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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended April 30, 2005



OR



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



For the transition period from  to



Commission File Number: 1-15529



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OPTIO SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Georgia                                                        |  | 58-1435435                          
|(State of other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|3015 Windward Plaza, Fairways II, Alpharetta, GA               |  | 30005                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



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



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
126-2 of the Securities Exchange Act of 1934).    Yes ̈No  x



There were 21,263,757 shares of the
Registrants common stock outstanding as of June 6, 2005.



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##### Table of Contents

OPTIO SOFTWARE, INC.



FORM 10-Q



For the Quarterly Period Ended April 30, 2005



TABLE OF CONTENTS



|                               |  |                                                                                       |  |     
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                       |  | Page
|PART I  FINANCIAL INFORMATION |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Financial Statements                                                                  |  | 4   
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 15  
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 22  
|Item 4.                        |  | Controls and Procedures  Evaluation and Disclosure Controls and Procedures           |  | 22  
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 23  
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 24  
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 24  
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 24  
|Item 5.                        |  | Other Information                                                                     |  | 24  
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                      |  | 24  



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FORWARD-LOOKING STATEMENTS



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



3



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##### Table of Contents

PART I  FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



Optio
Software, Inc.

Consolidated Condensed Balance Sheets



|                                                   |  |                 |             |   |                |   |             |  
|-------------------------------------------------- |  | --------------- | ----------- | - | -------------- | - | ----------- | -
|                                                   |  | January 31,2005 |             |   | April 30, 2005 |  
|                                                   |  |                 |             |   | (Unaudited)    |  
|ASSETS                                             |  |                 |             |   |                |   |             |  
|Current assets:                                    |  |                 |             |   |                |   |             |  
|Cash and cash equivalents                          |  | $               | 5,433,000   |   |                | $ | 5,797,000   |  
|Accounts receivable, net                           |  |                 | 4,734,000   |   |                |   | 4,245,000   |  
|Prepaid expenses and other current assets          |  |                 | 425,000     |   |                |   | 625,000     |  
|Notes receivable from related party                |  |                 | 5,000       |   |                |   | 5,000       |  
|Current portion of note receivable from M2         |  |                 | 353,000     |   |                |   | 376,000     |  
|                                                   |  |                 |             |   |                |   |             |  
|Total current assets                               |  |                 | 10,950,000  |   |                |   | 11,048,000  |  
|Property and equipment, net                        |  |                 | 668,000     |   |                |   | 699,000     |  
|Other assets:                                      |  |                 |             |   |                |   |             |  
|Note receivable from M2, net, less current portion |  |                 | 2,008,000   |   |                |   | 1,904,000   |  
|Goodwill                                           |  |                 | 1,748,000   |   |                |   | 1,763,000   |  
|Other intangible assets, net                       |  |                 | 2,030,000   |   |                |   | 1,946,000   |  
|Other                                              |  |                 | 91,000      |   |                |   | 147,000     |  
|                                                   |  |                 |             |   |                |   |             |  
|Total assets                                       |  | $               | 17,495,000  |   |                | $ | 17,507,000  |  
|                                                   |  |                 |             |   |                |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY               |  |                 |             |   |                |   |             |  
|Current liabilities:                               |  |                 |             |   |                |   |             |  
|Accounts payable                                   |  | $               | 932,000     |   |                | $ | 897,000     |  
|Accrued expenses                                   |  |                 | 2,000,000   |   |                |   | 1,634,000   |  
|Current portion of capital lease obligations       |  |                 | 86,000      |   |                |   | 65,000      |  
|Deferred revenue                                   |  |                 | 6,458,000   |   |                |   | 6,765,000   |  
|                                                   |  |                 |             |   |                |   |             |  
|Total current liabilities                          |  |                 | 9,476,000   |   |                |   | 9,361,000   |  
|                                                   |  |                
|Capital lease obligations, less current portion    |  |                 | 7,000       |   |                |   | 7,000       |  
|Other long-term liabilities                        |  |                 | 85,000      |   |                |   | 78,000      |  
|                                                   |  |                 |             |   |                |   |             |  
|Total liabilities                                  |  |                 | 9,568,000   |   |                |   | 9,446,000   |  
|Shareholders equity:                              |  |                 |             |   |                |   |             |  
|Common stock                                       |  |                 | 52,240,000  |   |                |   | 52,332,000  |  
|Accumulated deficit                                |  |                 | (44,431,000 | ) |                |   | (44,521,000 | )
|Accumulated other comprehensive income             |  |                 | 118,000     |   |                |   | 250,000     |  
|                                                   |  |                 |             |   |                |   |             |  
|Total shareholders equity                         |  |                 | 7,927,000   |   |                |   | 8,061,000   |  
|                                                   |  |                 |             |   |                |   |             |  
|Total liabilities and shareholders equity         |  | $               | 17,495,000  |   |                | $ | 17,507,000  |  
|                                                   |  |                 |             |   |                |   |             |  



See accompanying notes.



4



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##### Table of Contents

Optio Software, Inc.

Consolidated Condensed Statements of Operations

(Unaudited)



|                                                                                      |  |                              |            |   |      |   |            |  
|------------------------------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                      |  | Three Months Ended April 30, |           
|                                                                                      |  | 2004                         |            |   | 2005 |  
|Revenue:                                                                              |  |                              |            |   |      |   |            |  
|License fees                                                                          |  | $                            | 2,881,000  |   |      | $ | 2,211,000  |  
|Subscription revenue                                                                  |  |                              |           |   |      |   | 509,000    |  
|Services, maintenance, and other                                                      |  |                              | 4,325,000  |   |      |   | 4,196,000  |  
|                                                                                      |  |                              |            |   |      |   |            |  
|                                                                                      |  |                              | 7,206,000  |   |      |   | 6,916,000  |  
|Costs of revenue (exclusive of depreciation and amortization shown separately below): |  |                              |            |   |      |   |            |  
|License fees                                                                          |  |                              | 149,000    |   |      |   | 182,000    |  
|Services, maintenance, and other                                                      |  |                              | 1,586,000  |   |      |   | 1,615,000  |  
|                                                                                      |  |                              |            |   |      |   |            |  
|                                                                                      |  |                              | 1,735,000  |   |      |   | 1,797,000  |  
|                                                                                      |  |                              |            |   |      |   |            |  
|                                                                                      |  |                              | 5,471,000  |   |      |   | 5,119,000  |  
|Operating expenses:                                                                   |  |                              |            |   |      |   |            |  
|Sales and marketing                                                                   |  |                              | 2,695,000  |   |      |   | 2,861,000  |  
|Research and development                                                              |  |                              | 1,085,000  |   |      |   | 1,278,000  |  
|General and administrative                                                            |  |                              | 1,053,000  |   |      |   | 917,000    |  
|Depreciation and amortization                                                         |  |                              | 71,000     |   |      |   | 188,000    |  
|                                                                                      |  |                              |            |   |      |   |            |  
|                                                                                      |  |                              | 4,904,000  |   |      |   | 5,244,000  |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Income (loss) from operations                                                         |  |                              | 567,000    |   |      |   | (125,000   | )
|Other income (expense):                                                               |  |                              |            |   |      |   |            |  
|Interest income                                                                       |  |                              | 42,000     |   |      |   | 56,000     |  
|Interest expense                                                                      |  |                              | (4,000     | ) |      |   | (2,000     | )
|Other                                                                                 |  |                              | 21,000     |   |      |   | (1,000     | )
|                                                                                      |  |                              |            |   |      |   |            |  
|                                                                                      |  |                              | 59,000     |   |      |   | 53,000     |  
|                                                                                      |  |                             
|Income (loss) before income taxes                                                     |  |                              | 626,000    |   |      |   | (72,000    | )
|Income tax expense                                                                    |  |                              | 57,000     |   |      |   | 18,000     |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Net income (loss)                                                                     |  | $                            | 569,000    |   |      | $ | (90,000    | )
|                                                                                      |  |                              |            |   |      |   |            |  
|Net income (loss) per share  basic                                                   |  | $                            | 0.03       |   |      | $ | 0.00       |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Net income (loss) per share  diluted                                                 |  | $                            | 0.02       |   |      | $ | 0.00       |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Weighted average shares outstanding  basic                                           |  |                              | 19,399,918 |   |      |   | 20,860,295 |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Weighted average shares outstanding  diluted                                         |  |                              | 23,002,374 |   |      |   | 20,860,295 |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Comprehensive income:                                                                 |  |                              |            |   |      |   |            |  
|Net income (loss)                                                                     |  | $                            | 569,000    |   |      | $ | (90,000    | )
|Foreign currency translation adjustment                                               |  |                              | (34,000    | ) |      |   | 132,000    |  
|                                                                                      |  |                              |            |   |      |   |            |  
|Comprehensive income                                                                  |  | $                            | 535,000    |   |      | $ | 42,000     |  
|                                                                                      |  |                              |            |   |      |   |            |  



See accompanying notes.



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Optio Software, Inc.

Consolidated Condensed Statement of Shareholders Equity

(Unaudited)



|                                        |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   |           |  
|--------------------------------------- |  | ------------ |  | ------------------- | ---------- |  | ------------------------------------- | ----------- | -------------------------- |  | - | ------- |  | - | --------- | -
|                                        |  | Common Stock |  | Accumulated Deficit |            |  | Accumulated OtherComprehensive Income |             | Total Shareholders Equity | 
|                                        |  | Shares       |  | Amount              |            |  |                                      
|Balance at February 1, 2005             |  | 20,854,265   |  | $                   | 52,240,000 |  | $                                     | (44,431,000 | )                          |  | $ | 118,000 |  | $ | 7,927,000 |  
|Comprehensive income, net of tax:       |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   |           |  
|Net income (loss)                       |  |             |  |                     |           |  |                                       | (90,000     | )                          |  |   |        |  |   | (90,000   | )
|Foreign currency translation adjustment |  |             |  |                     |           |  |                                       |            |                            |  |   | 132,000 |  |   | 132,000   |  
|                                        |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   |           |  
|Comprehensive income                    |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   | 42,000    |  
|Exercise of stock options               |  | 97,774       |  |                     | 92,000     |  |                                       |            |                            |  |   |        |  |   | 92,000    |  
|                                        |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   |           |  
|Balance at April 30, 2005               |  | 20,952,039   |  | $                   | 52,332,000 |  | $                                     | (44,521,000 | )                          |  | $ | 250,000 |  | $ | 8,061,000 |  
|                                        |  |              |  |                     |            |  |                                       |             |                            |  |   |         |  |   |           |  



See accompanying notes.



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Optio Software, Inc.

Consolidated Condensed Statements of Cash Flows

(Unaudited)



|                                                                                  |  |                              |           |   |      |   |           |  
|--------------------------------------------------------------------------------- |  | ---------------------------- | --------- | - | ---- | - | --------- | -
|                                                                                  |  | Three Months Ended April 30, |          
|                                                                                  |  | 2004                         |           |   | 2005 |  
|Cash flows from operating activities:                                             |  |                              |           |   |      |   |           |  
|Net income (loss)                                                                 |  | $                            | 569,000   |   |      | $ | (90,000   | )
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                              |           |   |      |   |           |  
|Depreciation                                                                      |  |                              | 71,000    |   |      |   | 104,000   |  
|Amortization of intangibles                                                       |  |                              |          |   |      |   | 84,000    |  
|Provision for doubtful accounts                                                   |  |                              | 16,000    |   |      |   |          |  
|Provision for deferred taxes                                                      |  |                              |          |   |      |   | 10,000    |  
|Changes in operating assets and liabilities:                                      |  |                              |           |   |      |   |           |  
|Accounts receivable                                                               |  |                              | 480,000   |   |      |   | 473,000   |  
|Prepaid expenses and other assets                                                 |  |                              | (189,000  | ) |      |   | (261,000  | )
|Accounts payable                                                                  |  |                              | 212,000   |   |      |   | (32,000   | )
|Accrued expenses                                                                  |  |                              | (672,000  | ) |      |   | (390,000  | )
|Deferred revenue                                                                  |  |                              | 55,000    |   |      |   | 323,000   |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Net cash provided by operating activities                                         |  |                              | 542,000   |   |      |   | 221,000   |  
|                                                                                  |  |                             
|Cash flows from investing activities:                                             |  |                              |           |   |      |   |           |  
|Purchases of property and equipment                                               |  |                              | (74,000   | ) |      |   | (135,000  | )
|Repayment of note receivable from M2 Systems                                      |  |                              | 83,000    |   |      |   | 81,000    |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Net cash provided by (used in) investing activities                               |  |                              | 9,000     |   |      |   | (54,000   | )
|                                                                                  |  |                             
|Cash flows from financing activities:                                             |  |                              |           |   |      |   |           |  
|Payments of notes payable and capital lease obligations                           |  |                              | (19,000   | ) |      |   | (21,000   | )
|Proceeds from exercise of stock options                                           |  |                              | 144,000   |   |      |   | 92,000    |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Net cash provided by financing activities                                         |  |                              | 125,000   |   |      |   | 71,000    |  
|                                                                                  |  |                             
|Impact of foreign currency rate fluctuations on cash                              |  |                              | (13,000   | ) |      |   | 126,000   |  
|Net increase in cash and cash equivalents                                         |  |                              | 663,000   |   |      |   | 364,000   |  
|                                                                                  |  |                             
|Cash and cash equivalents at beginning of period                                  |  |                              | 5,328,000 |   |      |   | 5,433,000 |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Cash and cash equivalents at end of period                                        |  | $                            | 5,991,000 |   |      | $ | 5,797,000 |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Supplemental disclosures of cash flow information:                                |  |                              |           |   |      |   |           |  
|Cash paid during the year for:                                                    |  |                              |           |   |      |   |           |  
|Interest paid                                                                     |  | $                            | 4,000     |   |      | $ | 2,000     |  
|                                                                                  |  |                              |           |   |      |   |           |  
|Income taxes paid                                                                 |  | $                            | 57,000    |   |      | $ | 8,000     |  
|                                                                                  |  |                              |           |   |      |   |           |  



See accompanying notes.



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Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)



1. Description of Business



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



2. Basis of Presentation



Interim
Financial Information



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



The accompanying financial statements should be read in conjunction with the Companys audited consolidated financial statements for the year ended
January 31, 2005, included in the Companys Annual Report on Form 10-K, filed with the Securities and Exchange Commission on April 29, 2005. Results of operations for the three months ended April 30, 2005 are not necessarily indicative of the
results for the year ending January 31, 2006.



Employee Stock Options



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



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



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



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Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



the following weighted-average assumptions used for the three months ended
April 30, 2004 and 2005: risk-free interest rates of 3.45% and 4.20% for the three months ended April 30, 2004 and 2005, respectively; no dividend yield; volatility of 154% and 142% for the three months ended April 30, 2004 and 2005, respectively;
and an expected life of the options of 7.44 and 7.10 years for the three months ended April 30, 2004 and 2005, respectively.



For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting periods. The
weighted-average fair value of options granted during the three months ended April 30, 2004 and 2005 equaled $1.52 and $1.22 per share, respectively. The Companys pro forma information as determined using the fair value method of accounting
under SFAS 123, was as follows:



|                                                      |  |                              |         |   |      |   |          |  
|----------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | -------- | -
|                                                      |  | Three Months Ended April 30, |        
|                                                      |  | 2004                         |         |   | 2005 |  
|Net income (loss) as reported                         |  | $                            | 569,000 |   |      | $ | (90,000  | )
|Deduct: Compensation cost using the fair value method |  |                              | (77,000 | ) |      |   | (99,000  | )
|                                                      |  |                              |         |   |      |   |          |  
|Pro forma net income (loss)                           |  | $                            | 492,000 |   |      | $ | (189,000 | )
|                                                      |  |                              |         |   |      |   |          |  
|Net income (loss) per share as reported  basic       |  |                              | 0.03    |   |      |   | 0.00     |  
|Net income (loss) per share as reported  diluted     |  |                              | 0.02    |   |      |   | 0.00     |  
|Pro forma net income (loss) per share  basic         |  |                              | 0.03    |   |      |   | (0.01    | )
|Pro forma net income (loss) per share  diluted       |  |                              | 0.02    |   |      |   | (0.01    | )



Goodwill and Other Intangible
Assets



The Company acquired goodwill and other
intangible assets in connection with the acquisition of VertiSoft Corporation (VertiSoft) in August 2004. Under the purchase method of accounting pursuant to SFAS 141, the total purchase price was allocated to the acquired entitys
net tangible and intangible assets based on their estimated fair values as of the date of the completion of the acquisition. Any excess of the purchase price over the fair value of the net tangible assets/liabilities and identifiable intangible
assets acquired was recorded as goodwill. In accordance with SFAS 142, goodwill and intangible assets with indefinite lives resulting from business combinations have not been amortized but instead will be tested for impairment at least annually
(more frequently if certain indicators are present) while identifiable intangible assets with finite lives are amortized over their estimated useful lives. In the event that the Companys management determines that the value of goodwill or
intangible assets has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. The Company has selected August 1 as its annual impairment testing date for
its goodwill.



As of April 30, 2005, the gross carrying amount
and the accumulated amortization by major intangible asset class is as follows:



|                       |  |                     |           |                         |   |                   |  |   |          
|---------------------- |  | ------------------- | --------- | ----------------------- | - | ----------------- |  | - | ---------
|Intangible Asset       |  | Gross CarryingValue |           | AccumulatedAmortization |   | Net CarryingValue
|Customer relationships |  | $                   | 1,314,000 |                         | $ | 82,000            |  | $ | 1,232,000
|Technology             |  |                     | 839,000   |                         |   | 197,000           |  |   | 642,000  
|Non-compete agreement  |  |                     | 85,000    |                         |   | 13,000            |  |   | 72,000   



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



Estimated amortization expense for each of the next five
fiscal years is as follows:



|     |  |   |        
|---- |  | - | -------
|2006 |  | $ | 326,000
|2007 |  |   | 314,000
|2008 |  |   | 254,000
|2009 |  |   | 249,000
|2010 |  |   | 230,000



3. Net Income (Loss) per Share



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



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



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



|                                                                                                                |  |                              |            |      |   |            |  
|--------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ---------- | ---- | - | ---------- | -
|                                                                                                                |  | Three months ended April 30, |           
|                                                                                                                |  | 2004                         |            | 2005 |  
|Net income (loss)                                                                                               |  | $                            | 569,000    |      | $ | (90,000    | )
|                                                                                                                |  |                              |            |      |   |            |  
|Weighted average shares outstanding  basic                                                                     |  |                              | 19,399,918 |      |   | 20,860,295 |  
|Dilutive stock options                                                                                          |  |                              | 3,602,456  |      |   |           |  
|                                                                                                                |  |                              |            |      |   |            |  
|Weighted average shares outstanding  diluted                                                                   |  |                              | 23,002,374 |      |   | 20,860,295 |  
|                                                                                                                |  |                              |            |      |   |            |  
|Net income (loss) per share  basic                                                                             |  | $                            | 0.03       |      | $ | 0.00       |  
|                                                                                                                |  |                              |            |      |   |            |  
|Net income (loss) per share  diluted                                                                           |  | $                            | 0.02       |      | $ | 0.00       |  
|                                                                                                                |  |                              |            |      |   |            |  
|Potentially dilutive stock options, excluded from diluted average shares outstanding                            |  |                              |           |      |   | 3,242,652  |  
|                                                                                                                |  |                              |            |      |   |            |  
|Potentially dilutive Vertisoft shares held in escrow, excluded from diluted weighted average shares outstanding |  |                              |           |      |   | 310,000    |  
|                                                                                                                |  |                              |            |      |   |            |  



4. Segment and Geographic
Information



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



Segment information for the three
months ended April 30, 2004 and 2005 is summarized below.



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



|                                          |  |               |            |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|----------------------------------------- |  | ------------- | ---------- | ------ | - | --------- | ----- |  | -------- | ------ |  | ------------ | ---------- | - | ------------ | - | ---------- | - |  | - | ---------- | -
|Three Months ended April 30, 2004         |  | United States |            | Europe |   |           | Other |  | Combined |        |  | Eliminations |            |   | Consolidated |  
|Revenue from external customers:          |  |               |            |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|License fees                              |  | $             | 2,267,000  |        | $ | 614,000   |       |  | $        |       |  | $            | 2,881,000  |   |              | $ |           |   |  | $ | 2,881,000  |  
|Services, maintenance and other           |  |               | 3,696,000  |        |   | 629,000   |       |  |          |       |  |              | 4,325,000  |   |              |   |           |   |  |   | 4,325,000  |  
|Inter-segment revenue                     |  |               | 115,000    |        |   | 70,000    |       |  |          |       |  |              | 185,000    |   |              |   | (185,000   | ) |  |   |           |  
|                                          |  |               |            |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|Total revenue                             |  |               | 6,078,000  |        |   | 1,313,000 |       |  |          |       |  |              | 7,391,000  |   |              |   | (185,000   | ) |  |   | 7,206,000  |  
|Interest income                           |  |               | 37,000     |        |   | 5,000     |       |  |          |       |  |              | 42,000     |   |              |   |           |   |  |   | 42,000     |  
|Interest expense                          |  |               | 4,000      |        |   |          |       |  |          |       |  |              | 4,000      |   |              |   |           |   |  |   | 4,000      |  
|Depreciation and amortization             |  |               | 63,000     |        |   | 8,000     |       |  |          |       |  |              | 71,000     |   |              |   |           |   |  |   | 71,000     |  
|Income tax expense                        |  |               | 57,000     |        |   |          |       |  |          |       |  |              | 57,000     |   |              |   |           |   |  |   | 57,000     |  
|Segment income before income taxes        |  |               | 620,000    |        |   | 6,000     |       |  |          |       |  |              | 626,000    |   |              |   |           |   |  |   | 626,000    |  
|Segment net income                        |  |               | 563,000    |        |   | 6,000     |       |  |          |       |  |              | 569,000    |   |              |   |           |   |  |   | 569,000    |  
|Total segment assets                      |  |               | 15,978,000 |        |   | 2,965,000 |       |  |          | 87,000 |  |              | 19,030,000 |   |              |   | (4,592,000 | ) |  |   | 14,438,000 |  
|Expenditures for long-lived assets        |  |               | 44,000     |        |   | 30,000    |       |  |          |       |  |              | 74,000     |   |              |   |           |   |  |   | 74,000     |  
|                                          |  |               |            |        |   |          
|Three Months ended April 30, 2005         |  | United States |            | Europe |   |           | Other |  | Combined |        |  | Eliminations |            |   | Consolidated |  
|Revenue from external customers:          |  |               |            |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|License fees                              |  | $             | 1,939,000  |        | $ | 272,000   |       |  | $        |       |  | $            | 2,211,000  |   |              | $ |           |   |  | $ | 2,211,000  |  
|Subscription revenue                      |  |               | 509,000    |        |   |          |       |  |          |       |  |              | 509,000    |   |              |   |           |   |  |   | 509,000    |  
|Services, maintenance and other           |  |               | 3,602,000  |        |   | 594,000   |       |  |          |       |  |              | 4,196,000  |   |              |   |           |   |  |   | 4,196,000  |  
|Inter-segment revenue                     |  |               | 53,000     |        |   | 45,000    |       |  |          |       |  |              | 98,000     |   |              |   | (98,000    | ) |  |   |           |  
|                                          |  |               |            |        |   |           |       |  |          |        |  |              |            |   |              |   |            |   |  |   |            |  
|Total revenue                             |  |               | 6,103,000  |        |   | 911,000   |       |  |          |       |  |              | 7,014,000  |   |              |   | (98,000    | ) |  |   | 6,916,000  |  
|Interest income                           |  |               | 56,000     |        |   |          |       |  |          |       |  |              | 56,000     |   |              |   |           |   |  |   | 56,000     |  
|Interest expense                          |  |               | 2,000      |        |   |          |       |  |          |       |  |              | 2,000      |   |              |   |           |   |  |   | 2,000      |  
|Depreciation and amortization             |  |               | 178,000    |        |   | 10,000    |       |  |          |       |  |              | 188,000    |   |              |   |           |   |  |   | 188,000    |  
|Income tax expense                        |  |               | 18,000     |        |   |          |       |  |          |       |  |              | 18,000     |   |              |   |           |   |  |   | 18,000     |  
|Segment income (loss) before income taxes |  |               | 267,000    |        |   | (339,000  | )     |  |          |       |  |              | (72,000    | ) |              |   |           |   |  |   | (72,000    | )
|Segment net income (loss)                 |  |               | 249,000    |        |   | (339,000  | )     |  |          |       |  |              | (90,000    | ) |              |   |           |   |  |   | (90,000    | )
|Total segment assets                      |  |               | 17,271,000 |        |   | 3,361,000 |       |  |          |       |  |              | 20,632,000 |   |              |   | (3,125,000 | ) |  |   | 17,507,000 |  
|Expenditures for long-lived assets        |  |               | 118,000    |        |   | 17,000    |       |  |          |       |  |              | 135,000    |   |              |   |           |   |  |   | 135,000    |  



5. Note Receivable



As further explained in Notes 3 and 4 of the Notes to Consolidated
Financial Statements included in



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Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



Optios Annual Report on Form 10-K, Optio holds a note receivable
from M2 Systems Corporation (M2 Systems) as partial consideration for the sale by Optio of its Muscato Corporation (Muscato) and Translink Solutions Corporation business units. Under the terms of this note, M2 Systems was
required to make a payment of $100,000 each on September 1, 2003 and December 1, 2003 and a payment of $115,000 on June 1, 2004. M2 Systems failed to make these payments on their respective due dates; however, payment was made prior to an event of
default. All payments subsequent to June 1, 2004 have been made on their respective due dates.



During the third quarter of fiscal 2004, as a result of M2 Systems failure to make timely payments in the prior quarters, management determined that this was an indication that it was probable that Optio would be
unable to collect all amounts due according to the contractual terms of the note. At that time, the loan was considered impaired and was written down to the assessed fair value of the collateral. As of October 31, 2003, the collateral, including
technology, accounts receivable, fixed assets and the discounted net cash flows of maintenance contracts was estimated to have an approximate fair value of $2.8 million, substantially less than the $3.7 million note receivable balance as of October
31, 2003. Thus Optio recorded an impairment charge of $900,000 during the year ended January 31, 2004. Optio continues to reassess the value of the collateral on an ongoing basis. The amount of the note receivable recorded could be materially
different under different conditions or using different assumptions, including the varying assumptions regarding the fair value of the collateral. If M2 Systems defaults on the note and the collateral proves to be of no value to the Company, the
Company would incur an additional loss of approximately $2.3 million. On September 15, 2004 Optio notified M2 systems of certain non-monetary defaults under the M2 Systems note. M2 Systems disputed these defaults. Optio did not accelerate the
indebtedness under the M2 Systems note but the parties agreed to modify the loan documents to address the alleged defaults by M2 Systems to give Optio additional collateral. On May 18, 2005, the parties executed modified and additional
security documents granting Optio a security interest in the assets of certain M2 Systems affiliates and placing greater restrictions on the use of the collateral. Further, the Company has the right to receive the quarterly financial
statements of M2 Systems and its affiliates and has certain audit rights as to the collateral for the note; therefore, the Company periodically assesses the value of the collateral and the note, as reflected on the Companys financial
statements.



6. Acquisition of VertiSoft Corporation



On August 10, 2004, Optio consummated the merger of VertiSoft Corporation
(VertiSoft), a privately held Georgia corporation, and Optio Software II, Inc., a wholly owned subsidiary of Optio, whereby VertiSoft became the surviving wholly owned subsidiary of Optio. Subsequently, on September 15, 2004, VertiSoft
Corporation was merged with and into Optio, with Optio remaining the surviving corporation. VertiSoft provides document management solutions designed to streamline information access and distribution for physicians and clinical, medical records and
financial services staff through a single interface or Composite Patient View. Its
patented electronic document management system, QuickRecord, provides secure, individualized access to patient information retrieved from any system, inside or outside the enterprise. The primary reasons for the acquisition were that the QuickRecord
product broadens the Companys portfolio of healthcare solutions and establishes a subscription-based licensing model for a new line of solutions. The consideration given for all the common stock of VertiSoft included $348,000 in cash, the
issuance of 1.5 million shares of Optio common stock, of which 310,000 shares are to be held in escrow for a period of 18 months to secure the indemnification obligations of the shareholders of VertiSoft, the issuance of 340,000 stock options and
future conditional cash payments of $225,000 to be paid out in various installments over the following two years, contingent upon the achievement of certain customer retention and product development goals. The cash component of the consideration
given was paid from funds generated from the on-going operations of Optio. The preliminary purchase price is as follows:



|                                                                                    |  |   |          
|----------------------------------------------------------------------------------- |  | - | ---------
|Cash paid                                                                           |  | $ | 348,000  
|Common stock issued (1,190,000 shares, excluding the 310,000 shares held in escrow) |  |   | 1,309,000
|Stock options issued                                                                |  |   | 361,000  
|Preliminary acquisition costs                                                       |  |   | 331,000  
|                                                                                    |  |   |          
|                                                                                    |  | $ | 2,349,000
|                                                                                    |  |   |          



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Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



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



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



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



|                         |  |   |            |  
|------------------------ |  | - | ---------- | -
|Tangible assets acquired |  | $ | 280,000    |  
|Liabilities assumed      |  |   | (1,932,000 | )
|Technology               |  |   | 839,000    |  
|Customer relationships   |  |   | 1,314,000  |  
|Non-compete agreement    |  |   | 85,000     |  
|Goodwill                 |  |   | 1,763,000  |  
|                         |  |   |            |  
|                         |  | $ | 2,349,000  |  
|                         |  |   |            |  



The technology will be
amortized over periods ranging from 3 months to 5 years, the customer relationships will be amortized over 11 years and the non-compete agreement will be amortized over 5 years.



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



14



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##### Table of Contents

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



OVERVIEW



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



Optio markets and sells its software and
services throughout the United States, Europe and the Asia Pacific region, through its direct sales force and certified resellers. Optio has offices in the United States, France, the United Kingdom and Germany. Optio also offers consulting services,
which provide customers with implementation assistance and training. No single customer accounted for 10% or more of Optios revenue for the three months ended April 30, 2004 or 2005.



Critical Accounting Policies and Use of Estimates



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



Revenue
Recognition



Overview



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



License Fees



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



The Company recognizes revenue using the residual method pursuant to the requirements of SOP No. 97-2, as amended by SOP No. 98-9. Revenues recognized
from multiple-element software



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arrangements are allocated to each element of the arrangement based on the fair values of the elements, such as licenses
for software products, maintenance, consulting services or customer training. The determination of fair value is based on objective evidence, which is specific to the Company. The Company limits its assessment of objective evidence for each element
to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. If evidence of fair value of all undelivered elements exists
but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee
is recognized as revenue.



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



Subscription Revenue



The Company also licenses certain of its products in the form of a subscription service contract, typically ranging from 3 to 5 years. Subscription
revenue, which includes a license to the software product, technical support and future unspecified enhancements to the software product, is recognized on a daily basis over the agreement period once the product has been installed.



Services, Maintenance and Other Revenue



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



Note Receivable



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



During the third quarter of fiscal 2004, as a result of M2 Systems failure to make timely payments in the prior quarters, management determined that this was an indication that it was probable that Optio would be unable to collect all
amounts due according to the contractual terms of the note. At that time, the loan was considered impaired and was written down to the assessed fair value of the collateral. As of October 31, 2003, the collateral, including technology, accounts
receivable, fixed assets and the discounted net cash flows of maintenance contracts was estimated to have an approximate fair value of $2.8 million, substantially less than



16



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##### Table of Contents

the $3.7 million note receivable balance as of October 31, 2003. Thus Optio recorded an impairment charge of $900,000
during the year ended January 31, 2004. Optio continues to reassess the value of the collateral on an ongoing basis. The amount of the note receivable recorded could be materially different under different conditions or using different assumptions,
including the varying assumptions regarding the fair value of the collateral. In Optios assessment of the collateral, varying assumptions, including the length of time of which customers would continue on maintenance, resulted in estimates of
the value of the collateral ranging from $1.8 million to $3.5 million, which could have resulted in an impairment charge ranging from $200,000 to $1.9 million. If M2 Systems defaults on the note and the collateral proves to be of no value to Optio,
Optio would incur an additional loss of approximately $2.3 million.



On September 14, 2004, Optio notified M2 Systems of certain non-monetary defaults under the M2 Systems Note. Optio did not accelerate the indebtedness under the M2 Systems note and Optio and M2 Systems negotiated modifications to the
current loan documents to address the alleged defaults by M2 Systems. On May 18, 2005, the parties executed modified and additional security documents granting Optio a security interest in the assets of certain M2 Systems affiliates and
placing greater restrictions on the use of the collateral with non-affiliates.



Accounts Receivable



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



Impairment Assessments



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



Pursuant to SFAS 142, Optio is required to test goodwill for impairment upon adoption and annually or more often if events or changes in circumstances
indicate that the asset might be impaired. SFAS 142 provides for a two-stage approach to determining whether and by how much goodwill has been impaired. The first stage requires a comparison of the fair value of the reporting unit, in our case, the
former VertiSoft business, to its net book value. If the fair value is greater than book value, no impairment is deemed to have occurred. If the fair value is less than book value, then the second stage must be completed to determine the amount, if
any, of actual impairment. Optio has selected August 1 as its annual impairment testing date for its goodwill. August 1, 2005 will be Optios first annual testing date.



The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment
decisions. In estimating our fair value, we will make estimates and judgments about future revenues and cash flows. Our forecasts will be based upon assumptions that are consistent with the plans and



17



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##### Table of Contents

estimates we are using to manage our business. Changes in these estimates could change our conclusion regarding
impairment of goodwill and potentially result in a non-cash goodwill impairment charge for all or a portion of the goodwill balance as of January 31, 2005. For long-lived assets, accounting standards dictate that assets become impaired when the
undiscounted future cash flows expected to be generated by them are less than their carrying amounts. When that occurs, the affected assets are written down to their estimated fair value.



RESULTS OF OPERATIONS



Three Months Ended April 30, 2005 Compared to Three Months Ended April 30, 2004



Revenues



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



|                                                                            |  |                             |   |  |      |   
|--------------------------------------------------------------------------- |  | --------------------------- | - |  | ---- | --
|                                                                            |  | Three MonthsEnded April 30, |  
|                                                                            |  | 2004                        |   |  | 2005 |   
|Revenue:                                                                    |  |                             |   |  |      |   
|License fees                                                                |  | 40                          | % |  | 32   | % 
|Subscription fees                                                           |  |                            |   |  | 7    |   
|Services, maintenance and other                                             |  | 60                          |   |  | 61   |   
|                                                                            |  |                             |   |  |      |   
|Total revenue                                                               |  | 100                         |   |  | 100  |   
|Costs of revenue (excluding depreciation and amortization, included below): |  |                             |   |  |      |   
|License fees                                                                |  | 2                           |   |  | 3    |   
|Services, maintenance and other                                             |  | 22                          |   |  | 23   |   
|                                                                            |  |                             |   |  |      |   
|Total cost of revenue                                                       |  | 24                          |   |  | 26   |   
|                                                                            |  |                             |   |  |      |   
|                                                                            |  | 76                          |   |  | 74   |   
|                                                                            |  |                            
|Operating expenses:                                                         |  |                             |   |  |      |   
|Sales and marketing                                                         |  | 37                          |   |  | 42   |   
|Research and development                                                    |  | 15                          |   |  | 18   |   
|General and administrative                                                  |  | 15                          |   |  | 13   |   
|Depreciation and amortization                                               |  | 1                           |   |  | 3    |   
|                                                                            |  |                             |   |  |      |   
|Total operating expenses                                                    |  | 68                          |   |  | 76   |   
|                                                                            |  |                             |   |  |      |   
|Income (loss) from operations                                               |  | 8                           |   |  | (2   | ) 
|Interest and other income                                                   |  | 1                           |   |  | 1    |   
|Income tax expense                                                          |  | 1                           |   |  |     |   
|                                                                            |  |                             |   |  |      |   
|Net income (loss)                                                           |  | 8                           | % |  | (1   | )%
|                                                                            |  |                             |   |  |      |   



Revenues



Total revenues decreased 4% to $6.9 million from $7.2 million for the three
months ended April 30, 2005 and 2004, respectively.



License fees



Revenues from software licenses decreased 23% to $2.2
million from $2.9 million for the three months



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ended April 30, 2005 and 2004, respectively. Healthcare perpetual license revenues declined $270,000 between the first
quarter of fiscal 2004 and fiscal 2005. As the healthcare sales force began to focus on subscription based revenue, Optio experienced an anticipated decline in its perpetual license revenue. In addition, license revenue from Optios European
operations decreased $340,000 between the three months ended April 30, 2004, and April 30, 2005. Optios European operations failed to close several contracts as expected during the first quarter of 2006. Sales through Optios enterprise
group remained relatively consistent between the periods, including a consistent level of sales to Optios existing customer base. The average sale price between the two periods remained consistent as well at approximately $65,000.



Approximately $550,000 of Optios software license revenue during the
three months ended April 30, 2005 was derived from partners, such as resellers, value-added distributors or OEM relationships, representing 25% of license revenue for Optio. During the three months ended April 30, 2004, Optio generated $475,000 of
its software license revenue through partners, representing 16% of Optios license revenue.



Subscription fees



Optio added a new revenue source in the form of subscription revenue as a result of the acquisition of Vertisoft in August 2004. For the three months ended April 30, 2005, subscription revenue totaled $509,000.



Services, maintenance and other



Revenues from services, maintenance and other decreased to $4.2 million in
the three months ended April 30, 2005 from $4.3 million in same period of the prior year. Services revenue decreased to $1.4 million for the three months ended April 30, 2005 from $1.5 million in the three months ended April 30, 2004. Optios
license revenue has declined over the previous few quarters. As a result, the amount of services and training sold has declined as well, resulting in a decline in revenue. Maintenance revenue remained constant at $2.8 million for the three months
ended April 30, 2005 and April 30, 2004.



Revenue Mix



Revenues from licenses represented 32% of total revenue in the three months
ended April 30, 2005 and 40% of total revenue in the three months ended April 30, 2004. Services, maintenance and other revenue constituted 61% and 60% of total revenue in the three months ended April 30, 2005 and 2004, respectively. With the
introduction of subscription fee revenues, license fee revenues as a percentage of total revenue declined and may continue to decline.



Costs of Revenues



Total costs of revenues increased to $1.8 million from $1.7 million in the three months ended April 30, 2005 and 2004, respectively.



Licenses



Costs of revenues from licenses consist of costs related to the packaging and distribution of the products, fees paid for
integration of third-party software products and fees paid to referral partners. Costs of revenues from licenses increased to $182,000 in the three months ended April 30, 2005 from $149,000 in the three months ended April 30, 2004, primarily the
result of a $79,000 increase in royalties paid to strategic partners for the inclusion of their products offset by a $45,000 decrease in referral fees paid to referral partners.



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Services, maintenance and other



Costs of revenues from services, maintenance and other consist of personnel, subcontracting and other expenses relating to
the cost of providing customer support, education and consulting and implementation services. Costs of revenues from services, maintenance and other remained constant at $1.6 million for both the three months ended April 30, 2005 and 2004. The cost
of outsourcers, often used in the implementation of Optios products at customer sites, increased $50,000 between periods. In addition, Optios internal headcount for its consulting and support departments increased by three individuals.
The increase in salaries resulting from this increase in headcount was offset by cost savings of direct expenses of these departments.



Operating Expenses



Sales and Marketing



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



Sales and
marketing expenses increased 7% to $2.9 million from $2.7 million for the three months ended April 30, 2005 and 2004, respectively. Sales and marketing expenses were 42% and 37%, respectively, of total revenue for the same periods. Direct marketing
expenditures increased $170,000 between the two quarters. In addition, Optio increased its sales and marketing headcount by two individuals over the previous year, including one person in its marketing staff and one sales person who will focus on
existing customers.



Research and Development



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



Research and development expenses increased to $1.3 million in the three months ended April 30, 2005 from $1.1 million in the three months ended April 30, 2004. This increase was primarily due to the increase in
headcount from 31 employees as of April 30,2004 to 46 employees as of April 30, 2005, which included the addition of the Vertisoft employees as of August 10, 2004, which resulted in an additional $230,000 in salaries.



General and Administrative



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



General and administrative expenses decreased to $900,000 from $1.1 million
for the three months ended April 30, 2005 and 2004. The decrease primarily represents savings of $40,000 in legal expenses, $45,000 in bad debt expense and $50,000 in various other office expenses.



Depreciation and Amortization



Depreciation and amortization expense increased to $188,000 from $71,000 for
the three months ended April 30, 2005 and 2004, respectively. This increase was due in part to the addition of $85,000 of amortization expense in the three months ended April 30, 2005, related to the intangible assets acquired in the Vertisoft
acquisition on August 10, 2004.



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Interest Income



Interest income increased to $56,000 from $42,000 in the three months ended April 30, 2005 and 2004, respectively, primarily the result of the increased
interest rate applied to the principal of the M2 Systems note receivable.



Interest Expense



Interest expense decreased
to $2,000 from $4,000 in the three months ended April 30, 2005 and 2004, respectively. Interest expense primarily represents the interest paid on Optios capital leases.



LIQUIDITY AND CAPITAL RESOURCES



Optio had $5.8 million and $6.0 million in cash and cash equivalents at April 30, 2005 and 2004, respectively.



The following table sets forth certain selected statements of cash flow
information for the three months ended April 30, 2005:



|                                          |  |   |         |  
|----------------------------------------- |  | - | ------- | -
|Net cash provided by operations           |  | $ | 221,000 |  
|Net cash used in investing activities     |  |   | (54,000 | )
|Net cash provided by financing activities |  |   | 71,000  |  
|Net increase in cash and cash equivalents |  |   | 364,000 |  



Cash provided by
operations resulted from the net of a $90,000 net loss, plus a $198,000 add-back of non-cash depreciation, amortization and deferred tax expense, plus changes in working capital of $113,000, resulting in a $221,000 inflow of cash from operations.
The major component of the $113,000 working capital changes was the Companys use of funds to pay down accrued expenses by approximately $390,000, primarily representing the payment of Optios year-end commissions and bonuses and other
year-end expenses such as audit fees. In addition, Optio prepaid several of its renewed insurance policies and marketing expenses, resulting in a $261,000 cash outflow. This cash outflow was partially offset by improved collections on accounts
receivable resulting in additional cash inflow of $473,000. Finally, Optios deferred revenue increased by $323,000 due primarily to the timing of maintenance invoicing. In investing activities, Optio received $81,000 in payments on the
receivable from M2 Systems and purchased $135,000 of property and equipment in the ordinary course of business. Optios financing activities included receipts of $92,000 from the exercise of stock options, offset by payments of capital lease
obligations of $21,000.



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



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



On August 10, 2004, Optio
acquired VertiSoft Corporation. The terms of the purchase include future conditional cash payments of $225,000 to be paid out in various installments over the following two years, contingent upon the achievement of certain customer retention and
product development goals.



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



ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.



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



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



Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange
Act Rule 13a-15(e)) as of April 30, 2005 and have concluded that, as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commissions rules and forms.



The Companys management, including the Chief Executive Officer and the Chief Financial Officer, does not expect that the Companys disclosure
controls or the Companys internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only



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reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, have been detected. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and may not be detected. We will conduct periodic
evaluations of our internal controls to enhance, where necessary, our procedures and controls.



Changes in Internal Controls



There were no significant changes in our internal controls over financial reporting that occurred during the quarter ended April 30, 2005, that have materially affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.



PART II  OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



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



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



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



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



None.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None.



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



None.



ITEM 5. OTHER INFORMATION



None.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



(a)
Exhibits



| | 31.1 | Certification of CEO pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
| | ---- | ---------------------------------------------------------------------------------------------------



| | 31.2 | Certification of CFO pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
| | ---- | ---------------------------------------------------------------------------------------------------



| | 32.1 | Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------



| | 32.2 | Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------



| | 99.1 | Safe Harbor Compliance Statement for Forward-Looking Statements.
| | ---- | ----------------------------------------------------------------



(b) Reports on Form 8-K



| | (a) | A form 8-K was filed on April 15, 2005 to furnish the Companys fourth quarter and year-end earnings press release dated April 14, 2005.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 14thday of June, 2005.



OPTIO SOFTWARE, INC.By:

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




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