10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2007

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

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

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

Class	Outstanding at May 1, 2007
Common Stock, par value $.01 per share	15,038,053

AVATECH SOLUTIONS, INC. AND SUBSIDIARIES

INDEX

		Page
PART I	FINANCIAL INFORMATION
ITEM 1.	Consolidated Financial Statements
	Consolidated Balance Sheets – March 31, 2007 (Unaudited) and June 30, 2006	3
	Consolidated Statements of Operations – Three months ended March 31, 2007 and 2006 (Unaudited)	5
	Consolidated Statements of Operations – Nine months ended March 31, 2007 and 2006 (Unaudited)	6
	Consolidated Statement of Stockholders’ Equity – Nine months ended March 31, 2007 (Unaudited)	7
	Consolidated Statements of Cash Flows – Nine months ended March 31, 2007 and 2006 (Unaudited)	8
	Notes to Consolidated Financial Statements (Unaudited)	9
ITEM 2.	Management’s Discussion and Analysis of Results of Operations and Financial Condition	14
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	22
ITEM 4.	Controls and Procedures	23
PART II	OTHER INFORMATION
ITEM 1A.	Risk Factors	23
ITEM 6.	Exhibits	23
SIGNATURES		24

PART I. FINANCIAL INFORMATION

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets

	March 31, 2007		June 30, 2006
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	1,306,000	$	581,000
Accounts receivable, less allowance of $145,000 as of March 31, 2007 and $112,000 as of June 30, 2006		9,108,000		5,471,000
Other receivables		435,000		320,000
Inventory		884,000		1,414,000
Prepaid expenses and other current assets		281,000		305,000
Total current assets		12,014,000		8,091,000
Property and equipment:
Computer software and equipment		2,918,000		2,649,000
Office furniture and equipment		1,139,000		1,048,000
Leasehold improvements		170,000		133,000
		4,227,000		3,830,000
Less accumulated depreciation and amortization		3,255,000		2,960,000
		972,000		870,000
Customer list, net of accumulated amortization of $313,000 as of March 31, 2007 and $100,000 as of June 30, 2006		1,873,000		1,900,000
Goodwill		5,888,000		5,864,000
Other assets		95,000		125,000
Total assets	$	20,842,000	$	16,850,000

See accompanying notes.

3

Avatech Solutions, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)

	March 31, 2007			June 30, 2006
	(unaudited)
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable and accrued expenses	$	6,062,000		$	5,097,000
Accrued compensation and related benefits		1,014,000			725,000
Borrowings under lines-of-credit		1,561,000			1,409,000
Current portion of long-term debt		37,000			43,000
Deferred revenue		1,149,000			1,022,000
Other current liabilities		231,000			156,000
Total current liabilities		10,054,000			8,452,000
Long-term debt		3,000			51,000
Other long-term liabilities		1,000			67,000
Commitments and contingencies		—			—
Series F Convertible Preferred Stock		3,629,000			3,629,000
Stockholders’ equity:
Convertible Preferred Stock, $0.01 par value; 1,300,537 shares authorized and 1,298,728 issued at March 31, 2007 and June 30, 2006; outstanding shares of 1,148,721 at March 31, 2007 and 1,190,387 at June 30, 2006 with an aggregate liquidation preference of $1,892,000 at March 31, 2007 and June 30, 2006		12,000			12,000
Common stock, $0.01 par value; 80,000,000 shares authorized; issued and outstanding shares of 14,954,656 at March 31, 2007 and 13,517,296 at June 30, 2006		149,000			135,000
Additional paid-in capital		12,772,000			10,601,000
Accumulated deficit		(5,778,000	)		(6,097,000	)
Total stockholders’ equity		7,155,000			4,651,000
Total liabilities and stockholders’ equity	$	20,842,000		$	16,850,000

See accompanying notes.

4

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations

	Three Months Ended March 31,
	2007			2006
	(unaudited)			(unaudited)
Revenues:
Product sales	$	9,094,000		$	6,926,000
Service revenue		2,802,000			1,836,000
Commission revenue		2,688,000			2,251,000
		14,584,000			11,013,000
Cost of revenue:
Cost of product sales		6,236,000			3,827,000
Cost of service revenue		1,876,000			1,308,000
		8,112,000			5,135,000
Gross margin		6,472,000			5,878,000
Other operating expenses:
Selling, general and administrative		6,403,000			4,631,000
Depreciation and amortization		180,000			98,000
		6,583,000			4,729,000
Operating income (loss)		(111,000	)		1,149,000
Other income (expense):
Gain on early extinguishment of debt		—			233,000
Interest and other income		12,000			8,000
Interest expense		(42,000	)		(93,000	)
		(30,000	)		148,000
Income (loss) before income taxes		(141,000	)		1,297,000
Income tax expense		83,000			20,000
Net income (loss)		(224,000	)		1,277,000
Preferred stock dividends		(45,000	)		(48,000	)
Net income (loss) available to common stockholders	$	(269,000	)	$	1,229,000
Earnings (loss) per common share, basic	$	(0.02	)	$	0.11
Earnings (loss) per common share, diluted	$	(0.02	)	$	0.07
Shares used in computation—basic		14,484,564			11,585,455
Shares used in computation—diluted		14,484,564			17,338,249

See accompanying notes.

5

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Operations

	Nine Months Ended March 31,
	2007			2006
	(unaudited)			(unaudited)
Revenues:
Product sales	$	23,614,000		$	18,871,000
Service revenue		7,767,000			5,563,000
Commission revenue		7,660,000			5,258,000
		39,041,000			29,692,000
Cost of revenue:
Cost of product sales		15,418,000			11,029,000
Cost of service revenue		5,442,000			3,706,000
		20,860,000			14,735,000
Gross margin		18,181,000			14,957,000
Other operating expenses:
Selling, general and administrative		16,998,000			12,219,000
Depreciation and amortization		515,000			291,000
		17,513,000			12,510,000
Operating income		668,000			2,447,000
Other income (expense):
Gain on early extinguishment of debt		—			233,000
Interest and other income		43,000			15,000
Interest expense		(193,000	)		(356,000	)
		(150,000	)		(108,000	)
Income before income taxes		518,000			2,339,000
Income tax expense		199,000			52,000
Net income		319,000			2,287,000
Preferred stock dividends		(260,000	)		(137,000	)
Net income available to common stockholders	$	59,000		$	2,150,000
Earnings per common share, basic	$	0.00		$	0.19
Earnings per common share, diluted	$	0.00		$	0.14
Shares used in computation - basic		13,908,920			11,231,776
Shares used in computation - diluted		15,386,200			16,610,646

See accompanying notes.

6

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Equity (Unaudited)

	Preferred Stock				Common Stock
	Number of Shares		Par Value		Number of Shares	Par Value		Additional Paid-In Capital			Accumulated Deficit			Total
Balance at July 1, 2006	1,190,387		$	12,000	13,517,296	$	135,000	$	10,601,000		$	(6,097,000	)	$	4,651,000
Issuance of common stock as compensation	—			—	36,493		—		60,000			—			60,000
Issuance of common stock upon the exercise of stock options	—			—	30,858		—		16,000			—			16,000
Issuance of common stock under Employee Stock Purchase Plan	—			—	173,583		2,000		207,000			—			209,000
Vesting of stock options issued to employees	—			—	—		—		618,000						618,000
Issuance of common stock through private placement	—			—	1,085,170		11,000		1,531,000			—			1,542,000
Issuance of common stock pursuant to anti-dilution provision of previous offering	—			—	27,840		—		—			—			—
Conversion of preferred stock into common stock	(41,666	)		—	83,416		1,000		(1,000	)		—			—
Preferred stock dividends	—			—	—		—		(260,000	)		—			(260,000	)
Net income	—			—	—		—		—			319,000			319,000
Balance at March 31, 2007	1,148,721		$	12,000	14,954,656	$	149,000	$	12,772,000		$	(5,778,000	)	$	7,155,000

See accompanying notes.

7

Avatech Solutions, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

	Nine Months Ended March 31,
	2007			2006
	(unaudited)
Cash flows from operating activities
Net income	$	319,000		$	2,287,000
Adjustments to reconcile net income to net cash (used in) provided byby by operating activities:
Provision for (recovery) of bad debts		56,000			(2,000	)
Depreciation and amortization		515,000			291,000
Non-cash stock compensation expense		678,000			153,000
Loss on disposal of assets		—			9,000
Gain on early extinguishment of debt		—			(233,000	)
Changes in operating assets and liabilities:
Accounts and other receivables		(3,752,000	)		(25,000	)
Inventory		530,000			(664,000	)
Prepaid expenses and other current assets		24,000			52,000
Other assets		30,000			23,000
Accounts payable and accrued expenses		965,000			(200,000	)
Accrued compensation and related benefits		289,000			349,000
Deferred revenue		127,000			255,000
Other current liabilities		75,000			(146,000	)
Net cash (used in) provided by operating activities		(144,000	)		2,149,000
Cash flows from investing activities
Purchase of property and equipment		(395,000	)		(144,000	)
Acquisition of customer list		(224,000	)		—
Net cash used in investing activities		(619,000	)		(144,000	)
Cash flows from financing activities
Proceeds from borrowings under line-of-credit		52,503,000			41,154,000
Repayments of borrowings under line-of-credit		(52,351,000	)		(43,092,000	)
Repayments of long-term debt		(54,000	)		(1,447,000	)
Proceeds from sale of common stock through private placement		1,529,000			—
Proceeds from sale of preferred stock		—			1,191,000
Proceeds from sale of common stock to employees and exercise of stock options		225,000			266,000
Payment of preferred stock dividends		(260,000	)		(137,000	)
Change in accounts payable and accrued expenses related to financing financing		(38,000	)		78,000
Change in other long-term liabilities		(66,000	)		(141,000	)
Net cash provided by (used in) financing activities		1,488,000			(2,128,000	)
Net change in cash and cash equivalents		725,000			(123,000	)
Cash and cash equivalents - beginning of period		581,000			295,000
Cash and cash equivalents - end of period	$	1,306,000		$	172,000

See accompanying notes.

8

Avatech Solutions, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2007

1. Basis of Presentation

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

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect all adjustments (consisting of normal recurring accruals) which are, in management’s opinion, necessary to present a fair statement of results of the interim periods presented. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006. Operating results for the three and nine months ended March 31, 2007 are not necessarily indicative of results for the full fiscal year or any future interim period.

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

2. Recent Accounting Pronouncements

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

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

9

3. Employee Stock Compensation Plans

During fiscal year 2006, the Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment” (Statement 123R), which requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Previously, the Company accounted for stock-based compensation plans and the employee stock purchase plan in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations and provided the required pro forma disclosures of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation”. On July 1, 2005, the Company elected to adopt the modified prospective transition method as provided by Statement 123R. Under this transition method, compensation cost recognized during fiscal year 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant-date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of Statement 123R. The effect of applying Statement 123R was a decrease to net income of $365,000 for the quarter ended March 31, 2007, or $0.03 per basic and diluted share. For the nine months ended March 31, 2007, the effect of applying this Statement was $618,000, or $0.04 per basic and diluted share.

The Board of Directors may grant options under the Avatech Solutions, Inc. 2002 Stock Option Plan to purchase shares of the Company’s common stock at an exercise price of not less than the fair market value of the common stock on the date of grant. The plan provides for the granting of either incentive or non-qualified stock options to purchase an aggregate of up to 3,100,000 shares of common stock to eligible employees, officers, and directors of the Company. Stock options generally have a maximum term of 10 years. Options generally vest ratably over three or four years, depending on the specific grant award. For the three and nine months ended March 31, 2007, the Company issued 11,334 and 20,893 shares, respectively, of fully vested common stock to members of the Board of Directors under the Company’s Restricted Stock Award Plan, with an aggregate market value of $17,000 and $34,000, respectively. For the three and nine months ended March 31, 2007, total stock compensation expense charged against income for these plans was $390,000 and $678,000, respectively.

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

There were no stock options granted during the three months ended March 31, 2007. The following are the assumptions made in computing the fair value of stock-based awards for the other periods presented:

	Three months ended March 31,				Nine months ended March 31,
	2007	2006			2007			2006
Average risk-free interest rate	—		4.31	%		4.62	%		4.37	%
Dividend yield	—		0	%		0	%		0	%
Expected term	—		6.1 years			5.9 years			6.1 years
Average expected volatility	—		1.27			1.05			1.28
Weighted average fair value of granted options	—	$	1.42		$	1.39		$	1.31

10

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

A summary of stock option activity during the nine months ended March 31, 2007 and related information is included in the table below:

	Options		Weighted- Average Exercise Price		Aggregate Intrinsic Value
Outstanding at July 1, 2006	2,001,588		$	0.92
Granted	328,000			1.68
Exercised	(30,858	)		0.56
Forfeited	(32,924	)		1.68
Outstanding at March 31, 2007	2,265,806		$	1.02	$	1,314,000
Exercisable at March 31, 2007	1,675,765		$	0.92	$	1,140,000
Weighted-average remaining contractual life	7.8 Years

There were not stock options granted during the three months ended March 31, 2007. All options granted have an exercise price equal to the fair market value of the Company’s common stock on the date of grant. Exercise prices for options outstanding as of March 31, 2007 ranged from $0.12 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
$ 0.12 -0.34	579,602	$	0.17	6.2 years	569,602	$	0.17	6.2 years
0.35 – 0.91	794,667		0.64	7.7 years	648,001		0.64	7.6 years
1.05 –63.33	891,537		1.90	8.9 years	458,162		2.28	8.7 years
	2,265,806				1,675,765

Assuming that no additional share-based payments are granted after March 31, 2007, unamortized stock compensation expense of $527,000 will be recognized in the statement of operations over a weighted average period of 2.4 years.

4. Borrowings Under Line-of-Credit

The Company maintains a line of credit from a bank which provides for up to $5 million of borrowings limited to 80% of the Company’s aggregate eligible accounts receivable. The loan bears interest at a rate tied to the bank’s prime rate adjusted for changes in the Company’s capital structure. The interest rate ranges from the bank’s prime rate plus two percent to a low of the bank’s prime rate plus 0.25%. Based on the Company’s capital structure, the interest rate for the quarter ended March 31, 2007 was the bank’s prime rate plus one and one-half percent (9.75 % at March 31, 2007). The loan was renewed prior to its December 31, 2006 expiration date with a two year extension through December 31, 2008 and is secured by all of the Company’s assets, except inventory.

The aggregate outstanding borrowings from the bank under this credit line were $1,561,000 and $1,409,000 at March 31, 2007 and June 30, 2006, respectively.

11

5. Long-Term Debt

The Company entered into two loans in connection with its April 2005 acquisition of Comtrex Corporation which totaled $40,000 as of March 31, 2007.

6. Income Taxes

Income tax expense relates to the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Company’s profitable results. The Company, however, has significant net operating loss carry forwards however these carryforwards may be subject to certain limitations under Section 382 of the Internal Revenue Code. For all periods presented, valuation allowances have been provided for the full amount of all net deferred tax assets.

7. Earnings Per Share

Basic earnings per common share is computed as net earnings available to common stockholders divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share include the potential dilution that would occur from common shares issuable upon the exercise of outstanding stock options and warrants and the conversion of the Company’s preferred stock. As of March 31, 2007, 11,324,022 shares of common stock were issuable upon the conversion or exercise of options, warrants and preferred stock. For the three and nine months ended March 31, 2007, there were 7,557,742 and 7,991,669, respectively, of common stock equivalents excluded from the computation of diluted earnings per share because their effect would have been antidilutive.

The following summarizes the computations of basic and diluted earnings per common share for the three months ended March 31, 2007 and 2006:

	Three Months Ended March 31,
	2007			2006
Numerator for basic earnings per share:
Net (loss) income	$	(224,000	)	$	1,277,000
Less: preferred stock dividends		(45,000	)		(48,000	)
Net (loss) income available to common stockholders	$	(269,000	)	$	1,229,000
Denominator:
Weighted average shares outstanding—basic		14,484,564			11,585,455
Assumed conversion of preferred stock		—			4,212,709
Effect of outstanding stock options		—			1,130,553
Effect of outstanding stock warrants		—			409,532
Weighted average shares outstanding—fully diluted		14,484,564			17,338,249
Earnings (loss) per common share—basic	$	(0.02	)	$	0.11
Earnings (loss) per common share—diluted	$	(0.02	)	$	0.07

12

	Nine Months Ended March 31,
	2007			2006
Numerator for basic earnings per share:
Net income	$	319,000		$	2,287,000
Less: preferred stock dividends		(260,000	)		(137,000	)
Net income available to common stockholders—basic	$	59,000		$	2,150,000
Numerator for fully diluted earnings per share:
Net income	$	319,000		$	2,287,000
Less: preferred stock dividends		(260,000	)		—
Net income available to common stockholders—fully diluted	$	59,000		$	2,287,000
Denominator:
Weighted average shares outstanding—basic		13,908,920			11,231,776
Assumed conversion of preferred stock		—			4,297,776
Effect of outstanding stock options		1,087,807			815,020
Effect of outstanding stock warrants		389,473			266,074
Weighted average shares outstanding—fully diluted		15,386,200			16,610,646
Earnings (loss) per common share—basic	$	0.00		$	0.19
Earnings (loss) per common share—diluted	$	0.00		$	0.14

8. Liquidity and Capital Resources

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

As a result of terms of the private placement, in February 2007 the Company issued 27,840 shares of common stock to two investors to satisfy the anti-dilution provisions of their Stock Purchase Agreements dated June 2006.

The Company’s operations have significantly improved over the last twelve months and management believes that the Company has generated sufficient capital to fund its operations and strengthen its balance sheet. As of March 31, 2007, the Company had working capital of $1,960,000 and its stockholders’ equity was $7,155,000. Based on an evaluation of likely cash to be generated from operations in the near term and other available capital resources, management believes that it has sufficient sources of working capital to fund its operations in the normal course of business.

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

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

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

Overview

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

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

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

• employing highly qualified professionals in specialized areas;

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

• focusing on solutions and services selling.

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

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

• Archibus facilities management software for space planning, strategic planning, and lease/property administration;

• Cyco engineering data management solutions using Meridian software; and

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• Autodesk data management software.

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

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

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

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

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

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

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

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

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Three Months Ended March 31, 2007 Compared to the Three Months Ended March 31, 2006

The following tables set forth a comparison of the Company’s results of operations for the three-month period ended March 31, 2007 to the three-month period ended March 31, 2006. The amounts are derived from selected items reflected in the Company’s unaudited Consolidated Statements of Operations included elsewhere in this report. The three months financial results are not necessarily indicative of future results.

Revenues

	Three Months Ended March 31,
	2007		2006		% increase
Revenues:
Product sales	$	9,094,000	$	6,926,000	31.3	%
Service revenue		2,802,000		1,836,000	52.6	%
Commission revenue		2,688,000		2,251,000	19.4	%
Total revenues	$	14,584,000	$	11,013,000	32.4	%

Revenues. Total revenues for the three months ended March 31, 2007 increased $3,571,000, or 32.4%, when compared to the same period last year due to growth in all revenue categories. Subsequent to the May 2006 acquisition of Sterling Systems & Consulting, Inc. (“Sterling”), the Company integrated all Sterling personnel into a reorganized organization and as a result, lost the ability to accurately track the revenues from the pre-acquisition Sterling. However, the offices that were previously owned, managed and staffed with all Sterling personnel accounted for product sales of approximately $2,254,000, service revenue of $375,000 and commission revenue of $446,000 for the three months ended March 31, 2007.

Product sales increased to $9,094,000 for the quarter, an increase of $2,168,000 from the quarter ended March 31, 2006, or 31.3%, primarily due to the Sterling acquisition.

Service revenue showed the most significant growth, increasing by $966,000, or 52.6%, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year. Service revenue from the offices acquired in the Sterling acquisition accounted for approximately 39% of the increase with the remainder due to organic growth.

Commission revenue increased by 19.4%, or $437,000, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year, the result of the Sterling acquisition.

Cost of Revenues and Gross Margin

	Three Months Ended March 31,
	2007		2006		% increase
Cost of revenue:
Cost of product sales	$	6,236,000	$	3,827,000	62.9	%
Cost of service revenue		1,876,000		1,308,000	43.4	%
Total cost of revenue	$	8,112,000	$	5,135,000	58.0	%
Gross margin	$	6,472,000	$	5,878,000

Cost of revenue. The total cost of revenue increased $2,977,000, or 58.0%, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year.

The Company earns sales incentives from its primary supplier, Autodesk, based upon its achievement of sales targets and those incentives increase significantly when sales exceed 115% of the targeted amounts. Historically, these incentives were approximately 13% to 15% of product sales and were accounted for as a reduction of the cost of product

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sales. There were significant changes to the Company’s incentive plan that were communicated too late in the quarter to enable the Company to maximize its awards under the revised plan. As a result, most of the incentive targets given to the Company by Autodesk for the period that included the months of February 2007 and March 2007 were not achieved in spite of the Company’s 31.3% growth in product sales. Thus, the Company earned incentives totaling 2.3% of product sales, or approximately $725,000 less than the average amounts it had received over the previous five quarters. The Company and Autodesk are working to come to agreement on the incentive targets for future quarters.

As a direct result of the lower sales incentives realized by the Company, the cost of product sales for the second quarter of the current fiscal year were 62.9%, when compared to the second quarter of last year despite the fact that product sales increased by only 31.3% between periods. The cost of product sales as a percentage of related revenue for the three months ended March 31, 2007 was 68.6%, compared to 55.3% for the same period in 2006.

Cost of service revenue increased $568,000, or 43.4%, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year, while service revenues increased 52.6% to $2,802,000. Cost of service revenue as a percentage of related revenue for the three months ended March 31, 2007 decreased to 67.0% from 71.3% for the same period in the prior fiscal year. The Company hired a number of technical personnel during its first and second quarters of the current fiscal year and is beginning to see an increase in the billable utilization of these new hires. The Company expects that its services gross margins will continue to increase as the recently-hired personnel become more productive.

Gross margin. Due to the lowered sales incentives earned by the Company the overall gross margin percentage for the three months ended March 31, 2007 was 44.4% as compared to 53.4% for same period in the prior fiscal year.

Other Operating Expenses

	Three Months Ended March 31,
	2007		2006		% increase
Other operating expenses:
Selling, general and administrative	$	6,403,000	$	4,631,000	38.3	%
Depreciation and amortization		180,000		98,000	83.7	%
Total other operating expenses	$	6,583,000	$	4,729,000	39.2	%

Selling, General and Administrative Expense. Selling, general and administrative expenses increased $1,772,000, or 38.3%, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year. In February 2007, the Company’s President and Chief Operating Officer stepped down and in accordance with the terms of his employment agreement the Company accrued approximately $525,000 as severance costs for the three months ended March 31, 2007. Excluding the charge for severance costs, selling, general and administrative expense as a percent of total revenues was 40.3% for the three months ended March 31, 2007, down from 42.1% for the same period in the prior fiscal year.

Depreciation and Amortization. Depreciation and amortization expenses increased $82,000, or 83.7%, for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year. The increase was due to the additional depreciation as a result of the purchases of fixed assets in the current quarter, depreciation of the Sterling assets acquired and the amortization of the intangible asset, the Sterling customer list.

Other Income (Expense)

	Three Months Ended March 31,
	2007			2006			% increase
Other income (expense):
Gain on early extinguishment of debt	$	—		$	233,000		(100.0	)%
Interest and other income		12,000			8,000		50.0	%
Interest expense		(42,000	)		(93,000	)	(54.8	)%
Total other income (expense)	$	(30,000	)	$	148,000		(120.3	)%

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Other Income (Expense). Other income (expense) decreased $178,000 for the three months ended March 31, 2007 when compared to the same period in the prior fiscal year. This decrease was attributable primarily to the gain on early extinguishment of debt that occurred in the prior period offset by a decrease in interest expense and lowered borrowing levels as a result of the Company’s strengthened liquidity and overall financial position.

Income Tax Expense

	Three Months Ended March 31,
	2007		2006		% increase
Income tax expense	$	83,000	$	20,000	315.0	%

Income Tax Expense. As a result of its loss before income taxes, the Company recorded an $83,000 tax provision for the three months ended March 31, 2007 when compared to a $20,000 tax provision in the same period in the prior fiscal year. The increase in tax expense relates to the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Company’s results. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes until fiscal 2008. As the Company continues to demonstrate its ability to consistently earn net income, some portion of the deferred tax asset valuation allowance may need to be reversed in future periods. The Company will continue to evaluate the likelihood of this asset being realized and will adjust the valuation allowance when circumstances warrant its recordation.

Nine Months Ended March 31, 2007 Compared to the Nine Months Ended March 31, 2006

The following tables set forth a comparison of the Company’s results of operations for the nine month period ended March 31, 2007 to the nine month period ended March 31, 2006. The amounts are derived from selected items reflected in the Company’s unaudited Consolidated Statements of Operations included elsewhere in this report. The nine months financial results are not necessarily indicative of future results.

Revenues

	Nine Months Ended March 31,
	2007		2006		%
Revenues:
Product sales	$	23,614,000	$	18,871,000	25.1	%
Service revenue		7,767,000		5,563,000	39.6	%
Commission revenue		7,660,000		5,258,000	45.7	%
Total revenues	$	39,041,000	$	29,692,000	31.5	%

Revenues. The Company realized significant revenue growth during the nine months ended March 31, 2007 over the same period in the prior fiscal year. Total revenues increased $9,349,000, or 31.5%, between periods and all three categories of revenues showed large increases. As previously noted, the Company integrated all Sterling personnel into a reorganized organization and as a result, lost the ability to accurately track the revenues from the pre-acquisition Sterling. However, the offices that were previously owned, managed and staffed with all Sterling personnel accounted for product sales of approximately $5,102,000, service revenue of $1,023,000 and commission revenue of $1,115,000 for the nine months ended March 31, 2007, or a total of $7,240,000.

Product sales increased to $23,614,000 for the nine months ended March 31, 2007, an increase of $4,743,000 over the same period in 2006, or 25.1% due to the Sterling acquisition.

Service revenues increased $2,204,000, or 39.6%, for the nine months ended March 31, 2007 as compared to the same period in the prior fiscal year. The Company continued its strategy of investing in its services business by adding personnel and expanding its training, support and consulting capabilities. This strategy, coupled with the Sterling acquisition, resulted in the large growth in its services revenues.

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Commission revenues increased $2,402,000, or 45.7% for the nine months ended March 31, 2007, when compared to the same period in the prior fiscal year. Approximately 46% of the increase in commission revenues was a result of the Sterling acquisition. The remaining increase in commission revenues was a result of a significant industry-wide increase in sales volume and a continued focus by the Company and Autodesk to increase this category of business.

Cost of Revenues and Gross Margin

	Nine Months Ended March 31,
	2007		2006		%
Cost of revenue:
Cost of product sales	$	15,418,000	$	11,029,000	39.8	%
Cost of service revenue		5,442,000		3,706,000	46.8	%
Total cost of revenue	$	20,860,000	$	14,735,000	41.6	%
Gross margin	$	18,181,000	$	14,957,000

Costs of revenue. Total cost of revenue increased $6,125,000, or 41.6%, for the nine months ended March 31, 2007 as compared to the same period in the prior fiscal year.

The Company earns sales incentives based upon its achievement of sales targets and those incentives increase significantly when sales exceed 115% of the targeted amounts. Historically, these incentives were approximately 13% to 15% of product sales and were accounted for as a reduction of the cost of product sales. Most of the incentive targets given to the Company by Autodesk for the period that included the months of February 2007 and March 2007 were not achieved in spite of the Company’s 31.3% growth in product sales. As a result, the Company earned incentives totaling 2.3% of product sales, or approximately $725,000 less than the average amounts it had received over the previous five quarters. The Company and Autodesk are working to come to agreement on the incentive targets for future quarters.

As a direct result of the lower sales incentives realized by the Company during its third fiscal quarter, the cost of product sales for the nine months ended March 31, 2007 increased $4,389,000, or 39.8%, when compared to the same period in the prior fiscal year despite only a 25.1% increase in product revenues. The cost of product sales as a percentage of related revenue for the nine months ended March 31, 2007 was 65.3%, compared to 58.4% in the same period in 2006.

Cost of service revenue increased $1,736,000, or 46.8%, for the nine months ended March 31, 2007 when compared to the same period in the prior fiscal year, but service revenues increased by only 39.6%. As a result, cost of service revenue as a percentage of related revenue for the nine months ended March 31, 2007 increased to 71.1% from 66.6% for the same period in the prior fiscal year. The Company hired a number of technical personnel during its first and second quarter of the current fiscal year and it has taken longer than expected to increase the billable utilization of these new hires. The Company expects that its service revenue will increase once these personnel are fully trained and increase their billable hours resulting in an increase to the service gross margin percentage. The cost of service revenue as a percentage of related revenue for the third fiscal quarter dropped to 67.0% evidencing the increasing utilization of the personnel within the services division.

Gross margin. For the previously-stated reasons, the Company’s gross margin percentage decreased from 50.4% for the nine months ended March 31, 2006 to 46.6% for the same period in the current fiscal year.

Other Operating Expenses

	Nine Months Ended March 31,
	2007		2006		%
Other operating expenses:
Selling, general and administrative	$	16,998,000	$	12,219,000	39.2	%
Depreciation and amortization		515,000		291,000	77.0	%
Total other operating expenses	$	17,513,000	$	12,510,000	40.0	%

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Selling, General and Administrative Expense. Selling, general and administrative expenses increased $4,779,000, or 39.2%, for the nine months ended March 31, 2007 when 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 as well as severance costs incurred in the third fiscal quarter as a result of the departure of the Company’s President and Chief Operating Officer. Excluding the charge for severance costs, selling, general and administrative expense as a percent of total revenues was 42.1% for the nine months ended March 31, 2007, compared to 41.2% for the same period in the prior fiscal year due to the acquisition of Sterling in May 2006 and new sales personnel hired in the past twelve months.

Depreciation and Amortization. Depreciation and amortization expenses increased $224,000, or 77.0%, for the nine months ended March 31, 2007 when compared to the same period in the prior fiscal year. These expenses increased due to the Company’s investment in upgrading its information technology infrastructure, purchases of new, upgraded computers for several of the Company’s training centers as well as for new personnel that were hired during the last twelve months and the amortization of a customer list, recorded as a result of the Company’s purchase of Sterling in May 2006.

Other income (expense)

	Nine Months Ended March 31,
	2007			2006			%
Other income (expense):
Gain on early extinguishment of debt	$	—		$	233,000		(100.0	)%
Interest and other income		43,000			15,000		186.7	%
Interest expense		(193,000	)		(356,000	)	(45.8	)%
Total other income (expense)	$	(150,000	)	$	(108,000	)	38.9	%

Other Income (Expense). Other income (expense) increased $42,000 for the nine months ended March 31, 2007 when compared to the same period in the prior fiscal year. This increase was attributable primarily to the gain on early extinguishment of debt that occurred the prior period offset by a decrease in interest expense and lowered borrowing levels as a result of the Company’s strengthened liquidity and overall financial position.

Income tax expense

	Nine Months Ended March 31,
	2007		2006		%
Income tax expense	$	199,000	$	52,000	282.7	%

Income Tax Expense. The Company recorded a provision for income taxes of $199,000 for the nine months ended March 31, 2007 for the recordation of state income taxes and a federal alternative minimum tax provision as a result of the Company’s profitable results compared to $52,000 for the same period in the prior year. The Company, however, has significant net operating loss carry forwards and does not expect to pay significant federal income taxes until fiscal 2008. As the Company continues to demonstrate its ability to consistently earn net income, some portion of the deferred tax asset valuation allowance may need to be reversed in future periods. The Company will continue to evaluate the likelihood of this asset being realized and will adjust the valuation allowance when circumstances warrant its recordation.

Liquidity and Capital Resources

Historically, the Company has financed its operations and met its capital expenditure requirements primarily through cash flows provided by operations, borrowings under short-term and long-term debt arrangements, and sales of its securities. See Note 8 to the Company’s consolidated financial statements contained elsewhere in this report for information about the recent sale of securities.

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

The Company’s investing activities consist principally of investments in computer and office equipment. Capital expenditures for the nine months ended March 31, 2007 were approximately $395,000 compared to $144,000 for the same period in 2006.

For the nine months ended March 31, 2007, net cash used in operating activities was $144,000, an increase of $2,293,000 over the same period in 2006. The major difference between the periods was that the Company’s accounts and other receivables increased by $3,752,000 for the nine months ended March 31, 2007 compared with an increase of $25,000 during the same period in 2006. The accounts receivable grew due to sales levels. The increase in accounts and other receivables was offset by a $965,000 increase in accounts payable, a $530,000 growth in inventory levels and non-cash compensation expense of $678,000.

For the nine months ended March 31, 2007, the Company was provided with $1,488,000 of cash by financing activities compared with using cash of $2,128,000 for the same period in 2006. The main reason for this difference was reduced net borrowings on the line of credit between periods and the proceeds of the private placement of common stock during the third fiscal quarter ending March 31, 2007.

The Company maintains a line of credit from a bank which provides for up to $5 million of borrowings limited to 80% of the Company’s aggregate eligible accounts receivable. The loan bears interest at a rate tied to the bank’s prime rate adjusted for changes in the Company’s capital structure. The interest rate ranges from the bank’s prime rate plus two percent to a low of the bank’s prime rate plus 0.25%. Based on the Company’s capital structure, the interest rate for the quarter ended March 31, 2007 was the bank’s prime rate plus one and one-half percent (9.75 % at March 31, 2007). The loan was renewed prior to its March 31, 2007 expiration date with a two year extension through December 31, 2008 and is secured by all of the Company’s assets, except inventory.

The total borrowings from the bank under this line of credit were approximately $1.6 million and $1.4 million as of March 31, 2007 and 2006, respectively.

Outstanding long-term debt totaled approximately $3,000 at March 31, 2007, and the Company had working capital of approximately $1,960,000.

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

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

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Below is a summary of the Company’s contractual obligations and commitments at March 31, 2007:

	Total		Less than 1 year		1 – 3 years		3 – 5 years		More than 5 years
Contractual Obligations
Line of credit	$	1,561,000	$	1,561,000	$	—	$	—	$	—
Long-term obligations		40,000		37,000		3,000		—		—
Interest on fixed rate obligations		1,000		1,000		—		—		—
Operating leases		4,772,000		1,569,000		2,073,000		1,130,000		—
Capital lease obligations		42,000		42,000		—		—		—
Total obligations	$	6,416,000	$	3,210,000	$	2,076,000	$	1,130,000	$	—

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk from changes in interest rates associated with its variable rate line-of-credit. At March 31, 2007, virtually of the outstanding debt bore interest at variable rates. Accordingly, the Company’s earnings and cash flow are affected by changes in interest rates. Assuming the current level of borrowings at variable rates and assuming a 100 basis point change in the average interest rate under these borrowings, the Company estimates that its interest expense and net income would have changed by less than $10,000 for the nine months ended March 31, 2007. In the event of an adverse change in interest rates, management would likely take actions to further mitigate this exposure. However, due to the uncertainty of the actions that would be taken and their possible effects, the analysis assumes no such actions. Further, the analysis does not consider the effects of the change in the level of overall economic activity that could exist in such an environment.

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ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of March 31, 2007 was carried out under the supervision and with the participation of management, including the CEO and the CFO. Based on that evaluation, management, including the CEO and the CFO, has concluded that the Company’s disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

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

PART II. OTHER INFORMATION

ITEM 1A. Risk Factors

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

ITEM 6. EXHIBITS

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

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SIGNATURES

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

	AVATECH SOLUTIONS, INC.
Date: May 15, 2007	By	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer
Date: May 15, 2007	By	/s/ Lawrence Rychlak
	Lawrence Rychlak
	Executive Vice President and Chief Financial Officer
	(Principal financial and accounting officer)

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EXHIBIT INDEX

Exhibit	Description
3.1	Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)
3.2	First Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)
3.3	Reverse Split Amendment to Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)
3.4	Amendment of PlanetCAD’s Certificate of Incorporation to change the name of PlanetCAD, Inc. to Avatech Solutions, Inc. (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)
3.5	Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock (incorporated by reference to our Current Report on form 8-K, filed on May 28, 2002, File No. 001-31265)
3.6	Certificate of Amendment to Certificate of Designation of Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No. 001-31265)
3.7	Certificate of Amendment to Amended and Restated Certificate of Incorporation (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)
3.8	Certificate of Designation, Preferences and Rights of Series E Convertible Preferred Stock (incorporated by reference to our Current Report on form 8-K, filed on August 9, 2005, File No. 001-31265)
3.9	Certificate of Designation, Preferences and Rights of Series F Convertible Preferred Stock (incorporated by reference to Exhibit 10.22 hereto)
3.10	By-Laws (incorporated by reference to our Registration Statement on form SB-2 filed on November 21, 2000, File No. 333-50426)
10.01	Lease by and between Merritt-DM1, LLC and Avatech Solutions, Inc. effective June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)
10.02	Form of Purchase Agreement for Series D Convertible Preferred Stock (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 13, 2004, File No. 001-31265)
10.03	2002 Stock Option Plan (incorporated by reference to our Registration Statement on form S-4 filed on May 30, 2002, File No. 333-89386)
10.04	Restricted Stock Award Plan (incorporated by reference to our Registration Statement on form S-1, filed on March 26, 2003, File No. 333-104035)
10.05	Avatech Solutions, Inc. Employee Stock Purchase Plan (incorporated by reference to our Definitive Proxy Statement on form 14A, filed on May 7, 2004, File No. 001-31265)
10.06	Employment Agreement by and between Donald R. “Scotty” Walsh and Avatech Solutions, Inc. dated July 1, 2003 (incorporated by reference to our Annual Report on form 10-K, filed on October 3, 2003, File No. 001-31265)
10.07	Employment Agreement by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. dated as of June 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)
10.08	Separation Agreement dated February 28, 2007 by and between W. Scott Harris and Avatech Solutions Subsidiary, Inc. (incorporated by reference to Exhibit 10.1 of our Form 8-K filed on March 2, 2007)

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10.09	Employment Agreement by and between Christopher D. Olander and Avatech Solutions Subsidiary, Inc. dated June 18, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)
10.10	Warrants to purchase up to 51,828 shares of common stock issued by Avatech to W. James Hindman dated April 1, 2004 (incorporated by reference to our Registration Statement on form S-1, filed on July 19, 2004, File No. 333-114230)
10.11	Asset Purchase Agreement by and among Avatech Solutions, Inc., Comtrex Corp., Richard L. Aquino, and Stanton L. Hilburn dated April 8, 2005 (incorporated by reference to our Quarterly Report on form 10-Q, filed on May 13, 2005, File No. 001-31265)
10.12	Letter Agreement between Avatech Solutions, Inc. and W. James Hindman, with stock purchase warrant, dated December 6, 2004 (incorporated by reference to our Quarterly Report on form 10-Q, filed on February 15, 2005, File No. 001-31265)
10.13	Warrants to purchase up to 38,878 shares of common stock issued by Avatech Solutions, Inc. to W. James Hindman, dated July 1, 2005 (incorporated by reference to our Annual Report on Form 10-K, filed on November 14, 2005, File No. 001-31265)
10.14	Amendment to Avatech Solutions, Inc. Restricted Stock Award Plan, dated August 23, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.15	Warrant to purchase up to 100,000 shares of common stock issued by Avatech to W. James Hindman, dated October 22, 2005 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.16	Promissory Note issued by Avatech Solutions Subsidiary, Inc. to Mercantile Bank & Trust Co. dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.17	Loan and Security Agreement by and between Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.18	Guaranty Agreement by and between W. James Hindman and Mercantile Bank & Trust Co., dated January 27, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.19	Channel Partner Agreement, dated February 1, 2006, by and between Avatech Solutions Subsidiary, Inc. and Autodesk, Inc (incorporated by reference to our Quarterly Report on Form 10-Q, filed on November 14, 2005, File No 001-31265)
10.20	Stock Purchase Agreement, dated May 30, 2006, by and among Avatech Solutions, Inc., Sterling Systems & Consulting, Inc., Bruce White, and Shelly White (incorporated by reference to our Registration Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)
10.21	Membership Interest Purchase Agreement, dated May 30, 2006, by and between Avatech Solutions, Inc., Sterling – Indiana LLC, and Bruce White (incorporated by reference to our Registration Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)
10.22	Membership Interest Purchase Agreement, dated May 30, 2006, by and among Avatech Solutions, Inc., Sterling – Ohio LLC, Bruce White, Steve Wludyga, Kevin Breslin, Ken Williams, Marcy Nungesser, and Dave Press (incorporated by reference to our Registration Statement on Form S-1, filed on June 8, 2006, File No. 333-134862)
10.23	Certificate of Designation of the Powers, Preferences and Relative, Participating, Optional and Other Special Rights of Preferred Stock and Qualification, Limitations and Restriction Thereof of Series F 10% Cumulative Convertible Preferred Stock (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.24	Preferred Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.25	Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)

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10.26	Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.27	Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.28	Form of Common Stock Purchase Warrants issued to Sigma Opportunity Fund LLC and Pacific Asset Partners (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.29	Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on June 22, 2006, File No. 333-134862)
10.30	Second Modification Agreement by and between Avatech Solutions, Inc. and Avatech Solutions Subsidiary, Inc and Mercantile Bank & Trust Co., dated December 31, 2006 (incorporated by reference to our Quarterly Report on Form 10-Q, filed on February 14, 2007, File No 001-31265)
10.31	Common Stock and Warrant Purchase Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)
10.32	Investor Rights Agreement (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)
10.33	Common Stock Purchase Warrants (incorporated by reference to our Registration Statement on Form S-1, filed on February 2, 2007, File No. 333-140418)
31.1	Rule 15d-14(a) Certification of Chief Executive Officer (filed herewith)
31.2	Rule 15d-14(a) Certification of Chief Financial Officer (filed herewith)
32.1	Section 1350 Certifications (filed herewith)

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EX-31.1

Exhibit 31.1

Certifications of the Chief Executive Officer

Pursuant to Securities Exchange Act Rules 13a-1 and 15d-14

As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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: May 15, 2007	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer

EX-31.2

Exhibit 31.2

Certifications of the Chief Financial Officer

Pursuant to Securities Exchange Act Rules 13a-1 and 15d-14

As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

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: May 15, 2007	/s/ Lawrence Rychlak
	Lawrence Rychlak
	Executive Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

Certifications of Periodic Report by the Chief Executive Officer and Chief Financial Officer

Pursuant to 18 U.S.C. Section 1350

As adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report of Avatech Solutions, Inc. (the “Company”) on Form 10-Q for the period ending March 31, 2007 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: May 15, 2007	/s/ Donald R. Walsh
	Donald R. Walsh
	Chief Executive Officer
	/s/ Lawrence Rychlak
	Lawrence Rychlak
	Executive Vice President and Chief Financial Officer