Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended January 31, 2005

OR

For the transition period from              to             

Commission File Number: 1-15529

OPTIO SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

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

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

(Title of Class)

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting stock held by nonaffiliates of the Registrant, based upon the closing sale price for the Common Stock on July 31, 2004 as reported by the Over-the-Counter Bulletin Board, was approximately $12,654,837. The shares of Common Stock held by each officer and director and by each person known to the Registrant who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

There were 21,262,039 shares of the Registrant’s common stock outstanding as of April 15, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant’s Definitive Proxy Statement on Schedule 14A for its 2005 Annual Meeting of Stockholders are incorporated by reference in Part III of this Annual Report on Form 10-K. The Proxy Statement will be filed within 120 days of the end of the fiscal year covered by this Annual Report on Form 10-K.

Table of Contents

OPTIO SOFTWARE, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED JANUARY 31, 2005

TABLE OF CONTENTS

- 1 -

Table of Contents

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Annual Report contains forward-looking statements that involve risks and uncertainties. Such forward-looking statements are made pursuant to the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995 and are made based on management’s current expectations or beliefs as well as assumptions made by, and information currently available to, management. These forward-looking statements include, among other things, statements regarding Optio Software, Inc.’s (“Optio”) anticipated costs and expenses, Optio’s capital needs and financing plans, product and service development, Optio’s growth strategies, integration of acquired entities, market demand for Optio’s products and services, relationships with Optio’s strategic marketing alliances, and competition. These forward-looking statements include, among others, those statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Optio’s actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, risks associated with Optio’s reliance on strategic marketing and reseller relationships, collectibility of accounts receivable and notes receivable (specifically, the note receivable from M2 Systems Corporation), fluctuations in operating results because of acquisitions or dispositions, failure to integrate new products and newly acquired companies, diversion of management resources relating to acquisitions, reduction in cash reserves relating to acquisitions, challenges relating to acquisitions and the possibility that this may cause Optio to no longer be profitable, the negative effect on Optio’s earnings relating to the amortization or potential write-down of acquired assets or goodwill, failure to retain the business relationships with existing customers from acquisitions, changes in competition, changes in economic conditions in the U.S. and in other countries in which Optio currently does business (both general and relative to the technology industry), delays or inability in developing new or unique software products, market acceptance of new products, the failure of new products to operate as anticipated, expectation of achieving and sustaining operating profits and earnings, including timing of 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 Annual Report on Form 10-K. 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 Quarterly Reports on Form 10-Q 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 Annual Report on Form 10-K. 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.

PART I

Item 1. Business

Optio Software, Inc. (the “Company” or “Optio”), founded in 1981 as a Georgia corporation, provides infrastructure software and services that enhance the form, content, distribution and availability of business critical information. Our software allows information stored within or created by an organization’s wide range of enterprise systems, applications or databases to be intelligently captured, transformed and customized in formats according to the business needs of an organization’s customers, suppliers and partners. The information is then delivered to the appropriate destinations, which include print, fax, e-mail, wireless devices, the web or archive. Optio’s software also allows information to be transformed into a wide variety of formats, languages and standards and enables customers to create customized documents, based on their specific business requirements. For example, customers can use our software to create and deliver customized business documents (invoices, purchase orders, packing slips, etc.) and business-to-business transactions around the globe by web, e-mail, fax or print. In addition Optio’s solutions can also accept inbound documents from third parties such as suppliers and customers, capture and store their image for later retrieval, extract transactional data and inject them into operational workflows or integrate their data into a company’s enterprise systems. Optio’s solutions are non-intrusive and can be deployed without modifying the software or the business processes that created the original information. We reduce the cost and complexity of document-centric business processes while extending the value of existing technology investments.

We engage primarily in the development, sale and support of software for companies located principally in the United States and European regions. Optio was founded in 1981 and in Optio’s first 18 years, Optio’s primary business consisted of providing software and services that addressed organizations’ needs for customized information delivered via print, fax and e-mail to users of enterprise and healthcare applications. The type of solution that provides this functionality was traditionally known as a distributed output management solution.

- 2 -

Table of Contents

In August 1998, Optio acquired Optio Software Europe, S.A., a software product distributor in Europe, providing Optio’s first entry into the European markets. Optio Software, Asia Pacific was established in May 1999, but was subsequently closed in September 2002.

In addition to its distributed output management solutions, in 1999 Optio began pursuing the e-business market created by the evolution of the Internet. In September 1999, Optio introduced the first of its e.ComSeries of products, Optio e.ComPresent^TM, a browser-based software solution allowing document presentation to the web. In December 1999, Optio completed its initial public offering, raising $47.0 million in capital. In March 2000, Optio introduced its second product in the e.ComSeries of products, Optio e.ComIntegrate^®. Also in March 2000, Optio purchased Muscato Corporation (“Muscato”) and TransLink Solutions Corporation (“Translink”), further expanding its breadth into the e-commerce market. Muscato offered a product, e.ComEngine, which enabled the real-time exchange of information between systems utilizing dissimilar formats and protocols. Unfortunately, Optio was unsuccessful in the integration of these two companies and subsequently disposed of the two companies and the e.ComEngine product in December 2001. Since the disposal of Muscato and Translink, Optio has focused on expanding its core products and increasing the capability of its integrated solutions.

Most recently, Optio has focused on expanding from managing output only to managing the lifecycle of transactional documents. Optio has focused its development on features and functionality that enhance a customer’s ability to manage documents. In 2003, Optio introduced Optio Print Manager^TM, enabling reliable print delivery and a centralized management console for accessing printers and monitoring their status. In 2004, Optio introduced Optio Imaging Solutions^TM, its intelligent data capture, imaging and web-accessible archive solution that allows documents to be scanned, indexed and archived according a customer’s defined needs, as well as extracts transactional data and integrates it with enterprise systems. To address the needs of our healthcare market, in August 2004, Optio acquired VertiSoft Corporation (“VertiSoft”), bringing with it the Optio QuickRecord Suite^TM of products. These products automate the collection and distribution of healthcare documents, whether they be printed documents collected through scanning and indexing, on-line forms or data streams; create a central repository with web-enabled access by medical personnel or financial services; and provide physicians with the ability to electronically sign patient care documents with the product’s e-signature capability.

Internet Website

Optio’s Internet website can be found at www.optiosoftware.com. Optio makes available free of charge or through our internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our proxy statement and Forms 3, 4 and 5 filed by directors and executive officers and amendments to those reports as soon as reasonably practicable after such material is filed or furnished to the Securities and Exchange Commission (the “SEC”). They may be accessed by clicking on the Investor Relations page under “Company” on our home page, and then by clicking on “SEC Filings”. That is a direct link to Optio’s SEC filings on the SEC website which is at www.sec.gov. Additionally, Optio’s Code of Ethics for Financial Officers may also be found on the Optio website. From time to time, corporate governance materials on our website may be updated to comply with rules issued by the SEC or as desirable to promote the effective governance of Optio. In addition, amendments to the Code of Ethics and any grant of a waiver from a provision of the Code of Ethics requiring disclosure under applicable SEC rules will be disclosed on our website. Any stockholder wishing to receive, without charge, a copy of any of the Optio SEC filings or Code of Ethics materials should write to the Secretary, Optio Software, Inc., 3015 Windward Plaza, Windward Fairways II, Atlanta, Georgia 30005.

The reference to our website address does not constitute incorporation by reference of the information contained on the website and should not be construed as part of this annual report.

Wholly-Owned Subsidiaries

Optio currently has two wholly-owned foreign subsidiaries, Optio Software Europe, S.A. (“Optio Europe”) and VertiSoft Limited (“VertiSoft UK”). Optio Europe, a software product distributor in Europe, was acquired in August 1998, providing an entry into European markets. Optio Europe is directly involved in the sales, marketing and support

- 3 -

Table of Contents

activities for Optio’s products throughout mainland Europe and the United Kingdom through its wholly-owned subsidiaries Optio Software Deutschland GmbH (“Optio Germany”), formed in December 2002, and Optio Software UK, Pvt. Limited (“Optio UK”). VertiSoft UK is directly involved in the sales and marketing activities for certain customers acquired with VertiSoft. VertiSoft UK was acquired as a subsidiary of VertiSoft. VertiSoft merged into Optio on September 15, 2004. Optio previously had a wholly-owned foreign subsidiary in Australia, Optio Software, Asia Pacific (“Optio Australia”), which was closed in September 2002, and legally terminated in December 2004. The Company continues to market in the Asian Pacific region through resellers.

Segment Information

Optio is organized around geographic areas. Optio’s U.S. operations and European operations, which includes Optio Europe and VertiSoft UK, represent Optio’s current two reportable segments. Optio’s former Australian subsidiary is classified as “Other”. The foreign locations principally function as distributors of products developed by Optio in the United States. Optio attributes revenue to its operating segments based upon the location of the subsidiary originating the sale, which is typically the geographic location where the software is installed. The accounting policies, as described in the summary of significant accounting policies in Optio’s financial statements, 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 years ended January 31, 2003, 2004 and 2005 is summarized below.

- 4 -

Table of Contents

Optio’s European operations generated revenue from licenses, subscription fees and services to customers, excluding intersegment revenue, of $5.0 million in the year ended January 31, 2005, representing 17% of total revenue, compared to $4.2 million in the year ended January 31, 2004, representing 15% of total revenue and compared to $4.0 million the year ended January 31, 2003, representing 15% of total revenue.

Risks Inherent in Foreign Operations

Optio’s international operations pose additional risks to its operations as a result of the following factors:

Industry

Organizations are increasingly being driven to enhance the cost-effectiveness of their existing systems and overall productivity of the organization by sharing vital business information, in the proper format, with the proper users. Their objective is to improve the efficiency of mission-critical business processes such as procurement, manufacturing, warehousing, shipping, invoicing and collections, patient registration and billing, and patient care. This objective can be met by enhancing the form, content, distribution and availability of documents and content that enable these processes,

- 5 -

Table of Contents

thus reducing their cost and complexity and improving overall efficiency. To achieve these objectives, organizations must deliver focused, business-ready information derived from a multitude of sources across the enterprise, to employees, customers, suppliers and strategic partners. In addition, many organizations are embracing e-business to enhance their productivity and cost-savings. Organizations are attempting to maximize the value of their business processes by using the Internet to conduct business electronically and reach a large number of geographically dispersed users across the extended enterprise. Some examples of e-business applications include the electronic distribution of information related to the procurement of goods and services, presentation of bills and collection of payments over the Internet and the viewing of reports and other company information utilizing web browsers. Specifically, this environment has created the need for a comprehensive software solution that gathers information on a real-time basis from multiple sources, including enterprise, healthcare, legacy and custom applications, external databases and files; enhances the information to improve its suitability for business purposes; customizes and formats the information to meet business objectives; provides timely and reliable delivery of the information formats to the appropriate destinations, including the Internet, e-mail, printers, faxes and wireless devices; and provides a universal, web-enabled access point for all documents and information. Most business relationships pair buyers and sellers, providers and consumers, and care givers and patients in a series of interactions or transactions over a period of time. As a result these parties tend to exchange information in the form of documents and this has created the need for solutions that will accept documents created by other organizations, scan and capture their image, extract relevant data and integrate it into a company’s enterprise systems.

These needs have created a market for software that performs cost effective management of the transformation and delivery of information from various enterprise computing systems. The Gartner Group (“Gartner”) defines the markets that provide software solutions described above as the Distributed Output Management (“DOM”) Market and the Integrated Document Archive and Retrieval Systems (“IDARS”) Market. Gartner forecasts these two market segments will converge by the end of 2005. Gartner described DOM and IDARS as part of a more comprehensive market that is known as the Content Management (“CM”) Market. On March 11, 2005, Gartner further noted that they believed that IDARS will cease to be a stand-alone market and will become an integral component of a CM suite by 2007. The Meta Group stated in a report dated January 7, 2004 that this same market, which they call Enterprise Content Management (“ECM”) will grow to $9.3 billion (software and services) by 2007. This represents a compound annual growth rate of 15%.

Further research conducted by the Company through its Customer Advisory Board (“CAB”) indicates that extending the current solution set to manage more of the documents and business processes (e.g. inbound and outbound documents relating to procurement processes) would be of value. This approach, which is known collectively as business process management, is a further extension of the Content Management market and per International Data Corporation’s figures quoted in a May 2004 article in Information Week, grew to over $1 billion dollars in 2004; a growth rate of more than 100%.

Technology

Optio’s suite of products is used to enhance business critical documents and information, their subsequent distribution and the integration of corresponding documents received from other organizations into an organization’s business processes. It provides an organization’s systems and applications with the ability to share information, transfer documents and conduct business transactions with customers, suppliers and employees, in the proper format, with the appropriate content and at the time and location required. Optio’s software contains components for: communicating with Optio’s visual design software; collecting, transforming, and routing information from other enterprise application programs or databases; performing calculations and other types of data transformations; formatting the information into human-readable documents, e-business documents or database transactions; distributing information to a wide variety of digital destinations including web servers, fax servers, e-mail servers, alphanumeric pagers, printers, document archives and e-commerce application servers; maintaining and executing recipient specified rules for information notification and document delivery; and securely controlling the distribution and processing of information between multiple computers within the same network and over the Internet.

Optio’s software supports many industry standards for file, message and document formats, document delivery methods and data access from enterprise databases and other data sources. Optio’s software also supports many of the proprietary formats for data, documents and information produced by the software of third parties with whom Optio has strategic relationships and other common enterprise application software vendors. For example, e-business documents may be extracted from existing enterprise application output and transformed into XML, Adobe PDF and many other standard electronic document formats.

- 6 -

Table of Contents

Certain components of Optio’s technology have been developed by other manufacturers. In some cases, these other manufacturers, known as Original Equipment Manufacturers (“OEM”), have granted Optio a license to embed their technology within Optio’s products for re-licensing to end-users. In other cases, Optio has a value-added reseller agreement in place, which allows Optio to resell the manufacturer’s product as a part of Optio’s own solution set. These agreements provide for a minimum two or three-year contractual commitment; however, the contract may be terminated by either party thereafter with ninety days written notice. Termination of these agreements could have a material impact upon Optio’s product offerings, strategic initiatives and results of operations.

Technical Advantages

Optio’s technology provides customers with the following advantages:

Strategic Initiatives

Optio’s objective is to be a global innovator and leading provider of solutions that transform and exchange vital business information. Optio is dedicated to helping our customers achieve long term success by reducing the cost and complexity of their document-centric business processes while extending the value of existing technology investments. To achieve these objectives, Optio intends to:

- 7 -

Table of Contents

information between systems and people. In other words, improved document formats and distribution may no longer be the sole intended result. Instead, documents may become interactive; presenting, collecting and validating information with the user. During fiscal year 2004, Optio introduced its Optio Imaging Solutions, just one example of how Optio has broadened its integrated solution to include features and functionality that enhance an organizations ability to manage documents. Optio may continue to expand its products to deliver high-value document driven features and functionality.

Additionally, during fiscal year 2004, one of Optio’s initiatives was to extend our US relationships with certain strategic partners to our European subsidiary. In doing so, our European revenues grew from 15% of total revenues in the year ended January 31, 2004 to 17% of total revenue in the year ended January 31, 2005. Optio believes that continuing its efforts in extending these partner relationships will aid in the growth of our European revenues. Finally, Optio believes that by continuing to manage and develop our reseller and other strategic partner relationships, we may strengthen our indirect revenue.

Products

Software

Optio’s software enables the cost-effective, efficient delivery of highly customized information across the extended enterprise. Our software is divided into two suites: the Optio Enterprise Suite and the Optio Healthcare Suite.

The Optio Enterprise Suite is designed to meet the needs of the general business marketplace. The Optio Healthcare Suite is tailored to the special needs of the healthcare marketplace.

In each case, Optio’s customers may purchase the entire suite or may purchase one or more of the software products that make up the suite. Typically, customers buy either Optio e.ComIntegrate or Optio MedEx as well as one or more other components of the applicable suite. The Optio e.ComIntegrate solution sets are geared to companies of different sizes, with varying functional needs across industries. Optio offers tiered solution sets that include Optio’s server technology, Optio e.ComIntegrate, and design tool, Optio DesignStudio, along with services and training to implement the solution. As advanced functions are required, customers can add support for XML, double-byte characters and presenting documents and reports to the web. Other components of the suite of products may include OptioFax^TM, our fax server product; Optio e.ComPresent, our web accessible document repository; Optio Print Manager, our application providing assured delivery and printer definition management; and Optio Imaging Solutions, our intelligent data capture, image and archive solution. Most of the revenue derived from the enterprise suite is attributable to Optio e.ComIntegrate, and most of the revenue derived from the healthcare suite is attributable to Optio Medex.

- 8 -

Table of Contents

The Optio Enterprise Suite

- 9 -

Table of Contents

Services

Consulting. Optio’s consulting services provide customers with expertise and assistance in evaluating, planning and implementing Optio’s software products. To ensure a successful implementation of Optio’s software products, consultants assist customers with the evaluation, planning and design process, the initial installation of a system, the integration of Optio’s software products with the customer’s existing enterprise computing applications and ongoing

- 10 -

Table of Contents

training and upgrades. Management believes that consulting services enable rapid implementation of Optio’s software products, ensure success with the Optio solution, strengthen the customer relationship and add to Optio’s industry-specific knowledge base.

While consulting services are optional, substantially all of Optio’s customers utilize these services to facilitate the rapid implementation of the software. These services are billed on an hourly or daily basis that varies based on the type of service provided.

Optio employs its own staff of consultants, systems analysts and technical personnel devoted to assisting customers in all phases of systems implementation, including evaluation, planning and design, customer-specific configuring of modules and on-site implementation or conversion from existing systems. In addition, Optio utilizes third party consultants, such as those from major systems integrators, to assist in certain implementations. During the years ended January 31, 2003 and 2004, Optio focused on higher utilization rates of its internal employees, allowing the company to reduce its internal consulting services staff to 15 employees from 33 in fiscal year 2002. For the year ended January 31, 2003, Optio outsourced approximately 50% of its services business, a trend that continued into the year ended January 31, 2004. During the year ended January 31, 2005, Optio continued to reduce its internal consulting staff to 12 employees. In addition, select employees within the consulting services organization were given opportunities elsewhere within the company, requiring us to rehire their positions and train the new employee. This required us to increase our use of outsourcers during fiscal year 2005. Separately, seven additional employees are dedicated as training staff for internal, customer and partner training, as well as to developing curriculum materials for training programs.

In September 2004, Optio announced the introduction of Rapid Document Design (“RDD”), a new toolkit that allows Optio’s consulting services personnel to streamline and accelerate implementations by allowing organizations to quickly deploy high volumes of documents. Optio’s RDD facility enables organizations to leverage their investment in existing forms and documents by converting them directly into granular, editable documents for use in Optio DesignStudio. RDD can utilize both electronic documents created by applications such as Microsoft Word or existing printed documents that can be scanned in and automatically converted. RDD may effectively reduce document layout times by up to 90 percent.

Maintenance

Optio offers a comprehensive maintenance program that provides customer telephone support, as well as timely software updates and designated upgrades offering increased functionality and technology advances. Optio offers these services for a fee equal to a percentage of the current software license fee per annum. As of January 31, 2005, a majority of Optio’s customers had subscribed to the comprehensive maintenance support program. However, for customers who pay on a subscription basis, the maintenance fee is included in their subscription payment.

Research and Development

Overview

To maintain Optio’s competitive position, Optio must continually enhance its current products and introduce new features or functionality to address customers’ needs to make document and output management more efficient and cost effective. Product development activities for the year ended January 31, 2005 were focused on (i) enhancements and functional improvements to Optio’s MedEx product, (ii) a new release of Optio Print Manager, version 2.0, (iii) the introduction of the Optio XML Solution Kit, (iv) a new release of Optio e.ComPresent, (v) the re-architecture of Optio’s core design and platform technology, the foundation of its products, (vi) a new release of the QuickRecord Suite and (vii) the continued integration of Optio’s products with international ERP vendors. During the year ended January 31, 2005, Optio spent $4.6 million, or 16% of revenues, on research and development activities, an increase from the $4.1 million, or 15% of revenues, spent in the prior year. Optio has estimated that during the year ended January 31, 2005, personnel time spent on the above projects, and thus the associated percentage of the total $4.6 million spent on research and development, was divided as follows: 8% allocated to the improvements of Optio e.ComPresent; 54% allocated to the modification and improvements to Optio’s core technology; 2% to the continued integration of Optio’s products with ERP vendors; 22% allocated to enhancements to Optio MedEx; 1% allocated to the introduction of version 2.0 of Optio Print Manager; 11% allocated to a new release of the QuickRecord Suite; and 2% allocated to the introduction of Optio XML Solution Kits.

- 11 -

Table of Contents

Current development projects as of January 31, 2005 include (i) continuing enhancements to MedEx that include key customer features and performance improvements, scheduled for release in the second quarter of 2006, (ii) a QuickRecord release which includes community health record initiatives, scheduled for release in the third quarter of 2006, (iii) an e.ComPresent release including enhanced features and improvements, also scheduled for release in the second quarter of 2006, (iv) the next generation of DesignStudio and e.ComIntegrate using the re-architected core technology, scheduled for release in the fourth quarter of 2006 and (v) continued integration of Optio’s products with international ERP vendors.

All of Optio’s research and development employees are located in the US. The products sold by Optio are developed in the US and distributed to Optio’s foreign segments for resale.

Future Product Development Activities

In addition to completing the current development projects discussed above, product development activities for fiscal year 2006 and following are focused on supporting Optio’s strategic initiatives. In general, Optio intends to offer new features focused on improving business processes, partner alignment and seamless integration with partners, creating application transparency.

A major initiative for the year ending January 31, 2006 is the release of the re-architected core and design platform technology, allowing for greater ease of integration of features across Optio’s products and platforms, expansion of the Optio Imaging Solutions, and the release of new versions of both of Optio’s primary healthcare products, Optio MedEx and Optio QuickRecord. Finally, Optio will continue to produce maintenance releases to repair software defects, to modify products to accommodate changes to partner software design or to upgrade vendor supported application programming interfaces.

Retirement

In the future, Optio intends to no longer offer or support certain older versions of our existing products and the operating systems on which they operate. Optio is in the process of developing migration paths for our customers on these products and intends to retire certain products once the migration path is defined and communicated to our customer base.

Sales and Marketing

During the year ended January 31, 2005, approximately 74% of Optio’s software revenue was generated through Optio’s direct sales force, compared to 69% in the year ended January 31, 2004. Optio had 32, 37 and 36 US sales representatives and sales support staff as of January 31, 2003, 2004, and 2005, respectively. Optio’s US sales representatives are divided into teams that:

Optio’s international sales organization, focused on Europe, was composed of 8, 10, and 11 sales representatives as of January 31, 2003, 2004 and 2005, respectively.

The percentage of Optio’s license revenues generated through its worldwide reseller network decreased in the year ended January 31, 2005 to 26% of total revenues, from 31% of license revenue in the year ended January 31, 2004. This decrease was primarily the result of contracts with a smaller average sales prices through Optio’s healthcare resellers during the fiscal year 2005.

- 12 -

Table of Contents

Optio’s marketing activities during the year ended January 31, 2005 were principally focused on trade shows and webinars where we were able to demonstrate our products and their capabilities. Other marketing processes included direct mail and electronic media campaigns as well as distribution of product brochures and other literature to inform new and existing customers about our new product offerings.

Strategic Relationships

Optio has strategic relationships with third parties that help market, sell, implement, support and enhance Optio’s solutions that include:

Distributor Relationships. Optio has relationships with distributors who market and resell Optio’s software. These distributors may also provide education, implementation and customization services for their customers. Optio’s major distributors include Harvest Technology, Lexmark International, Inc. and Deloitte Consulting Product Services LLC.

Independent Software Vendor/Value-Added Reseller Relationships. Optio has relationships with resellers that market and resell Optio’s software as a component of their own solutions and who often provide software-related education, implementation and customization services as well. These resellers have their own software solutions that typically address a specific market sector and utilize Optio’s software to enhance the functionality of their own solution. Optio’s software is sold along with their own solutions under the Optio brand name. Optio’s major value-added resellers include Daly.Commerce, Inc., Epicor, SunGuard Pentamation Inc. and Strategic Information Group. During fiscal year 2005, Optio and McKesson Corporation, who had been Optio’s largest healthcare reseller, terminated their relationship, subject to a twelve month termination period; however, this termination is not expected to have a significant impact on Optio’s revenues.

OEM Relationships. Certain companies may choose to embed Optio’s software within their software and re-label the software with their own name. Because resellers who embed or include Optio’s products within their solutions provide substantially all of the sales and marketing efforts and the initial support services with respect to this embedded software, they receive price discounts on Optio’s software.

Referral Relationships. Optio has established relationships with over 30 partners including QAD, Inc., Carolina System Solutions, Inc. and Appshop, Inc. to refer prospects to Optio that may have an interest in licensing Optio’s solution. As part of a defined process, Optio validates that it is not currently working with that prospect and if Optio secures a licensing agreement with that prospect within a fixed period of time, Optio will pay a referral fee to the referring partner.

Implementation Relationships. Optio has active relationships with 10 consulting organizations to provide value added services that assist customers in implementing Optio’s software. Optio trains and tests these organizations’ consultants to install and use Optio’s software and certifies them once they have demonstrated their proficiency in delivering complete solutions that meet the needs of the customers.

Vendor Relationships. Optio has relationships with major ERP and healthcare software vendors where Optio has demonstrated that its solutions are compatible with their applications and provide complimentary functionality. These vendors include Oracle Corporation, QAD, Inc. and SAP. In most cases, Optio’s products are certified as to their compatibility with these vendors. As a result, these vendors will include descriptions of Optio products’ key features and benefits in their directories that are published periodically and on their web sites. Optio can also feature the vendors’ logos in its advertising and promotional materials and participate in vendor sponsored trade shows, marketing programs and other events. In the past, these vendor relationships have resulted in significant revenues and Optio expects that they will continue to do so in the foreseeable future.

Customers

Optio’s customers consist of enterprises across a broad spectrum of industries; however, healthcare, manufacturing, retail and distribution customers represent approximately 60% of Optio’s customers. Other customer industry types include technology, banks, financial institutions and the public sector. As of January 31, 2005, Optio licensed its products for use by more than 5,000 customers.

- 13 -

Table of Contents

No single customer accounted for 10% or more of Optio’s total revenue during the years ended January 31, 2003, 2004 or 2005.

Competition

The market for Optio’s software and services is intensely competitive, quickly evolving and subject to rapid technological change. Management expects competition to intensify in the future. Optio’s potential competitors vary in size and in the scope and breadth of the products and services offered. Our potential competitors fit into three separate categories. The first is custom software developers. The second is comprised of distributed output management, imaging or print management solutions from organizations such as Adobe Systems Incorporated, AFP Technology (Formscape), Bottomline Technologies, The Hewlett Packard Company, StreamServe, McKesson Corporation, Standard Register, Cypress Corporation (now owned by ASG Software Solutions), FormFast, and Evergreen. Lastly, the ERP or healthcare software vendor partners with which Optio typically partners may enhance their own software products to include functionality currently handled by Optio, thus directly competing with Optio.

Some ERP vendors have begun to recognize their end-users’ requirement for better output from their ERP applications. Thus, select ERP vendors have begun to include minimal functionality to address their customer needs and now compete with Optio’s core technology. This has put pressure on Optio to expand our offerings to address the full range of business process solutions and document management, as opposed to simply output management, which we believe is a differentiating factor.

Management believes that Optio is differentiated relative to its competitors due to its software’s ability to combine capabilities including information customization, distributed output management, information integration and exchange, print management, imaging and e-business enablement to one integrated solution. Management believes that, to the best of its knowledge, none of Optio’s competitors provides all of this functionality in a single integrated solution. Management believes that Optio also competes on the basis of its software’s ability to operate across multiple operating systems. With respect to the Optio Healthcare Suite, management believes that Optio compares favorably with its competitors because Optio offers a vertically oriented solution to address the needs of the healthcare marketplace, including new HIPAA regulation concerns.

Management believes that the principal competitive factors present in Optio’s market include: product performance, quality, functionality and features; cost of solution; customer service; core technology; ease of implementation and use; and value derived from the solution. Although management believes that Optio’s products and services currently compete favorably with respect to each of these factors, Optio’s market is evolving rapidly and it may not be able to maintain its competitive position against current and potential competitors.

Intellectual Property

Optio distributes its products under software license agreements, which generally grant clients perpetual or subscription-based licenses to use, rather than own, Optio’s products. These licenses contain various provisions protecting our ownership and the confidentiality of the underlying technology. The majority of Optio’s software products are protected from unauthorized use through electronic activation keys tied to the system on which the software is licensed to operate. The source code, or the intellectual property underlying Optio’s software, is protected as a trade secret and as unpublished copyrighted work.

Optio protects its proprietary rights by relying on copyright, trade secret, trademark, confidentiality procedures and contractual provisions. Some of Optio’s software, documentation and other written materials are protected under the federal copyright law. Optio has registered “Optio” and its accompanying logo, as well as its products’ names such as “Optio e.ComIntegrate” as trademarks in the United States and in certain countries in which Optio sells its products. Optio has used the “Optio” trademark in the European Economic Community since 1997, but has not registered the mark there, although an application has been filed. During 1999, Optio was made aware of an EEC registration of a mark similar to Optio’s which was filed after Optio began using the mark. Two oppositions have been filed against Optio’s attempt to register the mark in the EEC. No assurance can be given that Optio will be able to register the “Optio” mark in these markets or that the existing EEC registration or United Kingdom use will not ultimately have an adverse effect on Optio’s ability to use its “Optio” marks in those markets. Optio also relies on trade secret laws of the State of Georgia and the states in which it does business to protect its software designs and other proprietary information. In addition, non-disclosure agreements contained in employment contracts protect Optio’s proprietary information from disclosure by current and former employees.

- 14 -

Table of Contents

Optio has not applied for any U.S. patents, however, it did acquire a patent in the acquisition of VertiSoft, patent number 5,437,024, which relates to a method for distributing reports. It is possible that Optio may not develop proprietary products or technologies that are patentable, that any patent issued to Optio may not provide Optio with any competitive advantages, or that the patents of others will seriously harm our ability to do business.

Despite Optio’s efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of Optio’s products or to obtain and use information that Optio regards as proprietary. Policing unauthorized use of Optio’s products is difficult, and while Optio is unable to determine the extent to which piracy of Optio’s software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect Optio’s proprietary rights to as great an extent as do the laws of the United States. Optio’s means of protecting its proprietary rights may not be adequate and Optio’s competitors may independently develop similar technology, duplicate Optio’s products or design around patents issued to Optio or Optio’s other intellectual property.

There has been a substantial amount of litigation in the software and Internet industries regarding intellectual property rights. It is possible that in the future third parties may claim that Optio or its current or potential future products infringe on their intellectual property. Management expects that software product developers and providers of e-commerce solutions will increasingly be subject to infringement claims as the number of products and competitors in the industry grows and the functionality of products in different industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require Optio to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to Optio or at all, which could seriously harm our business.

Employees

Optio had 145, 153 and 167 employees as of January 31, 2003, 2004 and 2005, respectively. No employees are covered by any collective bargaining agreements. Optio considers its relationships with its employees to be good.

Executive Officers of the Registrant

As of the date of this report, the executive officers of Optio and certain information about them are as follows:

C. Wayne Cape, the founder of Optio, served as Chief Executive Officer and President of Optio from its inception in 1981 through June 2001 and again since February 2003. Mr. Cape has acted as a member of Optio’s Board of Directors since the Company’s inception and became Chairman of the Board in September 1999. Prior to launching Optio, Mr. Cape was an employee at Digital Communication Associates from 1974 to 1981 where he served in a variety of technical, sales and regional sales management positions.

Paul O’Callaghan has served as Senior Vice President of Sales since February 2003. He also previously held this position from May 2001 to July 2001. Prior to joining Optio, from June 2000 to May 2001, Mr. O’Callaghan served as SVP Sales and Services for Idapta, Inc., a B2B solutions company providing electronic trading exchanges to major consortium organizations. From 1998 to 2000 Mr. O’Callaghan was Vice President of Sales for startup XACCT

- 15 -

Table of Contents

Technologies, which delivered internet-based, IP mediation software solutions to telecommunications industry leaders. Mr. O’Callaghan has also served in senior executive positions with Cisco Systems, IMNET Systems and Network Systems Corporation.

Terry Kraft has served as Senior Vice President of Technical Services since February 2005. From November 2001 to February 2005, Mr. Kraft served as the Senior Vice President of Product Development of Optio. Prior to joining Optio, Mr. Kraft served as Vice President and General Manager for the Wireless and Calling Card Division of Glenayre Technologies, Inc. from 1998 to 2001. From 1997 to 1998, Mr. Kraft served in a key technology and management role with Comverse Network Systems, Inc., an enhanced voice application services company.

Steve Kaye has served as Senior Vice President of Marketing and Product Management since January 2004. From July 2003 to January 2004, Mr. Kaye served as Senior Vice President of Marketing. Since September 2002 and prior to joining Optio, Mr. Kaye served as a consultant to various public and private companies. From November 2000 until September 2002, Mr. Kaye was employed by Lombardi Software, Inc., as Vice President of Global Alliances. From May 1999 until November 2000, Mr. Kaye served as Senior Vice President of Marketing and Business Development for Optio. From February 1998 until April 1999, Mr. Kaye served as Vice President of Marketing for Softlab, Inc. Previously, Mr. Kaye served in executive positions with KnowledgeWare and Deloitte Consulting.

Donald French has served as Senior Vice President of Research and Development since February 2005. Previously, Mr. French served as the Company’s Senior Vice President of Product Development – Healthcare Products from August 2004, when he joined the Company with the acquisition of VertiSoft. Mr French was the founder and president of VertiSoft in 1988, a healthcare pioneer in clinical document management systems. Prior to that, Mr. French founded Epic Development, a company based upon the concept of streamlining information access and distribution for physicians and hospital administrators. Mr. French originally became involved in healthcare solutions as the founder of FMG Corp., established in 1978. Prior to establishing FMG Corp., he was instrumental in developing the Tandy TRS-80 microcomputer, as well as other software and hardware for Radio Shack.

Daryl G. Hatton has served as Chief Technology Officer for Optio since February 1997. From October 1993 to February 1997, he served as director of research for Optio. From 1988 through 1993, Mr. Hatton was a co-founder and president of Pacific Genesys Development, Inc., a Canadian corporation in the electronic forms software development industry, which was acquired by Optio in 1993. Prior to that, Mr. Hatton was Vice President of Product Development for Modatech Systems, Inc., a publicly traded software developer of sales force automation solutions.

Caroline Bembry has served as Optio’s Chief Financial Officer since August 2003. From December 2002 to August 2003, she served as the Vice President of Finance of Optio and from November 1999 to December 2002, she served as the Controller of Optio. Prior to joining Optio, Ms. Bembry was Assistant Corporate Controller for WebMD Medical Manager from June 1997 to November 1999. Prior to WebMD Medical Manager, Ms. Bembry held positions with Coopers & Lybrand LLP. She is certified as a CPA in Florida.

Item 2. Properties

Optio’s principal corporate offices are located in approximately 62,000 square feet at 3015 Windward Plaza, Windward Fairways II, Atlanta, Georgia. The term of this lease is through December 31, 2006. Sales offices are also located in France and the United Kingdom, providing Optio with an additional 7,000 square feet.

Optio leases all of its properties with remaining terms between one and two years. Management believes that its facilities are adequate for its current needs and that suitable additional space will be available as required.

Item 3. Legal Proceedings

On June 19, 2001, a lawsuit styled Wagner, et al v. Optio Software, Inc., was filed in the United States District Court for the Southern District of Ohio, Western Division, Case No. C-1-01-406 and later amended to include a corporate officer as a defendant. The lawsuit, filed by 19 shareholders of the now bankrupt company known as Prograde Technologies, Inc. (“PTI”), alleged breach of contract, promissory estoppel and promissory fraud arising out of the termination by Optio of negotiations of a possible merger with PTI. The plaintiffs were seeking compensatory damages

- 16 -

Table of Contents

of an unspecified amount, but in excess of $1.0 million, as well as punitive damages in excess of $10.0 million, reimbursement for the plaintiff’s attorney’s fees and associated costs and expenses of the lawsuit. Optio counterclaimed against two of the plaintiffs for failure to pay on a guarantee on a promissory note. On July 21, 2003, the parties executed a Settlement Agreement and Mutual General Release. The settlement included the release by PTI’s trustee in bankruptcy of all claims against the plaintiffs, the Company and a Company officer and a non-appealable order approving the release of the trustee’s claims by the bankruptcy court. Under the terms of the settlement, Optio paid a total of $875,000 and received immediate reimbursement from its insurer of $750,000. Both parties were required to release all claims each may have in the PTI bankruptcy in exchange for a reciprocal release from the bankruptcy trustee. The Company had previously recorded a liability for the settlement and a receivable for the amount to be contributed by the insurance carrier, after which settlement was made on July 21, 2003.

On April 8, 2003, a lawsuit styled Donald K. Dunaway v. Optio Software, Inc. was filed in the Circuit Court of the Eighteenth Judicial Circuit for Seminole County, Florida. Optio removed the lawsuit to Federal District Court in the Middle District of Florida, Orlando Division. The complaint was filed by a former employee of Optio claiming that he was entitled to certain unpaid commissions earned while employed at Optio. The plaintiff was seeking compensatory, actual, special and consequential damages as a result of Optio’s alleged actions, as well as reimbursement of plaintiff’s attorney’s fees, prejudgment interest and the costs of the action. The lawsuit was settled on January 15, 2004 for approximately $86,000. Optio recorded the settlement in its financial statements for the year ended January 31, 2004.

On November 13, 2001, a lawsuit styled Kevin Dewey vs. Optio Software, Inc., et. al. was filed in the United States District Court for the Southern District of New York. The complaint was filed against the underwriters in the Company’s initial public offering as well as Optio and certain officers and directors of Optio, by a single plaintiff purportedly on behalf of persons purchasing Optio’s common stock between December 14, 1999 and December 6, 2000 and seeks class action status. Optio is a co-defendant with approximately 300 other issuers in this suit. The complaint includes allegations of violations of (i) Section 11 of the Securities Act of 1933 by all named defendants, (ii) Section 12(a)(2) of the Securities Act of 1933 by the underwriter defendants, (iii) Section 15 of the Securities Act of 1933 by the individual defendants, and (iv) Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by the underwriter defendants. The complaint alleges that Optio’s prospectus was materially false and misleading because it failed to disclose, among other things, that: (i) the underwriters had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors material portions of a limited number of Optio shares issued in connection with the Optio initial public offering; and (ii) the underwriters had entered into agreements with customers whereby the underwriters agreed to allocate Optio shares to those customers in the Optio initial public offering in exchange for which the customers agreed to purchase additional Optio shares in the aftermarket at pre-determined prices. The complaint seeks unspecified amounts as compensatory damages as a result of Optio’s alleged actions, as well as punitive damages and reimbursement for the 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. The Court preliminarily approved the settlement on February 15, 2005, subject to certain modifications which are currently pending approval by the defendants. Under the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in the action. Optio may still have yet undetermined exposure to the underwriters pursuant to indemnification provisions in the underwriting agreement entered into at the time of the initial public offering. Under the guaranty, all the insurers for all the issuers will be required to pay an amount equal to $1.0 billion less any amounts ultimately collected by the plaintiffs from the underwriter defendants in all the cases.

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.

- 17 -

Table of Contents

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

None.

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

On December 15, 1999, Optio’s common stock began trading on the Nasdaq National Market under the symbol “OPTO” until June 19, 2002, when Optio’s common stock began trading on the Nasdaq SmallCap Market. Effective January 8, 2003, Optio failed to meet the qualifications for listing on the Nasdaq SmallCap Market and began trading on the Over-the-Counter Bulletin Board under the symbol “OPTO.OB”. On April 15, 2005, the closing price of the common stock on the Over-the-Counter Bulletin Board was $1.12.

The following table reflects the range of high and low sale prices of Optio’s common stock by quarter, for the two most recent fiscal years. Bid prices reflect inter dealer prices without retail mark-up, mark-down or commissions.

Holders

As of April 15, 2005, there were approximately 110 holders of record of Optio’s common stock.

Dividends

Optio did not pay any dividends during the years ended January 31, 2003, 2004 or 2005. Optio intends to retain all of its earnings to finance the expansion of its business and for general corporate purposes and does not anticipate paying any cash dividends on its common stock for the foreseeable future. In addition, Optio’s line of credit contains a covenant that prohibits the payment of dividends.

Recent Sales of Unregistered Securities

None.

Item 6. SELECTED FINANCIAL DATA

The following table sets forth the selected historical financial data of Optio. The selected financial data should be read together with the financial statements and related notes and the section of this Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected financial data as of and for the years ended January 31, 2001, 2002, 2003, 2004 and 2005 have been derived from the audited financial statements of Optio.

- 18 -

Table of Contents

- 19 -

Table of Contents

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the financial statements and related notes thereto and “Item 6. Selected Financial Data” appearing elsewhere in this report.

OVERVIEW

Optio is engaged primarily in the development, sale and support of infrastructure software that enhances the form, content, delivery and availability of business critical information. Optio’s primary business consists of providing software and services that address organizations’ needs for document output management, forms automation, print management and imaging solutions in the enterprise and healthcare industries.

Optio markets and sells its software and services throughout the United States and Europe, and in the Asia Pacific region, through its direct sales force and certified resellers. Optio also offers consulting services, which provide customers with implementation assistance and training. As of January 31, 2005, Optio had over 5,000 customers worldwide using Optio’s software and services. No single customer accounted for 10% or more of Optio’s revenue for the years ended January 31, 2003, 2004, or 2005.

Management Summary

For the year ending January 31, 2005, Optio had several strategic and financial goals, including (i) continuing to re-energize our healthcare market, (ii) focusing on key partners to enhance revenues, especially in Europe, Middle East, and Asia (“EMEA”) and in our indirect reseller market, (iii) broadening our integrated solution portfolio via licensing, development or acquisition, and (vi) maintaining a balanced focus on Company profitability and revenue growth.

Optio’s management believes that the consolidation of the large enterprise resource planning (“ERP”) vendors has impacted Optio during the year ended January 31, 2005. Historically, Optio’s primary partners have been J.D. Edwards and Oracle Corporation. During fiscal year 2004, J.D. Edwards, was acquired by PeopleSoft. In an effort to show our continued commitment to this market, Optio obtained its PeopleSoft integration certificate in March 2004. As anticipated, customers in the former J.D. Edwards and PeopleSoft user base, or prospects, were unsettled with the pending acquisition by Oracle, causing continued softness in this market. This consolidation of the ERP vendors caused some uncertainty that tended to delay new purchases and as a result Optio’s domestic direct, new customer sales decreased by approximately $800,000. Conversely, sales to existing customers increased more than $900,000 as a result of the introduction of broader, value-added solutions and the quality of our ongoing relationships.

Optio was able to continue its partner focus, build upon its relationships, and continue to generate revenues in these areas. Optio was able to capitalize on its Oracle marketplace, as well as build upon its relationship with QAD. With continued efforts in the Oracle space, including the installation of Optio’s software in Oracle’s own demonstration center and Optio’s selection by Oracle for its Oracle Partner Financing Initiative, Optio’s revenues from Oracle end-users grew to over 30% of Optio’s domestic license revenues. In addition, in October 2004, Optio announced its addition to QAD’s worldwide solution center, an information center used by QAD’s global sales force. Further, Optio contracted with QAD’s two largest resellers, RCM Technologies, Inc. and Strategic Information Group, to resell Optio’s own products as well.

During the year ended January 31, 2005, Optio continued its efforts in expanding the partnerships enjoyed by our domestic operations, especially with the large ERP vendors, to our EMEA operations. In addition, our EMEA operations focused on partnering with key resellers in the area, especially Germany, to increase revenue. As a result, license revenues from our European operations increased to $2.1 million in the year ended January 31, 2005, from $1.7 million in the year ended January 31, 2004.

Optio introduced Optio MedEx in January 2003, which allowed us to begin the process of re-energizing our healthcare market and improve revenue from our healthcare market in the year ended January 31, 2004, which increased to 31% of total domestic revenues from 20% in the prior year. While healthcare perpetual license revenues declined approximately $900,000 year over year, Optio did focus on improving the overall quality of its healthcare products, installed new sales management and expanded the expertise of its sales team. These actions enabled us to concentrate on expanding our healthcare focus and position us to consider acquisitions and their subsequent integration.

- 20 -

Table of Contents

To further address the needs of the healthcare market, Optio acquired VertiSoft Corporation (“VertiSoft”) in August 2004, bringing to Optio a healthcare electronic document management system. Not only did this acquisition supply the technology needed to address healthcare providers’ needs, it also introduced a subscription-based revenue model to Optio’s customers. Under this licensing model, customers pay a monthly subscription fee for the use and support of the software over a multi-year contract, thus providing a reliable and recurring revenue pattern for the Company. Subscription based licensing contracts contributed $930,000 in revenue during the year ended January 31, 2005.

The acquisition of VertiSoft, which provided the healthcare electronic document management system, represents just one example of how Optio broadened its integrated solution during the year ended January 31, 2005. In addition, Optio introduced Optio Imaging Solutions, an intelligent data capture, imaging and archive solution. The introduction of these solutions, along with the introduction of Optio Print Manager during fiscal year 2004, contributed significantly to the revenue growth within our customer base. As mentioned previously, our ability to sell additional products to existing customers allowed Optio to increase revenues to existing customers by $900,000 domestically.

In summary, total revenues remained relatively consistent between the years ended January 31, 2004 and 2005, even though Optio increased revenues in its EMEA operations, increased revenues to its existing customer base and added the VertiSoft subscription-based revenue model. Growth in our installed base, subscription fees and EMEA license revenues were offset by softness in perpetual license fees of healthcare products and new, direct sales to ERP customers. To maintain profitability, Optio has continued to focus on cost control, while beginning conservative, yet prudent, reinvestment in research and development and sales and marketing.

During 2005, Optio began to increase its expenditures in the sales and marketing area and the research and development area in an effort to build for future revenue growth. Sales and marketing expenses increased 16% over the previous year, which included an increase in direct marketing expenses, growth in our EMEA sales organization, especially in Germany, and an increase in marketing personnel. In addition, Optio continued to increase its research and development efforts, especially in regards to products that serve the healthcare market, by adding five of the former VertiSoft employees to its team. Research and development expenses, as a percentage of total revenue, increased to 16% in 2005 from 15% in 2004. Despite these investments, Optio continued to control costs in its general and administrative areas, decreasing its legal, insurance, bad debt and other administrative expenses, allowing it to achieve income from operations of approximately $1.5 million in 2005.

Critical Accounting Policies and Use of Estimates

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

Revenue Recognition

Overview

The Company’s revenue consists of perpetual license fees of the Company’s software products, maintenance, consulting services, customer training and subscription fees covering the licensing of the Company’s software products and maintenance. 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,

- 21 -

Table of Contents

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 based upon a percentage of list price. The Company does not grant its resellers the right of return.

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

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

Subscription Revenue

The Company also licenses certain of its products in the form of a subscription service contract, typically ranging from three to five years. Subscription revenue, which includes a license of 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 Corporation (“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, December 1, 2004 and March 1, 2005, 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

- 22 -

Table of Contents

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. 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. M2 Systems disputes these defaults. 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%, in its overall allowance for doubtful accounts. Based on management’s best estimate, it believes the Company’s allowance for doubtful accounts is adequate as presented; however, the amount of the reserve could be different under different conditions or using varying assumptions. If the percentage of the general reserve were to increase by 1%, an additional $50,000 reserve would be required. If the financial condition of Optio’s customers were to deteriorate, resulting in their inability to make payments, additional reserves would be required, increasing Optio’s bad debt expense included in general and administrative expenses.

Impairment Assessments

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

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

The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment decisions. In estimating our fair value, we will make estimates and judgments about future revenues and cash flows. Our forecasts will be based upon assumptions that are consistent with the plans and estimates we are using to manage our business. Changes in these estimates could change our conclusion regarding impairment of goodwill and potentially result in a non-cash goodwill impairment charge for all or a portion of the goodwill balance as of January 31, 2005. For long-lived assets, accounting standards dictate that assets become impaired when the undiscounted future cash flows expected to be generated by them are less than their carrying amounts. When that occurs, the affected assets are written down to their estimated fair value.

Foreign Currencies

The financial position and results of operations of the Company’s foreign subsidiaries are measured generally using local currencies as the functional currencies, including the British pound and the Euro. Assets and liabilities of these subsidiaries are translated into U.S. dollars at the exchange rate in effect at each year-end. Income and expense

- 23 -

Table of Contents

items are translated at average exchange rates for the year. The resulting translation adjustments are recorded in the foreign currency translation adjustment account. Optio and its subsidiaries conduct their business locally, thus the effects of changes in foreign currency exchange rates have had a minimal effect on the Company’s results of operations to date.

RESULTS OF OPERATIONS

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