** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**
| **(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, 2006**                                                                                                                                                                                                                            |
| ** **     |       | ** **                                                                                                                                                                                                                                                                     |
| **OR**         |
| ** **     |       | ** **                                                                                                                                                                                                                                                                     |
| **o**          | ** ** | **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**

**OPTIOSOFTWARE, INC.**

(Exact name ofregistrant as specified in its charter)

| **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’stelephone number, including area code: **(770) 576-3500**

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  x   No  o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act).
| Large accelerated  filer   o |   | Accelerated  filer   o |   | Non-accelerated  filer   x |
|---------------------------------------------|--------|---------------------------------------|--------|-------------------------------------------|

 

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

There were 22,484,795shares of the Registrant’s common stock outstanding as of December 13, 2006.

 

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**OPTIO SOFTWARE, INC.**

**FORM 10-Q**

# **For theQuarterly Period Ended October 31, 2006**

**TABLE OF CONTENTS**
|            |   |                                                                                         |   |   |
|------------|--------|----------------------------------------------------------------------------------------------|--------|--------|
| ** ** |   | **PART  I – FINANCIAL INFORMATION**                                                     |   |   |
| ** ** |   | ** **                                                                                   |   |   |
| Item 1.    |   | Financial Statements                                                                         |   |   |
|       |   |                                                                                         |   |   |
| Item 2.    |   | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations |   |   |
|       |   |                                                                                         |   |   |
| Item 3.    |   | Quantitative  and Qualitative Disclosures About Market Risk                                  |   |   |
|       |   |                                                                                         |   |   |
| Item 4.    |   | Controls and  Procedures                                                                     |   |   |
|       |   |                                                                                         |   |   |
| ** ** |   | **PART  II – OTHER INFORMATION**                                                        |   |   |
| ** ** |   | ** **                                                                                   |   |   |
| Item 1.    |   | Legal Proceedings                                                                            |   |   |
|       |   |                                                                                         |   |   |
| Item  1A.  |   | Risk  Factors                                                                                |   |   |
|       |   |                                                                                         |   |   |
| Item 2.    |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                 |   |   |
|       |   |                                                                                         |   |   |
| Item 3.    |   | Defaults Upon  Senior Securities                                                             |   |   |
|       |   |                                                                                         |   |   |
| Item 4.    |   | Submission of  Matters to a Vote of Security Holders                                         |   |   |
|       |   |                                                                                         |   |   |
| Item 5.    |   | Other Information                                                                            |   |   |
|       |   |                                                                                         |   |   |
| Item  6.   |   | Exhibits                                                                                     |   |   |

 

2

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# **FORWARD-LOOKINGSTATEMENTS**

In addition to historical information, this QuarterlyReport on Form 10-Q for the quarter ended October 31, 2006 containsforward-looking statements that involve risks and uncertainties. Suchforward-looking statements are made pursuant to the “safe-harbor” provisions ofthe Private Securities Litigation Reform Act of 1995 and are made based onmanagement’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 ofacquired 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 statementsincluding the words “expects,” “anticipates,” “intends,” “believes” and similarlanguage. Optio’s actual results may differ significantly from those projectedin the forward-looking statements. Factors that might cause or contribute tosuch differences include, but are not limited to, risks associated with Optio’sreliance on strategic marketing and reseller relationships, collectibility ofaccounts receivable, fluctuations in operating results because of acquisitionsor dispositions, failure to integrate new products and newly acquiredcompanies, diversion of management resources relating to acquisitions,reduction in cash reserves relating to acquisitions, challenges relating toacquisitions and the possibility that this may cause Optio to no longer beprofitable, the negative effect on Optio’s earnings relating to theamortization or potential write-down of acquired assets or goodwill,failure  to retain the businessrelationships with existing customers from acquisitions, changes incompetition, changes in economic conditions in the U.S. and in other countriesin which Optio currently does business (both general and relative to thetechnology industry), delays or inability to develop new or unique softwareproducts, market acceptance of new products, the failure of new products tooperate as anticipated, expectation of achieving and sustaining operatingprofits and earnings, including timing of such cash flows and companyperformance, disputes regarding Optio’s intellectual property, risks relatingto the delisting of Optio’s stock, possible adverse results of pending orfuture litigation, or risks associated with Optio’s international operations.These and additional factors are set forth in Item 1A of Optio’s Annual Reporton Form 10-K for the fiscal year ended January 31, 2006 (the “2006 Annual Report”),filed with the Securities and Exchange Commission (“SEC”) on May 1, 2006. Youshould carefully review the risk factors in the 2006 Annual Report and anyadditional risks described in other documents that Optio files from time totime with the SEC. You are cautioned not to place undue reliance on theforward-looking statements in this document, which speak only as of the date ofthis Quarterly Report on Form 10-Q. Optio undertakes no obligation to publiclyrelease any revisions to the forward-looking statements or reflect events orcircumstances after the date of this document.

3

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# **PART I –FINANCIAL INFORMATION**

ITEM 1.  FINANCIAL STATEMENTS

**OptioSoftware, Inc.**

**Consolidated Condensed Balance Sheets**
| ** **                                                                                                | ** ** | **January 31,  2006** | ** ** | **October 31,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                                                | ** ** | ** **                 |       | **(Unaudited)**            |       |
| **ASSETS**                                                                                                | ** ** | ** **                 |       | ** **                 |       |
| Current assets:                                                                                           | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| Cash and cash  equivalents                                                                                |       | $                          | 7,954,000  |                       | $          | 8,011,000 |   |
| Accounts  receivable, net                                                                                 |       | 4,811,000                  |       | 4,103,000                  |       |
| Prepaid expenses  and other current assets                                                                |       | 720,000                    |       | 781,000                    |       |
| Notes receivable  from related party                                                                      |       | 5,000                      |       | 5,000                      |       |
| Current portion  of note receivable from M2                                                               |       | 323,000                    |       | 2,723,000                  |       |
| Total current assets                                                                                      |       | 13,813,000                 |       | 15,623,000                 |       |
| Property and equipment,  net                                                                              |       | 613,000                    |       | 2,776,000                  |       |
| Other assets:                                                                                             |       |                       |       |                       |       |
| Note receivable  from M2, net of valuation reserve of $900,000 at January 31, 2006, less  current portion |       | 1,720,000                  |       | —                     |       |
| Goodwill                                                                                                  |       | 1,846,000                  |       | 2,302,000                  |       |
| Other intangible  assets, net                                                                             |       | 1,615,000                  |       | 1,331,000                  |       |
| Other                                                                                                     |       | 91,000                     |       | 95,000                     |       |
| Total assets                                                                                              |       | $                          | 19,698,000 |                       | $          | 22,127,000 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                            |       |                       |       |                       |       |
| Current liabilities:                                                                                      |       |                       |       |                       |       |
| Accounts payable                                                                                          |       | $                          | 922,000    |                       | $          | 1,283,000 |   |
| Accrued expenses                                                                                          |       | 2,218,000                  |       | 1,279,000                  |       |
| Current portion  of lease incentive liability                                                             |       | —                     |       | 122,000                    |       |
| Current portion  of capital lease obligations                                                             |       | 1,000                      |       | 69,000                     |       |
| Deferred revenue                                                                                          |       | 7,373,000                  |       | 6,929,000                  |       |
| Total current  liabilities                                                                                |       | 10,514,000                 |       | 9,682,000                  |       |
|                                                                                                      |       |                       |       |                       |       |
| Long-term portion of  lease incentive liability                                                           |       | —                     |       | 836,000                    |       |
| Long-term portion of  capital lease obligations                                                           |       | —                     |       | 340,000                    |       |
| Other long-term  liabilities                                                                              |       | 63,000                     |       | 394,000                    |       |
| Total liabilities                                                                                         |       | 10,577,000                 |       | 11,252,000                 |       |
| Commitments and  contingencies                                                                            |       |                       |       |                       |       |
| Shareholders’ equity:                                                                                |       |                       |       |                       |       |
| Common stock                                                                                              |       | 52,577,000                 |       | 53,680,000                 |       |
| Accumulated  deficit                                                                                      |       | (43,533,000                | )          | (42,948,000                | )          |
| Accumulated  other comprehensive income                                                                   |       | 77,000                     |       | 143,000                    |       |
| Total shareholders’  equity                                                                          |       | 9,121,000                  |       | 10,875,000                 |       |
| Total liabilities and shareholders’ equity                                                           |       | $                          | 19,698,000 |                       | $          | 22,127,000 |   |

 

***Seeaccompanying notes***

4

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**OptioSoftware, Inc.**

**Consolidated Condensed Statementsof Operations and Comprehensive Income**

**(Unaudited)**
| ** **                                                                             | ** ** | **Three Months Ended October 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                                               | ** ** | **2006** | ** ** |
| Revenue:                                                                               |       |                                                   |       |   |   |
| License fees                                                                           |       | $                                                      | 2,078,000  |   | $ | 2,201,000 |   |
| Subscription fees                                                                      |       | 542,000                                                |       | 597,000 |   |
| Services, maintenance, and other                                                       |       | 4,460,000                                              |       | 4,776,000 |   |
|                                                                                   |       | 7,080,000                                              |       | 7,574,000 |   |
| Costs of revenue  (exclusive of depreciation and amortization shown separately below): |       |                                                   |       |   |   |
| License fees                                                                           |       | 187,000                                                |       | 112,000 |   |
| Services, maintenance, and other                                                       |       | 1,609,000                                              |       | 1,830,000 |   |
|                                                                                   |       | 1,796,000                                              |       | 1,942,000 |   |
|                                                                                   |       | 5,284,000                                              |       | 5,632,000 |   |
| Operating  expenses:                                                                   |       |                                                   |       |   |   |
| Sales and marketing                                                                    |       | 2,852,000                                              |       | 2,619,000 |   |
| Research and development                                                               |       | 1,311,000                                              |       | 1,385,000 |   |
| General and administrative                                                             |       | 957,000                                                |       | 1,272,000 |   |
| Gain on reversal of valuation reserve on M2 note                                       |       | —                                                 |       | (900,000 | ) |
| Depreciation and amortization                                                          |       | 202,000                                                |       | 266,000 |   |
|                                                                                   |       | 5,322,000                                              |       | 4,642,000 |   |
| Income (loss)  from operations                                                         |       | (38,000                                                | )          | 990,000 |   |
| Other income  (expense):                                                               |       |                                                   |       |   |   |
| Interest income                                                                        |       | 69,000                                                 |       | 119,000 |   |
| Interest expense                                                                       |       | (10,000                                                | )          | (2,000 | ) |
| Other                                                                                  |       | (1,000                                                 | )          | — |   |
|                                                                                   |       | 58,000                                                 |       | 117,000 |   |
|                                                                                   |       |                                                   |       |   |   |
| Income before  income taxes                                                            |       | 20,000                                                 |       | 1,107,000 |   |
| Income tax  expense                                                                    |       | 14,000                                                 |       | 19,000 |   |
| Net income                                                                             |       | $                                                      | 6,000      |   | $ | 1,088,000 |   |
| Net income per  share – basic                                                     |       | $                                                      | 0.00       |   | $ | 0.05 |   |
| Net income per  share – diluted                                                   |       | $                                                      | 0.00       |   | $ | 0.04 |   |
| Weighted average  common shares outstanding – basic                               |       | 21,093,459                                             |       | 22,301,466 |   |
| Weighted average  common shares outstanding – diluted                             |       | 23,809,293                                             |       | 24,662,565 |   |
| Comprehensive  income:                                                                 |       |                                                   |       |   |   |
| Net income                                                                             |       | $                                                      | 6,000      |   | $ | 1,088,000 |   |
| Foreign currency translation adjustment                                                |       | 5,000                                                  |       | (1,000 | ) |
| Comprehensive  income                                                                  |       | $                                                      | 11,000     |   | $ | 1,087,000 |   |

 

***Seeaccompanying notes.***

 

5

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**OptioSoftware, Inc.**

**Consolidated Condensed Statementsof Operations and Comprehensive Income**

**(Unaudited)**

 

 
| ** **                                                                             | ** ** | **Nine Months Ended October 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                                              | ** ** | **2006** | ** ** |
| Revenue:                                                                               |       |                                                  |       |   |   |
| License fees                                                                           |       | $                                                     | 6,833,000  |   | $ | 5,742,000 |   |
| Subscription fees                                                                      |       | 1,577,000                                             |       | 1,712,000 |   |
| Services, maintenance, and other                                                       |       | 12,965,000                                            |       | 13,750,000 |   |
|                                                                                   |       | 21,375,000                                            |       | 21,204,000 |   |
| Costs of revenue  (exclusive of depreciation and amortization shown separately below): |       |                                                  |       |   |   |
| License fees                                                                           |       | 544,000                                               |       | 390,000 |   |
| Services, maintenance, and other                                                       |       | 4,785,000                                             |       | 5,151,000 |   |
|                                                                                   |       | 5,329,000                                             |       | 5,541,000 |   |
|                                                                                   |       | 16,046,000                                            |       | 15,663,000 |   |
| Operating  expenses:                                                                   |       |                                                  |       |   |   |
| Sales and marketing                                                                    |       | 8,461,000                                             |       | 7,701,000 |   |
| Research and development                                                               |       | 3,905,000                                             |       | 4,082,000 |   |
| General and administrative                                                             |       | 3,001,000                                             |       | 3,794,000 |   |
| Gain on reversal of valuation reserve on M2 note                                       |       | —                                                |       | (900,000 | ) |
| Depreciation and amortization                                                          |       | 633,000                                               |       | 650,000 |   |
|                                                                                   |       | 16,000,000                                            |       | 15,327,000 |   |
| Income from  operations                                                                |       | 46,000                                                |       | 336,000 |   |
| Other income  (expense):                                                               |       |                                                  |       |   |   |
| Interest income                                                                        |       | 185,000                                               |       | 327,000 |   |
| Interest expense                                                                       |       | (14,000                                               | )          | (4,000 | ) |
| Other                                                                                  |       | (15,000                                               | )          | (3,000 | ) |
|                                                                                   |       | 156,000                                               |       | 320,000 |   |
|                                                                                   |       |                                                  |       |   |   |
| Income before  income taxes                                                            |       | 202,000                                               |       | 656,000 |   |
| Income tax  expense                                                                    |       | 42,000                                                |       | 71,000 |   |
| Net income                                                                             |       | $                                                     | 160,000    |   | $ | 585,000 |   |
| Net income per  share – basic                                                     |       | $                                                     | 0.01       |   | $ | 0.03 |   |
| Net income per  share – diluted                                                   |       | $                                                     | 0.01       |   | $ | 0.02 |   |
| Weighted average  common shares outstanding – basic                               |       | 20,918,084                                            |       | 22,149,422 |   |
| Weighted average  common shares outstanding – diluted                             |       | 24,033,407                                            |       | 24,731,182 |   |
| Comprehensive  income:                                                                 |       |                                                  |       |   |   |
| Net income                                                                             |       | $                                                     | 160,000    |   | $ | 585,000 |   |
| Foreign currency translation adjustment                                                |       | (39,000                                               | )          | 66,000 |   |
| Comprehensive  income                                                                  |       | $                                                     | 121,000    |   | $ | 651,000 |   |

 

***Seeaccompanying notes.***

6

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**OptioSoftware, Inc.**

**Consolidated Condensed Statementof Shareholders’ Equity**

**(Unaudited)**
| ** **                                    | ** ** | **Common Stock** | ** ** | **Accumulated** | ** ** | **Accumulated Other   Comprehensive** | ** ** | **Total Shareholders’** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-----------------|------------|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                    | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Deficit**                                     | ** ** | **Income**                        | ** ** | **Equity** | ** ** |
|                                          |       |                  |       |            |       |                                            |       |                              |       |   |   |
| Balance at  February 1, 2006                  |       | 21,435,826            |       | $               | 52,577,000 |                                            | $          | (43,533,000                       | )          | $ | 77,000 |   | $ | 9,121,000 |   |
| Comprehensive income, net of tax:             |       |                  |       |            |       |                                            |       |                              |       |   |   |
| Net income                                    |       | —                |       | —          |       | 585,000                                         |       | —                            |       | 585,000 |   |
| Foreign currency translation adjustment       |       | —                |       | —          |       | —                                          |       | 66,000                            |       | 66,000 |   |
| Comprehensive income                          |       |                  |       |            |       |                                            |       |                              |       | 651,000 |   |
| Exercise of stock options                     |       | 730,374               |       | 404,000         |       | —                                          |       | —                            |       | 404,000 |   |
| VertiSoft Shares released from escrow         |       | 310,000               |       | 381,000         |       | —                                          |       | —                            |       | 381,000 |   |
| Compensation expense related to stock options |       | —                |       | 318,000         |       | —                                          |       | —                            |       | 318,000 |   |
| Balance at October 31,  2006                  |       | 22,476,200            |       | $               | 53,680,000 |                                            | $          | (42,948,000                       | )          | $ | 143,000 |   | $ | 10,875,000 |   |

 

***See accompanying notes****.*

7

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**OptioSoftware, Inc.**

**Consolidated Condensed Statementsof Cash Flows**

**(Unaudited)**
| ** **                                                                           | ** ** | **Nine Months Ended October 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                              | ** ** | **2006** | ** ** |
|                                                                                 |       |                                                  |       |   |   |
| Cash flows from  operating activities:                                               |       |                                                  |       |   |   |
| Net income                                                                           |       | $                                                     | 160,000    |   | $ | 585,000 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:   |       |                                                  |       |   |   |
| Depreciation and amortization                                                        |       | 317,000                                               |       | 367,000 |   |
| Amortization of intangibles                                                          |       | 318,000                                               |       | 283,000 |   |
| Non-cash stock compensation                                                          |       | —                                                |       | 318,000 |   |
| Loss on disposal of assets                                                           |       | —                                                |       | 2,000 |   |
| Provision for doubtful accounts                                                      |       | —                                                |       | 33,000 |   |
| Gain on reversal of valuation reserve on M2 Systems  note                            |       | —                                                |       | (900,000 | ) |
| Provision for deferred taxes                                                         |       | 30,000                                                |       | 60,000 |   |
| Changes in operating assets and liabilities,  exclusive of effects from acquisition: |       |                                                  |       |   |   |
| Accounts receivable                                                                  |       | 319,000                                               |       | 749,000 |   |
| Prepaid expenses and other assets                                                    |       | (142,000                                              | )          | (96,000 | ) |
| Accounts payable                                                                     |       | (126,000                                              | )          | 343,000 |   |
| Accrued expenses                                                                     |       | (282,000                                              | )          | (658,000 | ) |
| Income taxes payable                                                                 |       | —                                                |       | (50,000 | ) |
| Deferred revenue                                                                     |       | 402,000                                               |       | (508,000 | ) |
| Net cash  provided by operating activities                                           |       | 996,000                                               |       | 528,000 |   |
|                                                                                 |       |                                                  |       |   |   |
| Cash flows from  investing activities:                                               |       |                                                  |       |   |   |
| Purchases of property and equipment                                                  |       | (264,000                                              | )          | (1,093,000 | ) |
| Purchase of VertiSoft                                                                |       | (75,000                                               | )          | (75,000 | ) |
| Repayment of note receivable from M2 Systems                                         |       | 238,000                                               |       | 220,000 |   |
| Net cash used in  investing activities                                               |       | (101,000                                              | )          | (948,000 | ) |
|                                                                                 |       |                                                  |       |   |   |
| Cash flows from  financing activities:                                               |       |                                                  |       |   |   |
| Payments of notes payable and capital lease  obligations                             |       | (66,000                                               | )          | (11,000 | ) |
| Proceeds from exercise of stock options                                              |       | 213,000                                               |       | 404,000 |   |
| Net cash  provided by financing activities                                           |       | 147,000                                               |       | 393,000 |   |
|                                                                                 |       |                                                  |       |   |   |
| Impact of  foreign currency rate fluctuations on cash                                |       | (60,000                                               | )          | 84,000 |   |
| Net increase in  cash and cash equivalents                                           |       | 982,000                                               |       | 57,000 |   |
|                                                                                 |       |                                                  |       |   |   |
| Cash and cash  equivalents at beginning of period                                    |       | 5,433,000                                             |       | 7,954,000 |   |
| Cash and cash  equivalents at end of period                                          |       | $                                                     | 6,415,000  |   | $ | 8,011,000 |   |
|                                                                                 |       |                                                  |       |   |   |
| Supplemental  disclosures of cash flow information:                                  |       |                                                  |       |   |   |
| Cash paid during the period for:                                                     |       |                                                  |       |   |   |
| Interest paid                                                                        |       | $                                                     | 13,000     |   | $ | 4,000 |   |
| Income taxes  paid                                                                   |       | $                                                     | 12,000     |   | $ | 15,000 |   |

 

***Seeaccompanying notes.***

8

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**Optio Software, Inc.**

**Notes to the ConsolidatedCondensed Financial Statements**

**(Unaudited)**

**1.Description of Business**

OptioSoftware, Inc. (the “Company” or “Optio”), provides document automation andelectronic health record solutions that enable organizations to achieveunprecedented speed, accuracy, functionality and quality in their inbound andoutbound documents. The Company’s infrastructure software and services enhancethe form, content, distribution and availability of business criticalinformation. The Company markets primarily to companies located principally inthe United States and Europe.  Theindustry in which the Company operates is subject to rapid change due todevelopment of new technologies and products.

**2. Basisof Presentation**

#### ***Interim FinancialInformation***

The accompanying interim consolidated condensedfinancial statements of the Company have been prepared in accordance with theinstructions for Quarterly Reports on Form 10-Q. Accordingly, certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted. In the opinion ofmanagement, all adjustments, consisting of normal recurring adjustments unlessotherwise disclosed in a separate note, considered necessary for a fairpresentation of the financial information for the interim period reported havebeen made.

The accompanying financial statements should be readin conjunction with the Company’s audited consolidated financial statements forthe year ended January 31, 2006, included in the Company’s Annual Report onForm 10-K for the year ended January 31, 2006 (the “2006 Annual Report”), filedwith the Securities and Exchange Commission on May 1, 2006. Results ofoperations for the three and nine months ended October 31, 2006 are notnecessarily indicative of the results for the year ending January 31, 2007.

***Share-Based Compensation Plans***

Priorto February 1, 2006, the Company accounted for its stock-based employeecompensation arrangements under the intrinsic value method prescribed byAccounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees* (“APB No. 25”), as allowed byStatement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*,as amended by SFAS No. 148, *Accounting forStock-Based Compensation-Transition and Disclosure*. As a result, noexpense was recognized for options that were granted with an exercise priceequal to quoted market price at the date of grant. In December 2004, theFinancial Accounting Standards Board (FASB) issued SFAS No. 123R, *Share-Based Payment*, which amended SFASNo. 123 and supersedes APB No. 25. SFAS No. 123R requires measurement of thecost of share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues beginning with the first interim or annual period after June 15, 2005.Subsequent to the effective date, the pro forma disclosures previouslypermitted under SFAS No. 123 are no longer an alternative to financialstatement recognition. Effective February 1, 2006, the Company has adopted SFASNo. 123R using the modified prospective method. Under this method, compensationcost recognized during the three and nine-month periods ended October 31, 2006includes: (a) compensation cost for all share-based payments granted prior to,but not yet vested as of February 1, 2006, based on the grant date fair valueestimated in accordance with the original provisions of SFAS No. 123 amortizedover the 

9

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employees’ serviceperiod (typically the options’ vesting period) and (b) compensation cost forall share-based payments granted subsequent to February 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of SFAS No.123R amortized ratably over the options’ vesting period.

Forperiods prior to adoption of SFAS No. 123R, companies were required tocalculate the estimated fair value of options and could elect to either includethe estimated cost in earnings or disclose the pro forma effect in thefootnotes to their financial statements. The Company chose to disclose the proforma effect.

Thefair value of the options used for the application of SFAS No. 123R disclosuresis estimated at the date of grant using the Black - Scholes option pricingmodel. In determining the fair value of options using the Black-Scholes optionpricing model, various assumptions such as expected life, volatility, risk-freeinterest rate, dividend yield and forfeiture rates are used.  The expected life of awards grantedrepresents the period of time that they are expected to be outstanding. TheCompany determines the expected life using the “simplified method” inaccordance with Staff Accounting Bulletin No. 107. Using the Black-Scholesoption valuation model, the Company estimates the volatility of our commonstock at the date of grant based on the historical volatility of our commonstock. Optio bases the risk-free interest rate used in the Black-Scholes optionvaluation model on the implied yield currently available on U.S. Treasuryzero-coupon issues with an equivalent remaining term equal to the expected lifeof the award. Optio has not paid any cash dividends on our common stock in thelast ten years and we do not anticipate paying any cash dividends in theforeseeable future. Consequently, the Company used an expected dividend yieldof zero in the Black-Scholes option valuation model. Finally, the Company useshistorical data to estimate pre-vesting option forfeitures. Stock-basedcompensation is recorded for only those awards that are expected to vest. Thefollowing weighted-average assumptions were used for the three and nine monthsended October 31, 2006: risk-free interest rate of 5.07% and 5.01%,respectively; no dividend yield; volatility of 122% and 122% in both periods; aforfeiture rate of 19.9% and 19.9% in both periods; and an expected life of theoptions of 5.3 and 5.3 years, in both periods.

Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized to expense over the service period, which is generally the options’vesting period. The following table illustrates the effect on net income andnet income per share had the Company applied the fair value recognitionprovisions of SFAS No. 123 to account for our employee stock option plan forthe three and nine-month periods ended October 31, 2005, because stock-basedemployee compensation was not accounted for using the fair value recognitionmethod during that period (in thousands, except per share data):
| ** **                                                 | ** ** | **Three Months  Ended October 31,  2005** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                                                       |       |                                                     |       |
| Net income as  reported                                    |       | $                                                        | 6,000      |   |
| Deduct:  Compensation cost using the fair value method     |       | $                                                        | (76,000    | ) |
| Pro forma net  income (loss)                               |       | $                                                        | (70,000    | ) |
| Net income per  share as reported – basic and diluted |       | $                                                        | 0.00       |   |
| Pro forma net income  per share – basic and diluted   |       | $                                                        | 0.00       |   |

 

10

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| ** **                                                 | ** ** | **Nine Months Ended   October 31,  2005** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                                                       |       |                                                     |       |
| Net income as  reported                                    |       | $                                                        | 160,000    |   |
| Deduct:  Compensation cost using the fair value method     |       | $                                                        | (293,000   | ) |
| Pro forma net  loss                                        |       | $                                                        | (133,000   | ) |
| Net income per  share as reported – basic and diluted |       | $                                                        | 0.01       |   |
| Pro forma net loss per  share – basic and diluted     |       | $                                                        | (0.01      | ) |

 

Thehistorical pro forma impact of applying the fair value method prescribed bySFAS No. 123 is not representative of the impact that may be expected in thefuture due to changes resulting from additional grants in future years andchanges in assumptions such as volatility, interest rates and expected lifeused to estimate fair value of the grants in future years.

Notethat the above pro forma disclosure was not presented for the three andnine-month periods ended October 31, 2006 because stock-based employeecompensation has been accounted for using the fair value recognition methodunder SFAS No. 123R for this period. Implementation of SFAS No. 123R resultedin $120,000 and $318,000 of share-based compensation expense in the three andnine months ended October 31, 2006, respectively, reflected entirely within thegeneral and administrative line item of the Consolidated Condensed Statement ofOperations and Comprehensive Income. No deferred tax asset was recognizedduring the three and nine months ended October 31, 2006 due to the valuationallowance placed on the Company’s deferred tax assets. The adoption of SFAS No.123R had no impact on cash flows from operations or financing activities.

Asummary of stock option activity for the nine months ended October 31, 2006 isas follows:
| ** **                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (in Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------|------------|-------------------------------------|------------|
|                                     |       |                       |       |                                       |       |                                                                     |       |                                |       |
| Outstanding options at  January 31, 2006 |       | 6,874,052                  |       | $                                          | 0.93       |                                                                     |       |                                |       |   |
| Options granted                          |       | 784,740                    |       | $                                          | 1.38       |                                                                     |       |                                |       |   |
| Options  exercised                       |       | (730,377                   | )          | $                                          | 0.55       |                                                                     |       |                                |       |   |
| Options  canceled/forfeited              |       | (462,922                   | )          | $                                          | 1.35       |                                                                     |       |                                |       |   |
| Outstanding options at  October 31, 2006 |       | 6,465,493                  |       | $                                          | 1.00       |                                                                     | 3.67       |                                | $          | 3,056,117 |   |
| Exercisable options at October 31, 2006  |       | 5,117,302                  |       | $                                          | 0.93       |                                                                     | 2.32       |                                | $          | 2,951,938 |   |

 

Other informationpertaining to option activity during the nine months ended October 31, 2006 and2005 was as follows:
|                                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                             |       |     |       |     |       |
| Weighted average grant  date fair value of stock options granted |       | $        | 1.19       |     | $          | 1.17 |   |
|  Total fair value of stock options vested                   |       | $        | 907,707    |     | $          | 1,342,932 |   |
|  Total intrinsic value of stock  options exercised          |       | $        | 952,417    |     | $          | 285,530 |   |

 

Thefollowing table summarizes information concerning options outstanding andexercisable as of October 31, 2006:
| Options Outstanding  | ** ** | **Options Exercisable**    | ** ** |
|----------------------|------------|----------------------------|------------|
| Exercise Prices | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                 |       |                       |       |   |   |   |   |   |   |   |   |
| $0.002 - $0.10       |       | 1,214,900                  |       | N/A |   | $ | 0.03 |   | 1,214,900 |   | $ | 0.03 |   |
| $0.24 - $0.78        |       | 502,573                    |       | 7.19 |   | $ | 0.54 |   | 407,653 |   | $ | 0.50 |   |
| $0.80 - $0.80        |       | 2,539,955                  |       | 1.27 |   | $ | 0.80 |   | 2,539,955 |   | $ | 0.80 |   |
| $0.85 - $1.09        |       | 54,040                     |       | 8.28 |   | $ | 0.99 |   | 39,581 |   | $ | 0.97 |   |
| $1.10 - $1.10        |       | 720,500                    |       | 7.87 |   | $ | 1.10 |   | 381,502 |   | $ | 1.10 |   |
| $1.12 - $1.31        |       | 659,057                    |       | 9.09 |   | $ | 1.29 |   | 153,707 |   | $ | 1.28 |   |
| $1.35 - $2.00        |       | 660,328                    |       | 7.38 |   | $ | 1.52 |   | 265,864 |   | $ | 1.60 |   |
| $4.05 - $10.00       |       | 65,575                     |       | 3.38 |   | $ | 9.28 |   | 65,575 |   | $ | 9.28 |   |
| $12.50 - $12.50      |       | 1,300                      |       | 3.42 |   | $ | 12.50 |   | 1,300 |   | $ | 12.50 |   |
| $16.00 - $16.00      |       | 47,265                     |       | 3.25 |   | $ | 16.00 |   | 47,265 |   | $ | 16.00 |   |
|                 |       | 6,465,493                  |       | 3.67 |   | $ | 1.00 |   | 5,117,302 |   | $ | 0.93 |   |

 

***Goodwill and Other IntangibleAssets***

TheCompany acquired goodwill and other intangible assets in connection with theacquisition of VertiSoft Corporation (“VertiSoft”) in August 2004. Under thepurchase method of accounting pursuant to Statement of Financial AccountingStandards (“SFAS”) No. 141, *BusinessCombinations*, the total purchase price was allocated to the acquiredentity’s net tangible and intangible assets based on their estimated fairvalues as of the date of the acquisition. The excess of the purchase price overthe fair value of the net tangible assets/liabilities and identifiableintangible assets acquired was recorded as goodwill. In accordance with SFAS142, *Goodwill and Other Intangibles,*goodwilland intangible assets with indefinite lives resulting from businesscombinations have not been amortized but instead will be tested for impairmentat least annually (more frequently if certain indicators are present) whileidentifiable intangible assets with finite lives are being amortized over theirestimated useful lives. In the event that the Company’s management determinesthat the value of goodwill or intangible assets has become impaired, theCompany will incur an accounting charge for the amount of impairment during thefiscal quarter in which the determination is made. The Company has selectedAugust 1 as its annual impairment testing date for its goodwill. The Companyperformed an analysis comparing the fair value of the reporting units with thecarrying value of such reporting units, including goodwill, and determined thatno impairment of its goodwill existed.

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As of October 31,2006, the gross carrying amount and the accumulated amortization by majorintangible asset class is as follows:
| **Intangible Asset** | ** ** | **Estimated  Useful Life** | ** ** | **Gross Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
|---------------------------|------------|---------------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------------------------|------------|
| Customer  relationships   |       | 11.5  years                     |       | $                              | 1,260,000  |                          | $          | 375,000                      |       | $ | 885,000 |   |
| Technology                |       | 3  months – 5 years        |       | 893,000                        |       | 494,000                       |       | 399,000                      |       |
| Non-compete agreement     |       | 5 years                         |       | 85,000                         |       | 38,000                        |       | 47,000                       |       |
|                           |            |                                 |            |                                |            |                               |            |                              |            |  |  |  |

 

***Non-CashTransactions***

During the second quarter of the current fiscal year, Optio enteredinto a capital lease for telephone equipment in the amount of $422,000. Inaddition, Optio renegotiated the lease for its headquarter facilities. As partof the new lease agreement, the landlord contributed $1.0 million towards theimprovements of the space. This $1.0 million in leasehold improvements isreflected as a fixed asset with an offsetting lease incentive liability of $1.0million, which will reduce future rent expense, has been recorded as aliability on Optio’s condensed consolidated balance sheet.

***New Accounting Pronouncements***

In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes-an interpretation of SFAS No. 109” (“FIN 48”). FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in financial statementsin accordance with SFAS No. 109, and recommends a recognition threshold andmeasurement characteristic for financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. Thedifferences between a tax position taken in a tax return and amounts recognizedin the financial statements may result in an increase in a liability for incometaxes payable, a reduction of an income tax refund receivable, a reduction in adeferred tax asset or an increase in a deferred tax liability. FIN 48 alsoprovides guidance on classification, interest and penalties, accounting ininterim periods, disclosure, and transition. FIN 48 is effective for fiscalyears beginning after December 16, 2006, with early adoption encouraged. TheCompany intends to adopt FIN 48 on February 1, 2007. The Company has not yetdetermined the effects of adopting FIN 48.

In September 2006,the FASB issued FASB No. 157, “Fair Value Measurements” (“FASB 157”). FASB 157redefines fair value, establishes a framework for measuring fair value andexpands the disclosure requirements regarding fair value measurement. FASB 157is effective for fiscal years beginning after November 15, 2007, and interimperiods within those fiscal years. The Company does not expect that theadoption of FASB 157 will have a material impact on its results of operationsor financial position; however, additional disclosures will be required underFASB 157.

In September 2006, the FASB issued FASB No. 158, “Employers’ Accountingfor Defined Benefit Pension and Other Postretirement Plans – an Amendment ofFASB Statements No. 87, 88, 106 and 132(R)” (“FASB 158”). FASB 158 improvesfinancial reporting by requiring an employer to recognize the overfunded orunderfunded status of a defined benefit postretirement plan (other than amultiemployer plan) as an asset or liability in its statement of financialposition and to recognize changes in that funded status in the year in whichthe changes occur through comprehensive income of a business entity or changesin unrestricted net assets of a not-for-profit organization. FASB 158 alsoimproves financial reporting by requiring an employer to measure the fundedstatus of a plan as of the date of its year-end statement of financialposition, with limited exceptions. An employer with publicly traded equitysecurities is required to initially recognize the funded status of a 

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defined benefit postretirement plan and to provide the requireddisclosures as of the end of a fiscal year ending after December 15, 2006. TheCompany does not expect FASB 158 to have a material impact on the Company’s  results of operations or financial position.

**3. Net Income per Share**

Netincome per share has been computed in accordance with SFAS 128, *Earnings per Share*, which requiresdisclosure of basic and diluted earnings per share. Basic earnings per shareexcludes any dilutive effects of stock options. Diluted earnings per share includesthe impact of potentially dilutive securities.

Thefollowing table sets forth the computation of net income per share:
| ** **                                                                                                              | ** ** | **Three months ended October 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2005**                                               | ** ** | **2006** | ** ** |
|                                                                                                                    |       |                                                   |       |   |   |
| Net income                                                                                                              |       | $                                                      | 6,000      |   | $ | 1,088,000 |   |
| Weighted average  shares outstanding – basic                                                                       |       | 21,093,459                                             |       | 22,301,466 |   |
| Dilutive  securities                                                                                                    |       | 2,715,834                                              |       | 2,361,099 |   |
| Weighted average  shares outstanding – diluted                                                                     |       | 23,809,293                                             |       | 24,662,565 |   |
| Net income per  share – basic                                                                                      |       | $                                                      | 0.00       |   | $ | 0.05 |   |
| Net income per  share – diluted                                                                                    |       | $                                                      | 0.00       |   | $ | 0.04 |   |
| Potentially  dilutive stock options, excluded from diluted weighted average shares  outstanding                         |       | 1,698,513                                              |       | 1,941,991 |   |
| Potentially dilutive  VertiSoft shares held in escrow excluded from diluted weighted average common  shares outstanding |       | 310,000                                                |       | — |   |

 
| ** **                                                                                                              | ** ** | **Nine months ended October 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2005**                                              | ** ** | **2006** | ** ** |
|                                                                                                                    |       |                                                  |       |   |   |
| Net income                                                                                                              |       | $                                                     | 160,000    |   | $ | 585,000 |   |
| Weighted average  shares outstanding – basic                                                                       |       | 20,918,084                                            |       | 22,149,422 |   |
| Dilutive  securities                                                                                                    |       | 3,115,323                                             |       | 2,581,760 |   |
| Weighted average  shares outstanding – diluted                                                                     |       | 24,033,407                                            |       | 24,731,182 |   |
| Net income per  share – basic                                                                                      |       | $                                                     | 0.01       |   | $ | 0.03 |   |
| Net income per  share – diluted                                                                                    |       | $                                                     | 0.01       |   | $ | 0.02 |   |
| Potentially  dilutive stock options, excluded from diluted weighted average shares  outstanding                         |       | 1,021,053                                             |       | 1,704,031 |   |
| Potentially dilutive  VertiSoft shares held in escrow excluded from diluted weighted average common  shares outstanding |       | 310,000                                               |       | — |   |

 

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**4. Segment and Geographic Information**

The Company’sbusiness is organized around geographic areas. Optio’s U.S. operations andEuropean operations represent Optio’s two reportable segments. The foreignlocations principally function as distributors of products developed by theCompany in the United States. The accounting policies described in the summaryof significant accounting policies are applied consistently across thesegments. Intersegment sales are based on intercompany transfer prices toachieve a reasonable margin upon distribution. Revenues are attributable toeach segment based on the location of the subsidiary originating the sale,which is typically the geographic location where the software is installed.

Segment information forthe three and nine months ended October 31, 2006 and 2005 is summarized below.
| **Three Months ended  October 31, 2005** | ** ** | **United States** | ** ** | **Europe** | ** ** | **Combined** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|------------|------------|--------------|------------|------------------|------------|------------------|------------|
| Revenue from  external customers:                            |       |                   |       |       |       |         |       |             |       |             |       |
| License fees                                                 |       | $                      | 1,671,000  |       | $          | 407,000      |       | $                | 2,078,000  |             | $          | — |   | $ | 2,078,000 |   |
| Subscription revenue                                         |       | 542,000                |       | —     |       | 542,000      |       | —           |       | 542,000          |       |
| Services, maintenance andother                               |       | 3,742,000              |       | 718,000    |       | 4,460,000    |       | —           |       | 4,460,000        |       |
| 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  expense                                          |       | 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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| **Three Months ended  October 31, 2006** | ** ** | **United  States** | ** ** | **Europe** | ** ** | **Combined** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|------------------|------------|------------------|------------|
| Revenue from  external customers:                            |       |               |       |       |       |         |       |             |       |             |       |
| License fees                                                 |       | $                  | 1,845,000  |       | $          | 356,000      |       | $                | 2,201,000  |             | $          | — |   | $ | 2,201,000 |   |
| Subscription revenue                                         |       | 586,000            |       | 11,000     |       | 597,000      |       | —           |       | 597,000          |       |
| Services, maintenance andother                               |       | 3,958,000          |       | 818,000    |       | 4,776,000    |       | —           |       | 4,776,000        |       |
| Inter-segment revenue                                        |       | 40,000             |       | 12,000     |       | 52,000       |       | (52,000          | )          | —           |       |
| Total revenue                                                |       | 6,429,000          |       | 1,197,000  |       | 7,626,000    |       | (52,000          | )          | 7,574,000        |       |
| Interest income                                              |       | 119,000            |       | —     |       | 119,000      |       | —           |       | 119,000          |       |
| Interest expense                                             |       | 2,000              |       | —     |       | 2,000        |       | —           |       | 2,000            |       |
| Depreciation and  amortization                               |       | 257,000            |       | 9,000      |       | 266,000      |       | —           |       | 266,000          |       |
| Income tax  expense                                          |       | 19,000             |       | —     |       | 19,000       |       | —           |       | 19,000           |       |
| Segment income  (loss) before income taxes                   |       | 1,177,000          |       | (70,000    | )          | 1,107,000    |       | —           |       | 1,107,000        |       |
| Segment net  income (loss)                                   |       | 1,158,000          |       | (70,000    | )          | 1,088,000    |       | —           |       | 1,088,000        |       |
| Total segment  assets                                        |       | 22,091,000         |       | 3,624,000  |       | 25,715,000   |       | (3,588,000       | )          | 22,127,000       |       |
| Expenditures for  long-lived assets                          |       | 446,000            |       | 165,000    |       | 611,000      |       | —           |       | 611,000          |       |
|                                                              |            |                    |            |            |            |              |            |                  |            |                  |            |  |  |  |  |  |

 
| **Nine Months ended  October 31, 2005** | ** ** | **United  States** | ** ** | **Europe** | ** ** | **Combined** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|------------------|------------|------------------|------------|
| Revenue from external  customers:                           |       |               |       |       |       |         |       |             |       |             |       |
| License fees                                                |       | $                  | 5,542,000  |       | $          | 1,291,000    |       | $                | 6,833,000  |             | $          | — |   | $ | 6,833,000 |   |
| Subscription revenue                                        |       | 1,577,000          |       | —     |       | 1,577,000    |       | —           |       | 1,577,000        |       |
| Services, maintenance andother                              |       | 10,933,000         |       | 2,032,000  |       | 12,965,000   |       | —           |       | 12,965,000       |       |
| 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          |       |
|                                                             |            |                    |            |            |            |              |            |                  |            |                  |            |  |  |  |  |  |

 

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** **
| **Nine Months ended  October 31, 2006** | ** ** | **United  States** | ** ** | **Europe** | ** ** | **Combined** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|------------------|------------|------------------|------------|
| Revenue from  external customers:                           |       |               |       |       |       |         |       |             |       |             |       |
| License fees                                                |       | $                  | 4,627,000  |       | $          | 1,115,000    |       | $                | 5,742,000  |             | $          | — |   | $ | 5,742,000 |   |
| Subscription revenue                                        |       | 1,682,000          |       | 30,000     |       | 1,712,000    |       | —           |       | 1,712,000        |       |
| Services, maintenance andother                              |       | 11,448,000         |       | 2,302,000  |       | 13,750,000   |       | —           |       | 13,750,000       |       |
| Inter-segment revenue                                       |       | 165,000            |       | 61,000     |       | 226,000      |       | (226,000         | )          | —           |       |
| Total revenue                                               |       | 17,922,000         |       | 3,508,000  |       | 21,430,000   |       | (226,000         | )          | 21,204,000       |       |
| Interest income                                             |       | 327,000            |       | —     |       | 327,000      |       | —           |       | 327,000          |       |
| Interest expense                                            |       | 4,000              |       | —     |       | 4,000        |       | —           |       | 4,000            |       |
| Depreciation and  amortization                              |       | 626,000            |       | 24,000     |       | 650,000      |       | —           |       | 650,000          |       |
| Income tax  expense (benefit)                               |       | 75,000             |       | (4,000     | )          | 71,000       |       | —           |       | 71,000           |       |
| Segment income  (loss) before income taxes                  |       | 807,000            |       | (151,000   | )          | 656,000      |       | —           |       | 656,000          |       |
| Segment net  income (loss)                                  |       | 732,000            |       | (147,000   | )          | 585,000      |       | —           |       | 585,000          |       |
| Total segment  assets                                       |       | 22,091,000         |       | 3,624,000  |       | 25,715,000   |       | (3,588,000       | )          | 22,127,000       |       |
| Expenditures for  long-lived assets                         |       | 918,000            |       | 175,000    |       | 1,093,000    |       | —           |       | 1,093,000        |       |
|                                                             |            |                    |            |            |            |              |            |                  |            |                  |            |  |  |  |  |  |

 

**5.Note Receivable**

As furtherexplained in Note 3 of the Notes to Consolidated Financial Statements includedin Optio’s 2006 Annual Report, Optio holds a note receivable from M2 SystemsCorporation (“M2 Systems”) as partial consideration for the sale by Optio ofits Muscato Corporation (“Muscato”) and Translink Solutions Corporationbusiness units. Under the terms of the note, M2 Systems was required to makepayments of $100,000 each on September 1, 2003 and December 1, 2003 and apayment of $115,000 on June 1, 2004. M2 Systems failed to make these paymentson their respective due dates; however, payment was made prior to an event ofdefault. All scheduled payments subsequent to June 1, 2004 have beenappropriately made on their respective due dates.

During the thirdquarter of fiscal 2004, as a result of M2 Systems’ failure to make timelypayments in the prior quarters, management determined that this was anindication that it was probable that Optio would be unable to collect allamounts due according to the contractual terms of the note.  At that time, the loan was consideredimpaired and was written down to the assessed fair value of the collateral. Asof October 31, 2003, the collateral, including technology, accounts receivable,fixed assets and the discounted net cash flows of maintenance contracts wasestimated to have an approximate fair value of $2.8 million, substantially lessthan the $3.7 million note receivable balance as of October 31, 2003. ThusOptio recorded an impairment charge of $900,000 during the year ended January31, 2004.

During the thirdquarter ending October 31, 2006, M2 Systems notified Optio of their intentionto pay in full the outstanding note balance. On November 6, 2006, after the sale of stock of M2 Systems andaffiliates, Optio received $2,758,000 in cash, representing full repayment of theM2 Systems note receivable, plus accrued interest.  Such repayment represents an early retirementof the note, originally due December 1, 2007. In connection with such repayment, Optio released its lien on the assetsof M2 Systems, its subsidiaries and related entities and the parties executedmutual releases.

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In accordance withFAS 114, as amended by FAS 118, when there is a change in the value of the underlyingcollateral that would indicate the value of the loan has increased (is nolonger impaired), the net carrying value of the loan should be adjusted to suchvaluation. The collateral supporting the M2 Systems note was sold in anindependent, third party transaction, thus providing a basis for valuing thecollateral based upon market prices in excess of the $2.8 million owed toOptio. Based on the facts surrounding the value of the underlying collateral,it appears improbable that the value of the collateral as of October 31, 2006was less than such value at November 6, 2006, the date of payment.  As a result, the carrying value of the M2Systems note was  written up to its fullface value and the valuation reserve previously recorded by Optio relating tothe M2 Systems note was reversed during the quarter ended October 31, 2006.Optio recognized income of $900,000 that was a reduction of the Company’s thirdquarter operating expenses.

Because as ofOctober 31, 2006 it was probable that Optio would receive payment in full onthe M2 Systems note, the note has been reclassified as a current asset on theconsolidated condensed balance sheet.

**6.Acquisition of VertiSoft Corporation**

OnAugust 10, 2004, Optio consummated the merger of VertiSoft, a privately heldGeorgia corporation, and Optio Software II, Inc., a wholly owned subsidiary ofOptio, 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. The consideration paid for allof the common stock of VertiSoft included $348,000 in cash, the issuance of 1.5million shares of Optio common stock, of which 310,000 shares were held inescrow for a period of 18 months to secure the indemnification obligations ofthe shareholders of VertiSoft, the issuance of options for the purchase of340,000 shares of common stock and future conditional cash payments of $225,000to be paid out in various installments over the following two years, contingentupon the achievement of certain customer retention and product developmentgoals, which are included in goodwill when the uncertainties associated withits contingencies are recorded. Two contingent cash payments of $75,000 each,were paid in August  2005 and in May2006, for total contingent consideration of $150,000.   The cash component of the considerationgiven was paid from funds generated from the on-going operations of Optio.  The purchase price for VertiSoft consisted ofthe following:

| Cash paid in initial  transaction       |   | $         | 348,000   |   |
|-----------------------------------------|--------|-----------|-----------|--------|
| Cash paid in  contingent payment        |   | 150,000   |      |
| Common stock  issued (1,500,000 shares) |   | 1,690,000 |      |
| Stock options  issued                   |   | 361,000   |      |
| Acquisition  costs                      |   | 339,000   |      |
|                                    |   | $         | 2,888,000 |   |

 

Thevalue of the common stock issued above was based on the market price of Optio’scommon stock for a reasonable period before and after the date the merger wasannounced. The 310,000 shares held in escrow were released at the end of the 18month period, and the value of the shares based on the market value of Optio’scommon stock on that date was added to goodwill.

Theacquired 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, salescontracts, service agreements, and purchase orders. In connection with theacquisition, Optio also assumed the liabilities of VertiSoft, consistingprimarily of promissory notes payable (totaling approximately $1,100,000),accounts payable, accrued payroll, and service agreements.

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

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| Tangible assets acquired |   | $          | 280,000   |   |
|--------------------------|--------|------------|-----------|--------|
| Liabilities  assumed     |   | (1,932,000 | )         |
| Technology               |   | 893,000    |      |
| Customer  relationships  |   | 1,260,000  |      |
| Non-compete  agreement   |   | 85,000     |      |
| Goodwill                 |   | 2,302,000  |      |
|                     |   | $          | 2,888,000 |   |

 

Theacquired technology is being amortized over periods ranging from three monthsto five years, the customer relationships are being amortized over 11.5 yearsand the non-compete agreement with the shareholders of VertiSoft is beingamortized over five years.

The results ofoperations of VertiSoft have been included in Optio’s consolidated condensedfinancial statements from the date of acquisition.

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

#### **OVERVIEW**

Optio is engagedprimarily in the development, sale and support of infrastructure software thatenhances the form, content, distribution and availability of businessinformation. Optio’s primary business consists of providing software andservices that address organizations’ needs for customized information deliveredvia print, fax and e-mail to users of enterprise and healthcareapplications.

Optiomarkets and sells its software and services throughout the United States,Europe and the Asia Pacific region, through its direct sales force andcertified resellers. Optio has offices in the United States, France, the UnitedKingdom and Germany. Optio also offers consulting services, which providecustomers with implementation assistance and training. No single customeraccounted for 10% or more of Optio’s revenue for the three and nine monthsended October 31, 2006 or 2005.

**CriticalAccounting Policies and Use of Estimates**

Optio has identified significant accountingpolicies and estimates that are critical to the understanding of its financialstatements.

*Revenue Recognition*

*Overview*

TheCompany’s revenue consists of perpetual fees derived from the Company’ssoftware products, maintenance, consulting services, customer training andsubscription fees received from the licensing of the Company’s softwareproducts and maintenance. The Company generally charges fees for licenses ofits 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 numberof persons or hospital beds registered to use the product. The Company’srevenue recognition policies are in accordance with Statement of Position (“SOP”)No. 97-2, *Software Revenue Recognition*,as amended by SOP No. 98-9, *SoftwareRevenue Recognition With Respect to Certain Transactions* and theSecurities and Exchange Commission’s Staff Accounting Bulletin (“SAB”)No. 101, *Revenue Recognition inFinancial Statements,* as amended by SAB 104, *Revenue Recognition*.

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*LicenseFees*

TheCompany licenses its products through its direct sales force and indirectlythrough resellers. In general, software license revenues are recognized when anon-cancelable license agreement has been signed and the customer acknowledgesan unconditional obligation to pay, the software product has been delivered,there are no significant uncertainties surrounding product acceptance, the feesare fixed or determinable, collection is considered probable, the remainingelements such as future services are not considered essential to thefunctionality of the software and the Company has a legally enforceable claimnot subject to refund or forfeiture if future services are not rendered.Delivery is considered to have occurred when title and risk of loss have beentransferred to the customer, which generally occurs when media containing thelicensed programs is provided to a common carrier. In case of electronicdelivery, delivery occurs when the customer is given access to the licensedprograms. If collectibility is not considered probable, revenue is recognizedwhen the fee is collected. The Company enters into reseller arrangements that typicallyprovide for sublicense fees payable based upon a percentage of list price. TheCompany does not grant its resellers the right of return.

TheCompany recognizes revenue using the residual method pursuant to therequirements of SOP No. 97-2, as amended by SOP No. 98-9.Revenues recognized from multiple-element software arrangements are allocatedto each element of the arrangement based on the fair values of the elements,such as licenses for software products, maintenance, consulting services or customertraining. The determination of fair value is based on objective evidence, whichis specific to the Company and can differ from amounts contained in thecustomer arrangement. The Company limits its assessment of objective evidencefor each element to either the price charged when the same element is soldseparately or the price established by management having the relevant authorityto do so, for an element not yet sold separately. If evidence of fair value ofall undelivered elements exists but evidence does not exist for one or moredelivered elements, then revenue is recognized using the residual method. Underthe residual method, the fair value of the undelivered elements is deferred andthe remaining portion of the arrangement fee is allocated to the deliveredelements and recognized as revenue when the aforementioned criteria is met.

TheCompany records deferred revenue for software license agreements when cash hasbeen received from the customer and the agreement does not qualify for revenuerecognition under the Company’s revenue recognition policy. The Company recordsaccounts receivable for software license agreements when the agreementqualifies for revenue recognition but cash or other consideration has not beenreceived from the customer.

*SubscriptionRevenue*

TheCompany**also licenses certain of its productsin the form of a subscription service contract, with terms typically rangingfrom three to five years.  Subscriptionrevenue, which includes a license of the software product, technical supportand future unspecified enhancements to the software product, is recognized on adaily basis over the term of the agreement. Unlike license fee revenue,subscription service agreements include licenses that are not perpetual induration.

*Services,Maintenance and Other Revenue*

Consulting servicesrevenue and customer training revenue are recognized as such services areperformed because they are incidental to the functionality of the Company’ssoftware.  Maintenance revenues, whichinclude revenues bundled with software license agreements that entitle thecustomers to technical support and future unspecified enhancements to theCompany’s products, are deferred and recognized ratably over the related termof the maintenance agreement, which is generally twelve months. In accordancewith 

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Emerging IssuesTask Force release 01-14, *Income StatementCharacterization of Reimbursements Received for Out of Pocket Expenses Incurred*,the Company recognizes reimbursable expenses as revenue and as an expense incost of revenue in all periods presented.

*NoteReceivable*

Optio holds a note from M2 Systemsas 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 on September 1, 2003 and December 1, 2003 and a payment of $115,000 onJune 1, 2004. M2 Systems failed to make these payments on their respective duedates; however, each payment was made prior to an event of default under theterms of the note. All payments subsequent to June 1, 2004 have been made ontheir respective due dates.

During the third quarter of 2004, as a result of M2 Systems’ failure tomake timely payments, management determined that this was an indication that itwas probable that Optio would be unable to collect all amounts due according tothe contractual terms of the note.  Atthat time, the loan was considered impaired and was written down to theassessed fair value of the collateral. As of October 31, 2003, the collateral,including technology, accounts receivable, fixed assets and the discounted netcash flows of maintenance contracts was estimated to have an approximate fairvalue of $2.8 million, substantially less than the $3.7 million note receivablebalance as of October 31, 2003. Thus Optio recorded an impairment charge of$900,000 during the year ended January 31, 2004.

During the third quarter ending October 31, 2006, M2 Systems notifiedOptio of their intention to pay in full the outstanding note balance.  On November 6, 2006, after the sale of stockof M2 Systems and affiliates, Optio received $2,758,000 in cash, representingfull repayment of the M2 Systems note receivable, plus accrued interest.  Such repayment represents an early retirementof the note, originally due December 1, 2007. In connection with such repayment, Optio released its lien on the assetsof M2 Systems, its subsidiaries and related entities and the parties executedmutual releases.

In accordance withFAS 114, as amended by FAS 118, when there is a change in the value of the underlyingcollateral that would indicate the value of the loan has increased (is nolonger impaired), the net carrying value of the loan should be adjusted to suchvaluation. The collateral supporting the M2 Systems note was sold in anindependent, third party transaction, thus providing a basis for valuing theunderlying collateral based upon market prices in excess of the $2.8 millionowed to Optio. Based on the facts surrounding the value of the collateral, itappears improbable that the value of the collateral as of October 31, 2006 wasless than such value at November 6, 2006, the date of the payment.  As a result, the carrying value of the M2Systems note was  written up to its fullface value and the valuation reserve previously recorded by Optio relating tothe M2 Systems note was reversed during the quarter ended October 31, 2006.Optio recognized income of $900,000 that was a reduction of the Company’s thirdquarter operating expenses.

Because as ofOctober 31, 2006 it was probable that Optio would receive payment in full onthe M2 Systems note, the note has been reclassified as a current asset on theconsolidated condensed balance sheet.

*AccountsReceivable*

Optio maintains allowances fordoubtful accounts for estimated losses resulting from customers’ inability tomake payments required under their contracts. The amount of Optio’s reserve is based on historical experience and Optio’s specific review and analysis of thereceivables outstanding. Management reviews its accounts receivable on aregular basis to determine if any such amounts may be potentiallyuncollectible. The Company includes any balances that are determined to beuncollectible, along with a general reserve at varying percentages of 2% fordomestic and 3% for international balances less than 30 days old, respectively,to 50% for international accounts more than 90 days old, in its overallallowance for doubtful accounts. Based on management’s best estimate, itbelieves the Company’s allowance for doubtful accounts is adequate as 

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presented; however, the amountof the reserve could be different under different conditions or using varyingassumptions. If the percentage of the general reserve were to increase by 1%,an additional $34,000 reserve would be required. If the financial condition of Optio’scustomers were to deteriorate, resulting in their inability to make payments,additional reserves would be required, increasing Optio’s bad debt expense included in general andadministrative expenses.

*ImpairmentAssessments*

Optio adopted Statement of Financial AccountingStandards (“SFAS”) No. 142, *Goodwill andOther Intangible Assets,* on February 1, 2002. This standard requiresthat goodwill no longer be amortized and instead be tested for impairment on aperiodic basis.

Pursuant to SFAS 142, Optio isrequired to test goodwill for impairment upon adoption and annually or moreoften if events or changes in circumstances indicate that the asset might beimpaired. SFAS 142 provides for a two-stage approach to determining whether andby how much goodwill has been impaired. The first stage requires a comparisonof the fair value of the reporting unit, in our case, the former VertiSoftbusiness, 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 bookvalue, then the second stage must be completed to determine the amount, if any,of actual impairment. Optio has selected August 1 as its annual impairmenttesting date for its goodwill. The Company performed an analysis as of August 1,2006, comparing the fair value of the reporting units with the carrying valueof such reporting units, including goodwill, and determined that no impairmentof its goodwill existed. While noimpairment charge was determined to be necessary in the current year, theCompany’s future assessments could lead management to determine that thegoodwill is completely or partially impaired, which would require the Companyto record an impairment charge of up to $2.3 million.

The process of evaluating the potentialimpairment of goodwill is highly subjective and requires significant judgmentdecisions. In estimating our fair value, we will make estimates and judgmentsabout future revenues and cash flows. Our forecasts will be based uponassumptions that are consistent with the plans and estimates we are using tomanage our business. Changes in these estimates could change our conclusionregarding impairment of goodwill and potentially result in a non-cash goodwillimpairment charge for all or a portion of the goodwill balance. For long-livedassets, accounting standards dictate that assets become impaired when theundiscounted future cash flows expected to be generated by them are less thantheir carrying amounts. In such cases, the affected assets are written down totheir estimated fair value.

*Foreign Currencies*

The financial position and results of operations ofthe Company’s foreign subsidiaries are generally measured using localcurrencies as the functional currencies, including the British pound and theEuro. Assets and liabilities of these subsidiaries are translated into U.S.dollars at the exchange rate in effect at each reporting period. Income andexpense items are translated at average exchange rates for the period. Theresulting translation adjustments are recorded in the foreign currencytranslation adjustment account. Optio and its subsidiaries conduct theirbusiness locally, thus the effects of changes in foreign currency exchangerates have had a minimal effect on the Company’s results of operations to date.

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**RESULTSOF OPERATIONS**

***ThreeMonths Ended October 31, 2006 Compared to Three Months Ended October 31, 2005***

## **Revenues**

The followingtable sets forth certain items from Optio’s condensed consolidated statementsof operations as a percentage of total revenue for the periods indicated. 
| ** **                                                                   | ** ** | **Three Months **     | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **Ended October 31,** | ** ** |
| ** **                                                                   | ** ** | **2005**                        | ** ** | **2006** | ** ** |
| Revenue:                                                                     | ** ** | ** **                      | ** ** | ** ** | ** ** |
| License fees                                                                 |       | 29                              | %          | 29 | % |
| Subscription  fees                                                           |       | 8                               |       | 8 |   |
| Services,  maintenance and other                                             |       | 63                              |       | 63 |   |
|                                                                         |       |                                 |       |  |   |
| Total revenue                                                                |       | 100                             |       | 100 |   |
| Costs of revenue  (excluding depreciation and amortization, included below): |       |                            |       |   |   |
| License fees                                                                 |       | 3                               |       | 2 |   |
| Services,  maintenance and other                                             |       | 23                              |       | 24 |   |
|                                                                         |       |                                 |       |  |   |
| Total cost of  revenue                                                       |       | 26                              |       | 26 |   |
|                                                                         |       | 74                              |       | 74 |   |
| Operating expenses:                                                          |       |                            |       |   |   |
| Sales and  marketing                                                         |       | 40                              |       | 35 |   |
| Research and  development                                                    |       | 18                              |       | 18 |   |
| General and  administrative                                                  |       | 13                              |       | 17 |   |
| Gain on reversal  of impairment of M2 note                                   |       | —                          |       | (12 | ) |
| Depreciation and  amortization                                               |       | 3                               |       | 3 |   |
|                                                                         |       |                            |       |   |   |
| Total operating  expenses                                                    |       | 74                              |       | 61 |   |
| Income from operations                                                       |       | 0                               |       | 13 |   |
| Interest and other  income                                                   |       | —                          |       | 1 |   |
| Income tax expense                                                           |       | —                          |       | — |   |
| Net income                                                                   |       | 0                               | %          | 14 | % |

 

**Revenues**

Totalrevenues increased to $7.6 million in the three months ended October 31, 2006from $7.1 million in the three months ended October 31, 2005.

*License fees*

Revenuesfrom software licenses increased to $2.2 million in the three months endedOctober 31, 2006 from $2.1 million for the three months ended October 31,2005.  During the three months endedOctober 31, 2006, Optio’s healthcare team closed a single contract worth$600,000 in software, accounting for a $450,000 increase in healthcare salesalone. The enterprise direct business, on the other hand, saw a $300,000decline in software sales during the three months ended October 31, 2006, asOptio continues to face pressure in the 

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document outputmanagement market and longer than anticipated sales cycles in the businessprocess management market.

Approximately$421,000 of Optio’s software license revenue during the three months endedOctober 31, 2006 was derived from partners, such as resellers, value-addeddistributors or OEM relationships, representing 19% of license revenue forOptio. During the three months ended October 31, 2005, Optio generated $637,000of its software license revenue through partners, representing 31% of Optio’slicense revenue.  The decrease in revenuederived from partners is largely due to sales turnover in our Germansubsidiary, which primarily represents sales through distributors. The turnovercaused disruption in the reseller business in Germany, decreasing sales byapproximately $100,000. In addition, in the prior year, Optio had a single saleto a reseller in excess of $100,000, where no such sale was made in the currentquarter.

*Subscriptionfees*

 Subscription revenue increased to $597,000 inthe three months ended October 31, 2006 from $542,000 in the three months endedOctober 31, 2005. Optio has signed additional contracts and additional modulesfor existing contracts, increasing the monthly amount recognized on asubscription basis.

*Services, maintenance and other*

Revenues from services, maintenance and otherincreased to $4.8 million from $4.5 million during   the three months ended October 31, 2006 and2005, respectively. Services revenue remained consistent at $1.4 million forboth three months ended October 31, 2006 and 2005, respectively.  Maintenance revenue increased $300,000 to$3.3 million in the three months ended October 31, 2006 from $3.0 million inthe three months ended October 31, 2005. Maintenance revenue continues toincrease as Optio adds to its customer base and increases the price of itsannual maintenance fees.

*Revenue Mix*

Revenue from licenses represented 29% of total revenuein the three months ended October 31, 2006, consistent with license revenuealso at 29% of total revenue in the three months ended October 31, 2005.Subscription revenue represented 8% of total revenue in the three months endedOctober 31, 2006, also matching the percentage contribution from the samequarter last year.   Services, maintenanceand other revenue constituted 63% of total revenue in the three months endedOctober 31, 2006, the same percentage contribution as the prior yearcomparative period as well. Accordingly, the overall revenue mix was consistentfor the three months ended October 31, 2006 and 2005, respectively.

 **Costs of Revenues**

Total costs of revenuesincreased slightly to  $1.9 million inthe three months ended October 31, 2006 from $1.8 million in the three monthsended October 31, 2005.

*Licenses*

Costs of revenues from licensesconsist of costs related to the packaging and distribution of the products,fees paid for integration of third-party software products and fees paid toreferral partners. Costs of revenues from licenses decreased to $112,000 in thethree months ended October 31, 2006 from $187,000 in the three months endedOctober 31, 2005. Fees paid for the integration of third-party softwareproducts declined approximately $18,000. Fewer products which include third-party software were sold during the 

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three months ended October 31,2006, as compared to the three months ended October 31, 2005, reducing thecosts of revenue from licenses. In addition, fees paid to referral partnersdeclined $46,000 from the three months ended October 31, 2005 to the threemonths ended October 31, 2006 as we had fewer deals referred by independentparties.

*Services, Maintenance and Other*

Costs of revenues from services,maintenance and other consist of personnel, subcontracting and other expensesrelating to the cost of providing customer support, education and consultingand implementation services. Costs of revenues from services, maintenance andother increased to $1.8 million in the three months ended October 31, 2006 from$1.6 million in the three months ended October 31, 2005. Optio continued tokeep a reduced number of internal implementation staff and, as a result, Optiorelied more heavily on external outsourcers. This resulted in a $154,000increase in the cost of outsourcers in the three months ended October 31, 2006as compared to the three months ended October 31, 2005. The cost of internalstaff and their associated costs increased slightly by $50,000 between theperiods October 31, 2006 and 2005 due to salary increases.

**Operating Expenses**

*Sales and Marketing*

Sales and marketing expensesconsist primarily of salaries, commissions, bonuses and benefits earned bysales 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 expensesdecreased 9% to $2.6 million from $2.9 million for the three months endedOctober 31, 2006 and 2005, respectively. Sales and marketing expenseswere 35% and 40%  of total revenue forthe three months ended October 31, 2006 and 2005, respectively.  Commissions and bonuses decreasedapproximately $180,000 between the two quarters.   This decrease was primarily the result ofsignificantly fewer individuals achieving the required bonus goals.  In addition, there was a modification to theCompany’s sales compensation plans, providing for lower commission rates untila certain level of productivity is achieved. Other discretionary spending, in the aggregate, was also lower ascompared to the same quarter in the prior fiscal year.  Partly offsetting this expense reduction weredirect marketing expenditures, which increased $47,000 between the three monthsended October 31, 2006 and the three months ended October 31, 2005.

*Research and Development*

Research and development expense consists primarily ofsalaries, benefits and equipment for software developers, quality assurancepersonnel, and product managers.

Research and development expenses increased 6% to $1.4million for the three months ended October 31, 2006 from $1.3 million in thethree months ended October 31, 2005. Research and development salaries and associated benefits increased$100,000 between the periods, primarily due to salary increases, asopposed  to additional staff.

 *General and Administrative*

General and administrative expenses consist primarilyof salaries, benefits and related costs for 

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executive, finance, human resources and informationservices personnel. General and administrative expenses also include legal,accounting, insurance and other professional services.

General and administrative expenses increased to $1.3million from $1.0 million in the three months ended October 31, 2006 and 2005,respectively. General and administrative expenses increased due to thefollowing: (i) $120,000 of compensation expense related to stock options withthe adoption of SFAS No. 123R, (ii) an increase of $120,000 in recruiting feesrelated to sales and accounting staff augmentation (iii) increased bad debtexpense of $20,000, and (iv) increased salaries of approximately $60,000 foradditional accounting and administrative staff. Optio adopted SFAS No. 123R asof February 1, 2006. This Statement requires companies to expense the fairvalue of stock options over the related service period. As SFAS No. 123R wasadopted effective for the first quarter of fiscal 2007, no such expense isreflected in fiscal 2006.

*Gain on reversal of valuation reserve of M2 note*

In accordance withFAS 114, as amended by FAS 118, when there is a change in the value of thecollateral that would indicate the value of the loan has increased (is nolonger impaired), the net carrying value of the loan should be adjusted to suchvaluation. The collateral supporting the M2 Systems note was sold in anindependent, third party transaction, thus providing a basis for valuing thecollateral based upon market prices in excess of the $2.8 million owed toOptio. As a result, the carrying value of the M2 Systems note was effectivelywritten up to its full face value and the impairment charge previously recordedby Optio relating to the M2 Systems note was eliminated. Optio recognizedincome of $900,000 that was a reduction of the Company’s third quarteroperating expenses.

*Depreciation and Amortization*

Depreciation and amortization expense increased to$266,000 from $202,000 for the three months ended October 31, 2006 and 2005,respectively. The increase was primarily due to Optio’s renegotiation of thelease for Optio’s headquarters in which the landlord contributed $1.0 milliontowards the improvements of the space. These leasehold improvements, as well as an additional $700,000purchased directly by Optio, are being depreciated over the term of the newlease or the expected life of the assets, as appropriate.  This increase was partly offset by a decreasein amortization expense as intangibles are amortized over the estimated usefullife of the asset using the cash flow method, which results in a greaterexpense in the earlier periods and reduced expense in the later periods. Thisresulted in a greater expense in periods prior to fiscal year 2007.

*Interest Income*

Interest income increased to $119,000 in the threemonths ended October 31, 2006 from $69,000 in the three months ended October31, 2005. Interest income primarily represents interest earned on the principalof the M2 Systems note receivable and has increased due to an increase in theinterest rate on the note.

*Interest Expense*

Interest expense decreased to $2,000 in the threemonths ended October  31, 2006, areduction from $10,000 in the three months ended October 31, 2005. Interestexpense primarily represents the interest paid on Optio’s capital leases.

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***Nine Months Ended October 31,2006 Compared to Nine Months Ended October 31, 2005***

## **Revenues**

The followingtable sets forth certain items from Optio’s statements of operations as apercentage of total revenue for the periods indicated. 
| ** **                                                                   | ** ** | **Nine Months **      | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **Ended October 31,** | ** ** |
| ** **                                                                   | ** ** | **2005**                        | ** ** | **2006** | ** ** |
| Revenue:                                                                     |       |                            |       |   |   |
| License fees                                                                 |       | 32                              | %          | 27 | % |
| Subscription fees                                                            |       | 7                               |       | 8 |   |
| Services, maintenance and other                                              |       | 61                              |       | 65 |   |
|                                                                         |       |                                 |       |  |   |
| Total revenue                                                                |       | 100                             |       | 100 |   |
| Costs of revenue  (excluding depreciation and amortization, included below): |       |                            |       |   |   |
| License fees                                                                 |       | 3                               |       | 2 |   |
| Services, maintenance and other                                              |       | 22                              |       | 24 |   |
|                                                                         |       |                                 |       |  |   |
| Total cost of revenue                                                        |       | 25                              |       | 26 |   |
|                                                                         |       | 75                              |       | 74 |   |
|                                                                         |       |                            |       |   |   |
| Operating  expenses:                                                         |       |                            |       |   |   |
| Sales and marketing                                                          |       | 40                              |       | 36 |   |
| Research and development                                                     |       | 18                              |       | 19 |   |
| General and administrative                                                   |       | 14                              |       | 18 |   |
| Gain on reversal of impairment of M2 note                                    |       | —                          |       | (4 | ) |
| Depreciation and amortization                                                |       | 3                               |       | 3 |   |
|                                                                         |       |                                 |       |  |   |
| Total operating expenses                                                     |       | 75                              |       | 72 |   |
|                                                                         |       |                                 |       |  |   |
| Income from  operations                                                      |       | —                          |       | 2 |   |
| Interest and  other income                                                   |       | 1                               |       | 1 |   |
| Income tax  expense                                                          |       | —                          |       | — |   |
| Net income                                                                   |       | 1                               | %          | 3 | % |

 

**Revenues**

Totalrevenues declined slightly to $21.2 million in the nine months ended October31, 2006 from $21.4 million in the nine months ended October 31, 2005.

*License fees*

Revenues from software licenses decreased to $5.7million in the nine months ended October 31, 2006 from $6.8 million for thenine months ended October 31, 2005. Optio has continued to see a decline in software license revenue fromits document output management business. During the three months ended October31, 2006, Optio closed a single contract to a healthcare customer totaling$600,000, slightly offsetting this downturn in the document output managementmarket. However, Optio continues to face pressure in the document outputmanagement market in its enterprise industry. Our business process management solutions have not generated revenue asquickly as we anticipated. Sales of Optio’s newer products, including Optio 

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Imaging Solutions, require a longer sales cycle than our traditionaloutput solutions products. During the nine months ended October 31, 2005, Optioentered into a single contract with a new customer valued at over $325,000 insoftware license revenue and four additional contracts over $100,000 insoftware license revenue. Alternatively, during the nine months ended October31, 2006, with the exception of the one large healthcare contract mentionedabove, Optio’s average contract size for new customers declined approximately50%, in large part due to the fact that there were only two contracts over$100,000. Optio’s second quarter of fiscal year 2007 was also impacted byturnover in the senior management sales position, causing disruption in thesales cycle of certain potential deals during that quarter.

Approximately$1.4 million of Optio’s software license revenue during the nine months endedOctober 31, 2006 was derived from partners, such as resellers, value-addeddistributors or OEM relationships, representing 24% of license revenue forOptio. During the nine months ended October 31, 2005, Optio generated $1.8million of its software license revenue through partners, representing 27% ofOptio’s license revenue. As with direct sales, Optio entered into a singlesignificant contract during the nine months ended October 31, 2005, while therewas no comparable agreement in the nine months ended October 31, 2006. Inaddition, there was a decrease in revenue derived from partners due to salesturnover in our German subsidiary. The turnover caused disruption in thereseller business in Germany, decreasing sales by approximately $100,000 in thethird quarter of fiscal 2007 compared to the third quarter of fiscal 2006.

*Subscriptionfees*

Subscriptionrevenue increased to $1.7 million in the nine months ended October 31, 2006from $1.6 million in the nine months ended October 31, 2005. Optio has signedadditional contracts and additional modules for existing contracts, increasingthe monthly amount recognized on a subscription basis.

*Services, maintenance and other*

Revenues from services, maintenance and otherincreased to $13.8 million from $13.0 million during   the nine months ended October 31, 2006 and2005, respectively. Services revenue decreased to $4.0 million from $4.3million for the nine months ended October 31, 2006 and 2005, respectively.  A decline in software license revenuecontributed to a decline in associated consulting services revenue. Maintenancerevenue increased  to $9.7 million in thenine months ended October 31, 2006 from $8.7 million in the nine months endedOctober 31, 2005. Maintenance revenue continues to increase as Optio adds toits customer base and increases the price of its annual maintenance fees.

*Revenue Mix*

Revenue from licenses represented 27% of total revenuein the nine months ended October 31, 2006 and 32% of total revenue in the ninemonths ended October 31, 2005. Subscription revenue represented 8% and 7% oftotal revenue in the nine months ended October 31, 2006 and 2005, respectively.   Services, maintenance and other revenueconstituted 65% and 61% of total revenue in the nine months ended October 31,2006 and 2005, respectively. Revenue from licenses declined between the ninemonths ended October 31, 2006 and 2005, thus causing the percentage of revenueto shift towards services, maintenance and other, which increased during thosesame periods.

**Costs ofRevenues**

Total costs of revenuesincreased slightly to  $5.5 million inthe nine months ended October 31, 2006 from $5.3 million in the nine months endedOctober 31, 2005.

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*Licenses*

Costs of revenues from licensesdecreased to $390,000 in the nine months ended October 31, 2006 from $544,000in the nine months ended October 31, 2005. Fees paid for the integration ofthird-party software products declined approximately $73,000.  Fewer products which include third-partysoftware were sold during the nine months ended October 31, 2006, as comparedto the nine months ended October 31, 2005. In addition, fees paid to referralpartners declined $48,000 from the nine months ended October 31, 2005 to thenine months ended October 31, 2006 as we had fewer deals referred byindependent parties.

*Services, Maintenance and Other*

Costs of revenues from services,maintenance and other increased to $5.2 million in the nine months endedOctober 31, 2006 from $4.8 million in the nine months ended October 31, 2005.Optio continued to keep a reduced number of internal implementation staff and,as a result, Optio relied more heavily on external outsourcers. This resultedin a $340,000 increase in the cost of outsourcers in the nine months endedOctober 31, 2006 as compared to the nine months ended October 31, 2005. Thecost of internal staff and their associated costs was mostly unchanged betweenthe periods October 31, 2006 and 2005.

**Operating Expenses**

*Sales and Marketing*

Sales and marketing expensesdecreased 9% to $7.7 million from $8.5 million for the nine months endedOctober 31, 2006 and 2005, respectively. Sales and marketing expenseswere 36% and 40%, respectively, of total revenue for the same periods. Directmarketing expenditures decreased $32,000 between the nine months ended October31, 2006 and the nine months ended October 31, 2005. In addition, commissionsand bonuses decreased approximately $450,000 between the two quarters. Thisdecrease was the result of a decline in software license revenue and amodification to the Company’s compensation plans, providing for lowercommission rates until a certain level of productivity is achieved as well asfewer individuals achieving their bonus goal requirements.

*Research and Development*

Research and development expenses increased 5% to $4.1million for the nine months ended October 31, 2006 from $3.9 million in thenine months ended October 31, 2005. Research and development salaries and associated benefits increasedapproximately $150,000 between the periods, primarily due to salary increasesand not due to additional staff.

*General and Administrative*

General and administrative expenses increased to $3.8million from $3.0 million in the nine months ended October 31, 2006 and 2005,respectively. General and administrative expenses increased due to thefollowing: (i) $318,000 of compensation expense related to stock options, (ii)an increase of $265,000 in recruiting fees related to sales staff augmentation(iii) increased salaries of approximately $135,000 for additional accountingand administrative staff, (v) bonuses paid of $75,000, offset by  a decrease in legal fees of $83,000 due toreduced legal activity. Optio adopted SFAS No. 123R as of February 1, 2006.This statement requires companies to expense the fair value of stock optionsover the related service period. As SFAS No. 123R was adopted effective for thefirst quarter of fiscal 2007, no such expense is reflected in fiscal 2006.

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*Gain on reversal of valuation reserve of M2 note*

In accordance withFAS 114, as amended by FAS 118, when there is a change in the value of thecollateral that would indicate the value of the loan has increased (is nolonger impaired), the net carrying value of the loan should be adjusted to suchvaluation. The collateral supporting the M2 Systems note was sold in anindependent, third party transaction, thus providing a basis for valuing thecollateral based upon market prices in excess of the $2.8 million owed toOptio. As a result, the carrying value of the M2 Systems note was effectivelywritten up to its full face value and the impairment charge previously recordedby Optio relating to the M2 Systems note was eliminated. Optio recognized incomeof $900,000 that was a reduction of the Company’s third quarter operatingexpenses.

*Depreciation and Amortization*

Depreciation and amortization expense increased to$650,000 from $633,000 for the nine months ended October 31, 2006 and 2005,respectively. This increase was primarily the result of the renegotiation ofthe lease by Optio for its headquarters facility in which the landlordcontributed $1.0 million towards the improvements of the space. These leaseholdimprovements, as well as an additional $700,000 purchased directly by Optio,are being depreciated over the term of the new lease or the expected life ofthe assets, as appropriate.   Partiallyoffsetting this was a decrease in amortization expense as the intangibles areamortized over the estimated useful life of the asset using the cash flowmethod, which results in a greater expense in the earlier periods and reducedexpense in the later periods. This resulted in a greater expense in periodsprior to fiscal year 2007.

*Interest Income*

Interest income increased to $327,000 in the ninemonths ended October 31, 2006 from $185,000 in the nine months ended October31, 2005. Interest income primarily represents interest earned on the principalof the M2 Systems’ note receivable and has increased due to an increase in theinterest rate on the note.

*Interest Expense*

Interest expense was $4,000 and $14,000 in the ninemonths ended October 31, 2006 and 2005, respectively. Interest expenseprimarily represents the interest paid on Optio’s capital leases.

**LIQUIDITY AND CAPITAL RESOURCES**

Optio had $8.0million in cash and cash equivalents at both October 31, 2006 and January 31,2006, respectively.

The followingtable sets forth certain selected statements of cash flow information for thenine months ended October 31, 2006:
| Net cash provided by  operations           |   | $        | 528,000 |   |
|--------------------------------------------|--------|----------|---------|--------|
| Net cash used in  investing activities     |   | (948,000 | )       |
| Net cash  provided by financing activities |   | 393,000  |    |
| Net increase in cash  and cash equivalents |   | 57,000   |    |

 

Cash provided by operations wasprimarily the result of net income of $585,000, plus a $1.1 million 

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add-back of non-cashdepreciation and amortization expense, stock compensation, loss on disposal ofassets, provision for doubtful accounts and provision for deferred taxes, lessthe deduction of a $900,000 non-cash gain on the reversal of impairment on theM2 Systems note and less changes in working capital resulting in a $220,000outflow of cash.  The major component ofsuch working capital changes was the Company’s use of funds to pay down accruedexpenses, an increase in deferred revenue, and an increase in spending forprepaids and other assets.  Favorablyaffecting working capital was a reduction in accounts receivable and anincrease in payments owed to vendors. The net payment of accrued expenses of$658,000 represented the payment of Optio’s year-end commissions and bonusesand other year-end accrued liabilities such as audit fees. In addition, Optioprepaid several of its renewed insurance policies and other marketing expenses,resulting in a $96,000 net cash outflow. Deferred revenue also increased by$508,000.  This amount was partiallyoffset by a decline in accounts receivable from the collection of several largereceivables outstanding as of January 31, 2006, resulting in additional cashinflow of $749,000. In investing activities, Optio received $220,000 inpayments on the receivable from M2 Systems, purchased $1,093,000 of propertyand equipment, primarily related to the remodeling of Optio’s headquarter’soffice space and paid $75,000 in conditional payments related to the purchaseof VertiSoft Corporation. Optio’s financing activities included receipts of$404,000 from the exercise of stock options.

On April 27, 2005, Optio extended its existing line of credit throughApril 19, 2006. Subsequently, on April 21, 2006, Optio extended the line ofcredit through April 19, 2007. The line of credit bears interest at prime rate,subject to increase based on Optio’s performance relative to certain financialratios.  Optio may borrow up to $4.0million, or such lesser amount as may be determined based on the level ofeligible accounts receivable.  Currently,Optio has estimated that approximately $2.0 million would be available forborrowings based upon Optio’s historical accounts receivable balance. Accountsreceivable, equipment, general intangibles and other assets, as defined in theloan agreement, collateralize the line of credit. The loan agreement containsvarious covenants, including liquidity and earnings before interest, taxes,depreciation and amortization (“EBITDA”) requirements and restrictions on thepayment of dividends. On December 4, 2003, the line of credit was amended,effective April 30, 2003, to modify the calculation of certain financial ratiosto exclude any impairment charges related to the M2 Systems note receivable. Asof October 31, 2006, Optio was in compliance with the required financialratios. There were no borrowings under the line of credit as of October 31,2006.

The Company holdsa note receivable from M2 Systems as partial consideration for the sale ofMuscato and TransLink. The payment schedule of the note required four quarterlyinstallments of $100,000, including interest calculated at the prime rate, upto a maximum of 6.75% (6.75% as of July 31, 2006), 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

During the thirdquarter of 2007, M2 Systems notified Optio of their intention to pay in fullthe outstanding note balance.  OnNovember 6, 2006, Optio received $2,758,000 in cash, representing fullrepayment of the M2 Systems note receivable, plus accrued interest.  Such repayment represents an early retirementof the note, originally due December 1, 2007. In connection with such repayment, Optio released its lien on the assetsof M2 systems, its subsidiaries and related entities and the parties executedmutual releases.

Managementbelieves that the existing cash and cash equivalents, together with the line ofcredit, will provide adequate cash to fund its anticipated cash needs at leastthrough the next twelve months. Optio intends to expand its product line, whichmay require acquisitions of companies or products that enhance the Company’sproduct line. As a result, Optio may attempt to raise additional funds throughequity or debt financing. There can be no assurance that Optio will be able toraise 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 

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change intechnology related to Optio’s products or services offered, could have anegative impact on Optio’s liquidity. This risk may include the potential for Optionot meeting its debt covenant requirements, making any borrowings under theline of credit unavailable.

**NewAccounting Pronouncements**

In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes-an interpretation of SFAS No. 109” (“FIN 48”). FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in financial statementsin accordance with SFAS No. 109, and recommends a recognition threshold andmeasurement characteristic for financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. Thedifferences between a tax position taken in a tax return and amounts recognizedin the financial statements may result in an increase in a liability for incometaxes payable, a reduction of an income tax refund receivable, a reduction in adeferred tax asset or an increase in a deferred tax liability. FIN 48 alsoprovides guidance on classification, interest and penalties, accounting ininterim periods, disclosure, and transition. FIN 48 is effective for fiscalyears beginning after December 16, 2006, with early adoption encouraged. TheCompany intends to adopt FIN 48 on February 1, 2007. The Company has not yetdetermined the effects of adopting FIN 48.

In September 2006,the FASB issued FASB No. 157, “Fair Value Measurements” (“FASB 157”). FASB 157redefines fair value, establishes a framework for measuring fair value andexpands the disclosure requirements regarding fair value measurement. FASB 157is effective for fiscal years beginning after November 15, 2007, and interimperiods within those fiscal years. The Company does not expect that theadoption of FASB 157 will have a material impact on its results of operationsor financial position; however, additional disclosures will be required underFASB 157.

In September 2006, the FASB issued FASB No. 158, “Employers’ Accountingfor Defined Benefit Pension and Other Postretirement Plans – an Amendment ofFASB Statements No. 87, 88, 106 and 132(R)” (“FASB 158”). FASB 158 improvesfinancial reporting by requiring an employer to recognize the overfunded orunderfunded status of a defined benefit postretirement plan (other than amultiemployer plan) as an asset or liability in its statement of financialposition and to recognize changes in that funded status in the year in whichthe changes occur through comprehensive income of a business entity or changesin unrestricted net assets of a not-for-profit organization. FASB 158 alsoimproves financial reporting by requiring an employer to measure the fundedstatus of a plan as of the date of its year-end statement of financialposition, with limited exceptions. An employer with publicly traded equitysecurities is required to initially recognize the funded status of a definedbenefit postretirement plan and to provide the required disclosures as of theend of the fiscal year ending after December 15, 2006. The Company does notexpect FASB 158 to have a material impact on the Company’s results ofoperations or financial position.

ITEM 3.** **QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Optio provides itsservices to customers primarily in the United States and, to a lesser extent,in Europe and elsewhere throughout the world. As a result, Optio’s financialresults could be affected by various factors, such as changes in foreigncurrency exchange rates or weak economic conditions in foreign markets. Allsales are currently made in both U.S. dollars and local currencies. Astrengthening of the U.S. dollar or the weakening of these local currenciescould make Optio’s products less competitive in foreign markets. Based upon therelative size of Optio’s foreign operations, Optio believes its exposure toforeign currency fluctuations is not a material risk. Optio’s interest incomeand expense are sensitive to changes in the general level of U.S. interestrates. Based on Optio’s cash equivalents balance and the nature of itsoutstanding debt, Optio believes 

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its exposure tointerest rate risk is not material.

ITEM 4.  CONTROLS AND PROCEDURES.

Our Chief Executive Officer and Chief Financial Officer have evaluatedthe effectiveness of our disclosure controls and procedures (as defined in Rule13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”))as of October 31, 2006, and have concluded that, as of such date, ourdisclosure controls and procedures are effective in ensuring that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms. Our Chief Executive Officer andChief Financial Officer also concluded that, as of October 31, 2006, ourdisclosure controls and procedures are effective in ensuring that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, to allow timely decisionsregarding required disclosure.

*Changesin Internal Controls*

There were no changes in our internal controls over financial reportingthat occurred during the quarter ended October 31, 2006, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

**PART II –OTHER INFORMATION**

ITEM 1. LEGALPROCEEDINGS

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 SouthernDistrict of New York. The complaint was filed against the underwriters in theCompany’s initial public offering as well as Optio and certain officers anddirectors of Optio, by a single plaintiff purportedly on behalf of personspurchasing Optio’s common stock between December 14, 1999 and December 6, 2000.The lawsuit also seeks class action status. Optio is a co-defendant withapproximately 300 other issuers in this suit. The complaint includesallegations of violations of (i) Section 11 of the Securities Act of 1933, asamended (the “Securities Act”), by all named defendants, (ii) Section 12(a)(2)of the Securities Act by the underwriter defendants, (iii) Section 15 of theSecurities Act by the individual defendants, and (iv) Section 10(b) of theSecurities Exchange Act of 1934, as amended, and Rule 10b-5 promulgatedthereunder by the underwriter defendants. The complaint alleges that Optio’sprospectus was materially false and misleading because it failed to disclose,among other things, that: (i) the underwriters had solicited and receivedexcessive and undisclosed commissions from certain investors in exchange forwhich the underwriters allocated to those investors material portions of alimited number of Optio shares issued in connection with the Optio initialpublic offering; and (ii) the underwriters had entered into agreements withcustomers whereby the underwriters agreed to allocate Optio shares to thosecustomers in the Optio initial public offering in exchange for which thecustomers agreed to purchase additional Optio shares in the aftermarket atpre-determined prices. The complaint seeks unspecified amounts as compensatorydamages as a result of Optio’s alleged actions, as well as punitive damages andreimbursement for the plaintiffs’ attorneys’ fees and associated costs andexpenses of the lawsuit. A proposal to settle the claims against Optio andother companies and individual defendants in the litigation was conditionallyaccepted by Optio. The completion of the settlement is subject to a number ofconditions, including Court approval. The Court preliminarily approved thesettlement on February 15, 2005, subject to certain modifications which arecurrently pending approval by the defendants. Under the settlement, theplaintiffs will dismiss and release all claims against 

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participatingdefendants in exchange for a contingent payment guaranty by the insurance companiescollectively responsible for insuring the issuers in the action. Optio maystill have yet undetermined exposure to the underwriters pursuant toindemnification provisions in the underwriting agreement entered into at thetime of the initial public offering. Under the guaranty, all of the insurersfor all the issuers will be required to pay an amount equal to $1.0 billionless any amounts ultimately collected by the plaintiffs from the underwriterdefendants in all of the pending cases. A settlement fairness hearing was heldon April 24, 2006, however no ruling has been issued yet by the Court. Therecan be no assurance that this proposed settlement will be approved andimplemented in its current form, or at all. The disposition of this matter islimited to Optio’s $300,000 corporate insurance deductible. The Company hascompleted payment of the insurance deductible through payment of legal fees.Optio will have no additional exposure unless the insurance companies becomeinsolvent or unless Optio’s liability exceeds its policy limits through thismatter or other matters. Optio’s insurance companies currently have an A or AArating. The range of loss, if any, cannot be estimated and thus no potentialloss is reflected in Optio’s condensed consolidated financial statements.

Managementbelieves that it has meritorious defenses in the foregoing matter and intendsto pursue its position vigorously.  Whilelitigation is inherently subject to many uncertainties, management does notbelieve that the outcome of this case will have a material adverse effect onthe financial position of Optio. However, depending on the amount and timing of an unfavorable resolutionof the lawsuit, it is possible that Optio’s financial condition, results ofoperation or liquidity could be materially affected.

In addition, Optiois party to routine litigation or administrative proceedings incidental to itsbusiness, none of which is believed by the Company to be likely to have amaterial effect on the financial condition, results of operations or liquidityof the Company.

ITEM 1A. RISKFACTORS

Inaddition to the other information set forth in this report, the factorsdiscussed under “Item 1A. Risk Factors” in Part I of the 2006 Annual Reportcould materially affect our business, financial condition or future results.The risks described in our 2006 Annual Report are not the only risks facing ourCompany. Additional risks and uncertainties not currently known to us or thatwe currently deem to be immaterial also may materially adversely affect ourbusiness, financial condition or operating results.

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

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHERINFORMATION

None.

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ITEM 6. EXHIBITS

(a) Exhibits
| 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. |

 

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# **SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized on the 15th day of December,2006.
|        | OPTIO SOFTWARE, INC. |
|--------|----------------------|
|   |                 |
|   | By:                  |  /s/ C. Wayne Cape |   |
|   |                 | C. Wayne Cape |
|   |                 | President and Chief Executive Officer |
|        |                      |  |  |  |

 

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