on January 2, April 1, and July 1, 2006 or on such earlier date as the entire principal amount shall become due and payable and shall be calculated on the basis of a 365-day year for the actual number of days elapsed. All principal of, and accrued and unpaid interest on, this Note shall be paid to the Lender on the Maturity Date.

3. Place of Payment. All amounts payable hereunder shall be payable to Lender at the following address: 2322 Nicodemus Road, Westminster, Maryland 21157.

4. Application of Payments. All payments on this Note shall first be applied to accrued interest and thereafter to the outstanding principal balance hereof.

5. Default.

5.1 Event of Default. The occurrence of any one or more of the following events shall constitute an event of default (“Event of Default”) hereunder:

(a) Failure to pay, when due, the principal, any interest, or any other sum payable hereunder;

(b) The admission by Borrower in writing of its inability to pay its debts as such debts become due, or the making by Borrower of any general assignment for the benefit of creditors;

(c) The commencement by Borrower of any case, proceeding, or other action seeking reorganization, arrangement, adjustment, liquidation, dissolution, or composition of its debts under any law relating to bankruptcy, insolvency, or reorganization, or relief of debtors, or seeking appointment of a receiver, trustee, custodian, or other similar official for it or for all or any substantial part of its property;

(d) The commencement of any case, proceeding, or other action against Borrower seeking to have any order for relief entered against it as debtor, or seeking reorganization, arrangement, adjustment, liquidation, dissolution, or composition of Borrower’s debts under any law relating to bankruptcy, insolvency, reorganization, or relief of debtors, or seeking appointment of a receiver, trustee, custodian, or other similar official for it or for all or any substantial part of the property of Borrower, and (i) Borrower, by any act or omission, indicates its consent to, approval of, or acquiescence in such case, proceeding, or action, or (ii) such case, proceeding, or action results in the entry of an order for relief which is not fully stayed within 60 days after the entry thereof, or (iii) such case, proceeding, or action remains undismissed for a period of 60 days or more; or

(e) Default in the performance of any obligation, covenant or agreement contained or referred to herein.

5.2 Consequences of Default. Upon the occurrence of any Event of Default, the entire principal amount hereof, and all accrued and unpaid interest thereon, shall be accelerated, and shall be due and payable, at the option of Lender, on the fifth day after Lender provides notice of such Event of Default, provided that such Event of Default is not cured to Lender’s satisfaction in that five-day period, and in addition thereto, and not in substitution therefor, Lender shall be entitled to exercise any one or more of the rights and remedies provided by applicable law. Failure to exercise said option or to pursue such other remedies shall not constitute a waiver of such option or such other remedies or of the right to exercise any of the same in the event of any subsequent Event of Default hereunder. Lender shall be entitled to collect all reasonable costs and expenses of collection and/or suit, including, but not limited to, reasonable attorneys’ fees.

6. Priority. All rights and priorities of the authorized holder of this Note and the indebtedness evidenced hereby shall rank in all respects junior to Borrower’s obligations under (i) that certain Guaranty dated September 11, 2003 between Key Bank and Borrower and (ii) that certain Guaranty dated July 22, 2003 between Dassault Systemes Corp. and Borrower and senior to all other indebtedness of the Borrower, including, without limitation, amounts owed under those obligations known as the 10% Subordinated Notes. Borrower shall not incur any indebtedness outside the ordinary course of business after the date hereof without Lender’s prior written consent.

7. IF ANY OF THE PAYMENTS OF PRINCIPAL AND/OR INTEREST ON THIS NOTE HAVE NOT BEEN PAID ON OR BEFORE THE DATE ON WHICH THE SAME ARE DUE AND PAYABLE (EXCEPT WITH RESPECT TO THE PERMISSIBLE SUSPENSION OF INTEREST PAYMENTS DESCRIBED HEREIN), WHETHER AS ORIGINALLY SCHEDULED, BY ACCELERATION, OR OTHERWISE, AND SUCH FAILURE TO PAY SHALL CONTINUE FOR TEN (10) DAYS AFTER WRITTEN NOTICE THEREOF, OR ANY OTHER DEFAULT OCCURS HEREUNDER, THE BORROWER DOES HEREBY AUTHORIZE AND EMPOWER THE CLERK OR ANY ATTORNEY OF ANY COURT OF RECORD HAVING JURISDICTION (INCLUDING FEDERAL COURT, IF APPROPRIATE JURISDICTION EXISTS) TO APPEAR FOR THE BORROWER BEFORE ANY SUCH COURT AND CONFESS JUDGMENT IN FAVOR OF THE LENDER AGAINST THE BORROWER FOR THE UNPAID PRINCIPAL BALANCE OF THIS NOTE, TOGETHER WITH ALL ACCRUED AND UNPAID INTEREST THEREON INCLUDING LATE CHARGES, AND TOGETHER WITH ALL COSTS OF SUIT AND ACTUAL ATTORNEYS’ FEES INCURRED AT STANDARD HOURLY RATES.

8. Waiver; Amendment. No delay or omission on the part of the Lender in the exercise of any right or remedy hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right or remedy preclude any other or further exercise thereof or the exercise of any other right or remedy. The Borrower hereby waives demand, presentment and protest and notices thereof as well as notice of non-payment. The provisions of this Note may be amended with the written consent of Borrower and Lender. The obligations of Borrower and the rights of Lender under this agreement may be waived by written notice delivered to Borrower.

9. Expenses. The Borrower agrees to pay on demand all costs and expenses, including, without limitation, reasonable attorney’s fees, incurred by the Lender in connection with this Note. In addition, the Borrower agrees to pay on demand all costs and expenses, including, without limitation, reasonable attorney’s fees, incurred by the Lender in endeavoring to enforce the rights of the Lender hereunder.

10. Governing Law. This Note shall be governed by, and construed and enforced in accordance with, the laws of the State of Maryland, excluding conflict of laws principles that would cause the application of laws of any other jurisdiction.

11. Assignment. This Note shall inure to the benefit of and be enforceable by Lender’s successors and authorized assigns, and shall be binding and enforceable against Borrower’s successors and assigns.

IN WITNESS WHEREOF, Borrower has executed this Note as of the date first written above.

WITNESS/ATTEST:	BORROWER:
	Avatech Solutions, Inc.
/s/ Christopher Olander	By:	/s/ Donald R. Walsh
Christopher Olander		Donald R. Walsh
Secretary		Chief Executive Officer

EX-10.2

Exhibit 10.2

No. W-106 38,878 shares

Avatech Solutions, Inc.

A Delaware Corporation

Common Stock, Par Value $.01 per share

Stock Purchase Warrant

W. James Hindman, or bearer of this warrant, is entitled, upon presentation of this Warrant and upon surrender of this warrant at the offices of the Company, to subscribe for, purchase and receive thirty-eight thousand eight hundred seventy-eight (38,878) shares of the Company’s common stock, for a purchase price of sixty cents ($.60) per share, provided, however, that no fractional shares will be issued. Upon such payment, the Company agrees to cause to be issued in the name of the registered holder, or his or her nominee, a certificate or certificates duly representing the shares so purchased.

In the event of the declaration and payment of share dividends by the Company on its Common Stock, or any split-up of the Common Stock, or recapitalization of the Company which changes the issued and outstanding shares of Common Stock, additional shares of the Company may be deliverable to the holder of this warrant upon the exercise of it without additional consideration, or the exercise price per share may be adjusted in the appropriate manner.

The purchase privilege herein contained shall expire on June 1, 2010.

Dated as of July 1, 2005.

Avatech Solutions, Inc.
By :	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer

EX-10.3

Exhibit 10.3

AVATECH SOLUTIONS, INC.

AMENDED AND RESTATED

RESTRICTED STOCK AWARD PLAN

Adopted May 14, 2003

Approved by the Shareholders October 30, 2003

Amended August 23, 2005

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”).

Administration. The Board of Directors (“Board”) of the Company shall supervise and administer the Plan. 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. The Compensation Committee of the Board of Directors (so long as the Compensation Committee is comprised of two or more non-employee directors within the meaning of Rule 16b-3 under the Exchange Act of 1934, 17 C.F.R. § 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 writing signed by a majority of the Committee members.

Awards. “Award Shares” are shares of Common Stock transferred to Participants (as defined in 0) pursuant to an Award in exchange for past or future service to the Company or its Subsidiaries without other payment therefore.

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.

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”).

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 0, the Unvested Shares will no longer be subject to restrictions on transfer, sale, assignment, etc. imposed by this Plan or any Award.

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.

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 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.

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:

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

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.

Shares Reserved Under the Plan. There is hereby reserved for issuance as Award Shares under the Plan an aggregate of 1,200,000 shares of Common Stock, which may be authorized but unissued or treasury shares.

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.

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.

Valuation. The fair market value of the Award Shares on any given day will be:

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;

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;

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.

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.

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

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.

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.

Duration, Amendment and Termination. 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.

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.

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.

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Donald R. Walsh, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Avatech Solutions, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: November 14, 2005	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Lawrence Rychlak, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Avatech Solutions, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: November 14, 2005	/s/ Lawrence Rychlak
	Lawrence Rychlak
	Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

SECTION 1350 CERTIFICATIONS

In connection with the Quarterly Report of Avatech Solutions, Inc. (the “Company”) on Form 10-Q for the period ending September 30, 2005 as filed with the Securities and Exchange Commission and to which this Certification is an exhibit (the “Report”), the undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company for the periods reflected therein.

Date: November 14, 2005	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer
	/s/ Lawrence Rychlak
	Lawrence Rychlak
	Vice President and Chief Financial Officer