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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended October 31, 2004



OR



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



For the transition period from  to



Commission File Number: 1-15529



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OPTIO SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



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



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



---



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



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



There were 21,118,149 shares of the
Registrants common stock outstanding as of December 13, 2004.



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##### Table of Contents

OPTIO SOFTWARE, INC.



FORM 10-Q



For the Quarterly Period Ended October 31, 2004



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 |  | 17  
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 28  
|Item 4.                        |  | Controls and Procedures                                                               |  | 28  
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                      
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 28  
|Item 2.                        |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities      |  | 29  
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 29  
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 29  
|Item 5.                        |  | Other Information                                                                     |  | 30  
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                      |  | 30  



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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, fluctuations in operating results because of acquisitions or dispositions, failure to integrate new products and newly acquired companies,
diversion of management resources relating to acquisitions, reduction in cash reserves relating to acquisitions, challenges relating to acquisitions and the possibility that this may cause Optio to no longer be profitable, the negative effective on
Optios earnings relating to the amortization or potential write-down of acquired assets or goodwill, failure to retain the business relationships with existing customers from acquisitions, changes in competition, changes in economic conditions
in the U.S. and in other countries in which Optio currently does business (both general and relative to the technology industry), delays or inability 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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PART I  FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



Optio
Software, Inc.



Consolidated Condensed Balance Sheets



|                                                   |  |                  |             |   |                 |   |             |  
|-------------------------------------------------- |  | ---------------- | ----------- | - | --------------- | - | ----------- | -
|                                                   |  | January 31, 2004 |             |   | October 31,2004 |  
|                                                   |  |                  |             |   | (Unaudited)     |  
|ASSETS                                             |  |                  |             |   |                 |   |             |  
|Current assets:                                    |  |                  |             |   |                 |   |             |  
|Cash and cash equivalents                          |  | $                | 5,328,000   |   |                 | $ | 4,754,000   |  
|Accounts receivable, net                           |  |                  | 5,293,000   |   |                 |   | 3,931,000   |  
|Prepaid expenses and other current assets          |  |                  | 283,000     |   |                 |   | 450,000     |  
|Notes receivable from related party                |  |                  | 5,000       |   |                 |   | 5,000       |  
|Current portion of note receivable from M2         |  |                  | 310,000     |   |                 |   | 346,000     |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total current assets                               |  |                  | 11,219,000  |   |                 |   | 9,486,000   |  
|Property and equipment, net                        |  |                  | 541,000     |   |                 |   | 648,000     |  
|Other assets:                                      |  |                  |             |   |                 |   |             |  
|Note receivable from M2, net, less current portion |  |                  | 2,376,000   |   |                 |   | 2,097,000   |  
|Goodwill                                           |  |                  |            |   |                 |   | 1,720,000   |  
|Other intangible assets, net                       |  |                  |            |   |                 |   | 2,130,000   |  
|Other                                              |  |                  | 110,000     |   |                 |   | 108,000     |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total assets                                       |  | $                | 14,246,000  |   |                 | $ | 16,189,000  |  
|                                                   |  |                  |             |   |                 |   |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY               |  |                  |             |   |                 |   |             |  
|Current liabilities:                               |  |                  |             |   |                 |   |             |  
|Accounts payable                                   |  | $                | 812,000     |   |                 | $ | 1,017,000   |  
|Accrued expenses                                   |  |                  | 2,627,000   |   |                 |   | 1,662,000   |  
|Current portion of capital lease obligations       |  |                  | 76,000      |   |                 |   | 22,000      |  
|Deferred revenue                                   |  |                  | 6,256,000   |   |                 |   | 5,774,000   |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total current liabilities                          |  |                  | 9,771,000   |   |                 |   | 8,475,000   |  
|                                                   |  |                 
|Capital lease obligations, less current portion    |  |                  | 87,000      |   |                 |   | 91,000      |  
|Other long-term liabilities                        |  |                  | 101,000     |   |                 |   | 92,000      |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total liabilities                                  |  |                  | 9,959,000   |   |                 |   | 8,658,000   |  
|Shareholders equity:                              |  |                  |             |   |                 |   |             |  
|Common stock                                       |  |                  | 50,291,000  |   |                 |   | 52,178,000  |  
|Accumulated deficit                                |  |                  | (46,084,000 | ) |                 |   | (44,736,000 | )
|Accumulated other comprehensive income             |  |                  | 80,000      |   |                 |   | 89,000      |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total shareholders equity                         |  |                  | 4,287,000   |   |                 |   | 7,531,000   |  
|                                                   |  |                  |             |   |                 |   |             |  
|Total liabilities and shareholders equity         |  | $                | 14,246,000  |   |                 | $ | 16,189,000  |  
|                                                   |  |                  |             |   |                 |   |             |  



See accompanying notes.



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Optio Software, Inc.



Consolidated Condensed Statements of Operations

(Unaudited)



|                                                                                      |  |                                |            |   |      |   |            |  
|------------------------------------------------------------------------------------- |  | ------------------------------ | ---------- | - | ---- | - | ---------- | -
|                                                                                      |  | Three Months Ended October 31, |           
|                                                                                      |  | 2003                           |            |   | 2004 |  
|Revenue:                                                                              |  |                                |            |   |      |   |            |  
|License fees                                                                          |  | $                              | 2,052,000  |   |      | $ | 1,783,000  |  
|Subscription fees                                                                     |  |                                |           |   |      |   | 417,000    |  
|Services, maintenance, and other                                                      |  |                                | 4,326,000  |   |      |   | 4,449,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 6,378,000  |   |      |   | 6,649,000  |  
|Costs of revenue (exclusive of depreciation and amortization shown separately below): |  |                                |            |   |      |   |            |  
|License fees                                                                          |  |                                | 59,000     |   |      |   | 121,000    |  
|Services, maintenance, and other                                                      |  |                                | 1,521,000  |   |      |   | 1,406,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 1,580,000  |   |      |   | 1,527,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 4,798,000  |   |      |   | 5,122,000  |  
|                                                                                      |  |                               
|Operating expenses:                                                                   |  |                                |            |   |      |   |            |  
|Sales and marketing                                                                   |  |                                | 2,119,000  |   |      |   | 2,538,000  |  
|Research and development                                                              |  |                                | 978,000    |   |      |   | 1,089,000  |  
|General and administrative                                                            |  |                                | 1,076,000  |   |      |   | 962,000    |  
|Impairment of M2 note receivable                                                      |  |                                | 900,000    |   |      |   |           |  
|Depreciation and amortization                                                         |  |                                | 122,000    |   |      |   | 221,000    |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 5,195,000  |   |      |   | 4,810,000  |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Income (loss) from operations                                                         |  |                                | (397,000   | ) |      |   | 312,000    |  
|Other income (expense):                                                               |  |                                |            |   |      |   |            |  
|Interest income                                                                       |  |                                | 41,000     |   |      |   | 38,000     |  
|Interest expense                                                                      |  |                                | (5,000     | ) |      |   | (3,000     | )
|Other                                                                                 |  |                                | 4,000      |   |      |   | 4,000      |  
|                                                                                      |  |                                |            |   |      |   |            |  
|                                                                                      |  |                                | 40,000     |   |      |   | 39,000     |  
|                                                                                      |  |                               
|Income (loss) before income taxes                                                     |  |                                | (357,000   | ) |      |   | 351,000    |  
|Income tax expense (benefit)                                                          |  |                                |           |   |      |   | (2,000     | )
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income (loss)                                                                     |  | $                              | (357,000   | ) |      | $ | 353,000    |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income (loss) per share  basic                                                   |  | $                              | (0.02      | ) |      | $ | 0.02       |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Net income (loss) per share  diluted                                                 |  | $                              | (0.02      | ) |      | $ | 0.02       |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Weighted average shares outstanding  basic                                           |  |                                | 19,214,942 |   |      |   | 20,632,738 |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Weighted average shares outstanding  diluted                                         |  |                                | 19,214,942 |   |      |   | 23,532,892 |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Comprehensive income:                                                                 |  |                                |            |   |      |   |            |  
|Net income (loss)                                                                     |  | $                              | (357,000   | ) |      | $ | 353,000    |  
|Foreign currency translation adjustment                                               |  |                                | 35,000     |   |      |   | 35,000     |  
|                                                                                      |  |                                |            |   |      |   |            |  
|Comprehensive income (loss)                                                           |  | $                              | (322,000   | ) |      | $ | 388,000    |  
|                                                                                      |  |                                |            |   |      |   |            |  



See accompanying notes.



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Optio Software, Inc.



Consolidated Condensed Statements of Operations

(Unaudited)



|                                                                                      |  |                               |            |   |      |   |            |  
|------------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                      |  | Nine Months Ended October 31, |           
|                                                                                      |  | 2003                          |            |   | 2004 |  
|Revenue:                                                                              |  |                               |            |   |      |   |            |  
|License fees                                                                          |  | $                             | 6,635,000  |   |      | $ | 7,243,000  |  
|Subscription fees                                                                     |  |                               |           |   |      |   | 417,000    |  
|Services, maintenance, and other                                                      |  |                               | 12,967,000 |   |      |   | 12,989,000 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 19,602,000 |   |      |   | 20,649,000 |  
|Costs of revenue (exclusive of depreciation and amortization shown separately below): |  |                               |            |   |      |   |            |  
|License fees                                                                          |  |                               | 285,000    |   |      |   | 444,000    |  
|Services, maintenance, and other                                                      |  |                               | 4,592,000  |   |      |   | 4,361,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 4,877,000  |   |      |   | 4,805,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 14,725,000 |   |      |   | 15,844,000 |  
|Operating expenses:                                                                   |  |                               |            |   |      |   |            |  
|Sales and marketing                                                                   |  |                               | 6,858,000  |   |      |   | 7,853,000  |  
|Research and development                                                              |  |                               | 2,969,000  |   |      |   | 3,247,000  |  
|General and administrative                                                            |  |                               | 3,367,000  |   |      |   | 3,095,000  |  
|Impairment of M2 note receivable                                                      |  |                               | 900,000    |   |      |   |           |  
|Depreciation and amortization                                                         |  |                               | 443,000    |   |      |   | 398,000    |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 14,537,000 |   |      |   | 14,593,000 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Income from operations                                                                |  |                               | 188,000    |   |      |   | 1,251,000  |  
|Other income (expense):                                                               |  |                               |            |   |      |   |            |  
|Interest income                                                                       |  |                               | 132,000    |   |      |   | 121,000    |  
|Interest expense                                                                      |  |                               | (13,000    | ) |      |   | (10,000    | )
|Other                                                                                 |  |                               | 31,000     |   |      |   | 42,000     |  
|                                                                                      |  |                               |            |   |      |   |            |  
|                                                                                      |  |                               | 150,000    |   |      |   | 153,000    |  
|                                                                                      |  |                              
|Income before income taxes                                                            |  |                               | 338,000    |   |      |   | 1,404,000  |  
|Income tax expense (benefit)                                                          |  |                               | (146,000   | ) |      |   | 56,000     |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income                                                                            |  | $                             | 484,000    |   |      | $ | 1,348,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income per share  basic                                                          |  | $                             | 0.03       |   |      | $ | 0.07       |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Net income per share  diluted                                                        |  | $                             | 0.02       |   |      | $ | 0.06       |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Weighted average shares outstanding  basic                                           |  |                               | 19,174,225 |   |      |   | 19,855,566 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Weighted average shares outstanding  diluted                                         |  |                               | 20,956,617 |   |      |   | 23,124,753 |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Comprehensive income:                                                                 |  |                               |            |   |      |   |            |  
|Net income                                                                            |  | $                             | 484,000    |   |      | $ | 1,348,000  |  
|Foreign currency translation adjustment                                               |  |                               | 57,000     |   |      |   | 9,000      |  
|                                                                                      |  |                               |            |   |      |   |            |  
|Comprehensive income                                                                  |  | $                             | 541,000    |   |      | $ | 1,357,000  |  
|                                                                                      |  |                               |            |   |      |   |            |  



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, 2004                                   |  | 19,261,144   |  | $                   | 50,291,000 |  | $                                     | (46,084,000 | )                          |  | $ | 80,000 |  | $ | 4,287,000
|Comprehensive income, net of tax:                             |  |              |  |                     |            |  |                                       |             |                            |  |   |        |  |   |          
|Net income                                                    |  |             |  |                     |           |  |                                       | 1,348,000   |                            |  |   |       |  |   | 1,348,000
|Foreign currency translation adjustment                       |  |             |  |                     |           |  |                                       |            |                            |  |   | 9,000  |  |   | 9,000    
|                                                              |  |              |  |                     |            |  |                                       |             |                            |  |   |        |  |   |          
|Comprehensive income                                          |  |              |  |                     |            |  |                                       |             |                            |  |   |        |  |   | 1,357,000
|Exercise of stock options                                     |  | 313,669      |  |                     | 217,000    |  |                                       |            |                            |  |   |       |  |   | 217,000  
|Issuance of common stock in Vertisoft acquisition             |  | 1,190,000    |  |                     | 1,309,000  |  |                                       |            |                            |  |   |       |  |   | 1,309,000
|Stock options issued in connection with Vertisoft acquisition |  |             |  |                     | 361,000    |  |                                       |            |                            |  |   |       |  |   | 361,000  
|                                                              |  |              |  |                     |            |  |                                       |             |                            |  |   |        |  |   |          
|Balance at October 31, 2004                                   |  | 20,764,813   |  | $                   | 52,178,000 |  | $                                     | (44,736,000 | )                          |  | $ | 89,000 |  | $ | 7,531,000
|                                                              |  |              |  |                     |            |  |                                       |             |                            |  |   |        |  |   |          



See accompanying notes.



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Optio Software, Inc.



Consolidated Condensed Statements of Cash Flows

(Unaudited)



|                                                                                  |  |                               |            |   |      |   |            |  
|--------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                  |  | Nine Months Ended October 31, |           
|                                                                                  |  | 2003                          |            |   | 2004 |  
|Cash flows from operating activities:                                             |  |                               |            |   |      |   |            |  
|Net income                                                                        |  | $                             | 484,000    |   |      | $ | 1,348,000  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                               |            |   |      |   |            |  
|Depreciation and amortization                                                     |  |                               | 443,000    |   |      |   | 290,000    |  
|Amortization of intangibles                                                       |  |                               |           |   |      |   | 108,000    |  
|Provision for doubtful accounts                                                   |  |                               | (193,000   | ) |      |   | 48,000     |  
|Impairment of M2 note receivable                                                  |  |                               | 900,000    |   |      |   |           |  
|Loss on disposal of property and equipment                                        |  |                               | 3,000      |   |      |   |           |  
|Changes in operating assets and liabilities:                                      |  |                               |            |   |      |   |            |  
|Accounts receivable                                                               |  |                               | 642,000    |   |      |   | 1,518,000  |  
|Prepaid expenses and other current assets                                         |  |                               | 662,000    |   |      |   | (131,000   | )
|Receivable from insurance claim                                                   |  |                               | 750,000    |   |      |   |           |  
|Accounts payable                                                                  |  |                               | (1,030,000 | ) |      |   | (1,000     | )
|Accrued expenses                                                                  |  |                               | (905,000   | ) |      |   | (1,623,000 | )
|Accrued settlement of lawsuit                                                     |  |                               | (875,000   | ) |      |   |           |  
|Income taxes payable                                                              |  |                               | 8,000      |   |      |   | (1,000     | )
|Deferred revenue                                                                  |  |                               | (342,000   | ) |      |   | (817,000   | )
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash provided by operating activities                                         |  |                               | 547,000    |   |      |   | 739,000    |  
|                                                                                  |  |                              
|Cash flows from investing activities:                                             |  |                               |            |   |      |   |            |  
|Purchases of property and equipment                                               |  |                               | (112,000   | ) |      |   | (326,000   | )
|Purchase of business                                                              |  |                               |           |   |      |   | (348,000   | )
|Repayment of note receivable from M2 Systems                                      |  |                               | 14,000     |   |      |   | 243,000    |  
|Repayments from related parties under notes receivable                            |  |                               | 84,000     |   |      |   |           |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash used in investing activities                                             |  |                               | (14,000    | ) |      |   | (431,000   | )
|                                                                                  |  |                              
|Cash flows from financing activities:                                             |  |                               |            |   |      |   |            |  
|Payments of notes payable and capital lease obligations                           |  |                               | (101,000   | ) |      |   | (1,140,000 | )
|Proceeds from exercise of stock options                                           |  |                               | 9,000      |   |      |   | 216,000    |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash used in financing activities                                             |  |                               | (92,000    | ) |      |   | (924,000   | )
|                                                                                  |  |                              
|Impact of foreign currency rate fluctuations on cash                              |  |                               | 31,000     |   |      |   | 42,000     |  
|Net increase (decrease) in cash and cash equivalents                              |  |                               | 472,000    |   |      |   | (574,000   | )
|                                                                                  |  |                              
|Cash and cash equivalents at beginning of period                                  |  |                               | 3,902,000  |   |      |   | 5,328,000  |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Cash and cash equivalents at end of period                                        |  | $                             | 4,374,000  |   |      | $ | 4,754,000  |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Supplemental disclosures of cash flow information:                                |  |                               |            |   |      |   |            |  
|Cash paid during the year for:                                                    |  |                               |            |   |      |   |            |  
|Interest paid                                                                     |  | $                             | 28,000     |   |      | $ | 10,000     |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Income taxes refunded (paid)                                                      |  | $                             | 150,000    |   |      | $ | (59,000    | )
|                                                                                  |  |                               |            |   |      |   |            |  



See accompanying notes.



8



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##### Table of Contents

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, 2004, included in the Companys Annual Report on Form 10-K, filed with the Securities and Exchange Commission on April 21, 2004. Results of operations for the three and nine months ended October 31, 2004 are not necessarily
indicative of the results for the year ending January 31, 2005.



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 Statement of Financial Accounting Standards (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



9



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



the following weighted-average assumptions used for the three months ended
October 31, 2003 and 2004 and the nine months ended October 31, 2003 and 2004: risk-free interest rates of 3.90% and 4.03% for the three months ended October 31 2003 and 2004, respectively; risk-free interest rates of 3.51% and 3.96% for the nine
months ended October 31, 2003 and October 31, 2004, respectively; no dividend yield; volatility of 162% and 148% for the three months ended October 31, 2003 and 2004, respectively; volatility of 162% and 148% for the nine months ended October 31,
2003 and 2004, respectively; and an expected life of the options of 7.54 years for the three and nine months ended October 31, 2003 and 7.31 years for the three and nine months ended October 31, 2004.



For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options vesting periods. The weighted-average fair value of options granted during the three months ended October 31, 2003 and 2004 equaled $0.77 and $1.10 per share, respectively. The weighted-average
fair value of options granted during the nine months ended October 31, 2003 and 2004 equaled $0.61 and $1.18 per share, respectively. The Companys pro forma information as determined using the fair value method of accounting under SFAS 123,
was as follows:



|                                                            |  |                                |          |   |      |   |           |  
|----------------------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | --------- | -
|                                                            |  | Three Months Ended October 31, |         
|                                                            |  | 2003                           |          |   | 2004 |  
|Net income (loss) as reported                               |  | $                              | (357,000 | ) |      | $ | 353,000   |  
|Deduct: Compensation cost using the fair value method       |  |                                | (190,000 | ) |      |   | (103,000  | )
|                                                            |  |                                |          |   |      |   |           |  
|Pro forma net income (loss)                                 |  | $                              | (547,000 | ) |      | $ | 250,000   |  
|                                                            |  |                                |          |   |      |   |           |  
|Net income (loss) per share as reported  basic and diluted |  |                                | (0.02    | ) |      |   | 0.02      |  
|Pro forma net income (loss) per share  basic and diluted   |  |                                | (0.03    | ) |      |   | 0.01      |  
|                                                            | 
|                                                            |  | Nine Months Ended October 31,  |         
|                                                            |  | 2003                           |          |   | 2004 |  
|Net income as reported                                      |  | $                              | 484,000  |   |      | $ | 1,348,000 |  
|Deduct: Compensation cost using the fair value method       |  |                                | (521,000 | ) |      |   | (297,000  | )
|                                                            |  |                                |          |   |      |   |           |  
|Pro forma net income (loss)                                 |  | $                              | (37,000  | ) |      | $ | 1,051,000 |  
|                                                            |  |                                |          |   |      |   |           |  
|Net income per share as reported  basic                    |  |                                | 0.03     |   |      |   | 0.07      |  
|Net income per share as reported  diluted                  |  |                                | 0.02     |   |      |   | 0.06      |  
|Pro forma net income (loss) per share  basic and diluted   |  |                                | 0.00     |   |      |   | 0.05      |  



3. Net Income per Share



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



10



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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 per share:



|                                                                                             |  |                                |            |   |      |   |           
|-------------------------------------------------------------------------------------------- |  | ------------------------------ | ---------- | - | ---- | - | ----------
|                                                                                             |  | Three months ended October 31,
|                                                                                             |  | 2003                           |            |   | 2004
|Net income (loss)                                                                            |  | $                              | (357,000   | ) |      | $ | 353,000   
|                                                                                             |  |                                |            |   |      |   |           
|Weighted average shares outstanding  basic                                                  |  |                                | 19,214,942 |   |      |   | 20,632,738
|Dilutive stock options                                                                       |  |                                |           |   |      |   | 2,900,154 
|                                                                                             |  |                                |            |   |      |   |           
|Weighted average shares outstanding  diluted                                                |  |                                | 19,214,942 |   |      |   | 23,532,892
|                                                                                             |  |                                |            |   |      |   |           
|Net income (loss) per share  basic and diluted                                              |  | $                              | (0.02      | ) |      | $ | 0.02      
|                                                                                             |  |                                |            |   |      |   |           
|Potentially dilutive stock options excluded from diluted weighted average shares outstanding |  |                                | 2,656,108  |   |      |   |          
|                                                                                             |  |                                |            |   |      |   |           
|                                                                                             | 
|                                                                                             |  | Nine months ended October 31, 
|                                                                                             |  | 2003                           |            |   | 2004
|Net income                                                                                   |  | $                              | 484,000    |   |      | $ | 1,348,000 
|                                                                                             |  |                                |            |   |      |   |           
|Weighted average shares outstanding  basic                                                  |  |                                | 19,174,225 |   |      |   | 19,855,566
|Dilutive stock options                                                                       |  |                                | 1,782,392  |   |      |   | 3,269,187 
|                                                                                             |  |                                |            |   |      |   |           
|Weighted average shares outstanding  diluted                                                |  |                                | 20,956,617 |   |      |   | 23,124,753
|                                                                                             |  |                                |            |   |      |   |           
|Net income per share  basic                                                                 |  | $                              | 0.03       |   |      | $ | 0.07      
|                                                                                             |  |                                |            |   |      |   |           
|Net income per share  diluted                                                               |  | $                              | 0.02       |   |      | $ | 0.06      
|                                                                                             |  |                                |            |   |      |   |           



11



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



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 subsidiaries are 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 nine months ended October 31, 2003
and 2004 is summarized below.



|                                          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|----------------------------------------- |  | ------------- | ---------- | ------ | - | --------- | ----- |  | -------- | ------ | ------------ | - | ---------- | ------------ | - | ---------- | - |  | - | ----------
|Nine Months ended October 31,
2003        |  | United States |            | Europe |   |           | Other |  | Combined |        | Eliminations |   |            | Consolidated
|Revenue from external customers:          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|License fees                              |  | $             | 5,726,000  |        | $ | 909,000   |       |  | $        |       |              | $ | 6,635,000  |              | $ |           |   |  | $ | 6,635,000 
|Services, maintenance and other           |  |               | 11,160,000 |        |   | 1,799,000 |       |  |          | 8,000  |              |   | 12,967,000 |              |   |           |   |  |   | 12,967,000
|Inter-segment revenue                     |  |               | 217,000    |        |   | 83,000    |       |  |          |       |              |   | 300,000    |              |   | (300,000   | ) |  |   |          
|                                          |  |               |            |        |   |           |       |  |          |        |              |   |            |              |   |            |   |  |   |           
|Total revenue                             |  |               | 17,103,000 |        |   | 2,791,000 |       |  |          | 8,000  |              |   | 19,902,000 |              |   | (300,000   | ) |  |   | 19,602,000
|Interest income                           |  |               | 132,000    |        |   |          |       |  |          |       |              |   | 132,000    |              |   |           |   |  |   | 132,000   
|Interest expense                          |  |               | 13,000     |        |   |          |       |  |          |       |              |   | 13,000     |              |   |           |   |  |   | 13,000    
|Depreciation and amortization             |  |               | 392,000    |        |   | 51,000    |       |  |          |       |              |   | 443,000    |              |   |           |   |  |   | 443,000   
|Income tax benefit (expense)              |  |               | 151,000    |        |   | (5,000    | )     |  |          |       |              |   | 146,000    |              |   |           |   |  |   | 146,000   
|Segment income (loss) before income taxes |  |               | 806,000    |        |   | (474,000  | )     |  |          | 6,000  |              |   | 338,000    |              |   |           |   |  |   | 338,000   
|Segment net income (loss)                 |  |               | 957,000    |        |   | (479,000  | )     |  |          | 6,000  |              |   | 484,000    |              |   |           |   |  |   | 484,000   
|Total segment assets                      |  |               | 13,905,000 |        |   | 2,153,000 |       |  |          | 87,000 |              |   | 16,145,000 |              |   | (4,313,000 | ) |  |   | 11,832,000
|Expenditures for long-lived assets        |  |               | 90,000     |        |   | 22,000    |       |  |          |       |              |   | 112,000    |              |   |           |   |  |   | 112,000   



12



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Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



|                                   |  |               |            |        |   |           |       |  |          |         |              |   |            |              |   |            |   |  |   |           
|---------------------------------- |  | ------------- | ---------- | ------ | - | --------- | ----- |  | -------- | ------- | ------------ | - | ---------- | ------------ | - | ---------- | - |  | - | ----------
|Nine Months ended October 31,
2004 |  | United States |            | Europe |   |           | Other |  | Combined |         | Eliminations |   |            | Consolidated
|Revenue from external customers:   |  |               |            |        |   |           |       |  |          |         |              |   |            |              |   |            |   |  |   |           
|License fees                       |  | $             | 5,756,000  |        | $ | 1,487,000 |       |  | $        |        |              | $ | 7,243,000  |              | $ |           |   |  | $ | 7,243,000 
|Services, maintenance and other    |  |               | 10,963,000 |        |   | 2,025,000 |       |  |          | 1,000   |              |   | 12,989,000 |              |   |           |   |  |   | 12,989,000
|Subscription revenue               |  |               | 399,000    |        |   |          |       |  |          | 18,000  |              |   | 417,000    |              |   |            |   |  |   | 417,000   
|Inter-segment revenue              |  |               | 315,000    |        |   | 167,000   |       |  |          |        |              |   | 482,000    |              |   | (482,000   | ) |  |   |          
|                                   |  |               |            |        |   |           |       |  |          |         |              |   |            |              |   |            |   |  |   |           
|Total revenue                      |  |               | 17,433,000 |        |   | 3,679,000 |       |  |          | 19,000  |              |   | 21,131,000 |              |   | (482,000   | ) |  |   | 20,649,000
|Interest income                    |  |               | 116,000    |        |   | 5,000     |       |  |          |        |              |   | 121,000    |              |   |           |   |  |   | 121,000   
|Interest expense                   |  |               | 10,000     |        |   |          |       |  |          |        |              |   | 10,000     |              |   |           |   |  |   | 10,000    
|Depreciation and amortization      |  |               | 386,000    |        |   | 12,000    |       |  |          |        |              |   | 398,000    |              |   |           |   |  |   | 398,000   
|Income tax expense                 |  |               | 54,000     |        |   | 2,000     |       |  |          |        |              |   | 56,000     |              |   |           |   |  |   | 56,000    
|Segment income before income taxes |  |               | 1,523,000  |        |   | (130,000  | )     |  |          | 11,000  |              |   | 1,404,000  |              |   |           |   |  |   | 1,404,000 
|Segment net income                 |  |               | 1,469,000  |        |   | (132,000  | )     |  |          | 11,000  |              |   | 1,348,000  |              |   |           |   |  |   | 1,348,000 
|Total segment assets               |  |               | 17,749,000 |        |   | 3,037,000 |       |  |          | 382,000 |              |   | 21,168,000 |              |   | (5,087,000 | ) |  |   | 16,081,000
|Expenditures for long-lived assets |  |               | 284,000    |        |   | 42,000    |       |  |          |        |              |   | 326,000    |              |   |           |   |  |   | 326,000   



5. 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 Optio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 plaintiffs attorneys 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. Under the settlement, the plaintiffs will dismiss and
release all claims



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



against participating defendants in exchange for a contingent payment
guaranty by the insurance companies collectively responsible for insuring the issuers in the action, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. 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. 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.



6. Note Receivable



As further explained in Notes 3 and 4 of the Notes to Consolidated Financial Statements included in Optios Annual Report on Form 10-K, Optio holds a
note receivable from M2 Systems Corporation (M2 Systems) as partial consideration for the sale by Optio of its Muscato Corporation (Muscato) and Translink Solutions Corporation business units. Under the terms of the note, M2
Systems was required to make payments of $100,000 each on September 1, 2003 and December 1, 2003 and a payment of $115,000 on June 1, 2004. M2 Systems failed to make these payments on their respective due dates; however, payment was made prior to an
event of default. The payments of $115,000 due September 1,2004 and December 1, 2004 were made when due.



During the third quarter of fiscal year 2004, as a result of M2 Systems failure to make timely payments, 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 $2.5 million. The Company has the right to receive the quarterly financial statements of M2 Systems and Muscato 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.



On September 15, 2004, Optio notified M2 Systems of certain non-monetary defaults under the Amended, Restated and
Consolidated Promissory Note dated March 1, 2003 (M2 Systems Note). Optio has not accelerated the indebtedness under the M2 Systems Note and Optio and M2 Systems are negotiating to modify the current loan documents to address the alleged
defaults by M2 Systems.



7. Acquisition of VertiSoft Corporation



On August 10, 2004, Optio consummated the merger of
VertiSoft Corporation (VertiSoft), a



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



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. The
consideration given for all the common stock of VertiSoft included $350,000 in cash, the issuance of 1.5 million shares of Optio common stock, of which 310,000 shares are to be held in escrow for a period of 18 months to secure the indemnification
obligations of the shareholders of VertiSoft, the issuance of 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                                                                           |  | $ | 350,000  
|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                                                       |  |   | 282,000  
|                                                                                    |  |   |          
|                                                                                    |  |   | 2,302,000
|                                                                                    |  |   |          



Should the 310,000
shares held in escrow be released to the VertiSoft shareholders 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 |  | $ | 268,000    |  
|Liabilities assumed      |  |   | (1,924,000 | )
|Technology               |  |   | 839,000    |  
|Customer relationships   |  |   | 1,314,000  |  
|Non-compete agreement    |  |   | 85,000     |  
|Goodwill                 |  |   | 1,720,000  |  
|                         |  |   |            |  
|                         |  |   | 2,302,000  |  
|                         |  |   |            |  



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.



Under the purchase method of accounting pursuant to SFAS 141, the total purchase prices as shown in the tables above were
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 were recorded as goodwill. In accordance with the 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 Optios management
determines that the value of goodwill or intangible assets has become impaired, Optio will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.



The results of operations of VertiSoft have been included in Optios
consolidated condensed financial statements from the date of the closing of the acquisition which was August 10, 2004. The following unaudited pro forma financial information presents the combined results of operations of combining VertiSoft and
Optio as though the acquisition had occurred as of the beginning of the periods presented. The pro forma financial information does not necessarily represent the



15



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##### Table of Contents

Optio Software, Inc.

Notes to the Consolidated Condensed Financial Statements

(Unaudited)  (Continued)



results of operations that would have occurred had VertiSoft and Optio
been a single company during the periods presented, nor does Optio believe that the pro forma financial information presented is necessarily representative of future operating results.



|                                              |  |                                |            |      |   |            |  
|--------------------------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | -
|                                              |  | Three Months Ended October 31, |           
|                                              |  | 2004                           |            | 2003 |  
|Revenue                                       |  | $                              | 6,883,000  |      | $ | 6,825,000  |  
|Net income (loss)                             |  | $                              | 175,000    |      | $ | (788,000   | )
|Net income (loss) per share-basic and diluted |  | $                              | 0.01       |      | $ | (0.04      | )
|Weighted average shares outstanding-basic     |  |                                | 20,632,738 |      |   | 19,214,942 |  
|Weighted average shares outstanding-diluted   |  |                                | 23,532,892 |      |   | 19,214,942 |  



|                                            |  |                               |            |      |   |            |  
|------------------------------------------- |  | ----------------------------- | ---------- | ---- | - | ---------- | -
|                                            |  | Nine Months Ended October 31, |           
|                                            |  | 2004                          |            | 2003 |  
|Revenue                                     |  | $                             | 21,812,000 |      | $ | 21,116,000 |  
|Net income (loss)                           |  | $                             | 1,290,000  |      | $ | (715,000   | )
|Net income per share-basic and diluted      |  | $                             | 0.06       |      | $ | (0.04      | )
|Weighted average shares outstanding-basic   |  |                               | 19,855,566 |      |   | 19,174,225 |  
|Weighted average shares outstanding-diluted |  |                               | 23,124,753 |      |   | 19,174,225 |  



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 Optios portfolio of healthcare solutions and
establishes a subscription-based licensing model for a new line of solutions.



In connection with the transaction described above, Optio entered into a written employment agreement with Donald H. French. Mr. French serves as Senior Vice President of Healthcare Products for Optio. Mr.
Frenchs employment agreement has a three year term. Mr. Frenchs current employment agreement provides for a base salary of $200,000. In addition, Mr. French was granted an option to acquire 350,000 shares of common stock at $1.10 per
share (the Options). The Options vest over a period of four years. Upon Mr. Frenchs resignation for good reason (as defined in the agreement) or termination without cause, the Company will be obligated to pay him his then-current
base salary for the remaining term of the employment agreement. If Mr. Frenchs employment is terminated by reason of disability occurring in the performance of his duties, he will receive his base salary for 12 months less any payments made to
him under any long-term or short-term disability insurance policies. If Mr. French is terminated for cause, including resignation, or the mutual consent of the parties, he will receive no severance. Mr. Frenchs employment agreement includes
post-employment restrictive covenants not to compete, solicit Optios customers or recruit Optios employees.



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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 or nine months ended October 31, 2004 or 2003.



Critical Accounting Policies and Use of Estimates



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



Revenue
Recognition



Overview



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



License Fees



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



The Company recognizes revenue using the residual method pursuant to the
requirements of



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##### Table of Contents

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



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



Subscription Revenue



The Company also licenses certain of its products in the form of a
subscription service contract, typically ranging from 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.



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. The payments of $115,000 due on September 1, 2004 and December 1, 2004, were made when due.



During the third quarter of 2004, as a result of M2 Systems failure to make timely payments, 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



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##### Table of Contents

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 $2.4 million.



On September 15, 2004, Optio notified M2 Systems of certain non-monetary defaults under the M2 Systems Note. Optio has not accelerated the indebtedness under the M2 Systems Note and the parties are negotiating to modify the current loan
documents to address the alleged defaults by M2 Systems.



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% of each aging category of the accounts receivable, in its overall allowance for doubtful accounts. Based on managements best estimate it believes the Companys allowance for doubtful accounts is
adequate as presented; however, the amount of the reserve could be different under different conditions or using varying assumptions. If the percentage of the general reserve were to increase by 1%, an additional reserve of approximately $50,000
would be required. If the financial condition of Optios customers were to deteriorate, resulting in their inability to make payments, additional reserves would be required, increasing Optios bad debt expense included in general and
administrative expenses.



RESULTS OF OPERATIONS



Three Months Ended October 31, 2004 Compared to Three Months Ended October 31, 2003



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 Months EndedOctober 31, |   
|                                                                            |  | 2003                          |    |  | 2004 |  
|Revenue:                                                                    |  |                               |    |  |      |  
|License fees                                                                |  | 32                            | %  |  | 27   | %
|Subscription fees                                                           |  |                              |    |  | 6    |  
|Services, maintenance and other                                             |  | 68                            |    |  | 67   |  
|                                                                            |  |                               |    |  |      |  
|Total revenue                                                               |  | 100                           |    |  | 100  |  
|                                                                            |  |                               |    |  |      |  
|Costs of revenue (excluding depreciation and amortization, included below): |  |                               |    |  |      |  
|License fees                                                                |  | 1                             |    |  | 2    |  
|Services, maintenance and other                                             |  | 24                            |    |  | 21   |  
|                                                                            |  |                               |    |  |      |  
|Total cost of revenue                                                       |  | 25                            |    |  | 23   |  
|                                                                            |  |                               |    |  |      |  
|                                                                            |  | 75                            |    |  | 77   |  
|Operating expenses:                                                         |  |                               |    |  |      |  
|Sales and marketing                                                         |  | 33                            |    |  | 38   |  
|Research and development                                                    |  | 15                            |    |  | 16   |  
|General and administrative                                                  |  | 17                            |    |  | 15   |  
|Impairment of M2 note receivable                                            |  | 14                            |    |  |     |  
|Depreciation and amortization                                               |  | 2                             |    |  | 3    |  
|                                                                            |  |                               |    |  |      |  
|Total operating expenses                                                    |  | 81                            |    |  | 72   |  
|                                                                            |  |                               |    |  |      |  
|Income (loss) from operations                                               |  | (6                            | )  |  | 5    |  
|Interest and other income                                                   |  | 1                             |    |  | 0    |  
|                                                                            |  |                              
|Income tax benefit                                                          |  |                              |    |  |     |  
|                                                                            |  |                               |    |  |      |  
|Net income (loss)                                                           |  | (5                            | %) |  | 5    | %
|                                                                            |  |                               |    |  |      |  



19



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##### Table of Contents

Revenues



Total revenues increased 4% to $6.6 million from $6.4 million for the three months ended October 31, 2004 and 2003, respectively.



License fees



Revenues from software licenses decreased 13% to $1.8 million from $2.1 million for the three months ended October 31, 2004
and 2003, respectively. The decline in software revenue resulted from several deals that failed to close during the third quarter as expected, particularly in the healthcare and United States ERP segments. As an example, in the three months ended
October 31, 2003 healthcare sales represented 36% of Optios domestic software sales. In the three months ended October 31, 2004 only 9% of Optios domestic revenues came from healthcare. Optios healthcare segment was also negatively
impacted by turnover of the majority of the members of its healthcare sales team, which resulted in fewer sales. Optio also experienced a decrease in software sales in the ERP business, a result of fewer new contracts and a lower overall average
sales price. License fee revenues from Optios European division increased from $216,000 in the three months ended October 31, 2003, to $366,000 in the three months ended October 31, 2004, largely as a result of efforts to build upon existing
partnerships in the European marketplace.



Approximately
$503,000 of Optios software license revenue during the three months ended October 31, 2004 was derived from partners, such as resellers, value-added distributors or OEM relationships, representing 28% of license revenue for Optio. During the
three months ended October 31, 2003, Optio generated $662,000 of its software license revenue through partners, representing 32% of Optios license revenue.



Subscription fees



Optio added a new revenue source in the form of subscription revenue coming from the acquisition of Vertisoft in August 2004. For the three months ended
October 31,2004 the subscription revenue totaled $417,000.



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##### Table of Contents

Services, maintenance and other



Revenues from services, maintenance and other increased to $4.4 million from $4.3 million during the three months ended
October 31, 2004 and 2003, respectively. Services revenue increased to $1.7 million from $1.6 million for the three months ended October 31, 2004 and 2003, respectively. Services revenue increased primarily as a result of better attendance in
Optios product training classes. Maintenance revenue increased $100,000 to $2.8 million in the three months ended October 31, 2004 from $2.7 million in the three months ended October 31, 2003. Maintenance revenue continues to increase as Optio
adds to its customer base and increases the price of its annual maintenance fees.



Revenue Mix



With the introduction of
subscription revenue during the third quarter the revenue mix is now allocated between three types of revenue versus the two types of revenue in the previous year. In the three months ended October 31, 2004, licenses fees represented 27%,
subscription fees represented 6% and services, maintenance and other represented 67% of total revenue.



Costs of Revenues



Total costs of revenues decreased 3% to $1.5 million in the three months ended October 31, 2004 from $1.6 million in the three months ended October 31, 2003.



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 $121,000 in the three months ended October 31, 2004 from $59,000 in the three months ended October 31, 2003, primarily the result of royalties due to
OEM partners for products introduced in the third quarter of last year and increased fees paid to referral partners.



Services, maintenance and other



Costs of revenues from services, maintenance and other consist of personnel, subcontracting and other expenses relating to the cost of providing customer
support, education and consulting and implementation services. Costs of revenues from services, maintenance and other decreased to $1.4 million in the three months ended October 31, 2004 from $1.5 million in the three months ended October 31, 2003.
For the three months ended October 31, 2004, the cost of outsourcers, often used in the implementation of Optios products at customer sites, decreased by $25,000 as compared to the three months ended October 31, 2003. The remaining reduction
in expense is primarily the result of the reversal of the year-end bonus accrual of approximately $80,000 that management has determined will not be payable this year. While Optios internal services and support personnel had initially declined
in the second quarter of fiscal year 2005, as compared to 2004, the acquisition of VertiSoft on August 10, 2004 brought the services and support personnel to an equal headcount as of October 31, 2004 and 2003.



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.



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##### Table of Contents

Sales and marketing expenses increased 20% to $2.5 million from $2.1 million for the three months ended
October 31, 2004 and 2003, respectively. Sales and marketing expenses were 38% and 33%, respectively, of total revenue for the same periods. Direct marketing expenditures increased by $185,000 between the two quarters, and Optio increased its sales
and marketing headcount by two individuals over the previous year, resulting in an additional $50,000 in salaries. In addition, office expenses and travel expenses incurred by Optios European sales offices increased in the three months ended
October 31, 2004 compared to the three months ended October 31, 2003.



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 $1.1 million from $1.0 million for the three months ended October 31, 2004 and 2003, respectively. This
increase was primarily due to the increase in headcount from 34 employees as of October 31,2003 to 43 employees as of October 31, 2004, which included the addition of the VertiSoft employees as of August 10, 2004, which resulted in an additional
$170,000 in salaries. This was offset by the reversal of the year end bonus accrual of approximately $100,000 that management has determined will not be payable this year.



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 $1.0 million in the three months ended October 31, 2004 from $1.1 million in the three months ended
October 31, 2003. The decrease primarily represents savings in various categories such as legal, insurance and various office expenses.



Impairment of M2 Note Receivable



As of October 31, 2003, Optio held a note receivable from M2 Systems with a principal and interest balance of $3.6 million. Under the terms of the note,
M2 Systems was required to make a payment of $100,000 on December 1, 2003. M2 Systems failed to make such payment and, as such, Optio believed that an impairment charge to write-down the note receivable to the fair market of the collateral which
supports the note was necessary at that time. Management estimated that the value of the collateral was $2.8 million, requiring a $900,000 impairment charge in the three months ended October 31, 2003. Optio will continue to evaluate the value of the
collateral securing the note receivable.



Depreciation and Amortization



Depreciation and amortization expense increased to
$221,000 from $122,000 for the three months ended October 31, 2004 and 2003, respectively. This increase was due to the addition of $108,000 of amortization expense in the three months ended October 31, 2004, related to the intangible assets
acquired in the VertiSoft acquisition on August 10, 2004.



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Interest Income



Interest income decreased to $38,000 from $41,000 in the three months ended October 31, 2004 and 2003, respectively. Interest income primarily represents
interest earned on the principal of the M2 Systems note receivable.



Interest Expense



Interest expense decreased
to $3,000 from $5,000 in the three months ended October 31, 2004 and 2003, respectively. Interest expense primarily represents the interest paid on Optios capital leases.



Nine Months Ended October 31, 2004 Compared to Nine Months Ended October 31, 2003



Revenues



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



|                                                                            |  |                              |   |  |      |  
|--------------------------------------------------------------------------- |  | ---------------------------- | - |  | ---- | -
|                                                                            |  | Nine Months EndedOctober 31, |  
|                                                                            |  | 2003                         |   |  | 2004 |  
|Revenue:                                                                    |  |                              |   |  |      |  
|License fees                                                                |  | 34                           | % |  | 35   | %
|Subscription fees                                                           |  |                             |   |  | 2    |  
|Services, maintenance and other                                             |  | 66                           |   |  | 63   |  
|                                                                            |  |                              |   |  |      |  
|Total revenue                                                               |  | 100                          |   |  | 100  |  
|                                                                            |  |                              |   |  |      |  
|Costs of revenue (excluding depreciation and amortization, included below): |  |                              |   |  |      |  
|License fees                                                                |  | 2                            |   |  | 2    |  
|Services, maintenance and other                                             |  | 23                           |   |  | 21   |  
|                                                                            |  |                              |   |  |      |  
|Total cost of revenue                                                       |  | 25                           |   |  | 23   |  
|                                                                            |  |                              |   |  |      |  
|                                                                            |  | 75                           |   |  | 77   |  
|Operating expenses:                                                         |  |                              |   |  |      |  
|Sales and marketing                                                         |  | 35                           |   |  | 38   |  
|Research and development                                                    |  | 15                           |   |  | 16   |  
|General and administrative                                                  |  | 17                           |   |  | 15   |  
|Impairment of M2 note receivable                                            |  | 5                            |   |  |     |  
|Depreciation and amortization                                               |  | 2                            |   |  | 2    |  
|                                                                            |  |                              |   |  |      |  
|Total operating expenses                                                    |  | 74                           |   |  | 71   |  
|                                                                            |  |                              |   |  |      |  
|Income from operations                                                      |  | 1                            |   |  | 6    |  
|Interest and other income                                                   |  | 1                            |   |  | 1    |  
|Income tax benefit                                                          |  |                             |   |  |     |  
|                                                                            |  |                              |   |  |      |  
|Net income                                                                  |  | 2                            | % |  | 7    | %
|                                                                            |  |                              |   |  |      |  



23



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##### Table of Contents

Revenues



Total revenues increased 5% to $20.6 million from $19.6 million for the nine months ended October 31, 2004 and 2003, respectively.



License fees



Revenues from software licenses increased 9% to $7.2 million from $6.6 million for the nine months ended October 31, 2004
and 2003, respectively. The introduction of new products has allowed Optio to slightly improve its average sales price over the nine month period ended October 31, 2004 and to sell additional products to existing customers, thus increasing overall
revenues. In addition, Optios efforts to build upon our existing partnerships in the European marketplace have resulted in improved software license fees from Europe, increasing to $1.5 million in the nine months ended October 31, 2004 from
$909,000 in the nine months ended October 31, 2003.



Approximately $1.7 million of Optios software license revenue during the nine months ended October 31, 2004 was derived from partners, such as resellers, value-added distributors or OEM relationships, representing 23% of license
revenue. During the nine months ended October 31, 2003, Optio generated $2.3 million of its software license revenue through partners, representing 35% of Optios license revenue. The reduction in revenue from partners resulted primarily from
smaller contracts through Optios healthcare reseller in the nine months ended October 31, 2004 than in the nine months ended October 31, 2003.



Subscription fees



Optio added a new revenue source in the form of subscription revenue coming from the acquisition of VertiSoft in August 2004. For the nine months ended
October 31,2004 the subscription revenue totaled $417,000.



Services,
maintenance and other



Revenues from services, maintenance
and other remained constant at $13.0 million in the nine months ended October 31, 2004 and 2003, respectively. Services revenue decreased to $4.5 million for the nine months ended October 31, 2004 from $5.0 million for the nine months ended October
31, 2003. In the nine months ended October 31, 2003, Optio was involved in large consulting engagements with specific large integrators, contributing an additional $340,000 to services revenue, thus accounting for the largest portion of the decrease
in the nine months ended October 31, 2004 from the nine months ended October 31, 2003. These projects were completed during the second quarter of fiscal year 2004. In addition, through the nine months ended October 31, 2004, Optio experienced
greater ease of implementation for some of its products, requiring less services and slightly reducing services revenue. Maintenance revenue increased $500,000 to $8.5 million in the nine months ended October 31, 2004 from $8.0 million in the nine
months ended October 31, 2003. Maintenance revenue continues to increase as Optio adds to its customer base and increases the price of its annual maintenance fees.



Revenue Mix



With the introduction of subscription revenue during the third quarter, the revenue mix is now allocated between three types of revenue versus the two
types of revenue in the previous year. In the nine months ended October 31, 2004, license fees represented 35%, subscription fees represented 2% and services, maintenance and other represented 63% of total revenue.



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##### Table of Contents

Costs of Revenues



Total costs of revenues decreased to $4.8 million in the nine months ended October 31, 2004 from the $4.9 million for the nine months ended October 31,
2003.



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 $444,000 in the nine months ended October 31, 2004 from $285,000 in the
nine months ended October 31, 2003, primarily the result of approximately $130,000 in additional referral fees created by Optios improved referral partner relationships and approximately $50,000 in additional royalties due to OEM partners.



Services, maintenance and other



Costs of revenues from services, maintenance and other consist of personnel,
subcontracting and other expenses relating to the cost of providing customer support, education and consulting and implementation services. Costs of revenues from services, maintenance and other decreased to $4.4 million for the nine months ended
October 31, 2004 from $4.6 million in the nine months ended October 31, 2003. The cost of outsourcers remained constant at approximately $1.1 million in both periods. However, Optios internal headcount for its support department declined
during the second quarter of fiscal year 2004, saving approximately $175,000 in salaries and related costs.



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 15% to $7.9 million from $6.9
million for the nine months ended October 31, 2004 and 2003, respectively. Sales and marketing expenses were 38% and 35%, respectively, of total revenue for the same periods. While direct marketing expenditures increased approximately $100,000
between the two periods, Optio increased its sales and marketing headcount by two individuals over the previous year which resulted in increased salaries of approximately $130,000. In addition, commissions and bonuses were increased approximately
$250,000, resulting from improved software sales. Furthermore, consulting fees for sales were increased by approximately $50,000 over the previous year. Travel and related expenses increased approximately $185,000, resulting from increased
headcount. Finally, a greater level of office expenses have been incurred by Optios European sales offices.



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 $3.2
million in the nine months ended October 31, 2004



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from $3.0 million in the nine months ended October 31, 2003. This increase is primarily the result of increased wages,
especially with the addition of the VertiSoft employees in August 2004, slightly increased travel and meeting expenses within the development group, plus the addition of approximately $75,000 in consulting fees related to the development of future
products.



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 $3.1 million in the nine
months ended October 31, 2004 from $3.4 million in the nine months ended October 31, 2003. Optio was able to save $200,000 in legal fees and $275,000 in insurance premiums. This was offset by increased salaries of $170,000, and an increase in
various other general and administrative expenses.



Depreciation and
Amortization



Depreciation and amortization expense
decreased to $398,000 from $443,000 for the nine months ended October 31, 2004 and 2003, respectively. Depreciation expense decreased $150,000 due to a greater number of Optios fixed assets becoming fully depreciated during the nine months
ended October 31, 2004. This was offset by the addition of $108,000 of amortization expense in the nine moths ended October 31, 2004 related to the amortization of intangible assets acquired from VertiSoft.



Impairment of M2 Note Receivable



As of October 31, 2003, Optio held a note receivable from M2 Systems with a
principal and interest balance of $3.6 million. Under the terms of the note, M2 Systems was required to make a payment of $100,000 on December 1, 2003. M2 Systems failed to make such payment and, as such, Optio believed that an impairment charge to
write-down the note receivable to the fair market of the collateral which supports the note was necessary at that time. Management estimated that the value of the collateral was $2.8 million, requiring a $900,000 impairment charge in the nine months
ended October 31,2003. Optio will continue to evaluate the value of the collateral securing the note receivable.



Interest Income



Interest income decreased to $121,000 from $132,000 in the nine months ended October 31, 2004 and 2003, respectively, primarily the result of a reduction
in principal of the M2 Systems note receivable and lower interest rates.



Interest Expense



Interest expense decreased
to $10,000 from $13,000 in the nine months ended October 31, 2004 and 2003, respectively. Interest expense primarily represents the interest paid on Optios capital leases.



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LIQUIDITY AND CAPITAL RESOURCES



Optio had $4.8 million and $4.4 million in cash and cash equivalents at October 31, 2004 and 2003, respectively.



The following table sets forth certain selected statements of cash flow
information for the nine months ended October 31, 2004:



|                                          |  |   |          |  
|----------------------------------------- |  | - | -------- | -
|Net cash provided by operations           |  | $ | 739,000  |  
|Net cash used in investing activities     |  |   | (431,000 | )
|Net cash used in financing activities     |  |   | (924,000 | )
|Net decrease in cash and cash equivalents |  |   | (574,000 | )



Cash provided by
operations was primarily the result of $1.3 million in net income, plus a $446,000 add-back of non-cash depreciation and amortization expense and provision for doubtful accounts, offset primarily by changes in working capital resulting in a $1.1
million outflow of cash. The major component of such working capital changes was the Companys use of funds to pay down accrued expenses by approximately $1.6 million, primarily representing the payment of Optios year-end bonuses and the
payment of various accrued expenses assumed in the VertiSoft acquisition. In addition, Optio prepaid several of its renewed insurance policies and other marketing expenses, resulting in a $131,000 cash outflow. This was partially offset by improved
collections on accounts receivable resulting in additional cash inflow of $1.5 million. Finally, Optios deferred revenue declined $817,000, as a result of the timing of renewal maintenance billings. In investing activities, Optio received
$243,000 in payments on the receivable from M2 Systems and purchased $326,000 of property and equipment in the ordinary course of business. In addition, Optio paid $348,000 towards the purchase price of VertiSoft. Optios financing activities
included receipts of $216,000 from the exercise of stock options, offset by payments of capital lease and other debt obligations of $1.1 million, almost all of which was assumed with the VertiSoft acquisition.



On April 8, 2004 Optio extended the line of credit with its bank through
April 19, 2005. The line of credit bears interest at the banks 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. During fiscal year 2005, 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.



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
(4.0% as of December 29, 2003), 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



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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.



As
of October 31, 2004, Optio, under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the
Companys disclosure controls and procedures (the Evaluation). Based upon the Evaluation, our Chief Executive Officer and Chief Financial Officer concluded that Optios disclosure controls and procedures are effective in
ensuring that material information relating to Optio, including its consolidated subsidiaries, is made known to them by others within the organization, particularly during the period in which this quarterly report was being prepared. There were no
significant changes in Optios internal controls or in other factors that could significantly affect these controls subsequent to the date of the Evaluation.



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 Optio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



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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 plaintiffs attorneys
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. 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, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. 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. Optios insurance companies currently have an A or
AA rating. The range of loss, if any, cannot be estimated and thus no potential loss is reflected in Optios financial statements.



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



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



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES



On August 10, 2004, the Company completed the acquisition of all the capital stock of VertiSoft Corporation (VertiSoft). The transaction was
accomplished pursuant to the merger (the Merger) of a newly created, wholly owned subsidiary of the Company with and into VertiSoft with VertiSoft surviving. In connection with the Merger, each shareholder of VertiSoft exchanged his or
her shares of capital stock of VertiSoft for his or her pro rata shares of the following: (a) 1,500,000 shares of common stock of the Company (with a fair market value of $1,650,000 as of the closing date); (b) approximately $350,000 in cash paid on
the closing date; and (c) up to $225,000 in cash that may be paid to the shareholders of VertiSoft in the future based on the achievement of certain milestones.



The shares of common stock of the Company were sold to the shareholders of VertiSoft without registration in reliance on Regulation D promulgated under
the Securities Act and based on representations and warranties made to the Company by the shareholders of VertiSoft.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None.



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



None



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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



(1) A form 8-K was filed on August 13,
2004 to report the acquisition of VertiSoft Corporation on August 10, 2004.



(2) A form 8-K was filed on September 3, 2004 to furnish the Companys second quarter earnings press release dated September 2, 2004.



(3) A form 8-K/A was filed on October 12, 2004 to report that the audited financial statements of VertiSoft Corporation and
pro forma financial information would be filed with the SEC on October 22, 2004.



(4) A form 8-K/A was filed on October 22, 2004 to report the audited financial statements of VertiSoft Corporation and pro forma financial information.



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 15thday of December, 2004.



OPTIO SOFTWARE, INC.By:

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




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