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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended October 31, 2005



OR



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



For the transition period from  to



Commission File Number: 1-15529



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OPTIO SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Georgia                                                        |  | 58-1435435                          
|(State of other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                                 |  |           
|------------------------------------------------ |  | ----------
|3015 Windward Plaza, Fairways II, Alpharetta, GA |  | 30005     
|(Address of principal executive offices)         |  | (Zip Code)



Registrants
telephone number, including area code: (770) 576-3500



---



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
126-2 of the Securities Exchange Act of 1934).    Yes ̈No  x



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



There were 21,603,106 shares of the Registrants common stock outstanding as of December 14, 2005.



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##### Table of Contents

OPTIO SOFTWARE, INC.



FORM 10-Q



For the Quarterly Period Ended October 31, 2005



TABLE OF CONTENTS



|                               |  |                                                                                       |  |   
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                 
|PART I  FINANCIAL INFORMATION |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Financial Statements                                                                  |  | 4 
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 16
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 28
|Item 4.                        |  | Controls and Procedures-Evaluation and Disclosure Controls and Procedures             |  | 28
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 29
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 30
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 30
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 30
|Item 5.                        |  | Other Information                                                                     |  | 30
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                      |  | 30



2



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FORWARD-LOOKING STATEMENTS



In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements that involve
risks and uncertainties. Such forward-looking statements are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995 and are made based on managements current expectations or beliefs as
well as assumptions made by, and information currently available to, management. These forward-looking statements include, among other things, statements regarding Optio Software, Inc.s (Optio) anticipated costs and expenses,
Optios capital needs and financing plans, product and service development, Optios growth strategies, integration of acquired entities, market demand for Optios products and services, relationships with Optios strategic
marketing alliances, and competition. These forward-looking statements include, among others, those statements including the words expects, anticipates, intends, believes and similar language.
Optios actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, risks associated with Optios reliance on
strategic marketing and reseller relationships, collectibility of accounts receivable and notes receivable (specifically, the note receivable from M2 Systems Corporation), fluctuations in operating results because of acquisitions or dispositions,
failure to integrate new products and newly acquired companies, diversion of management resources relating to acquisitions, reduction in cash reserves relating to acquisitions, challenges relating to acquisitions and the possibility that this may
cause Optio to no longer be profitable, the negative effective on Optios earnings relating to the amortization or potential write-down of acquired assets or goodwill, failure to retain the business relationships with existing customers from
acquisitions, changes in competition, changes in economic conditions in the U.S. and in other countries in which Optio currently does business (both general and relative to the technology industry), delays or inability to develop new or unique
software products, market acceptance of new products, the failure of new products to operate as anticipated, expectation of achieving and sustaining operating profits and earnings, including timing of such cash flows and company performance,
disputes regarding Optios intellectual property, risks relating to the delisting of Optios stock, possible adverse results of pending or future litigation, or risks associated with Optios international operations. These and
additional factors are set forth in Safe Harbor Compliance Statement for Forward-Looking Statements included as Exhibit 99.1 to this Quarterly Report on Form 10-Q. You should carefully review these risks and additional risks described in
other documents Optio files from time to time with the Securities and Exchange Commission, including the Annual Report on Form 10-K that Optio has filed. You are cautioned not to place undue reliance on the forward-looking statements in this
document, which speak only as of the date of this Quarterly Report on Form 10-Q. Optio undertakes no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.



3



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##### Table of Contents

PART I  FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



Optio Software, Inc.



Consolidated Condensed
Balance Sheets



|                                                                                     |  |                 |             |   |                  |   |             |  
|------------------------------------------------------------------------------------ |  | --------------- | ----------- | - | ---------------- | - | ----------- | -
|                                                                                     |  | January 31,2005 |             |   | October 31, 2005 |  
|                                                                                     |  |                 |             |   | (Unaudited)      |  
|ASSETS                                                                               |  |                 |             |   |                  |   |             |  
|Current assets:                                                                      |  |                 |             |   |                  |   |             |  
|Cash and cash equivalents                                                            |  | $               | 5,433,000   |   |                  | $ | 6,415,000   |  
|Accounts receivable, net                                                             |  |                 | 4,734,000   |   |                  |   | 4,295,000   |  
|Prepaid expenses and other current assets                                            |  |                 | 425,000     |   |                  |   | 529,000     |  
|Notes receivable from related party                                                  |  |                 | 5,000       |   |                  |   | 5,000       |  
|Current portion of note receivable from M2                                           |  |                 | 353,000     |   |                  |   | 323,000     |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total current assets                                                                 |  |                 | 10,950,000  |   |                  |   | 11,567,000  |  
|Property and equipment, net                                                          |  |                 | 668,000     |   |                  |   | 622,000     |  
|Other assets:                                                                        |  |                 |             |   |                  |   |             |  
|Note receivable from M2, net of impairment reserve of $900,000, less current portion |  |                 | 2,008,000   |   |                  |   | 1,800,000   |  
|Goodwill                                                                             |  |                 | 1,748,000   |   |                  |   | 1,846,000   |  
|Other intangible assets, net                                                         |  |                 | 2,030,000   |   |                  |   | 1,712,000   |  
|Other                                                                                |  |                 | 91,000      |   |                  |   | 108,000     |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total assets                                                                         |  | $               | 17,495,000  |   |                  | $ | 17,655,000  |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                 |  |                 |             |   |                  |   |             |  
|Current liabilities:                                                                 |  |                 |             |   |                  |   |             |  
|Accounts payable                                                                     |  | $               | 932,000     |   |                  | $ | 787,000     |  
|Accrued expenses                                                                     |  |                 | 2,000,000   |   |                  |   | 1,749,000   |  
|Current portion of capital lease obligations                                         |  |                 | 86,000      |   |                  |   | 26,000      |  
|Deferred revenue                                                                     |  |                 | 6,458,000   |   |                  |   | 6,768,000   |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total current liabilities                                                            |  |                 | 9,476,000   |   |                  |   | 9,330,000   |  
|                                                                                     |  |                
|Capital lease obligations, less current portion                                      |  |                 | 7,000       |   |                  |   | 1,000       |  
|Other long-term liabilities                                                          |  |                 | 85,000      |   |                  |   | 63,000      |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total liabilities                                                                    |  |                 | 9,568,000   |   |                  |   | 9,394,000   |  
|Shareholders equity:                                                                |  |                 |             |   |                  |   |             |  
|Common stock                                                                         |  |                 | 52,240,000  |   |                  |   | 52,453,000  |  
|Accumulated deficit                                                                  |  |                 | (44,431,000 | ) |                  |   | (44,271,000 | )
|Accumulated other comprehensive income                                               |  |                 | 118,000     |   |                  |   | 79,000      |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total shareholders equity                                                           |  |                 | 7,927,000   |   |                  |   | 8,261,000   |  
|                                                                                     |  |                 |             |   |                  |   |             |  
|Total liabilities and shareholders equity                                           |  | $               | 17,495,000  |   |                  | $ | 17,655,000  |  
|                                                                                     |  |                 |             |   |                  |   |             |  



See accompanying notes.



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##### Table of Contents

Optio Software, Inc.



Consolidated Condensed Statements of Operations

(Unaudited)



|                                                                                      |  |                                |            |   |      |   |            |  
|------------------------------------------------------------------------------------- |  | ------------------------------ | ---------- | - | ---- | - | ---------- | -
|                                                                                      |  | Three Months Ended October 31, |           
|                                                                                      |  | 2004                           |            |   | 2005 |  
|Revenue:                                                                              |  |                                |            |   |      |   |            |  
|License fees                                                                          |  | $                              | 1,783,000  |   |      | $ | 2,078,000  |  
|Subscription fees                                                                     |  |                                | 417,000    |   |      |   | 542,000    |  
|Services, maintenance, and other                                                      |  |                                | 4,449,000  |   |      |   | 4,460,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 6,649,000  |   |      |   | 7,080,000  |  
|Costs of revenue (exclusive of depreciation and amortization shown separately below): |  |                                |            |   |      |   |            |  
|License fees                                                                          |  |                                | 121,000    |   |      |   | 187,000    |  
|Services, maintenance, and other                                                      |  |                                | 1,406,000  |   |      |   | 1,609,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 1,527,000  |   |      |   | 1,796,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 5,122,000  |   |      |   | 5,284,000  |  
|                                                                                      |  |                               
|Operating expenses:                                                                   |  |                                |            |   |      |   |            |  
|Sales and marketing                                                                   |  |                                | 2,538,000  |   |      |   | 2,852,000  |  
|Research and development                                                              |  |                                | 1,089,000  |   |      |   | 1,311,000  |  
|General and administrative                                                            |  |                                | 962,000    |   |      |   | 957,000    |  
|Depreciation and amortization                                                         |  |                                | 221,000    |   |      |   | 202,000    |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 4,810,000  |   |      |   | 5,322,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Income (loss) from operations                                                         |  |                                | 312,000    |   |      |   | (38,000    | )
|Other income (expense):                                                               |  |                                |            |   |      |   |            |  
|Interest income                                                                       |  |                                | 38,000     |   |      |   | 69,000     |  
|Interest expense                                                                      |  |                                | (3,000     | ) |      |   | (10,000    | )
|Other                                                                                 |  |                                | 4,000      |   |      |   | (1,000     | )
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 39,000     |   |      |   | 58,000     |  
|                                                                                      |  |                               
|Income before income taxes                                                            |  |                                | 351,000    |   |      |   | 20,000     |  
|Income tax expense (benefit)                                                          |  |                                | (2,000     | ) |      |   | 14,000     |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income                                                                            |  | $                              | 353,000    |   |      | $ | 6,000      |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income per share  basic                                                          |  | $                              | 0.02       |   |      | $ | 0.00       |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income per share  diluted                                                        |  | $                              | 0.02       |   |      | $ | 0.00       |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Weighted average shares outstanding  basic                                           |  |                                | 20,632,738 |   |      |   | 21,093,459 |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Weighted average shares outstanding  diluted                                         |  |                                | 23,532,892 |   |      |   | 23,809,293 |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Comprehensive income:                                                                 |  |                                |            |   |      |   |            |  
|Net income                                                                            |  | $                              | 353,000    |   |      | $ | 6,000      |  
|Foreign currency translation adjustment                                               |  |                                | 35,000     |   |      |   | 5,000      |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Comprehensive income                                                                  |  | $                              | 388,000    |   |      | $ | 11,000     |  
|                                                                                      |  |                                |            |   |      |   |            |  



See accompanying notes.



5



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##### Table of Contents

Optio Software, Inc.



Consolidated Condensed Statements of Operations

(Unaudited)



|                                                                                      |  |                               |            |   |      |   |            |  
|------------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                      |  | Nine Months Ended October 31, |           
|                                                                                      |  | 2004                          |            |   | 2005 |  
|Revenue:                                                                              |  |                               |            |   |      |   |            |  
|License fees                                                                          |  | $                             | 7,243,000  |   |      | $ | 6,833,000  |  
|Subscription fees                                                                     |  |                               | 417,000    |   |      |   | 1,577,000  |  
|Services, maintenance, and other                                                      |  |                               | 12,989,000 |   |      |   | 12,965,000 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 20,649,000 |   |      |   | 21,375,000 |  
|Costs of revenue (exclusive of depreciation and amortization shown separately below): |  |                               |            |   |      |   |            |  
|License fees                                                                          |  |                               | 444,000    |   |      |   | 544,000    |  
|Services, maintenance, and other                                                      |  |                               | 4,361,000  |   |      |   | 4,785,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 4,805,000  |   |      |   | 5,329,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 15,844,000 |   |      |   | 16,046,000 |  
|                                                                                      |  |                              
|Operating expenses:                                                                   |  |                               |            |   |      |   |            |  
|Sales and marketing                                                                   |  |                               | 7,853,000  |   |      |   | 8,461,000  |  
|Research and development                                                              |  |                               | 3,247,000  |   |      |   | 3,905,000  |  
|General and administrative                                                            |  |                               | 3,095,000  |   |      |   | 3,001,000  |  
|Depreciation and amortization                                                         |  |                               | 398,000    |   |      |   | 633,000    |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 14,593,000 |   |      |   | 16,000,000 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Income from operations                                                                |  |                               | 1,251,000  |   |      |   | 46,000     |  
|Other income (expense):                                                               |  |                               |            |   |      |   |            |  
|Interest income                                                                       |  |                               | 121,000    |   |      |   | 185,000    |  
|Interest expense                                                                      |  |                               | (10,000    | ) |      |   | (14,000    | )
|Other                                                                                 |  |                               | 42,000     |   |      |   | (15,000    | )
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 153,000    |   |      |   | 156,000    |  
|                                                                                      |  |                              
|Income before income taxes                                                            |  |                               | 1,404,000  |   |      |   | 202,000    |  
|Income tax expense                                                                    |  |                               | 56,000     |   |      |   | 42,000     |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income                                                                            |  | $                             | 1,348,000  |   |      | $ | 160,000    |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income per share  basic                                                          |  | $                             | 0.07       |   |      | $ | 0.01       |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income per share  diluted                                                        |  | $                             | 0.06       |   |      | $ | 0.01       |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Weighted average shares outstanding  basic                                           |  |                               | 19,855,566 |   |      |   | 20,918,084 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Weighted average shares outstanding  diluted                                         |  |                               | 23,124,753 |   |      |   | 24,033,407 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Comprehensive income:                                                                 |  |                               |            |   |      |   |            |  
|Net income                                                                            |  | $                             | 1,348,000  |   |      | $ | 160,000    |  
|Foreign currency translation adjustment                                               |  |                               | 9,000      |   |      |   | (39,000    | )
|                                                                                      |  |                               |            |   |      |   |            |  
|Comprehensive income                                                                  |  | $                             | 1,357,000  |   |      | $ | 121,000    |  
|                                                                                      |  |                               |            |   |      |   |            |  



See accompanying notes.



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Optio Software, Inc.



Consolidated Condensed Statement of Shareholders Equity

(Unaudited)



|                                        |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   |           |  
|--------------------------------------- |  | ------------ |  | ------------------ | ---------- |  | ------------------------------------ | ----------- | - | ------------------------- | - | ------- | - |  | - | --------- | -
|                                        |  | Common Stock |  | AccumulatedDeficit |            |  | Accumulated OtherComprehensiveIncome |             |   | Total ShareholdersEquity |  
|                                        |  | Shares       |  | Amount             |            |  |                                     
|Balance at February 1, 2005             |  | 20,854,265   |  | $                  | 52,240,000 |  | $                                    | (44,431,000 | ) |                           | $ | 118,000 |   |  | $ | 7,927,000 |  
|Comprehensive income, net of tax:       |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   |           |  
|Net income                              |  |             |  |                    |           |  |                                      | 160,000     |   |                           |   |         |   |  |   | 160,000   |  
|Foreign currency translation adjustment |  |             |  |                    |           |  |                                      |            |   |                           |   | (39,000 | ) |  |   | (39,000   | )
|                                        |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   |           |  
|Comprehensive income                    |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   | 121,000   |  
|Exercise of stock options               |  | 358,850      |  |                    | 213,000    |  |                                      |            |   |                           |   |         |   |  |   | 213,000   |  
|                                        |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   |           |  
|Balance at October 31, 2005             |  | 21,213,115   |  | $                  | 52,453,000 |  | $                                    | (44,271,000 | ) |                           | $ | 79,000  |   |  | $ | 8,261,000 |  
|                                        |  |              |  |                    |            |  |                                      |             |   |                           |   |         |   |  |   |           |  



See accompanying notes.



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##### Table of Contents

Optio Software, Inc.



Consolidated Condensed Statements of Cash Flows

(Unaudited)



|                                                                                  |  |                               |            |   |      |   |           |  
|--------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ---- | - | --------- | -
|                                                                                  |  | Nine Months Ended October 31, |           
|                                                                                  |  | 2004                          |            |   | 2005 |  
|Cash flows from operating activities:                                             |  |                               |            |   |      |   |           |  
|Net income                                                                        |  | $                             | 1,348,000  |   |      | $ | 160,000   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                               |            |   |      |   |           |  
|Depreciation and amortization                                                     |  |                               | 290,000    |   |      |   | 317,000   |  
|Amortization of intangibles                                                       |  |                               | 108,000    |   |      |   | 318,000   |  
|Provision for doubtful accounts                                                   |  |                               | 48,000     |   |      |   |          |  
|Provision for deferred taxes                                                      |  |                               |           |   |      |   | 30,000    |  
|Changes in operating assets and liabilities:                                      |  |                               |            |   |      |   |           |  
|Accounts receivable                                                               |  |                               | 1,518,000  |   |      |   | 319,000   |  
|Prepaid expenses and other current assets                                         |  |                               | (131,000   | ) |      |   | (142,000  | )
|Accounts payable                                                                  |  |                               | (1,000     | ) |      |   | (126,000  | )
|Accrued expenses                                                                  |  |                               | (1,623,000 | ) |      |   | (282,000  | )
|Income taxes payable                                                              |  |                               | (1,000     | ) |      |   |          |  
|Deferred revenue                                                                  |  |                               | (817,000   | ) |      |   | 402,000   |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Net cash provided by operating activities                                         |  |                               | 739,000    |   |      |   | 996,000   |  
|                                                                                  |  |                              
|Cash flows from investing activities:                                             |  |                               |            |   |      |   |           |  
|Purchases of property and equipment                                               |  |                               | (326,000   | ) |      |   | (264,000  | )
|Purchase of VertiSoft business                                                    |  |                               | (348,000   | ) |      |   |          |  
|Contingent payment under Vertisoft purchase agreement                             |  |                               |           |   |      |   | (75,000   | )
|Repayment of note receivable from M2 Systems                                      |  |                               | 243,000    |   |      |   | 238,000   |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Net cash used in investing activities                                             |  |                               | (431,000   | ) |      |   | (101,000  | )
|                                                                                  |  |                              
|Cash flows from financing activities:                                             |  |                               |            |   |      |   |           |  
|Payments of notes payable and capital lease obligations                           |  |                               | (1,140,000 | ) |      |   | (66,000   | )
|Proceeds from exercise of stock options                                           |  |                               | 216,000    |   |      |   | 213,000   |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Net cash provided by (used in) financing activities                               |  |                               | (924,000   | ) |      |   | 147,000   |  
|                                                                                  |  |                              
|Impact of foreign currency rate fluctuations on cash                              |  |                               | 42,000     |   |      |   | (60,000   | )
|Net increase in cash and cash equivalents                                         |  |                               | (574,000   | ) |      |   | 982,000   |  
|                                                                                  |  |                              
|Cash and cash equivalents at beginning of period                                  |  |                               | 5,328,000  |   |      |   | 5,433,000 |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Cash and cash equivalents at end of period                                        |  | $                             | 4,754,000  |   |      | $ | 6,415,000 |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Supplemental disclosures of cash flow information:                                |  |                               |            |   |      |   |           |  
|Cash paid during the year for:                                                    |  |                               |            |   |      |   |           |  
|Interest paid                                                                     |  | $                             | 10,000     |   |      | $ | 13,000    |  
|                                                                                  |  |                               |            |   |      |   |           |  
|Income taxes paid                                                                 |  | $                             | 59,000     |   |      | $ | 12,000    |  
|                                                                                  |  |                               |            |   |      |   |           |  



See accompanying notes.



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Optio Software, Inc.



Notes to the Consolidated Condensed Financial Statements

(Unaudited)



1.
Description of Business



Optio Software, Inc.
(Optio or the Company) provides infrastructure software and services that enhance the form, content, distribution and availability of business critical information. The Company markets primarily to companies located
principally in the United States and Europe. The industry in which the Company operates is subject to rapid change due to development of new technologies and products.



2. Basis of Presentation



Interim Financial Information



The accompanying interim consolidated condensed financial statements of the Company have been prepared in accordance with the instructions for Form 10-Q.
Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. In the opinion
of management, all adjustments, consisting of normal recurring adjustments unless otherwise disclosed in a separate note, considered necessary for a fair presentation of the financial information for the interim period reported have been made.



The accompanying financial statements should be read in
conjunction with the Companys audited consolidated financial statements for the year ended January 31, 2005, included in the Companys Annual Report on Form 10-K, filed with the Securities and Exchange Commission on April 29,
2005. Results of operations for the three and nine months ended October 31, 2005 are not necessarily indicative of the results for the year ending January 31, 2006.



Employee Stock Options



The Company accounts for stock based awards using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25) and related interpretations. Under APB 25, when the exercise price of the Companys stock options equals or exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recorded.



Based on the additional
disclosure requirements of SFAS 148, Accounting for Stock Based Compensation  Transition and Disclosure  an Amendment to SFAS 123, the following illustrates the assumptions and the effect on net income and net income per share if
the Company had applied the fair value recognition provisions of SFAS 123.



Pro forma information regarding net income required by SFAS 123 Accounting for Stock-Based Compensation, requires that the information be determined as if the Company had accounted for its employee stock
options granted subsequent to December 31, 1994 under the fair value method. The fair value for these options was estimated at the date of grant using the minimum value method through December 15, 1999, the date of the Companys
initial public offering. For those options granted subsequent to December 15, 1999, the fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model with



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the following weighted-average assumptions used for the three months ended October 31, 2004 and 2005, and the nine
months ended October 31, 2004 and 2005: risk-free interest rates of 4.03% and 4.17% for the three months ended October 31, 2004 and 2005, respectively; risk-free interest rates of 3.96% and 4.14% for the nine months ended October 31,
2004 and 2005, respectively; no dividend yield; volatility of 148% and 138% for the three months ended October 31, 2004 and 2005, respectively; volatility of 148% and 138% for the nine months ended October 31, 2004 and 2005, respectively;
and an expected life of the options of 7.31 years for the three and nine months ended October 31, 2004 and 7.37 years for the three and nine months ended October 31, 2005.



For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the
options vesting periods. The weighted-average fair value of options granted during the three months ended October 31, 2004 and 2005 equaled $1.10 and $0.99 per share, respectively. The weighted-average fair value of options granted during
the nine months ended October 31, 2004 and 2005 equaled $1.18 and $1.17 per share, respectively. The Companys pro forma information as determined using the fair value method of accounting under SFAS 123, was as follows:



|                                                            |  |                                |           |   |      |   |          |  
|----------------------------------------------------------- |  | ------------------------------ | --------- | - | ---- | - | -------- | -
|                                                            |  | Three Months Ended October 31, |          
|                                                            |  | 2004                           |           |   | 2005 |  
|Net income as reported                                      |  | $                              | 353,000   |   |      | $ | 6,000    |  
|Deduct: Compensation cost using the fair value method       |  |                                | (103,000  | ) |      |   | (76,000  | )
|                                                            |  |                                |           |   |      |   |          |  
|Pro forma net income (loss)                                 |  | $                              | 250,000   |   |      | $ | (70,000  | )
|                                                            |  |                                |           |   |      |   |          |  
|Net income (loss) per share as reported  basic and diluted |  |                                | 0.02      |   |      |   | 0.00     |  
|Pro forma net income (loss) per share  basic and diluted   |  |                                | 0.01      |   |      |   | 0.00     |  
|                                                            | 
|                                                            |  | Nine Months Ended October 31,  |          
|                                                            |  | 2004                           |           |   | 2005 |  
|Net income as reported                                      |  | $                              | 1,348,000 |   |      | $ | 160,000  |  
|Deduct: Compensation cost using the fair value method       |  |                                | (297,000  | ) |      |   | (293,000 | )
|                                                            |  |                                |           |   |      |   |          |  
|Pro forma net income (loss)                                 |  | $                              | 1,051,000 |   |      | $ | (133,000 | )
|                                                            |  |                                |           |   |      |   |          |  
|Net income per share as reported  basic                    |  |                                | 0.07      |   |      |   | 0.01     |  
|Net income per share as reported  diluted                  |  |                                | 0.06      |   |      |   | 0.01     |  
|Pro forma net income (loss) per share  basic and diluted   |  |                                | 0.05      |   |      |   | (0.01    | )



Goodwill and Other Intangible
Assets



The Company acquired goodwill and other
intangible assets in connection with the acquisition of VertiSoft Corporation (VertiSoft) in August 2004. Under the purchase method of accounting pursuant to SFAS 141, the total purchase price was allocated to the acquired entitys
net tangible and intangible assets based on their estimated fair values as of the date of the completion of the acquisition. The excess of the purchase price over the fair value of the net tangible assets/liabilities and identifiable intangible
assets acquired was recorded as goodwill. In accordance with SFAS 142, goodwill and intangible assets with indefinite lives resulting from business combinations have not been amortized but instead will be tested for impairment at least annually
(more frequently if certain indicators are present) while identifiable intangible assets with finite lives



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are being amortized over their estimated useful lives. In the event that the Companys management determines that
the value of goodwill or intangible assets has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. The Company has selected August 1 as its
annual impairment testing date for its goodwill. The Company performed an analysis comparing the fair value of the reporting units with the carrying value of such reporting units, including goodwill, and determined that no impairment of its goodwill
existed.



As of October 31, 2005, the gross carrying
amount and the accumulated amortization by major intangible asset class is as follows:



|                       |  |                    |  |                     |           |                         |   |                   |  |   |          
|---------------------- |  | ------------------ |  | ------------------- | --------- | ----------------------- | - | ----------------- |  | - | ---------
|Intangible Asset       |  | Useful Life        |  | Gross CarryingValue |           | AccumulatedAmortization |   | Net CarryingValue
|Customer relationships |  | 11.5 years         |  | $                   | 1,260,000 |                         | $ | 209,000           |  | $ | 1,051,000
|Technology             |  | 3 months  5 years |  |                     | 893,000   |                         |   | 296,000           |  |   | 597,000  
|Non-compete agreement  |  | 5 years            |  |                     | 85,000    |                         |   | 21,000            |  |   | 64,000   



3. Net Income per Share



Net income per share has been computed in accordance with
SFAS 128, Earnings per Share, which requires disclosure of basic and diluted earnings per share. Basic earnings per share excludes any dilutive effects of stock options. Diluted earnings per share includes the impact of potentially dilutive
securities.



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The following table sets forth the computation of net income per share:



|                                                                                              |  |                                |            |      |   |           
|--------------------------------------------------------------------------------------------- |  | ------------------------------ | ---------- | ---- | - | ----------
|                                                                                              |  | Three months ended October 31,
|                                                                                              |  | 2004                           |            | 2005
|Net income                                                                                    |  | $                              | 353,000    |      | $ | 6,000     
|                                                                                              |  |                                |            |      |   |           
|Weighted average shares outstanding  basic                                                   |  |                                | 20,632,738 |      |   | 21,093,459
|Dilutive securities                                                                           |  |                                | 2,900,154  |      |   | 2,715,834 
|                                                                                              |  |                                |            |      |   |           
|Weighted average shares outstanding  diluted                                                 |  |                                | 23,532,892 |      |   | 23,809,293
|                                                                                              |  |                                |            |      |   |           
|Net income per share  basic and diluted                                                      |  | $                              | 0.02       |      | $ | 0.00      
|                                                                                              |  |                                |            |      |   |           
|Potentially dilutive stock options, excluded from diluted weighted average shares outstanding |  |                                | 786,765    |      |   | 1,698,513 
|                                                                                              |  |                                |            |      |   |           
|                                                                                              | 
|                                                                                              |  | Nine months ended October 31, 
|                                                                                              |  | 2004                           |            | 2005
|Net income                                                                                    |  | $                              | 1,348,000  |      | $ | 160,000   
|                                                                                              |  |                                |            |      |   |           
|Weighted average shares outstanding  basic                                                   |  |                                | 19,855,566 |      |   | 20,918,084
|Dilutive securities                                                                           |  |                                | 3,269,187  |      |   | 3,115,323 
|                                                                                              |  |                                |            |      |   |           
|Weighted average shares outstanding  diluted                                                 |  |                                | 23,124,753 |      |   | 24,033,407
|                                                                                              |  |                                |            |      |   |           
|Net income per share  basic                                                                  |  | $                              | 0.07       |      | $ | 0.01      
|                                                                                              |  |                                |            |      |   |           
|Net income per share  diluted                                                                |  | $                              | 0.06       |      | $ | 0.01      
|                                                                                              |  |                                |            |      |   |           
|Potentially dilutive stock options, excluded from diluted weighted average shares outstanding |  |                                | 634,829    |      |   | 1,021,053 
|                                                                                              |  |                                |            |      |   |           



4. Segment and Geographic
Information



The Company is organized around geographic
areas. Optios U.S. operations and Optio Europe represent Optios two reportable segments. Optios other foreign subsidiary, Optio Software, Asia Pacific, is classified as Other. Optio Software, Asia Pacific was legally
dissolved in December 2004. The foreign locations principally function as distributors of products developed by the Company in the United States. The accounting policies described in the summary of significant accounting policies are applied
consistently across the segments. Intersegment sales are based on intercompany transfer prices to achieve a reasonable margin upon distribution.



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Segment information for the three and nine months ended October 31, 2004 and 2005 is summarized below.



|                                          |  |               |            |   |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|----------------------------------------- |  | ------------- | ---------- | - | ------ | - | --------- | ----- |  | -------- | ------ |  | ------------ | ---------- | - | ------------ | - | ---------- | - |  | - | ---------- | -
|Three Months ended October 31,
2004       |  | United States |            |   | Europe |   |           | Other |  | Combined |        |  | Eliminations |            |   | Consolidated |  
|Revenue from external customers:          |  |               |            |   |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|License fees                              |  | $             | 1,417,000  |   |        | $ | 366,000   |       |  | $        |       |  | $            | 1,783,000  |   |              | $ |           |   |  | $ | 1,783,000  |  
|                                          |  |               |            |   |        |  
|Services, maintenance and other           |  |               | 3,715,000  |   |        |   | 734,000   |       |  |          |        |  |              | 4,449,000  |   |              |   |           |   |  |   | 4,449,000  |  
|Subscription Revenue                      |  |               | 399,000    |   |        |   | 18,000    |       |  |          |       |  |              | 417,000    |   |              |   |            |   |  |   | 417,000    |  
|Inter-segment revenue                     |  |               | 102,000    |   |        |   | 42,000    |       |  |          |       |  |              | 144,000    |   |              |   | (144,000   | ) |  |   |           |  
|                                          |  |               |            |   |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|Total revenue                             |  |               | 5,633,000  |   |        |   | 1,160,000 |       |  |          |       |  |              | 6,793,000  |   |              |   | (144,000   | ) |  |   | 6,649,000  |  
|Interest income                           |  |               | 38,000     |   |        |   |          |       |  |          |       |  |              | 38,000     |   |              |   |           |   |  |   | 38,000     |  
|Interest expense                          |  |               | 3,000      |   |        |   |          |       |  |          |       |  |              | 3,000      |   |              |   |           |   |  |   | 3,000      |  
|Depreciation and amortization             |  |               | 206,000    |   |        |   | 15,000    |       |  |          |       |  |              | 221,000    |   |              |   |           |   |  |   | 221,000    |  
|Income tax benefit (expense)              |  |               | (4,000     | ) |        |   | 2,000     |       |  |          |       |  |              | (2,000     | ) |              |   |           |   |  |   | (2,000     | )
|Segment income (loss) before income taxes |  |               | 502,000    |   |        |   | (151,000  | )     |  |          |       |  |              | 351,000    |   |              |   |           |   |  |   | 351,000    |  
|Segment net income (loss)                 |  |               | 506,000    |   |        |   | (153,000  | )     |  |          |       |  |              | 353,000    |   |              |   |           |   |  |   | 353,000    |  
|Total segment assets                      |  |               | 17,749,000 |   |        |   | 3,332,000 |       |  |          | 87,000 |  |              | 21,168,000 |   |              |   | (5,087,000 | ) |  |   | 16,081,000 |  
|Expenditures for long-lived assets        |  |               | 133,000    |   |        |   | 12,000    |       |  |          |       |  |              | 145,000    |   |              |   |           |   |  |   | 145,000    |  
|                                          |  |               |            |   |        |  
|Three Months ended October 31,
2005       |  | United States |            |   | Europe |   |           | Other |  | Combined |        |  | Eliminations |            |   | Consolidated |  
|Revenue from external customers:          |  |               |            |   |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|License fees                              |  | $             | 1,671,000  |   |        | $ | 407,000   |       |  | $        |       |  | $            | 2,078,000  |   |              | $ |           |   |  | $ | 2,078,000  |  
|                                          |  |               |            |   |        |  
|Services, maintenance and other           |  |               | 3,742,000  |   |        |   | 718,000   |       |  |          |       |  |              | 4,460,000  |   |              |   |           |   |  |   | 4,460,000  |  
|Subscription Revenue                      |  |               | 542,000    |   |        |   |          |       |  |          |       |  |              | 542,000    |   |              |   |            |   |  |   | 542,000    |  
|Inter-segment revenue                     |  |               | 61,000     |   |        |   | 21,000    |       |  |          |       |  |              | 82,000     |   |              |   | (82,000    | ) |  |   |           |  
|                                          |  |               |            |   |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|Total revenue                             |  |               | 6,016,000  |   |        |   | 1,146,000 |       |  |          |       |  |              | 7,162,000  |   |              |   | (82,000    | ) |  |   | 7,080,000  |  
|Interest income                           |  |               | 69,000     |   |        |   |          |       |  |          |       |  |              | 69,000     |   |              |   |           |   |  |   | 69,000     |  
|Interest expense                          |  |               | 10,000     |   |        |   |          |       |  |          |       |  |              | 10,000     |   |              |   |           |   |  |   | 10,000     |  
|Depreciation and amortization             |  |               | 195,000    |   |        |   | 7,000     |       |  |          |       |  |              | 202,000    |   |              |   |           |   |  |   | 202,000    |  
|Income tax benefit                        |  |               | 14,000     |   |        |   |          |       |  |          |       |  |              | 14,000     |   |              |   |           |   |  |   | 14,000     |  
|Segment income before income taxes        |  |               | 9,000      |   |        |   | 11,000    |       |  |          |       |  |              | 20,000     |   |              |   |           |   |  |   | 20,000     |  
|Segment net income (loss)                 |  |               | (5,000     | ) |        |   | 11,000    |       |  |          |       |  |              | 6,000      |   |              |   |           |   |  |   | 6,000      |  
|Total segment assets                      |  |               | 17,732,000 |   |        |   | 3,236,000 |       |  |          |       |  |              | 20,968,000 |   |              |   | (3,313,000 | ) |  |   | 17,655,000 |  
|Expenditures for long-lived assets        |  |               | 69,000     |   |        |   | 5,000     |       |  |          |       |  |              | 74,000     |   |              |   |           |   |  |   | 74,000     |  



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|                                          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|----------------------------------------- |  | ------------- | ---------- | ------ | - | --------- | ----- |  | -------- | ------ | ------------ | - | ---------- | ------------ | - | ---------- | - |  | - | ----------
|Nine Months ended October 31,
2004        |  | United States |            | Europe |   |           | Other |  | Combined |        | Eliminations |   |            | Consolidated
|Revenue from external customers:          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|License fees                              |  | $             | 5,756,000  |        | $ | 1,487,000 |       |  | $        |       |              | $ | 7,243,000  |              | $ |           |   |  | $ | 7,243,000 
|                                          |  |               |            |        |   |          
|Services, maintenance and other           |  |               | 10,963,000 |        |   | 2,026,000 |       |  |          |       |              |   | 12,989,000 |              |   |           |   |  |   | 12,989,000
|Subscription Revenue                      |  |               | 399,000    |        |   | 18,000    |       |  |          |       |              |   | 417,000    |              |   |            |   |  |   | 417,000   
|Inter-segment revenue                     |  |               | 315,000    |        |   | 167,000   |       |  |          |       |              |   | 482,000    |              |   | (482,000   | ) |  |   |          
|                                          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|Total revenue                             |  |               | 17,433,000 |        |   | 3,698,000 |       |  |          |       |              |   | 21,131,000 |              |   | (482,000   | ) |  |   | 20,649,000
|Interest income                           |  |               | 116,000    |        |   | 5,000     |       |  |          |       |              |   | 121,000    |              |   |           |   |  |   | 121,000   
|Interest expense                          |  |               | 10,000     |        |   |          |       |  |          |       |              |   | 10,000     |              |   |           |   |  |   | 10,000    
|Depreciation and amortization             |  |               | 386,000    |        |   | 12,000    |       |  |          |       |              |   | 398,000    |              |   |           |   |  |   | 398,000   
|Income tax expense                        |  |               | 54,000     |        |   | 2,000     |       |  |          |       |              |   | 56,000     |              |   |           |   |  |   | 56,000    
|Segment income (loss) before income taxes |  |               | 1,523,000  |        |   | (119,000  | )     |  |          |       |              |   | 1,404,000  |              |   |           |   |  |   | 1,404,000 
|Segment net income (loss)                 |  |               | 1,469,000  |        |   | (121,000  | )     |  |          |       |              |   | 1,348,000  |              |   |           |   |  |   | 1,348,000 
|Total segment assets                      |  |               | 17,749,000 |        |   | 3,332,000 |       |  |          | 87,000 |              |   | 21,168,000 |              |   | (5,087,000 | ) |  |   | 16,081,000
|Expenditures for long-lived assets        |  |               | 284,000    |        |   | 42,000    |       |  |          |       |              |   | 326,000    |              |   |           |   |  |   | 326,000   
|                                          |  |               |            |        |   |          
|Nine Months ended October 31,
2005        |  | United States |            | Europe |   |           | Other |  | Combined |        | Eliminations |   |            | Consolidated
|Revenue from external customers:          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|License fees                              |  | $             | 5,542,000  |        | $ | 1,291,000 |       |  | $        |       |              | $ | 6,833,000  |              | $ |           |   |  | $ | 6,833,000 
|                                          |  |               |            |        |   |          
|Services, maintenance and other           |  |               | 10,933,000 |        |   | 2,032,000 |       |  |          |       |              |   | 12,965,000 |              |   |           |   |  |   | 12,965,000
|Subscription revenue                      |  |               | 1,577,000  |        |   |          |       |  |          |       |              |   | 1,577,000  |              |   |            |   |  |   | 1,577,000 
|Inter-segment revenue                     |  |               | 241,000    |        |   | 75,000    |       |  |          |       |              |   | 316,000    |              |   | (316,000   | ) |  |   |          
|                                          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|Total revenue                             |  |               | 18,293,000 |        |   | 3,398,000 |       |  |          |       |              |   | 21,691,000 |              |   | (316,000   | ) |  |   | 21,375,000
|Interest income                           |  |               | 184,000    |        |   | 1,000     |       |  |          |       |              |   | 185,000    |              |   |           |   |  |   | 185,000   
|Interest expense                          |  |               | 14,000     |        |   |          |       |  |          |       |              |   | 14,000     |              |   |           |   |  |   | 14,000    
|Depreciation and amortization             |  |               | 608,000    |        |   | 25,000    |       |  |          |       |              |   | 633,000    |              |   |           |   |  |   | 633,000   
|Income tax expense                        |  |               | 42,000     |        |   |          |       |  |          |       |              |   | 42,000     |              |   |           |   |  |   | 42,000    
|Segment income (loss) before income taxes |  |               | 490,000    |        |   | (288,000  | )     |  |          |       |              |   | 202,000    |              |   |           |   |  |   | 202,000   
|Segment net income (loss)                 |  |               | 448,000    |        |   | (288,000  | )     |  |          |       |              |   | 160,000    |              |   |           |   |  |   | 160,000   
|Total segment assets                      |  |               | 17,732,000 |        |   | 3,236,000 |       |  |          |       |              |   | 20,968,000 |              |   | (3,313,000 | ) |  |   | 17,655,000
|Expenditures for long-lived assets        |  |               | 239,000    |        |   | 25,000    |       |  |          |       |              |   | 264,000    |              |   |           |   |  |   | 264,000   



5. Note Receivable



As further explained in Notes 3 and 4 of the Notes to Consolidated
Financial Statements included in Optios Annual Report on Form 10-K, Optio holds a note receivable from M2 Systems Corporation (M2



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Systems) as partial consideration for the sale by Optio of its Muscato Corporation (Muscato) and
Translink Solutions Corporation business units. Under the terms of the note, M2 Systems was required to make payments of $100,000 each on September 1, 2003 and December 1, 2003 and a payment of $115,000 on June 1, 2004. M2 Systems
failed to make these payments on their respective due dates; however, payment was made prior to an event of default. All payments subsequent to June1, 2004 have been made on their respective due dates.



During the third quarter of fiscal 2004, as a result of M2 Systems failure to
make timely payments in the prior quarters, management determined that this was an indication that it was probable that Optio would be unable to collect all amounts due according to the contractual terms of the note. At that time, the loan was
considered impaired and was written down to the assessed fair value of the collateral. As of October 31, 2003, the collateral, including technology, accounts receivable, fixed assets and the discounted net cash flows of maintenance contracts
was estimated to have an approximate fair value of $2.8 million, substantially less than the $3.7 million note receivable balance as of October 31, 2003. Thus Optio recorded an impairment charge of $900,000 during the year ended
January 31, 2004. Optio continues to reassess the value of the collateral on an ongoing basis. The amount of the note receivable recorded could be materially different under different conditions or using different assumptions, including the
varying assumptions regarding the fair value of the collateral. If M2 Systems defaults on the note and the collateral proves to be of no value to the Company, the Company would incur an additional loss of approximately $2.1 million.



On September 15, 2004 Optio notified M2 systems of certain non-monetary
defaults under the M2 Systems note. M2 Systems disputed these defaults. Optio did not accelerate the indebtedness under the M2 Systems note, but the parties agreed to modify the loan documents to address the alleged defaults by M2
Systems to give Optio additional collateral. On May 18, 2005, the parties executed modified and additional security documents granting Optio a security interest in the assets of certain of M2 Systems affiliates and placing greater
restrictions on the use of the collateral. Further, the Company has the right to receive the quarterly financial statements of M2 Systems and its affiliates and has certain audit rights as to the collateral for the note; therefore, the Company
periodically assesses the value of the collateral and the note, as reflected on the Companys financial statements.



6. Acquisition of VertiSoft Corporation



On August 10, 2004, Optio consummated the merger of VertiSoft Corporation (VertiSoft), a privately held Georgia corporation, and Optio
Software II, Inc., a wholly owned subsidiary of Optio, whereby VertiSoft became the surviving wholly owned subsidiary of Optio. Subsequently, on September 15, 2004, VertiSoft was merged with and into Optio, with Optio remaining the surviving
corporation. VertiSoft provides document management solutions designed to streamline information access and distribution for physicians and clinical, medical records and financial services staff through a single interface or Composite Patient
View. Its patented electronic document management system, QuickRecord, provides secure, individualized access
to patient information retrieved from any system, inside or outside the enterprise. The primary reasons for the acquisition were that the QuickRecord product broadens the Companys portfolio of healthcare solutions and establishes a
subscription-based licensing model for a new line of solutions. The consideration given for all the common stock of VertiSoft included $350,000 in cash, the issuance of 1.5 million shares of Optio common stock, of which 310,000 shares are to be
held in escrow for a period of 18 months to secure the indemnification obligations of the shareholders of VertiSoft, the issuance of options for the purchase of 340,000 shares of common stock and future conditional cash payments of $225,000 to be
paid out in various installments over the following two years, contingent upon the achievement of certain customer retention and product development goals. A cash payment of $75,000 was paid on August 30, 2005 due to the satisfaction of certain
contingences. The cash component of the consideration given was paid from funds generated from the on-going operations of Optio. The purchase price is as follows:



|                                                                                    |  |   |          
|----------------------------------------------------------------------------------- |  | - | ---------
|Cash paid in initial transaction                                                    |  | $ | 348,000  
|Cash paid in contingent payment                                                     |  |   | 75,000   
|Common stock issued (1,190,000 shares, excluding the 310,000 shares held in escrow) |  |   | 1,309,000
|Stock options issued                                                                |  |   | 361,000  
|Acquisition costs                                                                   |  |   | 339,000  
|                                                                                    |  |   |          
|                                                                                    |  |   | 2,432,000
|                                                                                    |  |   |          



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The value of the common stock issued above was based on the market price of Optios common stock for
a reasonable period before and after the date the merger was announced. Should the 310,000 shares held in escrow be released at the end of the 18 month period, the value of the shares based on the market value of Optios common stock on that
date will be added to goodwill.



The acquired assets consisted
primarily of accounts receivable, software, machinery, equipment, furniture and fixtures, cash, and all of the interests, rights and benefits accruing to VertiSoft under any sales orders, sales contracts, service agreements, and purchase orders. In
connection with the acquisition, Optio also assumed the liabilities of VertiSoft, consisting primarily of promissory notes payable (totaling approximately $1,100,000), accounts payable, accrued payroll, and service agreements.



The purchase price was allocated to the assets and liabilities assumed based
on their respective fair values on the date of acquisitions as follows:



|                         |  |   |            |  
|------------------------ |  | - | ---------- | -
|Tangible assets acquired |  | $ | 280,000    |  
|Liabilities assumed      |  |   | (1,932,000 | )
|Technology               |  |   | 839,000    |  
|Customer relationships   |  |   | 1,314,000  |  
|Non-compete agreement    |  |   | 85,000     |  
|Goodwill                 |  |   | 1,846,000  |  
|                         |  |   |            |  
|                         |  | $ | 2,432,000  |  
|                         |  |   |            |  



The technology is
being amortized over periods ranging from three months to five years, the customer relationships are being amortized over 11.5 years and the non-compete agreement is being amortized over five years.



The results of operations of VertiSoft have been included in Optios
consolidated condensed financial statements from the date of acquisition.



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



OVERVIEW



Optio is engaged primarily in the development, sale and support of infrastructure software that enhances the form, content, distribution and availability
of business information. Optios primary business consists of providing software and services that addresses organizations needs for customized information delivered via print, fax and e-mail to users of enterprise and healthcare
applications.



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Optio markets and sells its software and services throughout the United States, Europe and the Asia
Pacific region, through its direct sales force and certified resellers. Optio has offices in the United States, France, the United Kingdom and Germany. Optio also offers consulting services, which provide customers with implementation assistance and
training. No single customer accounted for 10% or more of Optios revenue for the three or nine months ended October 31, 2005 or 2004.



Critical Accounting Policies and Use of Estimates



Optio has identified significant accounting policies and estimates that are critical to the understanding of its financial statements.



Revenue Recognition



Overview



The Companys revenue consists of fees for licenses of the Companys software products, subscription fees, maintenance, consulting services and
customer training. The Company generally charges fees for licenses of its software products either based on the number of Central Processing Units (CPUs) on which the product is installed or, to a lesser extent, based on the number of
persons or hospital beds registered to use the product. The Companys revenue recognition policies are in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by
SOP No. 98-9, Software Revenue Recognition With Respect to Certain Transactions and the Securities and Exchange Commissions Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements, as amended by SAB 104, Revenue Recognition.



License
Fees



The Company licenses its products through its direct
sales force and indirectly through resellers. In general, software license revenues are recognized when a non-cancelable license agreement has been signed and the customer acknowledges an unconditional obligation to pay, the software product has
been delivered, there are no significant uncertainties surrounding product acceptance, the fees are fixed or determinable and collection is considered probable. Delivery is considered to have occurred when title and risk of loss have been
transferred to the customer, which generally occurs when media containing the licensed programs is provided to a common carrier. In case of electronic delivery, delivery occurs when the customer is given access to the licensed programs. If
collectibility is not considered probable, revenue is recognized when the fee is collected. The Company enters into reseller arrangements that typically provide for sublicense fees payable to the Company based upon a percentage of list price. The
Company does not grant its resellers the right of return.



The
Company recognizes revenue using the residual method pursuant to the requirements of SOP No. 97-2, as amended by SOP No. 98-9. Revenues recognized from multiple-element software arrangements are allocated to each element of the
arrangement based on the fair values of the elements, such as licenses for software products, maintenance, consulting services or customer training. The determination of fair value is based on objective evidence, which is specific to the Company.
The Company limits its assessment of objective evidence for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold
separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the
undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue.



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The Company records deferred revenue for software license agreements when cash has been received from the
customer and the agreement does not qualify for revenue recognition under the Companys revenue recognition policy. The Company records accounts receivable for software license agreements when the agreement qualifies for revenue recognition but
cash or other consideration has not been received from the customer.



Subscription Revenue



The Company also
licenses certain of its products in the form of a subscription service contract, typically ranging from three to five years. Subscription revenue, which includes a license to the software product, technical support and future unspecified
enhancements to the software product, is recognized on a daily basis over the agreement period once the product has been installed.



Services, Maintenance and Other Revenue



Consulting services revenues and customer training revenues are recognized as such services are performed, as they are incidental to the functionality of
the software. Maintenance revenues, which include revenues bundled with software license agreements that entitle the customers to technical support and future unspecified enhancements to the Companys products, are deferred and recognized
ratably over the related agreement period, generally twelve months. In accordance with Emerging Issues Task Force release 01-14, Income Statement Characterization of Reimbursements Received for Out of Pocket Expenses Incurred, the
Company recognizes reimbursable expenses as revenue and as an expense in cost of revenue in all periods presented.



Note Receivable



Optio holds a note from M2 Systems as partial consideration for the sale of Muscato and TransLink. Under the terms of this note, M2 Systems was required
to make payments of $100,000 each on September 1, 2003 and December 1, 2003 and a payment of $115,000 on June 1, 2004. M2 Systems failed to make these payments on their respective due dates; however, payment was made prior to an event
of default. All subsequent payments have been made on their respective due dates.



During the third quarter of 2004, as a result of M2 Systems failure to make timely payments in the prior quarters, management determined that this was an indication that it was probable that Optio would be
unable to collect all amounts due according to the contractual terms of the note. At that time, the loan was considered impaired and was written down to the assessed fair value of the collateral. As of October 31, 2003, the collateral,
including technology, accounts receivable, fixed assets and the discounted net cash flows of maintenance contracts was estimated to have an approximate fair value of $2.8 million, substantially less than the $3.7 million note receivable balance as
of October 31, 2003. Thus Optio recorded an impairment charge of $900,000 during the year ended January 31, 2004. Optio continues to reassess the value of the collateral on an ongoing basis. The amount of the note receivable recorded could
be materially different under different conditions or using different assumptions, including the varying assumptions regarding the fair value of the collateral. If M2 Systems defaults on the note and the collateral proves to be of no value to Optio,
Optio would incur an additional loss of approximately $2.1 million.



On September 14, 2004, Optio notified M2 Systems of certain non-monetary defaults under the M2 Systems Note. Optio did not accelerate the indebtedness under the M2 Systems note and Optio and M2



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Systems negotiated modifications to the current loan documents to address the alleged defaults by M2 Systems. On
May 18, 2005, the parties executed modified and additional security documents granting Optio a security interest in the assets of certain of M2 Systems affiliates and placing greater restrictions on the use of the collateral with
non-affiliates.



Accounts Receivable



Optio maintains allowances for doubtful accounts for estimated losses
resulting from customers inability to make payments required under their contracts. The amount of Optios reserve is based on historical experience and Optios specific review and analysis of the receivables outstanding. Management
reviews its accounts receivable on a regular basis to determine if any such amounts may be potentially uncollectible. The Company includes any balances that are determined to be uncollectible, along with a general reserve at varying percentages of
3% to 20%, in its overall allowance for doubtful accounts. Based on managements best estimate it believes the Companys allowance for doubtful accounts is adequate as presented; however, the amount of the reserve could be different under
different conditions or using varying assumptions. If the percentage of the general reserve were to increase by 1%, an additional reserve of approximately $50,000 would be required. If the financial condition of Optios customers were to
deteriorate, resulting in their inability to make payments, additional reserves would be required, increasing Optios bad debt expense included in general and administrative expenses.



Impairment Assessments



Optio adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets, on February 1, 2002. This standard requires that goodwill no longer be amortized and instead be tested for impairment on a periodic basis.



Pursuant to SFAS 142, Optio is required to test goodwill for impairment upon adoption and annually or more often if events or changes in circumstances
indicate that the asset might be impaired. SFAS 142 provides for a two-stage approach to determining whether and by how much goodwill has been impaired. The first stage requires a comparison of the fair value of the reporting unit, in our case, the
United States and European reporting units which contain the former VertiSoft Corporation and VertiSoft Limited business, to its net book value. If the fair value is greater than book value, no impairment is deemed to have occurred. If the fair
value is less than book value, then the second stage must be completed to determine the amount, if any, of actual impairment. Optio has selected August 1 as its annual impairment testing date for its goodwill. The Company performed an analysis
as of August 1, 2005, comparing the fair value of the reporting units with the carrying value of such reporting units, including goodwill, and determined that no impairment of its goodwill existed. While no impairment charge was determined to
be necessary in the current year, the Companys future assessments could lead management to determine that the goodwill is completely impaired, which would require the Company to record an impairment charge of $1.8 million.



The process of evaluating the potential impairment of goodwill is highly
subjective and requires significant judgment decisions. In estimating our fair value, we will make estimates and judgments about future revenues and cash flows. Our forecasts will be based upon assumptions that are consistent with the plans and
estimates we are using to manage our business. Changes in these estimates could change our conclusion regarding impairment of goodwill and potentially result in a non-cash goodwill impairment charge for all or a portion of the goodwill balance. For
long-lived assets, accounting standards dictate that assets become impaired when the undiscounted future cash flows expected to be generated by them are less than their carrying amounts. When that occurs, the affected assets are written down to
their estimated fair value.



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RESULTS OF OPERATIONS



Three Months Ended October 31, 2005 Compared to Three Months Ended October 31, 2004



Revenues



The following table sets forth certain items from Optios statements of operations as a percentage of total revenue for the periods indicated.



|                                                                            |  |                               |   |  |      |  
|--------------------------------------------------------------------------- |  | ----------------------------- | - |  | ---- | -
|                                                                            |  | Three MonthsEnded October 31, |  
|                                                                            |  | 2004                          |   |  | 2005 |  
|Revenue:                                                                    |  |                               |   |  |      |  
|License fees                                                                |  | 27                            | % |  | 29   | %
|Subscription fees                                                           |  | 6                             |   |  | 8    |  
|Services, maintenance and other                                             |  | 67                            |   |  | 63   |  
|                                                                            |  |                               |   |  |      |  
|Total revenue                                                               |  | 100                           |   |  | 100  |  
|                                                                            |  |                               |   |  |      |  
|Costs of revenue (excluding depreciation and amortization, included below): |  |                               |   |  |      |  
|License fees                                                                |  | 2                             |   |  | 3    |  
|Services, maintenance and other                                             |  | 21                            |   |  | 23   |  
|                                                                            |  |                               |   |  |      |  
|Total cost of revenue                                                       |  | 23                            |   |  | 26   |  
|                                                                            |  |                               |   |  |      |  
|                                                                            |  | 77                            |   |  | 74   |  
|Operating expenses:                                                         |  |                               |   |  |      |  
|Sales and marketing                                                         |  | 38                            |   |  | 40   |  
|Research and development                                                    |  | 16                            |   |  | 19   |  
|General and administrative                                                  |  | 15                            |   |  | 14   |  
|Depreciation and amortization                                               |  | 3                             |   |  | 3    |  
|                                                                            |  |                               |   |  |      |  
|Total operating expenses                                                    |  | 72                            |   |  | 76   |  
|                                                                            |  |                               |   |  |      |  
|Income (Loss) from operations                                               |  | 5                             |   |  | 0    |  
|Interest and other income                                                   |  | 0                             |   |  | 0    |  
|                                                                            |  |                              
|Income tax benefit                                                          |  |                               |   |  |     |  
|                                                                            |  |                               |   |  |      |  
|Net income                                                                  |  | 5                             | % |  | 0    | %
|                                                                            |  |                               |   |  |      |  



Revenues



Total revenues increased 6% to $7.1 million from $6.6 million for the three
months ended October 31, 2005 and 2004, respectively.



License fees



Revenues from software licenses increased 17% to $2.1
million from $1.8 million for the three months ended October 31, 2005 and 2004, respectively. In the third quarter of fiscal year 2005, Optios ERP and Healthcare segments failed to close several contracts and as a result experienced a
significant decline in software revenue in that quarter. In the third quarter of fiscal year 2006, Optios ERP team improved over the prior year, increasing software license revenue by approximately $175,000. Optios Healthcare team
remained



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relatively consistent, as expected, as it makes the transition to primarily a subscription model. Optios other
sales groups, including EMEA, US channels and installed base, each improved over the prior year as well, but to a lesser extent, for a total increase of $186,000.



Approximately $637,000 of Optios software license revenue during the three months ended October 31, 2005 was derived from
partners, such as resellers, value-added distributors or OEM relationships, representing 31% of license revenue for Optio. During the three months ended October 31, 2004, Optio generated $503,000 of its software license revenue through
partners, representing 28% of Optios license revenue.



Subscription
fees



Subscription revenue increased to $542,000 in the
three months ended October 31, 2005 from $417,000 in the three months ended October 31, 2004. Subscription revenue is a new revenue source added with the acquisition of Vertisoft on August 10, 2004. Because VertiSoft was acquired on
August 10, 2004, Optio was unable to recognize the subscription revenue for the nine days prior to the acquisition, thus making the prior year subscription revenues less than the current year, which reflects a full three months. In addition,
over the course of the previous year, Optio has been able to sign additional contracts and additional modules for existing contracts, increasing the monthly amount recognized on a subscription basis.



Services, maintenance and other



Revenues from services, maintenance and other increased to $4.5 million from
$4.4 million during the three months ended October 31, 2005 and 2004, respectively. Services revenue decreased to $1.4 million from $1.7 million for the three months ended October 31, 2005 and 2004, respectively. Services revenue decreased
primarily as a result of two factors. There was a $150,000 decline in training revenue in the US, resulting from a decrease in sales of training services, especially in Optios healthcare group, a result of the delay in the release of a new
version of MedEx. In addition, the UK experienced higher than average consulting revenue in the three months ended October 31, 2004 due to significant license sales in the first two quarters of the year. As license sales in the UK declined in
the fiscal 2006, year to date, we experienced an $80,000 decline in UK services revenue. Maintenance revenue increased $200,000 to $3.0 million in the three months ended October 31, 2005 from $2.8 million in the three months ended
October 31, 2004. Maintenance revenue continues to increase as Optio adds to its customer base and increases the price of its annual maintenance fees.



Revenue Mix



Because license fees revenue and subscription fees revenue increased significantly over the prior year, but services and maintenance revenue increased
only slightly, license and subscription fees became a larger percentage of total revenue, as compared to the prior year. As Optio continues to add additional contracts to its subscription revenue, the subscription fees as a percentage of revenue
will continue to grow as shown in the three months ended October 31, 2005. Revenues from licenses represented 29% of total revenue in the three months ended October 31, 2005 and 27% of total revenue in the three months ended
October 31, 2004. Subscription revenue represented 8% and 6% of total revenue in the three months ended October 31, 2005 and 2004, respectively. Services, maintenance and other revenue constituted 63% and 67% of total revenue in the three
months ended October 31, 2005 and 2004, respectively.



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##### Table of Contents

Costs of Revenues



Total costs of revenues increased 18% to $1.8 million in the three months ended October 31, 2005 from $1.5 million in
the three months ended October 31, 2004.



Licenses



Costs of revenues from licenses consist of costs related to the packaging
and distribution of the products, fees paid for integration of third-party software products and fees paid to referral partners. Costs of revenues from licenses increased to $187,000 in the three months ended October 31, 2005 from $121,000 in
the three months ended October 31, 2004, primarily the result of a $50,000 increase in royalties due to OEM partners.



Services, maintenance and other



Costs of revenues from services, maintenance and other consist of personnel, subcontracting and other expenses relating to the cost of providing customer
support, education and consulting and implementation services. Costs of revenues from services, maintenance and other increased to $1.6 million in the three months ended October 31, 2005 from $1.4 million in the three months ended
October 31, 2004. Optios internal implementation staff has been reduced and, as a result, during the three months ended October 31, 2005, Optio relied more heavily on external outsourcers. This resulted in a $190,000 increase in the
cost of outsourcers in the three months ended October 31, 2005 as compared to the three months ended October 31, 2004. Although Optios internal implementation staff has been reduced, Optios support personnel has increased, and
as a result, salaries between the two quarters have remained relatively consistent.



Operating Expenses



Sales and Marketing



Sales and marketing expenses consist primarily of salaries, commissions,
bonuses and benefits earned by sales and marketing personnel, direct expenditures such as travel, communication and occupancy and marketing expenditures related to direct mail, trade shows and other advertising.



Sales and marketing expenses increased 12% to $2.9 million from $2.5 million
for the three months ended October 31, 2005 and 2004, respectively. Sales and marketing expenses were 40% and 38%, respectively, of total revenue for the same periods. Direct marketing expenditures remained relatively consistent between the
three months ended October 31, 2005 and the three months ended October 31, 2004. However, salaries, commissions and bonuses increased by approximately $300,000 between the two quarters. Approximately $130,000 of this $300,000 increase was
from increased commissions and bonuses resulting from increased revenues between the two quarters. The remaining $170,000 increase results from salary increases and from the addition of five supplemental sales and marketing employees.



Research and Development



Research and development expense consists primarily of salaries, benefits
and equipment for software developers, quality assurance personnel, and product managers.



Research and development expenses increased to $1.3 million from $1.1 million for the three months ended October 31, 2005 and 2004, respectively. In the three months ended October 31, 2004, Optio reversed



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an expense accrual of $105,000 for year-end bonuses, which management determined would not be paid. As there was no such
reversal in the current year, expenses increased by this $105,000. In addition, while headcount remained consistent between the years at 43 employees, salaries increased by $75,000, a result of salary raises granted in April 2005.



General and Administrative



General and administrative expenses consist primarily of salaries, benefits
and related costs for executive, finance, human resources and information services personnel. General and administrative expenses also include legal, accounting, insurance and other professional services.



General and administrative expenses remained consistent at $1.0 million in
both the three months ended October 31, 2005 and 2004.



Depreciation
and Amortization



Depreciation and amortization expense
decreased to $202,000 from $221,000 for the three months ended October 31, 2005 and 2004, respectively. This decrease was primarily the result of a decrease in amortization expense related to the VertiSoft acquisition as the intangible assets
are amortized over their respective lives.



Interest Income



Interest income increased to $69,000 from $38,000 in the three months
ended October 31, 2005 and 2004. Interest income primarily represents interest earned on the principal of the M2 Systems note receivable and has increased due to an increase in the interest rate on the note.



Interest Expense



Interest expense increased to $10,000 from $3,000 in the three months ended October 31, 2005 and 2004, respectively.
Interest expense primarily represents the interest paid on Optios capital leases, however in the three months ended October 31, 2005, Optio paid additional interest on a tax settlement.



Nine Months Ended October 31, 2005 Compared to Nine Months Ended October 31,
2004



Revenues



The following table sets forth certain items from Optios statements of
operations as a percentage of total revenue for the periods indicated.



|                                                                            |  |                              |   |  |      |  
|--------------------------------------------------------------------------- |  | ---------------------------- | - |  | ---- | -
|                                                                            |  | Nine MonthsEnded October 31, |  
|                                                                            |  | 2004                         |   |  | 2005 |  
|Revenue:                                                                    |  |                              |   |  |      |  
|License fees                                                                |  | 35                           | % |  | 32   | %
|Subscription fees                                                           |  | 2                            |   |  | 7    |  
|Services, maintenance and other                                             |  | 63                           |   |  | 61   |  
|                                                                            |  |                              |   |  |      |  
|Total revenue                                                               |  | 100                          |   |  | 100  |  
|                                                                            |  |                              |   |  |      |  
|Costs of revenue (excluding depreciation and amortization, included below): |  |                              |   |  |      |  
|License fees                                                                |  | 2                            |   |  | 3    |  
|Services, maintenance and other                                             |  | 21                           |   |  | 22   |  
|                                                                            |  |                              |   |  |      |  
|Total cost of revenue                                                       |  | 23                           |   |  | 25   |  
|                                                                            |  |                              |   |  |      |  
|                                                                            |  | 77                           |   |  | 75   |  
|Operating expenses:                                                         |  |                              |   |  |      |  
|Sales and marketing                                                         |  | 38                           |   |  | 40   |  
|Research and development                                                    |  | 16                           |   |  | 18   |  
|General and administrative                                                  |  | 15                           |   |  | 14   |  
|Depreciation and amortization                                               |  | 2                            |   |  | 3    |  
|                                                                            |  |                              |   |  |      |  
|Total operating expenses                                                    |  | 71                           |   |  | 75   |  
|                                                                            |  |                              |   |  |      |  
|Income from operations                                                      |  | 6                            |   |  | 0    |  
|Interest and other income                                                   |  | 1                            |   |  | 1    |  
|Income tax benefit                                                          |  |                             |   |  |     |  
|                                                                            |  |                              |   |  |      |  
|Net income                                                                  |  | 7                            | % |  | 1    | %
|                                                                            |  |                              |   |  |      |  



23



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Revenues



Total revenues increased 4% to $21.4 million from $20.6 million for the nine months ended October 31, 2005 and 2004, respectively.



License fees



Revenues from software licenses decreased 6% to $6.8 million from $7.2 million for the nine months ended October 31,
2005 and 2004, respectively. Healthcare perpetual license revenues declined $400,000 between the first nine months of fiscal 2005 and fiscal 2006. As the healthcare sales force began to focus on subscription based revenue, Optio experienced an
anticipated decline in its perpetual license revenue. In addition, license revenue from Optios European operations decreased $225,000 between the nine months ended October 31, 2004, and October 31, 2005. Optios European
operations failed to close several contracts as expected during the first quarter of fiscal 2006. In the third quarter of fiscal year 2006, Optios perpetual license revenue improved over the prior year by approximately $250,000 for the nine
months ended October 31, 2005. This was due to the failure of Optio to close several ERP perpetual license contracts in the third quarter of fiscal 2005. Sales across each of Optios other sales groups, including its install base and
channels groups, remained relatively consistent between the two periods.



Approximately $1.8 million of Optios software license revenue during the nine months ended October 31, 2005 was derived from partners, such as resellers, value-added distributors or OEM relationships,
representing 27% of license revenue for Optio. During the nine months ended October 31, 2004, Optio generated $1.7 million of its software license revenue through partners, representing 23% of Optios license revenue.



Subscription fees



Subscription revenue increased to $1.6 million in the nine months ended October 31, 2005 from $417,000 in the nine
months ended October 31, 2004. Subscription revenue was a new revenue source added with the acquisition of Vertisoft on August 10, 2004. Subscription revenue has been reflected after the acquisition date and as a result, subscription
revenue for the nine months ended October 31, 2005 is significantly higher than for the nine months ended October 31, 2004 as the nine months ended October 31, 2005 contains an additional six months and nine days of activity.



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Services, maintenance and other



Revenues from services, maintenance and other remained constant at $13.0 million in the nine months ended October 31,
2005 and 2004, respectively. Services revenue decreased to $4.3 million for the nine months ended October 31,2005 from $4.5 million for the nine months ended October 31, 2004. Optios consulting revenue had declined in the first three
months of this fiscal year, a result of the previous quarters decline in new license revenue. In the second quarter of this fiscal year, Optio began two large consulting engagements which increased the consulting revenue to levels consistent
with the comparable prior year period. However, in the third quarter, there was a $150,000 decline in training revenue in the US, resulting from a decrease in sales of training services, especially in Optios healthcare group, a result of the
delay in the release of a new version of our healthcare product. In addition, the UK experienced higher than average consulting revenue in the three months ended October 31, 2004 due to significant license sales in the first two quarters of the
year. As license sales in the UK dropped in fiscal 2006 year to date, we experienced an $80,000 decline in services revenue. Maintenance revenue increased $200,000 to $8.7 million in the nine months ended October 31, 2005 from $8.5 million in
the nine months ended October 31, 2004. Maintenance revenue continues to increase as Optio adds to its customer base and increases the price of its annual maintenance fees.



Revenue Mix



With the introduction of subscription revenue during the third quarter of fiscal year 2005, fiscal year 2006 has had a full nine months of subscription
revenue. Therefore, the revenue mix is now more heavily allocated towards subscription revenue. In the nine months ended October 31,2005, licenses fees represented 32%, subscription fees represented 7% and services, maintenance and other
represented 61% of total revenue. Compared to the nine months ended October 31, 2004, license fees represented 35%, subscription fees represented 2% and services, maintenance and other represented 63% of total revenue.



Costs of Revenues



Total costs of revenues increased to $5.3 million in the nine months ended October 31, 2005 from $4.8 million for the
nine months ended October 31, 2004.



Licenses



Costs of revenues from licenses increased to $544,000 in the nine months
ended October 31, 2005 from $444,000 in the nine months ended October 31, 2004, primarily the result of approximately $165,000 in additional royalties due to OEM partners, offset by a $61,000 decline in referral fees.



Services, maintenance and other



Costs of revenues from services, maintenance and other increased to $4.8
million for the nine months ended October 31, 2005 from $4.4 million in the nine months ended October 31, 2004. Optios internal implementation staff has been reduced and was often used to assist in the beta introduction of select
Optio products. As a result, during the nine months ended October 31, 2005, Optio relied more heavily on external outsourcers. This resulted in a $340,000 increase in the cost of outsourcers in the nine months ended October 31, 2005 as
compared to the nine months ended October 31, 2004. Although Optios internal implementation staff has been reduced, Optios support personnel has increased, and as a result, salaries between the two periods increased by approximately
$150,000.



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Operating Expenses



Sales and Marketing



Sales and marketing expenses increased 8% to $8.5 million from $7.9 million for the nine months ended October 31, 2005 and 2004, respectively. Sales
and marketing expenses were 40% and 38%, respectively, of total revenue for the same periods. Direct marketing expenditures increased approximately $200,000 between the two nine month periods. In addition, salaries, commissions and bonuses increased
by approximately $400,000 between the two nine month periods. Approximately $130,000 of this $400,000 increase was from increased commissions and bonuses resulting from increased revenues between the nine month periods. The remaining $270,000
increase is the result of salary raises granted in April 2005 and from the addition of seven sales and marketing employees.



Research and Development



Research and development expenses increased to $3.9 million in the nine months ended October 31, 2005 from $3.2 million in the nine months ended
October 31, 2004. This increase was primarily due to the additional cost of the Vertisoft employees that were included for the entire nine months ending October 31,2005; whereas, they were only included as of August 10, 2004, in the
nine months ending October 31, 2004 which resulted in an additional $576,000 in salaries.



General and Administrative



General and administrative expenses decreased to $3.0 million in the nine months ended October 31, 2005 from $3.1 million in the nine months ended October 31, 2004. The decrease in general and administrative expenses primarily
resulted from a decrease in bad debt expense of $120,000, savings on various insurance policies of approximately $20,000, offset by increased legal fees of approximately $80,000.



Depreciation and Amortization



Depreciation and amortization expense increased to $633,000 from $398,000 for the nine months ended October 31, 2005 and 2004, respectively. This
increase was due in part to the addition of $215,000 of amortization expense in the nine months ended October 31, 2005, related to the intangible assets acquired in the VertiSoft acquisition on August 10, 2004.



Interest Income



Interest income increased to $185,000 from $121,000 in the nine months ended October 31, 2005 and 2004, respectively,
primarily the result of the increased interest applied to the principal of the M2 Systems note receivable.



Interest Expense



Interest expense increased to $14,000 from $10,000 in the nine months ended October 31, 2005 and 2004, respectively. Interest expense primarily represents the interest paid on Optios capital leases.



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LIQUIDITY AND CAPITAL RESOURCES



Optio had $6.4 million and $4.8 million in cash and cash equivalents at October 31, 2005 and 2004, respectively.



The following table sets forth certain selected statements of
cash flow information for the nine months ended October 31, 2005:



|                                          |  |   |          |  
|----------------------------------------- |  | - | -------- | -
|Net cash provided by operations           |  | $ | 996,000  |  
|Net cash used in investing activities     |  |   | (101,000 | )
|Net cash provided by financing activities |  |   | 147,000  |  
|Net increase in cash and cash equivalents |  |   | 982,000  |  



Cash provided by
operations was primarily the result of $160,000 in net income, plus a $665,000 add-back of non-cash depreciation and amortization expense and provision for deferred taxes, plus changes in working capital resulting in a $171,000 inflow of cash. The
major component of such working capital changes was the Companys use of funds to pay down accrued expenses and accounts payable by approximately $408,000, primarily representing the payment of Optios year-end commissions and bonuses and
other year-end expenses such as audit fees. In addition, Optio prepaid several of its renewed insurance policies and other marketing expenses, resulting in a $142,000 cash outflow. This was partially offset by improved collections on accounts
receivable resulting in additional cash inflow of $319,000. Finally, Optios deferred revenue increased $402,000, as Optios maintenance revenue and associated deferred maintenance billings increased. In investing activities, Optio
received $238,000 in payments on the receivable from M2 Systems and purchased $264,000 of property and equipment in the ordinary course of business. Optio paid the first $75,000 installment of conditional cash payments under the terms of the
VertiSoft purchase agreement. Optios financing activities included receipts of $213,000 from the exercise of stock options, offset by payments of capital lease and other debt obligations of $66,000.



On April 27, 2005 Optio extended the line of credit with its bank
through April 21, 2006. The line of credit bears interest at the prime rate, subject to increase based on Optios performance relative to certain financial ratios. Optio may borrow up to $4.0 million, or such lesser amount as may be
determined based on the level of accounts receivable. Accounts receivable, equipment, general intangibles and other assets as defined in the agreement collateralize the line of credit. The agreement contains various covenants, including liquidity
and EBITDA requirements and restrictions on dividends. Optio was in compliance with its required financial covenants as of April 30, 2005. During fiscal year 2006, Optio estimates that it will have approximately $2.0 million available for
borrowings under this line of credit based upon Optios historical accounts receivable balance. There were no borrowings under the line of credit during the nine months ended October 31, 2005.



The Company holds a note receivable from M2 Systems as consideration for the
sale of Muscato and TransLink. The payment schedule of the note requires four quarterly installments of $100,000, including interest calculated at the prime rate as of the third business day preceding each calendar year end (5.25% as of
January 31, 2005), through January 31, 2004, four quarterly payments of $115,000, including interest, through January 31, 2005, and eleven quarterly payments of $120,000 through October 31, 2007. The balance of the note, plus any
additional accrued interest, is to be paid in the quarter ending January 31, 2008.



On August 10, 2004, Optio acquired VertiSoft Corporation. The terms of the purchase included future



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conditional cash payments of $225,000 to be paid out in various installments over the following years, contingent upon
the achievement of certain customer retention and product development goals. Optio paid the first $75,000 installment of conditional cash payments in August 2005. Thus, an additional $150,000 of conditional cash payments may be due over the
following year.



Management believes that the existing cash and
cash equivalents, together with Optios line of credit, will provide adequate cash to fund its anticipated cash needs at least through the next twelve months. Optio intends to expand its product line, which may require acquisitions of companies
or products in an attempt to enhance our product line. As a result, we may attempt to raise additional funds through equity or debt financing. There can be no assurance that we will be able to raise additional funds on favorable terms, or at all.
Although not anticipated, a dramatic decrease in demand for Optios products or services, or a dramatic change in technology related to Optios products or services offered, could have a negative impact on Optios liquidity. This risk
may include the potential for Optio to not meet its debt covenant requirements, making any borrowings under the line of credit unavailable.



ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.



Optio provides its services to customers primarily in the United States and, to a lesser extent, in Europe and elsewhere throughout the world. As a
result, Optios financial results could be affected by factors, such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. All sales are currently made in both U.S. dollars and local currencies. A
strengthening of the U.S. dollar or the weakening of these local currencies could make Optios products less competitive in foreign markets. Based upon the relative size of Optios foreign operations, Optio believes its exposure to foreign
currency fluctuations is not a material risk. Optios interest income and expense are sensitive to changes in the general level of U.S. interest rates. Based on Optios cash equivalents balance and the nature of its outstanding debt, Optio
believes its exposure to interest rate risk is not material.



ITEM 4. CONTROLS AND PROCEDURE-EVALUATION AND DISCLOSURE CONTROLS AND PROCEDURES.



Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule
13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of October 31, 2005, and have concluded that, as of such date, our disclosure controls and procedures are effective in ensuring that information
required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commissions rules and forms. Our Chief Executive Officer and
Chief Financial Officer also concluded that, as of October 31, 2005, our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act
is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.



Changes in Internal Controls



There were no changes in our internal controls over financial reporting that occurred during the quarter ended October 31, 2005, that have materially
affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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PART II  OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



On
November 13, 2001, a lawsuit styled Kevin Dewey vs. Optio Software, Inc., et. al. was filed in the United States District Court for the Southern District of New York. The complaint was filed against the underwriters in the Companys
initial public offering as well as Optio and certain officers and directors of Optio, by a single plaintiff purportedly on behalf of persons purchasing Optios common stock between December 14, 1999 and December 6, 2000 and seeks
class action status. Optio is a co-defendant with approximately 300 other issuers in this suit. The complaint includes allegations of violations of (i) Section 11 of the Securities Act of 1933 by all named defendants,
(ii) Section 12(a)(2) of the Securities Act of 1933 by the underwriter defendants, (iii) Section 15 of the Securities Act of 1933 by the individual defendants, and (iv) Section 10(b) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder by the underwriter defendants. The complaint alleges that Optios prospectus was materially false and misleading because it failed to disclose, among other things, that: (i) the underwriters had
solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors material portions of a limited number of Optio shares issued in connection with the Optio initial
public offering; and (ii) the underwriters had entered into agreements with customers whereby the underwriters agreed to allocate Optio shares to those customers in the Optio initial public offering in exchange for which the customers agreed to
purchase additional Optio shares in the aftermarket at pre-determined prices. The complaint seeks unspecified amounts as compensatory damages as a result of Optios alleged actions, as well as punitive damages and reimbursement for the
plaintiffs attorneys fees and associated costs and expenses of the lawsuit. A proposal to settle the claims against Optio and other companies and individual defendants in the litigation was conditionally accepted by Optio. The completion
of the settlement is subject to a number of conditions, including Court approval. The Court preliminarily approved the settlement on February 15, 2005, subject to certain modifications which are currently pending approval by the defendants.
Under the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in the action. Optio
may still have yet undetermined exposure to the underwriters pursuant to indemnification provisions in the underwriting agreement entered into at the time of the initial public offering. Under the guaranty, all the insurers for all the issuers will
be required to pay an amount equal to $1.0 billion less any amounts ultimately collected by the plaintiffs from the underwriter defendants in all the cases. The disposition of this matter is limited to Optios $300,000 corporate insurance
deductible. The Company has completed payment of the insurance deductible through payment of legal fees. Optio will have no additional exposure unless the insurance companies become insolvent or unless Optios liability exceeds its policy
limits through this matter or other matters. Optios insurance companies currently have an A or AA rating. The range of loss, if any, cannot be estimated and thus no potential loss is reflected in Optios financial statements.



Management believes that it has meritorious defenses in the foregoing
matter and intends to pursue its position vigorously. Litigation is inherently subject to many uncertainties; however, management does not believe that the outcome of this case will have a material adverse effect on the financial position of Optio.
However, depending on the amount and timing of an unfavorable resolution of the contingency, it is possible that Optios future results of operations or cash flows could be materially affected.



Optio is from time to time involved in other routine litigation incidental to
the conduct of its business.



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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



None



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



None



ITEM 5. OTHER INFORMATION



None.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



(a)
Exhibits



|     |  |                                                                                                                                                                                                            
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1  |  | Amendment No. 1 to Agreement and Plan of Reorganization, by and among Optio Software, Inc., Optio Software II, Inc., VertiSoft Corporation and Shareholders of VertiSoft Corporation, dated
August 1, 2005.
|     | 
|31.1 |  | Certification of CEO pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                        
|     | 
|31.2 |  | Certification of CFO pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                        
|     | 
|32.1 |  | Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                             
|     | 
|32.2 |  | Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                             
|     | 
|99.1 |  | Safe Harbor Compliance Statement for Forward-Looking Statements.                                                                                                                                           



|(b) | Reports on Form 8-K
|--- | -------------------



|    |  |                                                                                                                                  
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------
|(a) |  | A form 8-K was filed on September 6, 2005 to furnish the Companys second quarter earnings press release dated September 1, 2005.



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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 on the 15thday of December, 2005.



OPTIO SOFTWARE, INC.By:

/s/ C. Wayne CapeC. Wayne CapePresident and Chief Executive Officer




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