**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**




(Mark
                One)**R**
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934****For
                the fiscal year ended January 31, 2007****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: 000-21287**




**Peerless
      Systems Corporation**


*(Exact
      Name of Registrant as Specified in Its Charter)*




**Delaware**
              *(State
                or Other Jurisdiction of*
              *Incorporation
                or Organization)*
            **95-3732595**
              *(I.R.S.
                Employer*
              *Identification
                No.)***2381
                Rosecrans Avenue, El Segundo, CA**
              *(Address
                of Principal Executive Offices)*
            **90245**
              *(Zip
                Code)*




**Registrant’s
      telephone number, including area code: (310) 536-0908**




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




**Title
                of Each Class**
            **Name
                of Each Exchange on which Registered****Common
                Stock, $.001 par value**
            **The
                NASDAQ Stock Market LLC****Preferred
                Stock Purchase Rights**
            **The
                NASDAQ Stock Market LLC**




**Securities
      registered pursuant to Section 12(g) of the Act: None**




Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes £ No R




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes £ No R




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 R  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 registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. £




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):


Large
      Accelerated Filer  £ Accelerated
      Filer  R Non-Accelerated
      filer  £




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




The
      aggregate market value of the registrant’s common equity held by non-affiliates
      was approximately $81,458,496 on July 31, 2006, based upon the last sale price
      of our common stock on the Nasdaq Capital Market on such date.




The
      number of shares of Common Stock outstanding as of April 10, 2007 was
      17,202,937.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Part
      III
      of this report incorporates certain information by reference from the
      registrant’s proxy statement for the annual meeting of stockholders to be held
      on or around June 11, 2007, which proxy statement will be filed no later than
      120 days after the close of the registrant’s fiscal year ended January 31,
      2007.










**PEERLESS
      SYSTEMS CORPORATION**





**ANNUAL
      REPORT ON FORM 10-K**


**For
      the Year Ended January 31, 2007**





**TABLE
      OF CONTENTS**





**Page****PART
                I**Item
                1.
            Business
            4Item
                1A.
            Risk
                Factors
            13Item
                1B.
            Unresolved
                Staff Comments
            24Item
                2.
            Properties
            24Item
                3.
            Legal
                Proceedings
            24Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            24**PART
                II**Item
                5.
            Market
                for Registrant’s Common Equity, Related Stockholder
                Matters and Issuer Purchases of Equity Securities
            25Item
                6.
            Selected
                Financial Data
            26Item
                7.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            26Item
                7A.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            35Item
                8.
            Financial
                Statements and Supplementary
                Data
            35Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting
                and Financial Disclosure
            35Item
                9A.
            Controls
                and Procedures
            35Item
                9B.
            Other
                Information
            40**PART
                III**Item
                10.
            Directors,
                Executive Officers and Corporate
                Governance
            40Item
                11.
            Executive
                Compensation
            40Item
                12.
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            40Item
                13.
            Certain
                Relationships and Related Transactions, and
                Director Independence
            40Item
                14.
            Principal
                Accountant Fees and Services
            40**PART
                IV**Item
                15.
            Exhibits
                and Financial Statement
                Schedules
            41





-2-




**TRADEMARKS**





Peerless ® ,
      PeerlessPrint ® ,
      QuickPrint ® ,
      Memory
      Reduction Technology ® (MRT),
      PeerlessPowered ® ,
      AccelePrint ® ,
      SyntheSys ® ,
      PerfecTone ® and
      VersaPage ® are
      registered trademarks of Peerless Systems Corporation. PeerlessNetTM,
      PeerlessPage TM ,
      PeerlessSPSTM, PeerlessTrapping TM ,
      PeerlessXPS TM ,  MagicPrint TM ,
      ImageWorks TM ,
      PeerlessDriver TM ,
      PeerlessColor TM ,  and
      WebWorks TM are
      trademarks of Peerless Systems Corporation. Peerless Systems, P logo, and
      Peerless logo are trademarks and service marks of Peerless Systems Corporation
      registered in Japan. Peerless is a trademark of Peerless Systems Corporation
      that is registered in Australia, China, France, Hong Kong, Spain, Taiwan, and
      the United Kingdom, and is the subject of applications for registration pending
      in the European Union, Italy, and Korea. PeerlessPrint is a trademark of
      Peerless Systems Corporation that is the subject of an application for
      registration pending in Japan. PeerlessPrint (in Katakana) is a trademark of
      Peerless Systems Corporation that is the subject of an application for
      registration pending in Japan.  -3-


Statements
      made by us in this report and in other reports and statements released by us
      that are not historical facts constitute “forward-looking statements” within the
      meaning of Section 27A of the Securities Act of 1933 and Section 21 of the
      Securities Exchange Act of 1934. These forward-looking statements are
      necessarily estimates reflecting the judgment of our senior management based
      on
      our current estimates, expectations, forecasts and projections and include
      comments that express our current opinions about trends and factors that may
      impact future operating results. Disclosures that use words such as “believe,”
“anticipate,” “estimate,” “intend,” “could,” “plan,” “expect,” “project” or the
      negative of these, as well as similar expressions, are intended to identify
      forward-looking statements. These statements are not guarantees of future
      performance, rely on a number of assumptions concerning future events, many
      of
      which are outside of our control, and involve known and unknown risks and
      uncertainties that could cause our actual results, performance or achievement,
      or industry results, to differ materially from any future results, performance
      or achievements, expressed or implied by such forward-looking statements. We
      discuss such risks, uncertainties and other factors throughout this report
      and
      specifically under the caption “Risk Factors” in Part I, Item 1A. below. Any
      such forward-looking statements, whether made in this report or elsewhere,
      should be considered in the context of the various disclosures made by us about
      our businesses including, without limitation, the risk factors discussed below.
      Except as required under the federal securities laws and the rules and
      regulations of the U.S. Securities and Exchange Commission, we do not have
      any
      intention or obligation to update publicly any forward-looking statements,
      whether as a result of new information, future events, changes in assumptions,
      or otherwise.





**PART
      I**





**Item
      1.  Business**





Peerless
      Systems Corporation licenses, develops and sells imaging and networking
      technologies and components to the digital document markets, which include
      original equipment manufacturers, or OEMs of color and monochrome printers,
      and
      multifunction office products and digital appliances. We develop and license
      software-based imaging and networking technology for controllers in embedded,
      attached and stand-alone digital document products and integrate proprietary
      software into printers, copiers, and multifunction products, or MFPs, of OEMs.
      We receive revenues from our license agreements, development agreements and
      service agreements and through direct sales of our products to our customers.
      Our broad line of scalable software enables our customers to shorten their
      time-to-market and reduce costs by offering unique solutions for multiple
      products. Our customer base includes companies such as Konica Minolta,
      Kyocera-Mita, OkiData, Panasonic, Ricoh, RISO, and Seiko Epson. We also maintain
      strategic partnerships with Adobe and Novell.





We
      were
      incorporated in California in 1982 and reincorporated in Delaware in September
      1996. We make our periodic and current reports and amendments to our reports
      available free of charge, on our website ( www.peerless.com )
      as soon
      as reasonably practicable after such filing is electronically filed with, or
      furnished to, the Securities and Exchange Commission. The information on our
      Internet website is not incorporated by reference into this Annual Report on
      Form 10-K.





We
      have
      developed controller products and applications for sale to OEMs. Digital
      document products include monochrome (black and white) and color printers,
      copiers, fax machines and scanners, as well as MFPs, that perform a combination
      of these imaging functions. In order to process digital text and graphics,
      digital document products rely on a core set of imaging software and supporting
      electronics, collectively known as a digital imaging system. Network interfaces
      supply the core technologies to digital document products that enable them
      to
      communicate over local and wide area networks and the Internet. Our products
      and
      engineering services provide fully integrated advanced and proprietary imaging
      and networking technologies that enable our OEM customers and third party
      developers for OEMs to develop stand-alone and networked digital printers,
      copiers and MFPs quickly and cost effectively. We license our technology, enter
      into development agreements and market our solutions directly to OEM customers
      including Konica Minolta, Kyocera-Mita, Oki Data, Panasonic, Ricoh, and Seiko
      Epson. We have also expanded our solution offerings by incorporating related
      imaging and networking technologies developed internally or licensed from third
      parties.  -4-




Our
      traditional embedded development focus has historically been to offer high
      performing systems at a lower cost compared to competitive offerings. Our
      controllers achieve their performance objectives by incorporating printer
      description languages, or PDL interpreters, such as Adobe PostScript3,
      PeerlessPrint ® 5c
      or
      PeerlessPrint ® 5e,
      PeerlessPrint ® 6,
      PeerlessPrint ® 7
      and
      PeerlessXPS tm ,
      while
      simultaneously executing raster image processing commands on our proprietary
      graphics co-processor. Lower component costs result from reducing the amount
      of
      random access memory, or RAM required to process raster images through the
      use
      of our proprietary hardware based compression technology. Integrating network
      components further reduces the cost of our solutions and software typically
      supplied by third party technology vendors in separately mounted network
      interface cards. Our software has a modular architecture allowing for fast
      replacement of the key components required to support new printer and copier
      engine interfaces. This architecture helps OEMs meet the fast time to market
      requirements in today’s hardcopy imaging business. These three core areas of
      higher performance, lower cost and fast time to market describe the competitive
      advantages of Peerless technologies in the printer controller
      markets.





In
      addition to our core monochrome technologies, we have developed and
      commercialized our Peerless high performance color technologies based on what
      was formerly regarded as “Peerless Sierra Technologies” *.* By
      leveraging the Peerless ** high
      performance color technology architecture, we can address key growth areas
      in
      the imaging market including: increased demand for color imaging in high growth
      market segments, the emergence of MFPs and continued demand for faster low
      cost
      monochrome printing solutions. The Peerless high performance color
      technologies ** line
      of
      products produces high resolution color quality imaging on an architecture
      that
      is capable of printing full continuous tone, or contone, color documents at
      speeds ranging from 20 pages per minute to more than 100 pages per minute.
      Peerless ** high
      performance color technologies use a common architecture for both monochrome
      and
      color, saving developers from supporting multiple code bases. In addition,
      Peerless’ high performance color technology ** architecture
      is re-usable across a variety of product segments including printers, and
      MFPs.





**Digital
      Document Products — Industry Background**





We
      believe that today’s office and home/office environment is increasingly
      dependent on a variety of electronic imaging products including printers, fax
      machines, scanners, MFPs and all-in-ones, or AIOs. Historically, most electronic
      imaging products in the office environment have been stand-alone, monochrome
      machines, which were dedicated to a single print, copy, fax or scan function.
      However, with the proliferation of personal computers, desktop publishing
      software, network computing and high resolution color graphics, documents are
      increasingly being created, stored and transmitted digitally, thereby increasing
      the need for digital document reproduction and printing.





**Developments
      in the Digital Document Products Market**





Rapid
      changes in technology and end-user requirements continue to create challenges
      for digital document product manufacturers, particularly in the area of digital
      imaging systems. These changes include the increased demand for higher
      performance products at lower prices, the demand for color imaging, the
      emergence of MFPs, the increased role of networking and the decline in the
      growth of our historical monochrome market.





*Demand
      for higher performance at lower prices.* The
      digital document products market continues to demand higher performance
      products, including faster print performance and increased imaging quality
      for
      less money. Our high performance color technologies address this market
      need.





*Demand
      for color imaging.* Demand
      continues to increase for products that offer high quality color printing
      solutions for the office. These products are designed to replace their
      monochrome equivalents at competitive price points with affordable total
      cost-of-ownership. Our high performance color technologies help bridge the
      gap
      between monochrome and color digital imaging.





*Emergence
      of multifunction products.* The
      advent of MFPs has eroded the boundaries between the previously distinct
      printer, copier, fax and scanner markets. MFPs offer several functions including
      copying, printing, emailing, scanning and faxing in one product. Our high
      performance color technologies ** address
      the complex requirements of driving and managing these richly featured MFPs
      and
      rapidly growing AIOs.  -5-


*Increased
      role of networking.* Within
      the office environment, digital document products are increasingly being
      deployed in networks. Because multiple network protocols and operating systems
      are deployed in the office environment, networked products must support a broad
      array of networking technologies. The network environment is also changing
      rapidly and becoming increasingly complex, with a growing requirement for remote
      network management that extends across local area networks, wide area networks,
      the Enterprise information technology environment and the Internet. Our core
      networking technology, the Peerless Software Print Server, or PeerlessSPS,
      is
      also available as a stand-alone Software Development Kit, or SDK. We believe
      the
      SPS SDK is one of the most complete networking solutions in the imaging
      industry. We have completed our next generation networking technology, which
      is
      being marketed as the PeerlessNet suite. PeerlessNet is a family of SDKs that
      currently includes PeerlessNet NetPrint software print server, PeerlessNet
      Web
      Services, and PeerlessNet Security.




*Decline
      in OEM demand.* There
      has been a general decline in the rates of growth for the monochrome printer
      and
      copier markets in which we, in the past, have been primarily engaged. While
      these markets have continued to grow in absolute numbers, the rates of growth
      have declined. With these declines in the rates of growth, OEMs that produce
      products in these markets have reacted by engaging in internal controller
      development and consolidating through mergers and acquisitions. In addition,
      OEMs are now introducing new products at a slower rate than they had in the
      past.





**Technology**





In
      response to the challenges and demands upon digital document manufacturers,
      we
      continue to develop proprietary technologies for the digital imaging and digital
      document marketplace that are designed to provide meaningful improvements in
      performance, cost and time-to-market for our OEM customers. Our proprietary
      object-based imaging system reduces the size of digital document imaging files
      with virtually no loss of visual quality. This proprietary technology enables
      our OEM customers to increase print quality and speed, and reduce memory cost.
      We incorporate complementary technologies, or make our technologies compatible
      with third party technologies, in order to provide our customers with a more
      comprehensive imaging solution. We have focused on the repackaging of our
      technologies into modules that can be used by other developers who have their
      own proprietary imaging and networking technologies and can utilize a portion
      of
      Peerless technologies to make their products better or to reach new markets
      such
      as the convenience color market for the walk-up end user. Some of our key
      proprietary technologies include the following:




*Object-based
      image processing.* We
      continue to make advances in our proprietary object-based image processing
      technology, which improve the quality of our color processing and enhance the
      fidelity of printed output. These advances include a new patent pending *lossless
      compression* algorithm.





The
      benefits of our technology become more apparent as the image processing workload
      increases, which occurs with increased resolution or a transition from
      monochrome to color printing. In addition to imaging devices that can accept
      ever increasing amounts of data in terms of color depth and resolution, new
      office applications are emerging that can generate highly sophisticated graphics
      expressed in XML. We are actively developing our PeerlessXPSTM interpreter and
      Raster Image Process, or RIP, to support the *XML
      Paper Specification* ,
      or XPS,
      a standard that was introduced by Microsoft as a key component of its new
      Windows *Vista* TM
      Operating System.





*Color
      management software.* Our
      color management software is based on the use of industry standard ICC profiles,
      which ensures the highest degree of fidelity and user-defined flexibility when
      rendering digital documents on color output devices. This software supports
      four
      different *rendering
      intents,* Perceptual, Saturation, Relative Colorimetric, and Absolute Colorimetric, which
      allows the end user to select the appropriate rendering mode for diverse
      document types such as reports, presentations and photographs.





*Technology
      partners.* We have
      established relationships that permit us to offer our customers complementary
      technologies developed by various technology partners, including Adobe and
      Novell. Adobe has been our development partner since 1992 and the relationship
      has grown with each new application Adobe develops and each new application
      we
      develop. In 1999, we entered into a PostScript Software Development License
      and
      Sublicense Agreement with Adobe, or Adobe License Agreement, that expanded
      the
      application and integration of our  -6-


respective
      technologies. Subsequently, we have amended this agreement many times to
      optimize our working relationship. The Adobe License Agreement permits us to
      offer a convenient and optimized Adobe PostScript-enabled solution, as well
      as
      directly sublicense PostScriptTM to our OEM customers.





We
      also
      have a strategic long term relationship with Novell. The relationship covers
      networking and device management software licenses for imaging devices across
      the Novell Directory Services server environment, which includes Novell Embedded
      Systems Technology Server Software. Our agreement with Novell enables us to
      directly sublicense embedded directory and network services technology for
      multiple market segments, allowing us to offer greater functionality for all
      network devices and extending our reach from digital output systems to other
      devices such as set top boxes and cable modems.





We
      have
      previously entered into semiconductor agreements with some of the leading
      developers and manufacturers of reduced instruction set computer, or RISC,
      microprocessors, including IBM and PMC-Sierra. These relationships allowed
      our
      semiconductor partners to attempt to offer integrated processor and co-processor
      solutions, which combine our basic imaging technology with an industry-standard
      microprocessor. Presently, we do not see microprocessors being developed and
      sold based upon these agreements.





**Strategy
      for Business**





Our
      overall business strategy has been adjusted to achieve better growth and
      profitability. First, the strategy is to improve our four core technology
      offerings: imaging, Adobe PostScriptTM, networking and hardware IP. We anticipate
      this will improve the demand for our core technologies and create customer
      opportunities. The second component of our strategy is to leverage our core
      technologies into the rapidly growing all-in-one product market which we believe
      may result in additional sales opportunities. The third part of our strategy
      is
      to diversify into new software applications in ancillary markets to our core
      technology offerings. It is our expectation that this strategy will strengthen
      our revenue streams and help achieve long term earnings growth.





Based
      on
      the foregoing strategy we are focused on the following:





*Targeted
      development of new technologies.* We will
      continue to invest in research and development in the imaging market place
      in
      order to expand the applications of our core technologies across a broader
      range
      of digital imaging devices. We continue to introduce imaging technology
      innovations designed to increase performance, reduce cost and address a broader
      range of emerging digital document product requirements (e.g. PeerlessXPS
      interpreter).





*Additional
      packaging options for our technologies include licensed SDKs and hardware IP
      cores.* As a
      result of the development of the modular Peerless high performance color
      technologies ** and
      our
      enhancement of its existing monochrome capabilities, we are packaging our
      technologies in SDKs allowing OEMs to pick and choose the components that they
      need to address specific product development needs. To
      capture the value inherent in Peerless' advanced rendering technology, this
      technology is being packaged as hardware IP cores so that the technology can
      more easily be integrated into proprietary ASICs and SoCs that our OEM customers
      and partners create for developing printer and MFP controllers. Hardware IP
      cores are a package of the Peerless rendering and imaging technology in a
      modular form that can be combined with other third party modules and the buyer’s
      own technology for integration into custom ASICs and SoCs.





*Develop
      and expand relationships with key industry participants.* We have
      established relationships with leading color and monochrome printer industry
      companies, such as Konica Minolta, Kyocera Mita, Lenovo, Oki Data, Panasonic,
      Ricoh, Seiko Epson, and Tally Genicom. We seek to expand our relationships
      with
      these partners by offering a broad range of solutions for additional digital
      color and monochrome devices produced by them. We are also establishing
      relationships with other digital copier and printer companies.





*Leverage
      technical expertise to expand products and markets.* We have
      an experienced team of technology experts with backgrounds in image processing,
      compression, language interpreters, printer drivers, networking, ASIC and
      hardware engineering, software engineering, color reproduction, real-time
      operating systems and systems integration. Applying their expertise in these
      areas helps us to continue to expand the technical capabilities of our products
      and gain access to new markets.  -7-




*Develop
      and enhance strategic relationships in the digital document
      market.* We
      intend to develop and enhance our relationships with key participants in the
      digital document product market including Adobe, Novell and
      Microsoft.





*Expand
      our product offerings.* We seek
      to position our product offerings to address emerging and high growth
      opportunities within the digital imaging market. The growth of color printers,
      MFPs, and AIOs in the enterprise and office represents a market that we will
      continue to target. Moreover, we are investigating the solution software
      application market as an opportunity to diversify our revenue
      streams.





*Expand
      geographical presence and market reach.* We have
      established relationships with co-development firms such as NTL of Japan. We
      are
      currently marketing and selling our products into the Peoples’ Republic of China
      and Taiwan.





As
      a
      result of the potential decline of OEM revenue and an uncertain future, the
      Company intends to diversify its business to better ensure growth and
      profitability. The Company intends to maximize its strength in the following
      traditional core areas: imaging, Adobe PostScriptTM, networking and hardware IP.
      In addition, we will focus on the solution software application area and the
      all-in-one or AIO market place. This would be attractive primarily, but not
      exclusively, to our existing customer base and could lead to additional revenue
      opportunities. The Company plans to acquire or invest in existing business
      enterprises to accomplish this goal. While the Company has begun research and
      investigation, no agreement has been entered into with any third party. It
      is
      our expectation that this strategy will strengthen our revenue streams and
      help
      achieve long term earnings growth. Our inability to implement our strategic
      plan, develop and offer products, and manage expansion in the aforementioned
      market places, as well as, the static to declining sales trend of our existing
      licenses, downward price pressure on our existing technologies, uncertainty
      surrounding third party license revenue sharing agreements, downward price
      pressure on OEM products and the anticipated consolidation of the number of
      OEMs
      in the market place may have a material adverse affect on our business and
      financial results. See, “Item 1A. Risk Factors.”


-8-




**Products
      and Solutions**





The
      main
      source of our revenues comes from our licensed software-based imaging and
      networking systems for the digital document product marketplace. Product
      licensing revenues and engineering services and maintenance revenues represented
      99%, 91% and 90% of total revenues in fiscal years 2007, 2006 and 2005,
      respectively. Licensing revenues were 65%, 58% and 79% of total revenues in
      fiscal years 2007, 2006 and 2005, respectively. Engineering services and
      maintenance revenues were 34%, 33% and 11% of total revenues in fiscal 2007,
      2006 and 2005, respectively. Our technology and engineering services provide
      advanced imaging solutions that enable our OEM customers to develop digital
      printers, copiers and MFPs cost effectively. We deliver our products to our
      OEM
      customers in multiple ways, including: licensing of SDKs that provide imaging
      and networking technology for the OEM’s internal product development; turnkey
      product development whereby we provide the technology and the additional
      engineering services necessary to integrate the appropriate technology into
      a
      complete imaging system solution optimized to the OEM’s specific requirements;
      and a co-development relationship that combines the licensing of our technology
      with joint or third party co-development firms and OEM engineering
      resources.





Our
      network technology allows printers and MFPs to be shared across work groups,
      a
      distributed enterprise and the Internet. Our print language products support
      a
      wide range of digital printing devices, including: desktop color printers;
      digital black and white MFPs; digital black and white laser printers; and
      digital color MFPs (i.e., Adobe PostScript, PeerlessPrint ® 5e/c,
      PeerlessPrint ® 6,
      PeerlessPrint ® 7,
      or
      PeerlessXPS).





We
      also
      announced the upcoming release of our PeerlessXPS TM SDK,
      a
      product which now makes our color imaging system compatible with Microsoft’s
      Windows *Vista* TM ** OS.
      PeerlessXPS TM includes
      all the advantages previously afforded by PeerlessPrint7 (ICC profile based
      color management known as PeerlessColor TM and
      Peerless Trapping TM for
      enhanced image quality), while supporting the improved printing experience
      available from Windows *Vista* TM *.* PeerlessXPS TM is
      specifically designed to meet the demands of low cost embedded imaging
      systems.





In
      March
      2005, we signed a Memorandum of Understanding, or MOU, with Kyocera-Mita
      Corporation to provide engineering services in the development of several new
      color products. This binding agreement is for three years, with payments of
      $2
      million dollars per quarter over that period and the possibility of earning
      an
      additional $250 thousand in incentive bonuses each quarter. Thus the total
      direct value of the MOU ranges from $24 million to $27 million in engineering
      services fees, which will be augmented by incremental licensing fees when the
      new technology developed under this agreement launches into the
      marketplace.





*Architecture.* Our high
      performance architecture includes all the components necessary to construct
      a
      world class controller supporting color printing, and scanning, with extensions
      to support the addition of value-added functions such as integrated copying.
      The
      architectural components consist of a complete object-based imaging system
      capable of rendering a variety of document formats into high fidelity printed
      output, as well as a print engine driver, object-based image processing model,
      graphics library, color management, font management, hard disk management,
      print
      job management, distributed scanning, user control panel interface and a full
      suite of direct and networked connectivity options.





*Page
      Description Languages.* We
      provide OEMs with support for the most widely used and standard Page Description
      Languages, namely Adobe’s PostScript Software and Hewlett-Packard’s Printer
      Control Language (PCL). We offer PeerlessPrint ® technology, which emulates Hewlett-Packard’s PCL. The current level of emulation
      coincides with Hewlett-Packard’s PCL6 or XL Protocol 3.0 specification. As
      mentioned earlier, we are in active development on our PeerlessXPS TM SDK,
      which is available at this time to OEMs to start development.





*Engineering
      services.* For
      those OEMs that wish to outsource the development of some or all of the imaging
      system for a digital document product, we offer engineering services. These
      services include controller design and custom engineering for vendor-specific
      features that complement our standard imaging technology. We have assembled
      an
      experienced team of technical personnel with backgrounds in image processing,
      compression, language interpreters, printer drivers, networking, ASIC and
      hardware engineering, software engineering, color reproduction, real-time
      operating systems and systems integration. The resulting systems conform to
      accepted standards, ranging from networking protocols to language syntaxes
      and
      color processing methodologies.





*Networking
      technology.* We
      support an array of networking protocols allowing our OEM customers to address
      a
      broad range of end-user networking requirements and scenarios. Our network
      software product family encompasses  -9-


network
      printing and scanning, internet fax, and network management features including
      Simple Network Management Protocol, Directory Services and Web-based services.
      Through integration of industry standard network management agents, the software
      can integrate seamlessly into existing organizational network management
      applications. We are developing Web Service functions to support the integration
      of network enabled MFPs and printers into Enterprise Service Oriented
      Architectures. These Web Services functions also support the new Windows RallyTM
networking and communications technologies incorporated into Windows *Vista* TM .
      We are
      also actively engaged in addressing advanced security requirements that are
      becoming mandatory for addressing both health provider and government-related
      industries. We believe that security of both the network and applications will
      open up new markets and opportunities for our network technology.




**Customers**





We
      currently derive substantially all of our revenues from direct sales to digital
      document product OEMs. Two of our customers, Konica Minolta and Kyocera-Mita,
      each generated more than 10% of our total revenues for fiscal year 2007.
      Revenues from our top two customers accounted for 70% and 50% of our total
      revenues for fiscal years 2007 and 2006, respectively. Although we have expanded
      and diversified our customer base through focused sales efforts and
      acquisitions, we anticipate that our future revenues may be similarly
      concentrated with a limited number of customers. Our largest customers vary
      to
      some extent from year to year as product cycles end, contractual relationships
      expire and new products and customers emerge. Many of the engineering services
      and a number of licensing arrangements with our customers are provided on a
      project-by-project basis, are terminable with limited or no notice, and in
      certain instances are not governed by long-term agreements. Because a limited
      number of customers generate a large percentage of our revenues, any loss of
      these customers would have a material adverse impact on our results of
      operations. See “Risk Factors - We rely on relationships with certain customers
      and any adverse change in those relationships will harm our business,” for a
      discussion of our reliance on a limited number of customers.





As
      discussed previously, there has been a general decline in the rates of growth
      for the monochrome work group printer and MFP market segments in which we are
      engaged. For those product platforms that do go forward for development and
      customer introduction, the OEMs, in a number of instances, have not selected
      our
      solutions. This occurred in some cases because the OEMs perceived that our
      solutions did not meet their technical requirements. In other cases it occurred
      because the OEMs either developed the technology themselves or utilized lower
      cost offshore software competitors. We continue to focus on higher growth
      segments such as color printing and color MFP markets with OEMs.




**Markets**





*Segments.* We sell
      our products and services to OEMs which produce products for the enterprise
      and
      office sector of the digital document product market, which is characterized
      by
      digital document products ranging in price from approximately $500 to $1,000
      at
      the low end to in excess of $50,000 each at the high end. These products
      typically offer high performance differentiated by customized features. As
      a
      result of these unique requirements, we typically address the office sector
      of
      the digital document product market via direct OEM relationships with individual
      digital document product manufacturers. Our major customers in the office market
      in the fiscal year 2007 included Kyocera- Mita, Konica Minolta, Oki Data,
      Panasonic, RISO and Seiko Epson.





*Geography.* Since
      the majority of our OEM customers are comprised primarily of companies
      headquartered in Japan, revenues from customers outside the United States
      accounted for 91%, 90%, and 85% of our total revenues in fiscal years 2007,
      2006, and 2005, respectively. Further, we expect that sales to customers located
      outside the United States may increase in absolute dollars in the future. These
      customers sell products containing our technology primarily in the North
      American, Japanese, and European marketplaces. See Note 10 of the Consolidated
      Financial Statements, included herein, for revenues by geographical region
      for
      the last three fiscal years.





All
      of
      our contracts with international customers are, and we expect that in the future
      will be, denominated in U.S. dollars. As a result, we are currently not subject
      to material foreign currency transaction and translation gains and losses.
      However, see “Risk Factors - Our international activities may expose us to risks
      associated with international business.”


-10-




**Sales
      and Marketing**





We
      market
      our products to OEMs that sell digital document products to the worldwide
      market. We direct most of our sales efforts through our headquarters in
      California and our subsidiary, Peerless K.K., in Japan. Sales to European
      digital document product manufacturers are conducted out of our California
      headquarters. We market our technology directly to OEMs, as well as through
      focused trade relations. Direct OEM marketing consists of focused public
      relations activities and the development of sales collateral, mailers, trade
      show attendance and sales support. We have devoted increased time and resources
      to increasing our presence in media accessed by OEM customers.





**Product
      Development and Engineering Services**





Our
      product development activities are located at two primary sites, El Segundo,
      California, and Kent, Washington. These activities primarily consist of new
      product development, enhancement of existing products, product testing and
      technical documentation. Our engineering is focused on two primary areas:
      research and development, which focuses on development and enhancement of our
      products and core technologies; and engineering services, which focuses on
      customized customer design activities. We also use the services of offshore
      development partners for specialized product customization and testing projects.
      In addition to extending the capacity of our permanent engineering staff, this
      approach has lead to labor cost reductions that allow us to offer engineering
      services to the global market at competitive rates. We spent approximately
      $6.7
      million , $5.7 million and $11.7 million on research and development activities
      during fiscal years 2007, 2006 and 2005, respectively.





Despite
      helping us achieve labor cost reductions, we have encountered quality control,
      security and project management issues that are inherent with this type of
      offshore engineering effort. We will continue to look for ways to drive down
      our
      engineering services cost, effectively use offshore labor to reduce cost and
      manage our rates to a more competitive level in the global market. See “Risk
      Factor - Our increased use of low-cost offshore engineering and test labor
      could
      significantly harm our business.”





Our
      engineers work closely with OEMs that desire custom solutions or packaging,
      or
      developing customized interfaces and applications specific to individual OEMs.
      We typically receive a fee for such engineering services. To further support
      the
      development of technology and products for our OEMs, we have established
      co-development relationships with NTL of Japan, to focus on the integration
      of
      server-based development.





**Intellectual
      Property and Proprietary Rights**





Our
      success is heavily dependent upon our proprietary technology. To protect our
      proprietary rights, we rely on the combination of patent, copyright, trade
      secret and trademark laws. We also enter into nondisclosure agreements and
      other
      contractual provisions and restrictions.





We
      have
      over sixty patents and patent applications pending on a world-wide basis. As
      of
      January 31, 2007, we had issued patents and/or applications in the United
      States, European Union, Japan, Hong Kong, Taiwan, China, Australia, India and
      Korea. The issued patents and applications relate to techniques developed by
      us
      for generating output for continuous synchronous raster output devices, such
      as
      laser printers, compressing data for use with output devices, filtering
      techniques for use with output devices and communicating with peripheral devices
      over a network.





There
      can
      be no guarantee that the patents held by us will not be challenged or
      invalidated, that patents will be issued for any of our pending applications
      or
      that any claims allowed from existing patents or pending applications will
      be of
      sufficient scope or strength (or issue in the countries where products
      incorporating our technology may be sold) to provide meaningful protection
      or
      any commercial advantage to us. In any event, effective protection of
      intellectual property rights may be unavailable or be limited in certain
      countries. The status of United States patent protection in the software
      industry continues to evolve as the United States Patent and Trademark Office
      grants additional patents in this area. Patents have been granted to fundamental
      technologies in software after the development of an industry around such
      technologies, and patents that relate to fundamental technologies related to
      our
      business may be issued to third parties.





As
      part
      of our confidentiality procedures, we enter into written nondisclosure
      agreements with our employees, consultants, prospective customers, OEMs and
      strategic partners and take further affirmative steps to limit access
      to  -11-


and
      distribution of our software, intellectual property and other proprietary
      information. Despite these efforts and in the event such agreements are not
      timely made, complied with or enforced, we may be unable to protect our
      proprietary rights. In any event, enforcement of our proprietary rights may
      be
      very expensive. Our source code also is protected as a trade secret. However,
      from time to time, we license our source code to OEMs pursuant to protective
      agreements, which subjects us to the risk of unauthorized use or
      misappropriation despite the contractual terms restricting disclosure,
      distribution, copying and use. In addition, it may be possible for unauthorized
      third parties to obtain, distribute, copy or use our proprietary information,
      or
      to reverse engineer our trade secrets.





As
      the
      number of patents, copyrights, trademarks and other intellectual property rights
      in our industry increases, products using our technologies increasingly may
      become the subject of infringement claims. There can be no assurance that third
      parties will not assert infringement claims against us in the future. Any such
      claims, regardless of merit, could be time consuming, divert the efforts of
      our
      technical and management personnel from productive tasks, result in costly
      litigation, cause product shipment delays or require us to enter into royalty
      or
      licensing agreements. Such royalty or licensing agreements, if required, may
      not
      be available on terms acceptable to us, or at all, which could have a material
      adverse effect on our operating results. In addition, we may initiate claims
      or
      litigation against third parties for infringement of our proprietary rights
      or
      to establish the validity of our proprietary rights. Litigation to determine
      the
      validity of any claims, whether or not such litigation is determined in favor
      of
      us, could result in significant expense to us and divert the efforts of our
      technical and management personnel from productive tasks. We may lack sufficient
      resources to initiate a meritorious claim. In the event of an adverse ruling
      in
      any litigation regarding intellectual property, we may be required to pay
      substantial damages, discontinue the use and sale of infringing products, expend
      significant resources to develop non-infringing technology, or obtain licenses
      to infringing or substituted technology. The failure of us to develop or license
      on acceptable terms a substitute technology, if required, could have a material
      adverse effect on our operating results. See “Risk Factors - If we fail to
      adequately protect our intellectual property or face a claim of intellectual
      property infringement by a third party, we could lose our intellectual property
      rights or be liable for damages.”





**Competition**





The
      market for outsourced imaging systems for digital document products is highly
      competitive and characterized by continuous pressure to enhance performance,
      add
      functionality, reduce costs and accelerate the release of new products. We
      compete on the basis of a refreshed base of core technologies and new MFP
      technologies, plus technology expertise, product functionality, development
      time
      and price. Our technology and services primarily compete with solutions
      developed internally by OEMs. Virtually all of our OEM customers have
      significant investments in their existing solutions and have the substantial
      resources necessary to enhance existing products and to develop future products.
      These OEMs have or may develop competing imaging system technologies and may
      implement these systems into their products, thereby replacing our current
      or
      proposed technologies, eliminating the need for our services and products and
      limiting future opportunities for us. In fact, OEMs have increasingly been
      shifting away from third party solutions in favor of in-house development.
      Therefore, we are required to persuade these OEMs to outsource the development
      of their imaging systems and to provide products and solutions to these OEMs
      that favorably compete with their internally developed products. The best way
      to
      accomplish this continues to be to offer products, services and time-to-market
      advantages that exceed what the OEMs are capable of doing using their own
      internal resources. We also compete with software and engineering services
      provided in the digital document product marketplace by other systems suppliers
      to OEMs. In this regard, we compete with, among others, Electronics for Imaging
      Inc., Primax Corporation (formerly known as Destiny Technology Corporation),
      Global Graphics Software Ltd., SOFHA GmbH, Software Imaging and Zoran
      Corporation (formerly Oak Technologies). Our networking and security products
      compete with, among others, Silex Technology Inc, SafeNet Inc., and RSA, a
      division of EMC Corporation. See “Risk Factors - The industry for imaging
      systems for digital document products involves intense competition and rapid
      technological changes, and our business may suffer if our competitors develop
      superior technology.”





As
      the
      industry continues to develop, we expect that competition and pricing pressures
      will increase from OEMs, existing competitors and other companies that may
      enter
      our existing or future markets with similar or substitute solutions that may
      be
      less costly or provide better performance or functionality. We anticipate
      increasing competition for our color and multifunction products, particularly
      as
      competitors develop and introduce products in this market. Some of our existing
      competitors, many of our potential competitors and virtually all of our OEM
      customers have substantially greater financial, technical, marketing and sales
      resources than we do. In the event that


-12-




price
      competition increases, competitive pressures could cause us to reduce the amount
      of royalties received on new licenses and to reduce the cost of our engineering
      services in order to maintain existing business and generate additional product
      licensing revenues. This could reduce profit margins and result in losses and
      a
      decrease in market share. No assurance can be given as to our ability to compete
      favorably with the internal development capabilities of our current and
      prospective OEM customers or with other third party imaging system suppliers,
      and the inability to do so would have a material adverse effect on our operating
      results. See “Risk Factors - The increased use of low-cost offshore engineering
      and test labor by our customers and competitors poses significant risks to
      our
      competitive position.”




**Employees**





As
      of
      January 31, 2007 we had a total of 99 employees plus 5 who performed efforts
      as
      consultants and contractors. None of our employees are represented by a labor
      union, and we have never experienced any work stoppage. We believe we have
      good
      relations with our employees.





**AVAILABLE
      INFORMATION**





Our
      website address is http://www.peerless.com. We make available, free of charge
      through our website, our Annual Reports on Form 10-K, Quarterly Reports on
      Form
      10-Q, Current Reports on Form 8-K, Proxy Statements, and amendments to those
      reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
      Act as soon as reasonably practicable after such material is electronically
      filed with or furnished to the Securities and Exchange Commission (the
“SEC”).




Our
      filings may also be read and copied at the SEC’s Public Reference Room at 100 F
      Street NE, Room 1580 Washington, DC 20549. Information on the operation of
      the
      Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.
      The
      SEC also maintains an Internet site that contains reports, proxy and information
      statements, and other information regarding issuers that file electronically
      with the SEC. The address of that website is www.sec.gov.




**Item
      1A.  Risk Factors**





Our
      short- and long-term success is subject to many factors that are beyond our
      control. Stockholders and prospective stockholders in the Company should
      consider carefully the following risk factors, in addition to the information
      contained in this report. This Annual Report on Form 10-K contains
      "forward-looking statements," within the meaning of Section 27A of the
      Securities Act of 1933 and Section 21 of the Securities Exchange Act of 1934,
      which are subject to a variety of risks and uncertainties. Our actual results
      could differ materially from those anticipated in these forward-looking
      statements as a result of various factors, including those set forth
      below.





*We
      rely on relationships with certain customers and any adverse change in those
      relationships will harm our business.*





A
      limited
      number of OEM customers continue to provide a substantial portion of our
      revenues. Presently, there are only a small number of OEM customers in the
      digital document product market to which we can market our technology and
      services. Therefore, our ability to offset a significant decrease in the
      revenues from a particular customer or to replace a lost customer is severely
      limited.




We
      currently rely upon our OEM block license agreements to maintain our current
      revenue levels. If we were unable to continue to recognize revenue upon the
      execution of some of our block license agreements there may be an immediate
      and
      significant drop in the amount of revenue being reported as earned in the
      short-term and this may have a material adverse effect on our business, results
      of operations and prospects.




During
      fiscal year 2007, two customers, Kyocera-Mita Corporation and Konica-Minolta
      each generated greater than 10% of our revenues, and collectively contributed
      70% of our revenues. Block license revenues during the same period were $16.7
      million, or 50% of revenues. During fiscal year 2006, three customers,
      Kyocera-Mita Corporation, Konica-Minolta, and Seiko Epson Corporation each
      generated greater than 10% of our revenues, and


-13-




collectively
      contributed 60% of revenues. Block license revenues during the same period
      were
      $15.8 million, or 44% of revenues.





*Our
      existing capital resources may not be sufficient and if we are unable to raise
      additional capital, our business may suffer.*





Our
      principal source of liquidity is our cash and cash equivalents, which, as of
      January 31, 2007 were approximately $16.4 million in the aggregate. The current
      ratio of current assets to current liabilities was 3.3:1. For the fiscal year
      ended January 31, 2007, our operations provided $3.4 million in
      cash.




On
      March
      1, 2005, we entered into a binding Memorandum of Understanding, or MOU, with
      Kyocera-Mita Corporation to provide a range of non-exclusive engineering
      services and product development services. Pursuant to the MOU, Kyocera-Mita
      has
      agreed to pay us an aggregate of $24.0 million, which will be paid in $2.0
      million quarterly payments over the initial three-year term of the MOU. Our
      long
      term liquidity is dependent upon this MOU. Should the MOU expire and we do
      not
      enter into definitive agreements on similar terms with Kyocera-Mita, our cash
      flow assumptions would be materially and adversely affected.




If
      we do
      not generate anticipated cash flow from licensing and services, or if
      expenditures are greater than expected, we most likely would attempt to reduce
      discretionary spending, which could require a delay, scaling back or elimination
      of some or all of our internal development efforts, any of which could have
      a
      material adverse effect on our business, results of operations and prospects.
      Furthermore, if we do not experience positive cash flows as anticipated, and
      we
      are unable to increase revenues or cut costs so that revenues generated from
      operating activities are sufficient to meet our obligations, we will be required
      to obtain additional capital from other sources, such as issuances of debt
      or
      equity securities, or bank financing. The Company may not be able to obtain
      additional capital on commercially reasonable terms or at all which could have
      a
      material adverse effect on our operations, liquidity and financial condition,
      our prospects, and the scope of strategic alternatives and initiatives available
      to us.




*We
      rely on relationships with Adobe Systems Incorporated and Novell Inc., and
      any
      adverse change in those relationships will harm our business.*




We
      have
      licensing agreements with Adobe Systems Incorporated and Novell Inc. to bundle
      and sublicense their licensed products with our licensed software. These
      relationships accounted for $15.2 million in revenues and an associated $4.6
      million in cost of revenues during fiscal year ended January 31, 2007. Should
      the agreements with either of these vendors be terminated or canceled, there
      is
      no assurance that we could replace that source of revenue within a short period
      of time, if at all. Such an event would have a material adverse effect on our
      operating results.




*Our
      current licensing agreement with Adobe Systems Incorporated expires in December
      31, 2007, and if we do not enter into an amendment to extend the Adobe License
      Agreement, or enter into a new Adobe licensing agreement before such expiration
      date, this may have a material adverse effect on our operating
      results.*




In
      1999,
      we entered into a PostScript Software Development License and Sublicense
      Agreement with Adobe Systems Incorporated, referred to here as the Adobe License
      Agreement, which enables us to offer a convenient and optimized Adobe
      PostScript-enabled solution, as well as directly sublicense PostScript, to
      our
      OEM customers. We have amended the Adobe License Agreement several times since
      1999. On December 7, 2006, the Adobe License Agreement was amended and extended
      from its termination date of July 23, 2007 to December 31, 2007. The Adobe
      License Agreement, as amended, is scheduled to expire on December 31, 2007,
      referred to here as the Adobe Expiration Date.




If
      we are
      unable to enter into a new licensing agreement with Adobe by the Adobe
      Expiration Date, or if we are unable to enter into an amendment extending the
      term of the Adobe License Agreement, we would lose the ability to sublicense
      Adobe PostScript and this would negatively impact our ability to earn future
      sublicensing revenue. This may adversely affect our financial condition and
      results of operations. See "We rely on relationships with Adobe Systems
      Incorporated and Novell Inc., and any adverse change in those relationships
      will
      harm our business."


-14-




*We
      have negotiated with Adobe Systems Incorporated and Canon Inc. to remedy a
      contract dispute, which, if not remedied, could result in the loss of the Adobe
      agreement and could harm our business.*





We
      have
      negotiated with Canon Inc. regarding the PostScript sublicense agreement between
      us and Canon executed as of April 1, 2001. The sublicense did not include
      several terms required to be included in all OEM sublicenses by our license
      with
      Adobe. Although Adobe has indicated to us that it has no current intention
      to
      pursue claims for alleged breach of the Adobe Peerless PostScript Sublicensing
      Agreement, Adobe has not agreed to waive the requirement that the missing terms
      be included in the Canon sublicense. To date, we have been unable to amend
      the
      Canon sublicense in a manner acceptable to both Canon and Adobe. Furthermore,
      there is no assurance that we will be able to resolve the issues in a manner
      acceptable to both Adobe and Canon. Thus, Adobe may exercise its right to
      terminate its license agreement with us and take other legal action against
      us,
      if it so chooses. Termination of the Adobe agreement would have a material
      adverse effect on our future operating results. See “Risk Factors - We rely on
      relationships with Adobe Systems Incorporated and Novell Inc., and any adverse
      change in those relationships will harm our business” above.




*If
      we
      do not enter into definitive agreements relating to the Memorandum of
      Understanding, or MOU, with Kyocera-Mita Corporation, it may harm our financial
      results.*





We
      may
      never come to agreement with Kyocera-Mita on the terms of definitive agreements
      regarding the development of Kyocera-Mita products by us or enter into
      definitive agreements relating to their relationship with us described in the
      MOU. If the parties do not enter into definitive agreements, our financial
      results may be harmed. We have not yet defined with Kyocera-Mita the products
      that will utilize our technologies, and we have not determined or finalized
      the
      terms and conditions associated with the licensing of our and any third party’s
      technologies arising out of this development relationship. Should the MOU be
      terminated and Kyocera-Mita and the Company not enter into definitive
      agreements, the Company’s cash flows may be materially and adversely affected.
      If the Company does not enter into a licensing agreement with Kyocera-Mita
      for
      the newly developed technologies, the Company’s cash flows may be materially and
      adversely affected and the Company would need to substantially reduce its
      operations to match the decrease in cash flows and may need to seek to raise
      additional capital. Under such circumstances, there is doubt as to whether
      we
      would be able to obtain additional capital on acceptable terms or at
      all.




In
      addition to delays in the finalizing of the definitive agreements, the Company
      has no control over how quickly, if at all, Kyocera-Mita will deliver our
      technologies into the market place for sale. We originally anticipated some
      of
      these technologies would be licensed in the fourth quarter of fiscal year 2007
      and that they would be delivered to the market for sale in late second or early
      third quarter of fiscal year 2008. It does not appear that this timeline will
      be
      achieved and it is uncertain as to when these products will be market ready.
      The
      Company’s expected licensing revenues, by any measure, are a function of many
      factors over which the Company has no control, including but not limited to
      the
      market’s acceptance of Kyocera-Mita products, the continued downward price
      pressure on the suggested retail price of printers in the Kyocera-Mita market
      segments, downward price pressure on the Company’s core intellectual properties
      and the overall volume of printers being delivered to the market.




*The
      uncertainty as to the introduction and success of the Kyocera-Mita products
      could materially and adversely affect our results of
      operations.*




The
      uncertainty as to the introduction and success of the Kyocera-Mita products,
      coupled with a static to declining sales trend of our existing licenses for
      next
      year, downward price pressure on our existing technologies, uncertainty
      surrounding third-party license revenue sharing agreements, (see “ Risk Factors
      - Our current licensing agreement with Adobe Systems International expires
      December 31, 2007, and if we do not enter into an amendment to extend the Adobe
      License Agreement, or enter into a new Adobe licensing agreement before such
      expiration date, this may have a material adverse effect on our operating
      results”), downward price pressure on OEM products and an anticipated
      consolidation of the number of OEMs in the marketplace may result in a decline
      in our operating revenues in the first half of fiscal year 2008. The Company
      is
      currently looking at ways to reduce its operating expenses over the next few
      quarters to achieve profitability as it weathers any delay in the delivery
      of
      new Kyocera-Mita products into the market.  -15-




This
      coupled with a static to declining sales trend of our existing licenses for
      next
      year, downward price pressure on our existing technologies, uncertainty
      surrounding third-party license revenue sharing agreements, (see “Risk Factors -
      Our current licensing agreement with Adobe Systems International expires in
      December 31, 2007 ** and
      if we
      do not enter into an amendment to extend the Adobe License Agreement, or enter
      into a new Adobe licensing agreement before such expiration date, this may
      have
      a material adverse effect on our operating results”), downward price pressure on
      OEM products and an anticipated consolidation of the number of OEMs in the
      marketplace may result in a decline in our operating revenues in the first
      half
      of fiscal year 2008. The Company is currently looking at ways to reduce its
      operating expenses over the next few quarters to achieve profitability as it
      weathers any delay in the delivery of new Kyocera-Mita products into the
      market.




*We
      may be unable to implement our business plan effectively.*




Our
      ability to implement our business plan, develop and offer products and manage
      expansion in rapidly developing and disparate marketplaces requires
      comprehensive and effective planning and management. The growth in the
      complexity of business relationships with current and potential customers and
      third parties has placed, and will continue to place, a significant strain
      on
      management systems and resources. Our failure to continue to improve upon the
      operational, managerial and financial controls, reporting systems and procedures
      in our imaging business or our failure to expand and manage our workforce could
      have a material adverse effect on our business and financial
      results.




*If
      we
      enter new markets or distribution channels this could result in higher operating
      expenses that may not be offset by increased revenue.*




We
      continue to explore opportunities to develop or acquire product lines different
      from our current products, such as software applications for document management
      and workflow, color laser multi-function products, and hardware/peripherals
      and
      communication applications. We expect to invest funds to develop new
      distribution and marketing channels for these new products and services, which
      will increase our operating expenses. We do not know if we will be successful
      in
      developing these channels or whether the market will accept any newly acquired
      products or services or if we will generate sufficient revenues from these
      activities to offset the additional operating expenses we incur. In addition,
      even if we are able to introduce new products or services, if customers do
      not
      accept these new products or services or if we are not able to price such
      products or services competitively, our operating results will likely
      suffer.




*While
      the Company intends to invest in or acquire a software solution company, there
      is no certainty or guarantee that the Company will be successful in finding
      and/or agreeing with a third party for such an investment or acquisition.*





While
      the
      Company intends to invest in or acquire a software solution company, there
      is no
      certainty or guarantee that the Company will be successful in finding and/or
      agreeing with a third party for such an investment or acquisition. In the event
      an agreement is reached, the Company may not have the necessary capital to
      complete a transaction. Even if we do invest in or acquire such a software
      solution company, there is no guarantee that the transaction will be successful
      in producing revenue or profits.




*The
      increased use of low-cost offshore engineering and test labor by our customers
      and competitors as well as the shift by OEMs towards in-house development poses
      significant risks to our competitive position.*





Our
      OEM
      customers, potential customers and competitors continue to seek lower cost
      alternatives for their engineering needs. Some of our OEM customers, potential
      customers and competitors have developed extensive offshore operations that
      may
      be capable of delivering lower cost solutions than we are able to deliver.
      The
      expanding use of lower cost offshore engineering and test labor may make it
      difficult for us to compete based on the  -16-


price
      of
      our services and result in a significant loss of sales. Similarly, our research
      and development costs may be higher than those of our OEM customers, potential
      customers and competitors who are using lower cost offshore engineering
      services, which may result in our development of less technology for a given
      research and development budget than our OEM customers, potential customers
      and/or competitors. In addition, nearly all our OEM customers have significant
      investments in their existing solutions and have the substantial resources
      necessary to enhance existing products and to develop future products. Our
      OEM
      customers have or may develop competing imaging system technologies in-house
      and
      may implement these systems into their products, thereby replacing our current
      or proposed technologies, eliminating the need for our services and products
      and
      limiting future opportunities for us. T hese
      trends could have a negative impact on our competitive position and financial
      results.




*Our
      increased use of low-cost offshore engineering and test labor could
      significantly harm our business.*





We
      continue to investigate ways to effectively increase our use of offshore
      engineering and test labor. In addition to the general risks of doing
      international business as noted below, our relationships with offshore companies
      pose specific risks. For example, although we have entered into confidentiality
      agreements with these offshore companies, we cannot ensure that they will not
      end their relationships with us and use information they gain from their
      relationship with us to launch competing products or offer competing services.
      Similarly, we cannot assure you that key personnel of these offshore companies
      will not be successfully solicited by our competitors especially in geographic
      regions where aggressive solicitation of skilled personnel is common, such
      as
      India and China. Should these companies, their personnel or others with specific
      knowledge of our business and technology, decide to compete with us, it could
      significantly harm our business.




*The
      impact of Microsoft’s Vista* TM *operating
      system could have an adverse impact on our future licensing
      revenues.*





Among
      the
      changes announced for Microsoft’s VistaTM operating system are fundamental
      changes to the printing and networking subsystems within the operating system.
      Of particular relevance to us is Microsoft’s development of a new page
      description language (XPS), and peripheral device connectivity methods (Windows
      Rally), the format of which would be licensed by Microsoft on a royalty-free
      basis to both OEMs and third party technology providers such as us. Should
      we
      fail to support these technologies on a timely basis or should OEMs decide
      to
      support these technologies on their own without the use of our products, it
      could have an adverse impact on our potential licensing revenues from these
      enhanced products. In addition, to the extent that our current PDL products
      are
      perceived as being gradually rendered obsolete over the long term by these
      new
      Microsoft technologies, it could have an adverse impact on our ability to
      generate new sales of our current PDL products.





*If
      we
      are unable to achieve our expected level of sales of* *Peerless
      imaging and networking technologies on a timely basis, our future revenue and
      operating results may be harmed.*





Our
      future operating results will depend to a significant extent on the success
      of
      our new Peerless imaging and networking technologies including licensing revenue
      from these new technologies *.* We have
      spent a significant amount of time and capital developing our new Peerless
      imaging and networking technologies *.* Peerless
      high performance color technologies ** may
      not
      be accepted by the marketplace for many reasons including, among others,
      incompatibility with existing or forthcoming systems, lack of perceived need
      by
      customers, uncertainty whether the benefits exceed the cost, the availability
      of
      alternatives and the unwillingness to use new or unproven products. If the
      marketplace does not accept Peerless imaging and networking
      technologies ** or
      if the
      marketplace takes additional time to accept Peerless imaging and networking
      technologies ** than
      we
      expect, our future revenues and operating results may be harmed.





*Our
      licensing revenue is subject to significant fluctuations*





Our
      recurring licensing revenue model has shifted from per-unit royalties paid
      upon
      OEM shipment of our product and guaranteed quarterly minimum royalties to a
      model that results in revenues associated with the sale of SDKs and block
      licenses. The reliance on block licenses has occurred due to aging OEM products
      in the marketplace, OEM demands in negotiating licensing agreements, reductions
      in the number of OEM products  -17-


shipping
      and a product mix that changed from object code licensing arrangements to SDKs.
      Revenues may continue to fluctuate significantly from quarter to quarter as
      the
      number and value of design wins vary, or if the signing of block licenses are
      delayed or the licensing opportunities are lost to competitors. Any of these
      factors could have a material adverse effect on our operating
      results.




*Our
      revenue from engineering services is subject to significant
      fluctuations.*





We
      have
      experienced a significant reduction in the financial performance of our
      engineering services that has been caused by many factors,
      including:





•
            product
                development delays;





•
            potential
                non-recurring engineering reduction for product
                customization;





•
            third
                party delays;





•
            loss
                of new engineering services contracts;
                and





•
            globalization
                of the engineering workforce.





There
      can
      be no assurance that these and similar factors will not continue to impact
      future engineering services results adversely.




*We
      may be unable to deploy our employees effectively in connection with changing
      demands from our OEM customers.*





The
      industry in which we operate has experienced significant downturns, both in
      the
      United States and abroad, often in connection with, or in anticipation of,
      maturing product cycles and declines in general economic conditions. Over the
      past four years, we have experienced a shift in OEM demand from the historically
      prevailing requirement for turnkey solutions toward SDKs. Because Peerless
      has
      experienced a general decrease in demand for engineering services, engineering
      services resources have been re-deployed to research and development. Should
      this trend abruptly change, we may be unable to re-deploy labor effectively
      and
      in a timely manner, which inability could have a material adverse effect on
      our
      operating results.




*The
      future demand for our products is uncertain.*




Our
      monochrome technology and products have been in the marketplace for an average
      of more than 33 months as of January 31, 2007. The average age of current
      technology and products in the marketplace reflects the aging of our monochrome
      technology and products. OEMs, in a number of instances, have not selected
      our
      solutions because the OEMs perceived that our solutions did not meet their
      technical requirements, developed the technology themselves or utilized lower
      cost offshore software competitors. Although we continue to license our current
      technology and products to certain OEMs, there can be no assurance that the
      OEMs
      will continue to need or utilize the products and technology we currently
      offer.




*We
      have a history of losses.*




Although
      we were profitable in fiscal years 2007 and 2006, we had been unprofitable
      in
      four of the previous five fiscal years. There is no assurance that we will
      continue to be profitable at any time in the future.


-18-




*We
      may be unable to develop additional new and enhanced products that achieve
      market acceptance.*




Our
      future success also depends in part on our ability to address the rapidly
      changing needs of potential customers in the marketplace, to introduce
      high-quality, cost-effective products, product enhancements and services on
      a
      timely basis, and to keep pace with technological developments and emerging
      industry standards. Our failure to achieve our business plan to develop and
      to
      successfully introduce new products and product enhancements in our prime
      markets would materially and adversely affect our business and financial
      results.




*If
      we
      are not in compliance with our licensing agreements, we may lose our rights
      to
      sublicense technology; our competitors are aggressively pursuing the sale of
      licensed third party technology.*





We
      currently sublicense third party technologies to our OEM customers, which
      sublicenses accounted for $15.2 and $17.7 in licensing revenue in fiscal 2007
      and 2006, respectively. Such sublicense agreements are non-exclusive. If
      Peerless is determined not to be in compliance with agreements between us and
      our licensors, we may forfeit our right to sublicense these technologies.
      Likewise, if such sublicense agreements expired, we would lose our right to
      sublicense the affected technologies. Additionally, the licensing of these
      technologies has become very competitive, with competitors possessing
      substantially greater financial and technical resources and market penetration
      than us. As competitors are pursuing aggressive strategies to obtain similar
      rights as held by us to sublicense these third party technologies, there is
      no
      assurance that we can remain competitive in the marketplace if one or more
      competitors are successful. See, “Risk Factors - We have negotiated with Adobe
      Systems Incorporated and Canon, Inc. to remedy a contract dispute, which, if
      not
      remedied, could result in the loss of the Adobe agreement and harm our
      business.”




*The
      industry for imaging systems for digital document products involves intense
      competition and rapid technological changes, and our business may suffer if
      our
      competitors develop superior technology.*





The
      market for imaging systems for digital document products is highly competitive
      and characterized by continuous pressure to enhance performance, to introduce
      new features and to accelerate the release of new products. We compete on the
      basis of technology expertise, product functionality, development time and
      price. Our technology and services primarily compete with solutions developed
      internally by OEMs. Virtually all of our OEM customers have significant
      investments in their existing solutions and have the substantial resources
      necessary to enhance existing products and to develop future products. These
      OEMs possess or may develop competing imaging systems technologies and may
      implement these systems into their products, thereby replacing our current
      or
      proposed technologies, eliminating a need for our services and products and
      limiting our future opportunities. Therefore, we must persuade these OEMs to
      outsource the development of their imaging systems to us and to provide products
      and solutions to these OEMs that cost-effectively compete with their internally
      developed products. We also compete with software and engineering services
      provided in the digital document product marketplace by other systems suppliers
      to OEMs.




As
      the
      digital document printing industry continues to develop, competition and pricing
      pressures will increase from OEMs, existing competitors and other companies
      that
      may enter our existing or future markets with similar or substitute solutions
      that may be less costly or provide better performance or functionality. We
      anticipate increasing competition for our color products under development,
      particularly as new competitors develop and sell competing products. Some of
      our
      existing competitors, many of our potential competitors, and virtually all
      of
      our OEM customers have substantially greater financial, technical, marketing
      and
      sales resources than we have. If price competition increases, competitive
      pressures could require us to reduce the amount of royalties received on new
      licenses and to reduce the cost of our engineering services in order to maintain
      existing business and generate additional product licensing revenues. This
      could
      reduce profit margins and result in losses and a decrease in market share.
      We
      cannot assure you that we have the ability to compete favorably with the
      internal development capabilities of our current and prospective OEM customers
      or with other third party digital imaging system suppliers and the failure
      to
      compete effectively would have a material adverse effect on our operating
      results.  -19-




*If
      we
      fail to adequately protect our intellectual property or face a claim of
      intellectual property infringement by a third party, we could lose our
      intellectual property rights or be liable for damages.*





Our
      success is heavily dependent upon our proprietary technology. To protect our
      proprietary rights, we rely on a combination of patent, copyright, trade secret
      and trademark laws, as well as the early implementation and enforcement of
      nondisclosure and other contractual restrictions. As part of our confidentiality
      procedures, we enter into written nondisclosure agreements with our employees,
      consultants, prospective customers, OEMs and strategic partners and take
      affirmative steps to limit access to and distribution of our software,
      intellectual property and other proprietary information.




Despite
      these efforts, and in the event such agreements are not timely made, complied
      with or enforced, we may be unable to effectively protect our proprietary rights
      and the enforcement of our proprietary rights may be cost prohibitive.
      Unauthorized parties may attempt to copy or otherwise obtain, distribute, or
      use
      our products or technology. Monitoring unauthorized use of our products is
      difficult. We cannot be certain that the steps we take to prevent unauthorized
      use of our technology, particularly in countries where the laws may not protect
      proprietary rights as fully as in the United States, will be
      effective.




Our
      source code also is protected as a trade secret. However, from time to time
      we
      license our source code to OEMs, which subjects us to the risk of unauthorized
      use or misappropriation despite the contractual terms restricting disclosure,
      distribution, copying and use. In addition, it may be possible for unauthorized
      third parties to obtain, distribute, copy or use our proprietary information
      or
      to reverse engineer our trade secrets.




We
      hold
      patents issued in the United States, France, Germany, Great Britain, Japan,
      Taiwan and Hong Kong. The issued patents relate to techniques developed by
      us
      for generating output for continuous synchronous raster output devices, such
      as
      laser printers, compressing data for use with output devices, filtering
      techniques for use with output devices and communicating with peripheral devices
      over a network. We also have patent applications pending in the United States,
      the European Patent Office, Japan, Hong Kong, Taiwan, China, Australia, Korea,
      and India. There can be no assurance that patents we hold will not be challenged
      or invalidated, that patents will issue from any of our pending applications
      or
      that any claims allowed from existing or pending patents will be of sufficient
      scope or strength (or issue in the countries where products incorporating our
      technology may be sold) to provide meaningful protection or be of any commercial
      advantage to us. In any event, effective protection of intellectual property
      rights may be unavailable or limited in certain countries. The status of United
      States patent protection in the software industry will evolve as the United
      States Patent and Trademark Office grants additional patents. Patents have
      been
      granted to fundamental technologies in software after the development of an
      industry around such technologies and patents may be issued to third parties
      that relate to fundamental technologies related to our technology.




As
      the
      number of patents, copyrights, trademarks and other intellectual property rights
      in our industry increases, products based on our technologies may become the
      subjects of infringement claims. There can be no assurance that third parties
      will not assert infringement claims against us in the future. Any such claims,
      regardless of merit, could be time consuming, divert the efforts of our
      technical and management personnel from productive tasks, result in costly
      litigation, cause product shipment delays or require us to enter into royalty
      or
      licensing agreements. Such royalty or licensing agreements, if required, may
      not
      be available on terms acceptable to us, or at all, which could have a material
      adverse effect on our operating results. In addition, we may initiate claims
      or
      litigation against third parties for infringement of our proprietary rights
      or
      to establish the validity of our proprietary rights. Litigation to determine
      the
      validity of any claims, whether or not such litigation is determined in our
      favor, could result in significant expenses and divert the efforts of our
      technical and management personnel from productive tasks. In addition, we may
      lack sufficient resources to initiate a meritorious claim. In the event of
      an
      adverse ruling in any litigation regarding intellectual property, we may be
      required to pay substantial damages, discontinue the use and sale of infringing
      products and expend significant resources to develop non-infringing technology
      or obtain licenses to infringing or substituted technology. Our failure to
      develop, or license on acceptable terms, a substitute technology, if required,
      could have a material adverse effect on our operating results.


-20-




*We
      currently face a potential claim of intellectual property infringement from
      Acacia Technologies Group, through one of our customers, and we may be liable
      for damages.*





Acacia
      Technologies Group ("Acacia") has recently made an allegation of patent
      infringement against one of our customers.  Our customer has requested that
      we handle Acacia's claims as it believes that the allegedly
      infringing functionality is resident in third party software which we
      sublicensed to them for use in certain of its products.  We are currently
      trying to determine if the allegedly infringing functionality is resident
      in the third party software, as alleged by our customer.  We may be unable
      to resolve this allegation of patent infringement with our customer or Acacia,
      or obtain any indemnification from the third party software provider from whom
      we licensed the software. This allegation of patent infringement could be time
      consuming, divert the efforts of our technical and management personnel from
      productive tasks, result in costly litigation, cause product shipment delays
      or
      require us to enter into royalty or licensing agreements.  In the event of
      an adverse ruling affecting us, we may be required to pay substantial
      damages and/or discontinue the use of such infringing patents.  Our
      failure to use such patents, if required, could have a material adverse effect
      on our licensing revenues and our operating results.




*Our
      international activities may expose us to risks associated with international
      business.*





We
      are
      substantially dependent on our international business activities. Risks inherent
      in these international business activities include:





•
            major
                currency rate fluctuations;





•
            changes
                in the economic condition of foreign countries;





•
            the
                imposition of government controls;





•
            tailoring
                of products to local requirements;





•
            trade
                restrictions;





•
            changes
                in tariffs and taxes; and





•
            the
                burdens of complying with a wide variety of foreign laws and regulations,
                any of which could have a material adverse effect on our operating
                results.





If
      we are
      unable to adapt to international conditions, our business may be adversely
      affected.




*We
      rely on the services of our executive officers and other key personnel, whose
      knowledge of our business and industry would be extremely difficult to
      replace.*





Our
      success depends to a significant degree upon the continuing contributions of
      our
      senior management. Management and other employees may voluntarily terminate
      their employment with us at any time upon short notice. The loss of key
      personnel could delay product development cycles or otherwise harm our business.
      We believe that our future success will also depend in large part on our ability
      to attract, integrate and retain highly-skilled engineering, managerial, sales
      and marketing personnel. Competition for such personnel is intense, and we
      may
      not be successful in attracting, integrating and retaining such personnel.
      Failure to attract, integrate and retain key personnel could harm our ability
      to
      carry out our business strategy and compete with other companies.




*Our
      stock price may experience extreme price and volume
      fluctuations.*




Our
      common stock has experienced price volatility. In the 60-day period ending
      February 28, 2007, the closing price of the stock ranged from $2.00 per share
      to
      $2.68 per share. For the period beginning February 1, 2006 and ending January
      31, 2007 the stock as closed as low as $2.29 per share and as high as $9.91
      per
      share. Such price volatility may occur in the future. Factors that could affect
      the trading price of our common stock include:  -21-




•
            macroeconomic
                conditions;





•
            actual
                or anticipated fluctuations in quarterly results of
                operations;





•
            announcements
                of new products or significant technological innovations by us or
                our
                competitors;





•
            developments
                or disputes with respect to proprietary rights;





•
            losses
                of major OEM customers;





•
            general
                trends in the industry;





•
            overall
                market conditions and other factors;
                and





•
            change
                in executive management.





In
      addition, the stock market historically has experienced extreme price and volume
      fluctuations, which have particularly affected the market price of securities
      of
      many related high technology companies and which at times have been unrelated
      or
      disproportionate to the operating performance of such companies.




*Our
      common stock was moved to the Nasdaq Capital Market and may not provide adequate
      liquidity.*





On
      July
      30, 2004, we announced that our common stock had been transferred from the
      Nasdaq National Market to the Nasdaq Capital Market. There can be no assurance,
      however, that we will be able to maintain compliance with the continued listing
      standards of the Nasdaq Capital Market. For example, if the minimum bid price
      of
      our common stock falls below $1.00, and remains below $1.00 for thirty
      consecutive business days, we will not be in compliance with the Nasdaq Capital
      Market minimum bid requirements under Marketplace Rule 4310(c)(4).




If
      we are
      not able to maintain compliance, our common stock may be subject to removal
      from
      listing on the Nasdaq Capital Market. Trading in our common stock after a
      delisting, if any, would likely be conducted in the over-the-counter markets
      in
      the so-called “pink sheets” or the National Association of Securities Dealers’
Electronic Bulletin Board and could also be subject to additional restrictions.
      As a consequence of a delisting, our stockholders would find it more difficult
      to dispose of, or to obtain accurate quotations as to the market value of,
      our
      common stock. In addition, a delisting would make our common stock substantially
      less attractive as collateral for margin and purpose loans, for investment
      by
      financial institutions under their internal policies or state legal investment
      laws or as consideration in future capital raising transactions.




*Failure
      to maintain our Nasdaq listing would adversely affect the trading price and
      liquidity of our common stock*





On
      December 27, 2006, the Company notified Nasdaq that, upon the effectiveness
      of
      the resignation of Thomas G. Rotherham from the Board of Directors and the
      Audit
      Committee on December 31, 2006, the Company would no longer be in compliance
      with Nasdaq Rule 4350(d)(2)(A), which requires each listed company to have
      an
      audit committee of at least three “independent” (as defined) members. On
      December 27, 2006, the Company received a letter from Nasdaq confirming that
      (i)
      the Company is not in compliance with Nasdaq’s audit committee composition
      requirement under Rule 4350(d)(2)(A), and (ii) Nasdaq will provide the Company
      a
      cure period in order to regain compliance as follows:




·
            until
                the earlier of the Company’s next annual meeting of stockholders or
                December 27, 2007; or




·
            if
                the next annual meeting of stockholders is held before June 25, 2007,
                then
                the Company must evidence compliance no later than June 25,
                2007.




The
      Company’s next annual meeting of stockholders is currently scheduled for June
      11, 2007. If the annual meeting is held on that date, the Company must have
      appointed at least one additional independent director to the  -22-


Board
      of
      Directors and the Audit Committee to fill the vacancy caused by Mr. Rotherham’s
      resignation by the date of such meeting or face possible delisting from Nasdaq.
      If we were delisted from Nasdaq we may apply for listing on another exchange.
      However, there is no assurance that we will meet the requirements for initial
      listing or maintain compliance with the continued listing requirements of such
      an exchange. As a result of the delisting, trading in our common stock would
      continue to be conducted in the over-the counter market. As a result, an
      investor could find it more difficult to dispose of or obtain accurate
      quotations as to the market value of our common stock. Delisting from Nasdaq
      would adversely affect the trading price of our common stock and significantly
      limit the liquidity of our common stock.




*We,
      as a sublicensor of third party intellectual property, are subject to audits
      of
      our licensing fee costs.*





Certain
      of our licensing agreements include third party intellectual property and result
      in royalties contractually due and payable to the third parties. The language
      of
      the contract is subject to interpretation and may result in disputes. We are
      subject to audits of our data serving as the basis for the royalties due. Such
      audits may result in adjustments to the royalty amounts due.




*There
      was a material weakness in revenue recognition as of fiscal year end January
      31,
      2007, which was the result of an operational deficiency. Specifically, our
      controls were not adequate to capture and analyze all the various terms of
      software contracts to ensure proper application of generally accepted accounting
      principles in the United States as it relates to the recording of revenue and
      costs associated with these contracts. Under regulations required by the
      Sarbanes-Oxley Act of 2002 (SOX), an adverse opinion on internal controls over
      financial reporting will be issued by our independent registered public
      accounting firm, and this could have a negative impact on our stock
      price.*





Section
      404 of SOX requires that we establish and maintain an adequate internal control
      structure and procedures for financial reporting and assess on an on-going
      basis
      the design and operating effectiveness of the internal control structure and
      procedures for financial reporting. Our independent registered public accounting
      firm is required to attest and audit both the design and operating effectiveness
      of our internal controls and management’s assessment of the design and the
      effectiveness of our internal controls beginning with the fiscal year ending
      on
      January 31, 2007 because we will become an accelerated-filer as defined by
      the
      SEC rules on January 31, 2007. During management’s assessment of internal
      controls for fiscal year 2007, management determined that a material weakness
      existed with regard to the operation of our revenue recognition process. If
      we
      are not successful in the remediation of this material weakness, it could have
      a
      material adverse effect on our results of operation in future periods and could
      have a negative impact on our stock price. It is possible that other material
      weaknesses may be found in the future.




*Recent
      and proposed regulations related to equity incentives could adversely affect
      our
      ability to attract and retain key personnel.*




Since
      our
      inception, we have used stock options and other long-term equity incentives
      as a
      fundamental component of our employee retention packages. We believe that stock
      options and other long-term equity incentives directly motivate our employees
      to
      maximize long-term stockholder value and, through the use of vesting, encourage
      employees to remain with us. The Financial Accounting Standards Board has
      announced changes that we have implemented in the first quarter of fiscal 2007
      quarter ending April 30, 2006 requiring us to record a charge to earnings for
      employee stock option grants and issuances of stock under employee stock
      purchase plans. This regulation negatively impacts our results of operations.
      In
      addition, new regulations implemented by the Nasdaq Capital Market requiring
      shareholder approval for all stock option plans could make it more difficult
      for
      us to grant options to employees in the future. To the extent that new
      regulations make it more difficult or expensive to grant options to employees,
      incur increased costs, change our equity incentive strategy or find it difficult
      to attract, retain and motivate employees, could materially and adversely affect
      our business.


-23-




**Item
      1B.  Unresolved Staff Comments**





None





**Item
      2.  Properties**





We
      lease
      our headquarters and primary administrative and research facilities in El
      Segundo, California. We also lease office space in Kent, Washington for PSIP
      and
      office space in Tokyo, Japan. We believe that our existing leased space is
      more
      than adequate for our current operations.





**Use**
            **Address**
            **Owned
                /**
              **Leased**
              **Expiration**
            **Approximate
                size**
              **(sq.
                ft.)**
            **Approximate**
              **Rental
                / Mo****Peerless
                System Corporation**
            **2381
                Rosecrans Avenue**
              **El
                Segundo, California 90245**
            **Leased**
              **June,
                2006**
            **44,
                653**
            **$102,702****Peerless
                Systems Imaging Products**
            **20415
                72****nd****Avenue S. Suite 400**
              **Kent,
                Washington 98032**
            **Leased**
              **Oct,
                2009**
            **10,756**
            **$10,308****Peerless
                Systems KK**
            **AIOS
                Gotanda 405**
              **1-10-7
                Higashi- Gotanda**
              **Shinagawa-ku**
              **Tokyo
                141-0022, Japan**
            **Leased**
              **Oct,
                2009**
            **426**
            **$3,299**




**Item
      3.  Legal Proceedings**





The
      Company is involved in various routine legal proceedings incidental to the
      conduct of its business, including those identified below. In accordance with
      SFAS No. 5, “Accounting Contingencies,” the Company records a provision for a
      liability when management believes that it is probable that a liability has
      been
      incurred and the Company can reasonably estimate the amount of the loss. The
      Company does not believe there is a need for such a provision at this time.
      The
      Company reviews these provisions at least quarterly and adjusts these provisions
      to reflect the impact of negotiations, settlements, rulings, advice of legal
      counsel and other information and events pertaining to a particular proceeding. See
      "Risk
      Factors - We have negotiated with Adobe Systems Incorporated and Canon Inc.
      to
      remedy a contract dispute, which if not remedied, could result in the loss
      of
      the Adobe agreement and could harm our business."  See also "Risk Factors -
      We currently face a potential claim of intellectual property infringement from
      Acacia Technologies Group, through one of our customers, and we may be liable
      for damages.”




**Item
      4.  Submission of Matters to a Vote of Security
      Holders**





No
      matters were submitted to a vote of our stockholders during the fourth quarter
      of fiscal year 2007.


-24-




**PART
      II**





**Item
          5.****Market
          for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
          of Equity Securities**





Our
      common stock was traded on the Nasdaq National Market under the symbol “PRLS”
from our initial public offering on September 26, 1996 until July 30, 2004
      when
      our common stock was moved to the Nasdaq Capital Market. The table below sets
      forth, during the periods indicated, the high and low sales price for our common
      stock as reported on the Nasdaq Capital Market.




**Fiscal
                Year Ended January 31,****2007**
            
            **2006****Quarter**
            
            **High**
            
            **Low**
            
            **High**
            
            **Low**First
            
            $
            10.00
            
            $
            5.81
            
            $
            3.30
            
            $
            1.30Second
            
            $
            7.60
            
            $
            4.15
            
            $
            4.20
            
            $
            2.56Third
            
            $
            5.00
            
            $
            2.55
            
            $
            8.19
            
            $
            3.66Fourth
            
            $
            4.23
            
            $
            2.15
            
            $
            9.65
            
            $
            6.31





The
      closing price of our common stock on April 10, 2007 was $2.36. Shareholders
      are
      urged to obtain current market quotations for our common stock. As of April
      10,
      2007, there were approximately 100 holders of record of our common
      stock.





**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      information included under Item 12 of Part III of this report is hereby included
      by reference into Item 5 of this report.





**Dividend
      Policy**





We
      have
      not declared or paid any cash dividends on our common stock during any period
      for which financial information is provided in this Annual Report on Form 10-K.
      We currently intend to retain future earnings, if any, to fund the development
      and growth of our business and do not anticipate paying any cash dividends
      on
      our common stock in the foreseeable future.









-25-




The
      table
      below sets forth, during the periods indicated, a comparison of cumulative
      total
      return of one or more companies, peer groups, industry indexes and/or broad
      markets:




**Years
                Ended January 31,****2007**
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Company/index/market:**Peerless
                Systems Corporation
            
            $
            178.91
            
            $
            510.16
            
            $
            103.13
            
            $
            199.22
            
            $
            115.63
            
            $
            100.00Application
                Software
            
            $
            108.79
            
            $
            98.09
            
            $
            88.98
            
            $
            87.84
            
            $
            68.68
            
            $
            100.00NASDAQ
                US only
            
            $
            138.31
            
            $
            126.98
            
            $
            111.45
            
            $
            111.03
            
            $
            69.82
            
            $
            100.00




**Item
      6.  Selected Financial Data**





The
      statement of operations data for the fiscal years ended January 31, 2007, 2006,
      2005, and the balance sheet data at January 31, 2007 and 2006 are derived from,
      and should be read in conjunction with, the audited consolidated financial
      statements and notes thereto included elsewhere in this Annual Report on Form
      10-K. The data set forth below (in thousands, except per share data) are
      qualified in their entirety by, and should be read in conjunction with,
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” and the audited consolidated financial statements and notes thereto
      included elsewhere in this Annual Report on Form 10-K.




**Years
                Ended January 31,****2007**
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**(In
                thousands)**Statement
                of Operations Data:**Net
                sales
            
            $
            33,383
            
            $
            36,157
            
            $
            23,078
            
            $
            25,254
            
            $
            31,757Income
                (loss) from operations
            
            
            2,841
            
            
            4,347
            
            
            (5,677
            )
            
            (5,793
            )
            
            240Net
                income (loss)
            
            
            3,286
            
            
            4,314
            
            
            (5,805
            )
            
            (4,861
            )
            
            124Basic
                earnings (loss) per share
            
            
            0.19
            
            
            0.26
            
            
            (0.37
            )
            
            (0.31
            )
            
            0.01Diluted
                earnings (loss) per share
            
            
            0.17
            
            
            0.23
            
            
            (0.37
            )
            
            (0.31
            )
            
            0.01








**Years
                Ended January 31,****(In
                thousands)****2007**
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003****Balance
                Sheet Data:**Total
                assets
            
            $
            23,601
            
            $
            20,034
            
            $
            12,647
            
            $
            19,307
            
            $
            24,107Long-term
                obligations
            
            
            459
            
            
            275
            
            
            418
            
            
            366
            
            
            1,384




**Selected
      Quarterly Financial Data (Unaudited):**





**Year
                Ended January 31, 2007**
            
            **Year
                Ended January 31, 2006****(In
                thousands)****Quarter**
            
            **Fourth**
            
            **Third**
            
            **Second**
            
            **First**
            
            **Fourth**
            
            **Third**
            
            **Second**
            
            **First**Net
                sales
            
            $
            8,704
            
            $
            7,980
            
            $
            7,896
            
            $
            8,804
            
            $
            9,638
            
            $
            9,646
            
            $
            9,658
            
            $
            7,215Gross
                margin
            
            
            5,495
            
            
            3,374
            
            
            4,276
            
            
            6,190
            
            
            5,494
            
            
            4,972
            
            
            4,727
            
            
            3,916Gross
                margin %
            
            
            63.13
            %
            
            42.28
            %
            
            54.15
            %
            
            70.31
            %
            
            57.00
            %
            
            51.51
            %
            
            48.94
            %
            
            54.28
            %Income
                (loss) from operations
            
            $
            1,460
            
            $
            (128
            )
            $
            (438
            )
            $
            1,946
            
            $
            1,732
            
            $
            1,053
            
            $
            1,124
            
            $
            437Net
                income (loss)
            
            $
            1,588
            
            $
            (18
            )
            $
            (327
            )
            $
            2,043
            
            $
            1,755
            
            $
            1,045
            
            $
            1,100
            
            $
            414Basic
                earnings (loss) per share
            
            
            0.09
            
            
            —
            
            
            (0.02
            )
            
            0.12
            
            
            0.10
            
            
            0.06
            
            
            0.07
            
            
            0.03Diluted
                earnings (loss) per share
            
            
            0.09
            
            
            —
            
            
            (0.02
            )
            
            0.11
            
            
            0.09
            
            
            0.06
            
            
            0.06
            
            
            0.02





**Item
      7.  Management’s Discussion and Analysis of Financial
      Condition and Results of Operations**





The
      following analysis contains forward-looking statements that involve risks and
      uncertainties. The statements contained in this Annual Report on Form 10-K
      that
      are not purely historical are forward-looking statements within  -26-


the
      meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
      Securities Exchange Act of 1934, including without limitation, statements
      regarding our expectations, beliefs, intentions or strategies regarding the
      future. All forward-looking statements included in this Annual Report on Form
      10-K are based on current expectations, estimates, forecasts and projections
      about the industry in which we operate, management’s beliefs and assumptions
      made by management. These statements are not guarantees of future performance
      and involve certain known and unknown risks, uncertainties and assumptions
      that
      are difficult to predict. Therefore, actual outcomes and results may differ
      materially from what is expressed or forecasted in such forward-looking
      statements. We undertake no obligation to update publicly any forward-looking
      statements, whether as a result of new information, future events or otherwise.
      For a discussion of factors and trends that could impact our business and
      results, please refer to the section above entitled “Risk Factors.”





The
      following should be read in conjunction with the audited consolidated financial
      statements and related notes thereto contained in this Annual Report on Form
      10-K.





**Highlights**





Consolidated
      revenues for fiscal year 2007 were $33.4 million, a 7.7% decline from the prior
      fiscal year. The decrease in revenues was primarily attributable to the
      discontinuation of our Everest Controller sales in the fourth quarter of fiscal
      2006 and our loss of revenues associated with the PMC-Sierra contract early
      in
      the year. Engineering services and maintenance revenues declined 5.8% primarily
      due to downward price pressure arising from an increasingly competitive global
      workforce as well as substantial pressure towards consolidation on our OEM
      customers. Product licensing revenues increased slightly as a result of an
      aggressive push by our sales and marketing department to close $16.7 million
      in
      block license revenues in fiscal 2007.





The
      company hired a new chief executive officer in the middle of the fourth quarter
      and has implemented a restructuring plan that is intended to streamline the
      business and improve operational efficiencies. In addition to a renewed emphasis
      on profitable operation, the chief executive officer initiated a detailed
      examination of the existing business and is in the process of evaluating
      strategic alternatives to fuel growth outside the core disciplines of imaging,
      Adobe postscript, networking and hardware IP. These alternatives may be select
      product segments that may blend well with our core business and be additive
      to
      our top-line performance over the long term. This may involve acquisitions,
      joint venture opportunities and strategic relationships and our focus is in
      the
      application software sector and all-in-one device market. Any new strategic
      initiative will bring new risks and we may not be successful. Nonetheless we
      are
      excited by the direction we have embarked on and the opportunities we are
      exploring with the objective of improving the growth performance of the
      business.





General
      and administrative expenses increased 21% over fiscal 2006 to $6.7 million.
      This
      increase was primarily due to a one-time charge associated with our reduction
      in
      work force; a one-time charge associated with the consultancy agreement with
      our
      former CEO, stock-based compensation expense that has not been required to
      be
      recorded in the Statement of Operations in previous years, Sarbanes-Oxley
      compliance expenses resulting from our recent classification as an accelerated
      filer and non-recurring legal fees associated with contractual matters related
      to agreements with some of our larger customers.





Our
      product development relationship with Kyocera-Mita is very meaningful to us.
      We
      are encouraged by the long-range opportunities this relationship represents
      to
      the Company. As has been stated in the past, we have no influence over when
      products containing Peerless technologies will enter the market, or how much
      Peerless IP will be included. The Company’s expected licensing revenues, by any
      measure, are a function of many factors over which the Company has no control,
      including, but not limited to, the market’s acceptance of Kyocera-Mita products,
      the continued downward pressure on the suggested retail price of printers in
      the
      Kyocera-Mita market segments, downward price pressure on the Company’s core
      intellectual properties and the overall volume of printers being delivered
      to
      the market. We are seeking to finalize the Kyocera-Mita agreements and position
      the Company to realize the benefit of these licensing agreements as soon as
      possible. Our ability to finalize these agreements is crucial to our
      profitability. See Note 14 of the Consolidated Financial Statements, included
      herein for subsequent events.




As
      previously stated, we are looking into alternatives to fuel growth and reduce
      our revenue concentration risks with our large OEM customers. In 2006, our
      top
      three customers accounted for 60% of our total revenues and we


-27-




saw
      this
      customer reliance deteriorate to our top two customers accounting for 70% of
      our
      total revenues in 2007. One of our key OEM customers no longer accounted for
      more than 10% of total revenues in that year. This customer concentration risk,
      as well as our reliance on the block licensing model, demonstrates our need
      to
      look for growth outside our core markets.





We
      have
      experienced two consecutive profitable fiscal years, 2007 and 2006. Prior to
      2006 we were unprofitable in four of the previous five fiscal years. There
      are
      many risks and uncertainties that may impact our performance and there can
      be no
      assurances that we will continue to be profitable at any time in the
      future.




As
      a
      result of the potential decline of OEM revenue and an uncertain future, the
      Company intends to diversify its business to better ensure growth and
      profitability. The Company intends to seek to maximize its strength in the
      following traditional core areas: imaging, Adobe PostScriptTM, networking and
      hardware IP. In addition, we will focus on the solution software application
      area and the all-in-one, or AIO, marketplace. This would be attractive
      primarily, but not exclusively, to our existing customer base and could lead
      to
      additional revenue opportunities. The Company plans to seek to acquire or invest
      in existing business enterprises to accomplish this goal. While the Company
      has
      begun research and investigation, no agreement has been entered into with any
      third party. It is our expectation that this strategy will strengthen our
      revenue streams and help achieve long term earnings growth. Our inability to
      implement our strategic plan, develop and offer products, and manage expansion
      in the aforementioned marketplaces, as well as the static to declining sales
      trend of our existing licenses, downward price pressure on our existing
      technologies, uncertainty surrounding third party license revenue sharing
      agreements, downward price pressure on OEM products and the anticipated
      consolidation of the number of OEMs in the marketplace, may have a material
      adverse effect on our business and financial results. See, “Item 1A. Risk
      Factors.”




**General**





We
      generate revenue from our OEMs through the licensing of our imaging solutions
      in
      SDK form and the sale of engineering services. Beginning in fiscal year 2000,
      we
      experienced a shift in demand away from turnkey engineering services contracts
      towards demand for software solutions in the form of SDKs. We have attempted
      to
      expand our high performance color solutions by seamlessly incorporating our
      networking technologies and related imaging technologies licensed from third
      parties into SDKs.




Our
      product licensing revenues are comprised of both recurring per unit and block
      licensing revenues and development licensing fees for source code or SDKs.
      Licensing revenues are derived from per unit fees paid periodically by our
      OEM
      customers upon manufacturing and subsequent commercial shipment of products
      incorporating our technology. Licensing revenues are also derived from
      arrangements in which we enable third party technology, such as solutions from
      Adobe or Novell, to be used with Peerless’ and/or our OEM partners’
products.




Block
      licenses are per unit licenses made in large volume quantities to an OEM for
      products either in or about to enter into distribution into the marketplace.
      Payment schedules for block licenses are negotiable and payment terms are often
      dependent on the size of the block and other terms and conditions of the block
      license being acquired. Typically, payments are made in either one lump sum
      or
      over a period of four quarters.




Revenue
      received for block licenses is recognized in accordance with SOP 97-2, which
      requires that revenue be recognized after acceptance by the OEM and if fees
      are
      fixed and determinable and the collection of fees is probable and the company
      has no future obligations. For block licenses that have payments due within
      twelve months, revenue is recognized at the time the block license becomes
      effective, assuming all other revenue recognition criteria has been
      met.




We
      also
      have engineering services revenues that are derived primarily from adapting
      our
      software and supporting electronics to specific OEM requirements. We provide
      our
      engineering services to OEMs seeking a turnkey imaging solution for their
      digital document products. Our maintenance revenues are derived from software
      maintenance agreements. Maintenance revenues currently constitute a small
      portion of total revenue.




Historically,
      a limited number of customers have provided a substantial portion of our
      revenues. Therefore, the availability and successful closing of new contracts,
      amendments to existing contracts or modifications or additions


-28-




to
      existing contracts with these customers may materially impact our financial
      position and results of operations from quarter to quarter.





Our
      technology has addressed the worldwide market for monochrome printers (21-69
      pages per minute) and MFP (21-151 pages per minute). This market has been
      consolidating, and the demand for the monochrome technology and products offered
      by us declined throughout fiscal year 2007.





OEMs
      have
      continued to reduce the absolute number of new products being developed and
      in
      some instances, OEMs have preferred to perform in-house development projects
      for
      the products that they are developing and/or planning to launch. Although there
      have been fewer opportunities for us to sell our turnkey services and SDKs,
      we
      continue to support our current OEM controller customers in the digital printing
      devices business with our existing and new technologies.





In
      response to our concern that the demand for our core monochrome offerings may
      decline and that we may continue to meet sales resistance from our customers,
      we
      have developed and commercialized high performance color imaging and printing
      technologies and a new open architecture *.* We
      believe that our products based on the Peerless high performance color
      architecture address key growth areas in the imaging market including: increased
      demand for color imaging, the emergence of AIOs, and continued demand for faster
      low cost monochrome printing solutions.




In
      addition, as a result of the complexities of the imaging industry, we continue
      to explore opportunities to enhance shareholder value, including aggressive
      marketing of our new technologies, developing new market opportunities, raising
      additional capital and evaluating potential merger and acquisition
      candidates.




As
      a
      result of potential decline of OEM revenue and uncertainty of future engineering
      services contracts of significant size the Company intends to diversify its
      business to better ensure growth and profitability. The Company intends to
      maximize its strength in the following traditional core areas: imaging; Adobe
      PostScriptTM; networking; and hardware intellectual property. In addition, the
      short term focus is on the solution software application area that would be
      attractive to primarily, but not exclusively, to our existing customer base.
      The
      Company plans to acquire or invest in existing enterprises to accomplish this
      goal. While the Company has begun research and investigation, no agreement
      has
      been entered into with any third party. The long term strategy is to analyze
      the
      benefits of expanding to hardware, devices, or means of transferring images
      and
      data that can leverage the core competencies and customers of the
      Company.




**Critical
      Accounting Policies**





“Management’s
      Discussion and Analysis of Financial Condition and Results of Operations”
addresses our consolidated financial statements, which have been prepared in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and the disclosure of contingent assets and liabilities at the
      date
      of the financial statements and the reported amounts of revenues and expenses
      during the reporting period. On an on-going basis, management evaluates its
      estimates and judgments. Management bases its estimates and judgments on
      historical experience and on various other factors that they believe are
      reasonable under the circumstances, the results of which form the basis for
      making judgments about the carrying values of assets and liabilities that are
      not readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions.





Management
      believes the following critical accounting policies, among others, affect its
      more significant judgments and estimates used in the preparation of its
      consolidated financial statements.





We
      account for our software revenues in accordance with Statement of Position,
      or
      SOP, 97-2, “Software Revenue Recognition”, as amended by SOP 98-9, Staff
      Accounting Bulletin No. 104, “Revenue Recognition”, and Emerging Issues Task
      Force 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.”
Over the past several years, we entered into block license agreements that
      represent unit licenses for products that will be licensed over a period of
      time. In accordance with SOP 97-2, revenue is recognized when the following
      attributes have been  -29-


met:
      1)
      an agreement exists between us and the OEM selling product utilizing our
      intellectual property and/or a third party’s intellectual property for which we
      are an authorized licensor; 2) delivery and acceptance of the intellectual
      property has occurred; 3) the fees associated with the sale are fixed and
      determinable; and 4) collection of the fees are probable. Under our accounting
      policies, fees are fixed and determinable if 90% of the fees are to be collected
      within a twelve-month period, in accordance with SOP 97-2. If more than 10%
      of
      the payments of fees extend beyond a twelve-month period, they are recognized
      as
      revenues when they are due for payment, in accordance with SOP 97-2.





For
      fees
      on multiple element arrangements, values are allocated among the elements based
      on vendor specific objective evidence of fair value, VSOE. We generally
      establish VSOE based upon the price charged when the same elements are sold
      separately. When VSOE exists for all undelivered elements, but not for the
      delivered elements, revenue is recognized using the “residual method” as
      prescribed by Statement of Position 98-9. If VSOE does not exist for the
      undelivered elements, all revenue for the arrangement is deferred until the
      earlier of the point at which such VSOE does exist for the undelivered elements
      or all elements of the arrangement have been delivered.





We
      recognize revenues for certain of our engineering services projects on a
      percentage-of-completion basis, in accordance with Accounting Research Bulletin
      45, “Long-Term Construction-Type Contracts”, and SOP 81-1, “Accounting for
      Performance of Construction-Type and Certain Production-Type Contracts.” The
      estimates to complete the projects are determined by the individual
      project-engineering manager responsible for the oversight of the individual
      projects. The estimates are made at the end of each accounting period and are
      subject to unforeseen circumstances that can increase or decrease the hours
      necessary to complete the efforts. For fiscal year 2007, we reported no
      engineering services revenues on a percentage-of-completion basis.





We
      provide an accrual for estimated product licensing costs owed to third party
      vendors whose technology is included in the products sold by us. The accrual
      is
      impacted by estimates of the mix of products shipped under certain of our block
      license agreements. The estimates are based on historical data and available
      information as provided by our customers concerning projected shipments. Should
      actual shipments under these agreements vary from these estimates, adjustments
      to the estimated accruals for product licensing costs may be required. Such
      adjustments have historically been within management’s expectations. However,
      product licensing cost increased by $0.4 million during the third quarter of
      fiscal 2007 as a result of a change in estimate reported by one of our OEM
      customers.





As
      of
      January 31, 2007, we had net operating loss carry-forwards available to reduce
      future federal and state income of approximately $5,187 thousand and $1,152
      thousand, respectively, which begin to expire in fiscal years 2025 for federal
      and 2009 for state, respectively. In addition, as of January 31, 2007, we had
      tax credit carry-forwards available to reduce future income tax liabilities
      of
      approximately $11,648 thousand which begin to expire in fiscal year 2008. The
      realization of these assets is based upon management’s estimates of future
      taxable income. We have provided a valuation allowance for all of our net
      deferred tax assets because of the uncertainty with respect to our ability
      to
      generate future taxable income to realize the deferred tax assets. With a change
      in management’s assessment of the uncertainty, the valuation allowance will be
      adjusted accordingly.





We
      grant
      credit terms in the normal course of business to our customers. We continuously
      monitor collections and payments from our customers and maintain allowances
      for
      doubtful accounts for estimated losses resulting from the inability of any
      customers to make required payments. Estimated losses are based primarily on
      specifically identified customer collection issues. If the financial condition
      of any of our customers, or the economy as a whole, were to deteriorate,
      resulting in an impairment of their ability to make payments, additional
      allowances may be required. Actual results have historically been consistent
      with management’s estimates.





Our
      recurring product licensing revenues are dependent, in part, on the timing
      and
      accuracy of product sales reports received from our OEM customers. These reports
      are provided only on a calendar quarter basis and, in any event, are subject
      to
      delay and potential revision by the OEM. Therefore, we are required to estimate
      all of the recurring product licensing revenues for the last month of each
      fiscal quarter and to further estimate all of our quarterly revenues from an
      OEM
      when the report from such OEM is not received in a timely manner. In the event
      we are unable to estimate such revenues accurately prior to reporting financial
      results, we may be required to adjust revenues in subsequent periods. Actual
      results have historically been consistent with management’s
      estimates.  -30-


On
      February 1, 2006, we adopted SFAS No. 123(R) using the modified-prospective
      transition method. Under this method, prior period results are not restated.
      Compensation cost recognized subsequent to adoption includes: (i) compensation
      cost for all share-based payments granted prior to, but unvested as of January
      31, 2006, based on the grant date fair value, which is determined in accordance
      with the original provision of SFAS No. 123 using a Black-Scholes option pricing
      model, and (ii) compensation cost for all share-based payments granted
      subsequent to February 1, 2006, based on the grant-date fair value, which is
      determined in accordance with the provisions of SFAS No. 123(R) using a
      Black-Scholes option pricing model to estimate the grant date fair value of
      share-based awards.




The
      Company uses its actual stock trading history as a basis to calculate the
      expected volatility assumption to value stock options. The expected dividend
      yield is based on Peerless’ practice of not paying dividends. The risk-free rate
      of return is based on the yield of U.S. Treasury Strips with terms equal to
      the
      expected life of the option as of the grant date. The expected life in years
      is
      based on historical actual stock option exercise experience.




SFAS
      No.
      123(R) requires forfeitures to be estimated at the time of grant and revised,
      if
      necessary, in subsequent periods if actual forfeitures differ from those
      estimates. If actual forfeitures vary from our estimates, we will recognize
      the
      difference in compensation cost in the period the actual forfeitures
      occur.




Upon
      adoption of SFAS 123(R), the Company changed its method of attributing the
      value
      of stock-based compensation expense from the multiple-option (i.e. accelerated)
      approach to the single-option (i.e. straight-line) method. Compensation expense
      for share-based awards granted through January 31, 2006 will continue to be
      subject to the accelerated multiple-option method, while compensation expense
      for share-based awards granted on or after February 1, 2006 will be recognized
      using a straight-line, or single-option method. The Company recognizes these
      compensation costs over the service period of the award, which is generally
      the
      options vesting term of four years.




We
      recorded $612 thousand in share-based compensation expense during the fiscal
      year ended January 31, 2007. Share-based compensation expense was allocated
      as
      follows for the twelve month period ended January 31, 2007: $57 thousand
      included in cost of sales; $251 thousand included in research and development
      expense; $91 thousand included in sales and marketing; $213 thousand included
      in
      general and administrative expense. The Company granted 1,356 thousand options
      for the fiscal year ended January 31, 2007.


-31-




**Results
      of Operations**





The
      following table sets forth, for the periods indicated, the percentage
      relationship of certain items from our statements of operations to total
      revenues.




**Percentage****Change****Percentage
                of Total**
            
            **Years
                Ended****Revenues
                Years Ended**
            
            **January
                31,****January
                31,**
            
            **2007
                vs.**
            
            **2006
                vs.****2007**
            
            **2006**
            
            **2005**
            
            **2006**
            
            **2005**Statements
                of Operations Data:Revenues:Product
                licensing
            
            
            65
            %
            
            58
            %
            
            79
            %
            
            4
            %
            
            16
            %Engineering
                services and maintenance
            
            
            34
            
            
            33
            
            
            11
            
            
            (6
            )
            
            347Other
            
            
            1
            
            
            9
            
            
            10
            
            
            (88
            )
            
            43Total
                revenues
            
            
            100
            
            
            100
            
            
            100
            
            
            (8
            )
            
            57Cost
                of revenues:Product
                licensing
            
            
            14
            
            
            18
            
            
            19
            
            
            (29
            )
            
            51Engineering
                services and maintenance
            
            
            26
            
            
            22
            
            
            14
            
            
            8
            
            
            141Other
            
            
            2
            
            
            7
            
            
            5
            
            
            (73
            )
            
            116Total
                cost of revenues
            
            
            42
            
            
            47
            
            
            38
            
            
            (18
            )
            
            93Gross
                margin
            
            
            58
            
            
            53
            
            
            62
            
            
            1
            
            
            34Operating
                expenses:Research
                and development
            
            
            20
            
            
            16
            
            
            51
            
            
            17
            
            
            (51
            )Sales
                and marketing
            
            
            9
            
            
            10
            
            
            16
            
            
            (13
            )
            
            (5
            )General
                and administrative
            
            
            20
            
            
            15
            
            
            20
            
            
            21
            
            
            22Total
                operating expenses
            
            
            49
            
            
            41
            
            
            87
            
            
            12
            
            
            (26
            )Income
                (loss) from operations
            
            
            9
            
            
            12
            
            
            (25
            )
            
            (35
            )
            
            177Other
                income
            
            
            1
            
            
            —
            
            
            —
            
            
            *
            
            
            *Income
                (loss) before income taxes
            
            
            10
            
            
            12
            
            
            (25
            )
            
            (24
            )
            
            177Provision
                for income taxes
            
            
            —
            
            
            —
            
            
            —
            
            
            (21
            )
            
            (81
            )Net
                income (loss)
            
            
            10
            %
            
            12
            %
            
            (25
            )%
            
            (24
            )%
            
            174
            %





*
            Percentage
                change calculations not meaningful.





*Net
      Income*





Net
      income for the twelve month period ended January 31, 2007 was $3.3 million
      or
      $0.19 per basic and $0.17 per diluted share, compared to a net income of $4.3
      million, or $0.26 per basic and $0.23 per diluted share, in fiscal year 2006,
      and a net loss of $(5.8) million, or $(0.37) per basic and diluted share, in
      fiscal year 2005.





*Revenues*





Consolidated
      revenues for fiscal year 2007 were $33.4 million, compared to $36.2 million
      in
      fiscal year 2006, and $23.1 million in fiscal year 2005. The decreases in fiscal
      year 2007 were primarily the result of the discontinuation of our Everest
      controller product and other hardware sales which amounted to $3.2 million in
      revenues in fiscal year 2006 and the cancellation of the PMC-Sierra contract.
      The increases in revenues from fiscal year 2005 to fiscal year 2006 were
      primarily the result of the $9.0 million in engineering services revenues from
      the Kyocera-Mita agreement and increases in product licensing.





Product
      licensing revenues for fiscal year 2007 were $21.8 million, compared to $21.0
      million in fiscal year 2006, and $18.2 million in fiscal year 2005. Block
      licensing agreements totaling $17.4 million were signed during fiscal year
      2007,
      of which $16.7 million was recognized as revenue during the year. The remaining
      $0.7 million will be recognized in fiscal year 2008. This is compared with
      block
      licensing agreements of $15.9 million signed in fiscal year 2006, of which
      $15.5
      million was recognized as revenue during fiscal year 2006. The increase in
      product  -32-


licensing
      revenues in fiscal year 2007 compared to fiscal year 2006 was the result of
      aggressive selling of block licenses on existing technologies to our larger
      customers in the latter half of the fiscal year.





Engineering
      services and maintenance revenues generated by us were $11.2 million in fiscal
      year 2007, compared to $11.9 million in fiscal year 2006, and $2.7 million
      in
      fiscal year 2005. The increase realized over the last two years was the result
      of the Kyocera-Mita agreement that generated approximately $9.0 million in
      revenues during fiscal year 2007 and 2006. Revenue generated by hardware sales
      was $0.4 million in fiscal year 2007, compared to $3.2 million in fiscal year
      2006, and $2.3 million in fiscal year 2005. The fiscal year 2007 decrease from
      the previous two years was the result of the discontinuance of the Everest
      controller product. Contract and maintenance backlog at January 31, 2007 was
      approximately $0.6 million, as compared with $0.3 million at January 31, 2006,
      which does not include the amounts expected under the Kyocera-Mita
      agreement.





*Cost
      of Revenues*





Cost
      of
      revenues for fiscal year 2007 was $14.1 million, compared to $17.0 million
      in
      fiscal year 2006, and $8.8 million in fiscal year 2005. Product licensing costs
      were $4.6 million in fiscal year 2007, compared to $6.5 million in fiscal year
      2006, and $4.3 million in fiscal year 2005. The decrease in fiscal year 2007
      compared to fiscal year 2006 was the result of lower levels of third party
      technologies in our product licensing revenues. The increase in fiscal year
      2006
      as compared to fiscal year 2005 was due to increased product licensing revenues.
      Engineering services and maintenance cost of sales increased to $8.8 million
      in
      fiscal year 2007 compared to $8.1 and $3.4 million in fiscal years 2006 and
      2005, respectively. The increase realized over the last twenty-four months
      was
      the result of the engineering staffing applied to the approximately $9 million
      in services revenue generated by the Kyocera-Mita agreement.





*Gross
      Margin*





Gross
      margin as a percentage of total revenues was 58% in fiscal year 2007, compared
      to 53% in fiscal year 2006, and 62% in fiscal year 2005. The percentage increase
      in fiscal year 2007 was the result of the higher proportion of licensing
      revenues combined with a higher level of our intellectual property offsetting
      the lower gross margins attributable to engineering services and hardware sales.
      The decrease in fiscal year 2006 comparatively was the result of much higher
      levels of engineering services revenues which generate lower margins than
      licensing.





*Operating
      Expenses*





Operating
      expenses for fiscal year 2007 were $16.5 million, compared to $14.8 million
      in
      fiscal year 2006, and $19.9 million in fiscal year 2005.





•
            Research
                and development expenses were $6.7 million in fiscal year 2007, compared
                to $5.7 million in fiscal year 2006, and $11.7 million in fiscal
                year
                2005. The increase in fiscal year 2007 expenses compared to the previous
                fiscal year was the result of development efforts associated with
                the
                System on a Chip (SoC) networking and new color technologies. The
                decrease
                in fiscal year 2006 compared to fiscal year 2005 was the result of
                a
                substantial portion of engineering staffing being applied to the
                Kyocera-Mita services effort.





•
            Sales
                and marketing expenses were $3.0 million in fiscal year 2007, compared
                to
                $3.5 million in fiscal year 2006, and $3.7 million in fiscal year
                2005.
                The decrease in fiscal year 2007 from fiscal year 2006 was the result
                of a
                reduction in staffing levels and sales commission expense. We continued
                to
                focus on the launch of new Peerless imaging and networking
                technologies**and
                on developing new OEM customers, attending industry trade shows,
                and
                evaluating other opportunities to promote our core and new color
                imaging
                and network solutions.





•
            General
                and administrative expenses were $6.7 million in fiscal year 2007,
                compared to $5.6 million in fiscal year 2006, and $4.6 million in
                fiscal
                year 2005. The fiscal 2007 increase was primarily due to a one-time
                charge
                associated with our expense reduction program, a one-time charge
                associated with the consultancy agreement with our former CEO, stock-based
                compensation expense that has not been required to be recorded in
                the
                statement of operations in previous years, Sarbanes-Oxley compliance
                expenses


-33-


resulting
      from our recent classification as an accelerated-filer and non-recurring legal
      fees associated with contractual matters related to agreements with some of
      our
      larger customers.




*Interest
      Income, Other Income and Expenses, and Taxes*





Interest
      income earned in all fiscal years was attributable to interest and investment
      income earned on cash and cash equivalents and investment balances. The increase
      in fiscal year 2007 was a result of a higher level of investments.





The
      provisions for income taxes for prior fiscal years were primarily the result
      of
      foreign income taxes paid. These income taxes were paid through withholdings
      on
      payments of licensing revenues made by our customers to us. In July 2004, a
      new
      tax treaty between the United States and Japan ended the requirement for such
      income taxes. The effect was to nearly eliminate our foreign income tax
      provision in all periods subsequent to the effective date of the new treaty.
      We
      have provided a valuation allowance on our net deferred tax assets because
      of
      the uncertainty with respect to our ability to generate future taxable income
      to
      realize the deferred tax assets.





**Contractual
      Obligations**





The
      following table summarizes our significant contractual obligations at January
      31, 2007, and the effect such obligations are expected to have on our liquidity
      and cash flows in future periods. This table excludes amounts already recorded
      on our consolidated balance sheets at January 31, 2007.





**Payments
                Due by Period****Total**
            
            **Less
                than**
              **1
                Year**
            
            **1-3
                Years**
            
            **3-5
                Years**
            
            **More
                than**
              **5
                Years****(In
                thousands)**Operating
                lease obligations
            
            $
            13,823
            
            $
            1,425
            
            $
            4,368
            
            $
            2,831
            
            $
            5,199Outstanding
                purchase orders
            
            
            31
            
            
            31
            
            
            —
            
            
            —
            
            
            —Total
            
            $
            13,854
            
            $
            1,456
            
            $
            4,368
            
            $
            2,831
            
            $
            5,199




**Liquidity
      and Capital Resources**





Our
      principal source of liquidity is our cash and cash equivalents which, as of
      January 31, 2007 were $16.4 million in the aggregate, compared to $13.2 million
      at January 31, 2006. The increase was primarily the result of cash provided
      by
      operations $3.4 million, $0.4 million in funds provided by stock options being
      exercised and cash used by investing activities in the amount of $0.6 million.





Compared
      to January 31, 2006, total assets at January 31, 2007 increased 18% to $23.6
      million and stockholders’ equity increased 36% to $16.2 million. The ratio of
      current assets to current liabilities was 3.3:1 compared to 2.4:1 last year.
      We
      generated $3.4 million in cash during the twelve month period ended January
      31,
      2007 from operations as compared to $6.1 million in cash provided by operations
      during the twelve month period ended January 31, 2006.





Our
      investing activities during the fiscal year ended January 31, 2007 used cash
      of
      $0.6 million compared to $0.8 million provided in fiscal year 2006. The
      difference was attributed to the proceeds from the sale of securities of $1.4
      million in fiscal year 2006.





During
      fiscal year 2007, $0.4 million was provided by exercise of stock options. Net
      cash provided by financing activities was $1.2 million during fiscal year 2006
      and $0.3 million in fiscal year 2005.





At
      January 31, 2007, net trade receivables were $0.4 million lower than at January
      31, 2006, due primarily to the timing of the signings and collections of new
      licensing agreements at the end of the fiscal years.





As
      previously mentioned, subsequent to January 31, 2005, we signed an MOU with
      Kyocera-Mita Corporation. The MOU provides, among other things, for quarterly
      payments of $2.0 million for the next three years for the development of future
      products.  -34-


We
      expect
      cash and investments will increase during fiscal year 2008. We expect the MOU
      with Kyocera-Mita to provide much of the increase, and, although we expect
      the
      cash position to further increase *,* there
      can be no assurances that we will experience the anticipated increase. We expect
      to reduce operating expenses as a result of completion of the majority of
      Peerless ** imaging
      and networking technologies ** development
      effort. However, if the level of Peerless imaging and networking
      technologies ** sales
      is
      lower than anticipated, we may need to take significant measures to preserve
      and
      maintain continued business operations. In such event, we may need to further
      reduce costs and may have to access the capital markets to raise additional
      funding. There is no assurance that we would be successful in raising capital
      at
      attractive terms or at all, and should we be successful in raising capital,
      the
      financing may be dilutive to current shareholders.





**Item
      7A.  Quantitative and Qualitative Disclosures About Market
      Risk**





As
      of
      January 31, 2007, we do not hold any positions in equity securities of other
      publicly traded companies.





Our
      exposure to interest rate risk in the past relates primarily to our non-equity
      investment portfolio. The primary objectives of our investment activities are
      to
      preserve the principal while at the same time maximizing yields without
      significantly increasing risk. To achieve this objective, we, from time to
      time,
      maintain a portfolio of cash equivalents, fixed rate debt instruments of the
      federal, state and local governments and high-quality corporate issuers and
      short-term investments in money market funds. As of January 31, 2007, we did
      not
      hold any corporate debt securities. Although we are subject to interest rate
      risks in any future investments in these types of securities, we believe an
      effective increase or decrease of 10% in interest rate percentages would not
      have a material adverse effect on our results from operations. Consequently,
      our
      interest rate risk is minimal.





We
      have
      not entered into any derivative financial instruments. Currently all of our
      contracts, including those involving foreign entities, are denominated in U.S.
      dollars and as a result, we have experienced no significant foreign exchange
      gains and losses to date. We have not engaged in foreign currency hedging
      activities to date, and have no intention of doing so.





**Item
      8.  Financial Statements and Supplementary
      Data**





See
Index
      to Financial Statements on page
      F-1.





**Item
      9.  Changes in and Disagreements with Accountants on
      Accounting and Financial Disclosure**





None.




**Item
      9A.  Controls and Procedures**




**Evaluation
      of Disclosure Controls and Procedures**




As
      of the
      end of the period covered by this Annual Report on Form 10-K, we carried out
      an
      evaluation under the supervision and with the participation of our Disclosure
      Committee and our management, including the Chief Executive Officer and the
      Chief Financial Officer, of the effectiveness of the design and operation of
      our
      disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e).
      Disclosure controls and procedures are procedures that are designed to ensure
      that information required to be disclosed in our reports filed under the
      Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this
      Annual Report on Form 10-K, is recorded, processed, summarized and reported
      within the time periods specified by the SEC. Disclosure controls and procedures
      are also designed to ensure that such information is accumulated and
      communicated to our management, including our Chief Executive Officer and Chief
      Financial Officer, as appropriate to allow timely decisions regarding required
      disclosure.




The
      evaluation of our disclosure controls and procedures included a review of their
      objectives and design, our implementation of them and their effect on the
      information generated for use in this Annual Report on Form 10-K. In the course
      of the controls evaluation, we reviewed any data errors or control problems
      that
      we had identified and sought to confirm that appropriate corrective actions,
      including process improvements, were being undertaken. This type of evaluation
      is performed on a quarterly basis so that the conclusions of management,
      including our Chief Executive Officer and Chief Financial Officer, concerning
      the effectiveness of the disclosure controls can be


-35-




reported
      in our periodic reports on Form 10-K and Form 10-Q. Many of the components
      of
      our disclosure controls and procedures are also evaluated on an ongoing basis
      by
      both our internal audit firm and finance functions. The overall goals of these
      various evaluation activities are to monitor our disclosure controls and
      procedures and to modify them as necessary. We intend to maintain the disclosure
      controls and procedures as dynamic systems that we adjust as circumstances
      merit.




As
      discussed below, we identified a material weakness in our internal control
      over
      financial reporting as of January 31, 2007. Accordingly, and based upon that
      evaluation, our Chief Executive Officer and Chief Financial Officer concluded
      that our disclosure controls and procedures were not effective as of the end
      of
      the period covered by this report.




**Management’s
      Report on Internal Control over Financial Reporting**




Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Exchange Act Rule
      13a-15(f). Under the supervision and with the participation of our management,
      including our Chief Executive Officer and Chief Financial Officer, we conducted
      an evaluation of the effectiveness of our internal control over financial
      reporting as of January 31, 2007 based on the guidelines established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      Our internal control over financial reporting includes policies and procedures
      designed to provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external reporting
      purposes in accordance with United States generally accepted accounting
      principles.




A
      material weakness is a control deficiency, or a combination of control
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. Based upon our evaluation of internal control over financial
      reporting as of January 31, 2007, we identified a material weakness in our
      internal control over financial reporting that resulted in adjustments to
      certain financial statement accounts described below.




Software
      Revenue Recognition




As
      a
      result of substantial turnover in accounting personnel and the retirement of
      the
      Chief Financial Officer, the Company did not maintain effective controls over
      the revenue recognition process. Certain of our revenue transactions are
      accounted for in accordance with AICPA’s Statement of Position 97-2, “Software
      Revenue Recognition” (SOP 97-2), as amended, which includes complex revenue
      recognition principles. Our controls were not adequate to capture and analyze
      all the various terms of software contracts to ensure proper application of
      such
      revenue recognition principles. This deficiency resulted in improper recognition
      of revenues and cost of sales on certain software arrangements, which required
      adjustments to interim and annual financial statements.




Based
      on
      the results of our evaluation, our management concluded that our internal
      control over financial reporting was not effective, as described above, as
      of
      January 31, 2007. We have reviewed the results of management’s assessment with
      our Audit Committee.




Management’s
      assessment of the effectiveness of our internal control over financial reporting
      as of January 31, 2007 has been audited by Ernst & Young LLP, an independent
      registered public accounting firm, as stated in their report which is presented
      below.


-36-




**Remediation
      to Address Material Weakness**





Management
      has responded to the identification of this material weakness by:




A.
            Engaging
                the services of an outside consultant with sufficient software revenue
                recognition expertise to assist in the design and development of
                policies
                and procedures to ensure that the Company’s revenues and costs are
                reported in accordance with SOP 97-2, as well as Staff Accounting
                Bulletin
                No. 104, “Revenue in Financial Statements”, and EITF 00-21, “Revenue
                Arrangements with Multiple Deliverables.”


B.
            Establishing
                a review function for all revenue contracts which requires the preparation
                of a contract position paper stating relevant guidance and management’s
                assessment of each contract and documented review by the Accounting
                Manager, Controller and Chief Financial
                Officer.


C.
            Investing
                in professional development and continued education of accounting
                staff
                responsible for the initial evaluation of revenue
                contracts.


D.
            Establishing
                meetings with representatives of business development and engineering
                to
                ensure a thorough understanding of the substance of significant
                contracts.





As
      of
      January 31, 2007, management believes the design of the internal controls
      surrounding revenue recognition were appropriate, although evidence of the
      operational effectiveness of such internal control was insufficient to
      demonstrate remediation.





**Changes
      in Internal Control over Financial Reporting**





Except
      as
      described above, there were no changes in our internal control over financial
      reporting identified in connection with the evaluation required by paragraph
      (d)
      of Exchange Act Rule 13a-15 that was conducted during the fiscal quarter ended
      January 31, 2007 that have materially affected, or are reasonably likely to
      materially affect, our internal control over financial reporting.





**Management
      Certifications**




The
      certifications of our Chief Executive Officer and Chief Financial Officer
      required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
      are attached as exhibits to this Annual Report on Form 10-K. The disclosures
      set
      forth in this Item 9A contain information concerning (i) the
      evaluation of our disclosure controls and procedures referred to in paragraph
      4
      of the certifications, and (ii) material weaknesses in the operation of our
      internal control over financial reporting referred to in paragraph 5 of the
      certifications. Those certifications should be read in conjunction with this
      Item 9A for a more complete understanding of the matters covered by the
      certifications.




**Inherent
      Limitations on Effectiveness of Controls**




Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      do not expect that our disclosure controls and procedures or our internal
      control over financial reporting will prevent all errors and all fraud. A
      control system, no matter how well conceived and operated, can provide only
      reasonable, not absolute, assurance that the objectives of the control system
      are met. Further, the design of a control system must reflect the fact that
      there are resource constraints, and the benefits of controls must be considered
      relative to their costs. Because of the inherent limitations in all control
      systems, no evaluation of controls can provide absolute assurance that all
      control issues and instances of fraud, if any, within a company have been
      detected. These inherent limitations include the realities that judgments in
      decision making can be faulty, and that breakdowns can occur because of a simple
      error or mistake. Additionally, controls can be circumvented by the individual
      acts of some persons, by collusion of two or more people or by management
      override of the controls. The design of any system of controls also is based
      in
      part upon certain assumptions about the likelihood of future events, and there
      can be no assurance that any design will succeed in achieving its stated goals
      under all potential future conditions; over time, controls may become inadequate
      because of changes in conditions, or the degree of compliance with policies
      or
      procedures may deteriorate. Because of the inherent limitations in a
      cost-effective control system, misstatements due to error or fraud may occur
      and
      not be detected.


-37-




**Report
      of Independent Registered Public Accounting Firm**








**The
      Board of Directors and Stockholders of Peerless Systems
      Corporation**




We
      have
      audited management’s assessment, included in the accompanying
      Management ’s
      Report
      on Internal Control Over Financial Reporting, that Peerless Systems Corporation
      did not maintain effective internal control over financial reporting as of
      January 31, 2007, because of the effect of the material weakness identified
      in
      management’s assessment and described below, based on criteria established in
      Internal Control—Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (the COSO criteria). Peerless Systems
      Corporation’s management is responsible for maintaining effective internal
      control over financial reporting and for its assessment of the effectiveness
      of
      internal control over financial reporting. Our responsibility is to express
      an
      opinion on management’s assessment and an opinion on the effectiveness of the
      Company’s internal control over financial reporting based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





A
      material weakness is a control deficiency, or combination of control
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. The following material weakness has been identified and included
      in
      management’s assessment. The Company did not maintain effective controls over
      the revenue recognition process. The Company’s controls were not adequate to
      capture and analyze all of the various terms of software contracts to ensure
      proper application of its revenue recognition principles. This deficiency
      resulted in improper recognition of revenues and cost of sales on
      certain revenue contracts, which required adjustments to the interim and annual
      financial statements. This material weakness was considered in determining
      the
      nature, timing, and extent of audit tests applied in our audit of the fiscal
      year 2007 financial statements, and this report does not affect our report
      dated
      April 10, 2007, on those financial statements.  -38-


In
      our
      opinion, management’s assessment that Peerless Systems Corporation did not
      maintain effective internal control over financial reporting as of January
      31,
      2007, is fairly stated, in all material respects, based on the COSO criteria.
      Also, in our opinion, because of the effect of the material weakness described
      above on the achievement of the objectives of the control criteria, Peerless
      Systems Corporation has not maintained effective internal control over financial
      reporting as of January 31, 2007, based on the COSO criteria.






/s/
      Ernst
& Young LLP











Los
      Angeles, California


April
      10,
      2007


-39-




**Item
      9B.  Other Information**





None.




**PART
      III**





**Item
      10.  Directors, Executive Officers and Corporate
      Governance**





The
      information concerning the directors, executive officers and corporate
      governance of the Company is incorporated herein by reference from the sections
      entitled “Proposal No. 1, Election of Directors”, “Executive Officers”, “Section
      16(a) Beneficial Ownership Reporting Compliance” and “Code of Business Conduct
      and Ethics” contained in the definitive proxy statement of the Company to be
      filed pursuant to Regulation 14A within 120 days after the Company’s fiscal year
      end of January 31, 2007, for its annual stockholders’ meeting for 2007 (the
“Proxy Statement”).





We
      have
      adopted a code of ethics that applies to our Chief Executive Officer and senior
      financial officers. The code of ethics has been posted on our website under
      the
      Corporate Governance portion of the Investor Relations section at www.peerless.com .
      We
      intend to satisfy disclosure requirements regarding amendments to, or waivers
      from, any provisions of our code of ethics on our website.





**Item
      11.  Executive Compensation**





The
      information concerning executive compensation is incorporated herein by
      reference from the sections entitled “Proposal No. 1, Election of Directors” and
“Executive Compensation and Other Matters” contained in the Proxy
      Statement.





**Item
      12.  Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder****Matters**





The
      information concerning the security ownership of certain beneficial owners
      and
      management and related stockholder matters is incorporated herein by reference
      from the sections entitled “Security Ownership of Certain Beneficial Owners and
      Management” and “Executive Compensation and Other Matters” contained in the
      Proxy Statement.





**Item
      13.  Certain Relationships and Related Transactions, and
      Director Independence**





The
      information concerning certain relationships, related transactions and director
      independence is incorporated herein by reference from the sections entitled
      “Proposal No. 1, Election of Directors” and “Certain Relationships and Related
      Transactions” contained in the Proxy Statement.





**Item
      14.  Principal Accountant Fees and
      Services**





The
      information concerning the Company’s principal accountant’s fees and services is
      incorporated herein by reference from the section entitled “Proposal No. 3,
      Ratification of Selection of Independent Registered Public Accounting Firm”
contained in the Proxy Statement.


-40-




**PART
      IV**





**Item
      15.  Exhibits and Financial Statement
      Schedules**





(a)
            *Financial
                Statements and Schedules*





(1)
            *Financial
                Statements:*





**Page**Report
                of Independent Registered Public Accounting
                Firm
            F-2Consolidated
                Statements of Operations
            F-3Consolidated
                Balance Sheets
            F-4Consolidated
                Statements of Stockholders’
                Equity
            F-5Consolidated
                Statements of Cash Flows
            F-6Notes
                to Consolidated Financial
                Statements
            F-7





(2)
            *Financial
                Statement Schedule:*





The
      following financial statement schedule of the Company is filed as part of this
      Report and should be read in conjunction with the Financial Statements of the
      Company.





**Schedule**
            **Page**II
                Valuation and Qualifying Accounts
            S-1





Schedules
      not listed above have been omitted because they are not applicable or are not
      required or the information required to be set forth therein is included in
      the
      Financial Statements or Notes thereto.





(b)
            *Exhibits:*





The
      following exhibits are filed as part of, or incorporated by reference into,
      this
      Annual Report on Form 10-K:





**Exhibit**
              **Number**3.1(1)
            
            Certificate
                of Incorporation of the Company.3.2(9)
            
            Amended
                and Restated Bylaws of the Company.4.1
            
            Instruments
                defining the rights of security holders. Reference is made to Exhibits
                3.1
                and 3.2.4.2(4)
            
            Rights
                Agreement, dated October 7, 1998, between the Company and Wells Fargo
                Shareowner Services, a division of Wells Fargo Bank Minnesota, N.A.,
                formerly known as Norwest Shareowner Services, as Rights
                Agent.10.1(10)(2)
            
            1996
                Equity Incentive Plan, as amended and form of stock option agreements
                thereunder.10.2(11)(2)
            
            1996
                Employee Stock Purchase Plan, as amended.10.3(1)(3)
            
            Reference
                Post Appendix No. 2 to the Adobe Third Party License dated February
                11,
                1993.10.4(1)
            
            Amendment
                No. 1 to the Adobe Third Party License dated November 29,
                1993.10.5(1)(3)
            
            PCL
                Development and License Agreement (the “PCL License”) dated June 14, 1993,
                between the Registrant and Adobe.10.6(1)(3)
            
            Amendment
                No. 1 to the PCL License dated October 31, 1993.10.7(1)(3)
            
            Letter
                Modification to the PCL License dated August 5, 1994.10.8(1)(3)
            
            Addendum
                No. 1 to the PCL License dated March 31, 1995.10.9(1)(3)
            
            Letter
                Modification to the PCL License dated August 30, 1995.10.10(1)
            
            Lease
                Agreement between the Company and Continental Development Corporation
                dated February 6, 1992, and Addendum, dated February 6,
                1992.




-41-




**Exhibit**
              **Number**10.11(1)
            
            First
                Amendment to Office Lease dated December 1, 1995, between the Company
                and
                Continental Development Corporation.10.12(5)
            
            Second
                Amendment to Office Lease dated April 8, 1997, between the Company
                and
                Continental Development Corporation.10.13(5)
            
            Third
                Amendment to Office Lease dated December 16, 1997, between the Company
                and
                Continental Development Corporation.10.14(6)
            
            Fourth
                Amendment to Office Lease dated April 22, 1998, between the Company
                and
                Continental Development Corporation.10.15(7)
            
            Agreement
                and Plan of reorganization and Merger by and among Peerless Systems
                Corporation, Auco Merger and Auco, Inc. dated as of April 6,
                1999.10.16(8)
            
            Marubun
                Supplier/Distribution Agreement dated December 14,
                1999.10.17(8)
            
            Lease
                PSN McKelvy Family Trust (386 Main Street) Standard Industrial/Commercial
                Single-Tenant dated March 14, 1997.10.18(8)
            
            Lease
                PSIP Kent Centennial Limited Partnership dated January 31,
                1996.10.19(2)(12)
            
            Form
                of Indemnification Agreement, effective as of March 12,
                2001.10.20(13)
            
            Settlement
                Agreement and Mutual Release dated April 11, 2001 between Peerless
                Systems
                Corporation and Gordon L. Hanson.10.21(9)
            
            Settlement
                Agreement and Mutual Release, effective as of April 27, 2001, by
                and among
                the State of Wisconsin Investment Board, Peerless Systems Corporation
                and
                Edward A. Gavaldon.10.22(14)
            
            Series
                A Preferred Stock Purchase Agreement dated January 29, 2002 by and
                among
                Netreon, Inc., a Delaware corporation, Netreon, Inc., a California
                corporation and each of the several purchasers named
                therein.10.23(14)
            
            Series
                A Preferred Stock Contribution Agreement dated January 29, 2002 by
                and
                between Netreon, Inc., a Delaware corporation and Peerless Systems
                Corporation.10.24(3)(15)
            
            Postscript
                Software Development License and Sublicense Agreement between Adobe
                Systems Incorporated and the Company effective as of July 23,
                1999.10.25(3)(15)
            
            Custom
                Sales Agreement between the Company and International Business Machines
                effective as of April 23, 2001.10.26(3)(15)
            
            Master
                Technology License Agreement dated January 16, 2000 between Konica
                Corporation and Peerless Systems Corporation.10.27(3)(15)
            
            License
                Software Addendum #1 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 16,
                2000.10.28(3)(15)
            
            License
                Software Addendum #2 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 19,
                2000.10.29(3)(15)
            
            License
                Software Addendum #3 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of July 21,
                2000.10.30(3)(15)
            
            License
                Software Addendum #4 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of March 1,
                2001.10.31(3)(15)
            
            License
                Software Addendum #5 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of July 1,
                2001.10.32(3)(15)
            
            License
                Software Addendum #7 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.10.33(3)(15)
            
            License
                Software Addendum #8 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.10.34(3)(15)
            
            License
                Software Addendum #9 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.




-42-




**Exhibit**
              **Number**10.35(15)
            
            Master
                Technology License Agreement dated April 1, 1997 between Kyocera
                Corporation and Peerless Systems Corporation.10.36(3)(15)
            
            Licensed
                Software Addendum #1 to Master Technology License Agreement by and
                between
                Kyocera Corporation and the Company effective as of December 28,
                1999.10.37(3)(15)
            
            Amendment
                #3 to Licensed Software Addendum #1 to Master Technology License
                Agreement
                by and between Kyocera Corporation and the Company effective as of
                September 28, 2001.10.38(3)(15)
            
            Licensed
                Software Addendum #3 to Master Technology License Agreement by and
                between
                Kyocera-Mita Corporation and the Company effective as of May 1,
                2002.10.39(3)(15)
            
            Master
                Technology License Agreement between Oki Data Corporation and Peerless
                Systems Imaging Products, Inc.10.40(3)(15)
            
            Licensed
                System Addendum No. 1 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products,
                Inc.10.41(3)(15)
            
            Licensed
                System Addendum No. 2 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products,
                Inc.10.42(3)(15)
            
            Licensed
                System Addendum No. 3 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products, Inc. effective
                as
                of August 25, 2000.10.43(3)(15)
            
            Attachment
                #1 to Licensed System Addendum #3 by and between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated March 1,
                2001.10.44(3)(15)
            
            Attachment
                #2 to Licensed System Addendum #3 by and between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated July 1,
                2001.10.45(3)(15)
            
            Licensed
                System Addendum No. 4 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products, Inc. effective
                as
                of February 1, 2002.10.46(15)
            
            Master
                Technology License Agreement dated April 1, 2000 between Seiko Epson
                Corporation and Peerless Systems Imaging Products, Inc.10.47(3)(15)
            
            Licensed
                System Addendum #1 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                dated
                April 1, 2000.10.48(3)(15)
            
            Licensed
                System Addendum #2 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products,
                Inc.10.49(3)(15)
            
            Licensed
                System Addendum #3 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products,
                Inc.10.50(3)(15)
            
            Attachment
                #1 to Licensed System Addendum #3 by and between Seiko Epson Corporation
                and Peerless Systems Imaging Products, Inc. dated May 1,
                2001.10.51(3)(15)
            
            Attachment
                #2 to Licensed System Addendum #3 by and between Seiko Epson Corporation
                and Peerless Systems Imaging Products, Inc. dated July 23,
                2001.10.52(3)(15)
            
            Licensed
                System Addendum #4 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of October 19, 2001.10.53(3)(15)
            
            Licensed
                System Addendum #5 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of December 1, 2001.10.54(3)(15)
            
            Licensed
                System Addendum #6 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of April 30, 2002.10.55(3)(15)
            
            Nest
                Office SDK Development and Reseller Agreement Statement of Work 8
                to BDA
                No. N-A-1 between Novell, Inc. and Peerless Systems Networking effective
                as of August 17, 1999.




-43-




**Exhibit**
              **Number**10.56(3)(15)
            
            Amendment
                No. 1 to Nest Office SDK Development and Reseller Agreement Statement
                of
                Work 8 to BDA No. N-A-1 between Novell, Inc. and Peerless Systems
                Networking effective as of August 17, 1999.10.57(15)
            
            Business
                Development Agreement by and between Novell and Auco, Inc. effective
                as of
                September 6, 1996.10.58(16)
            
            Amendment
                No. 4 to Licensed System Addendum No. 4 dated February 1, 2002 by
                and
                between Oki Data Corporation and Peerless Systems Imaging Products,
                Inc.
                dated September 1, 2002.(15)10.59(16)
            
            Amendment
                No. 3 to Postscript Software Development Agreement by and between
                Adobe
                Systems Incorporated and the Company dated October 25,
                2002.10.60(3)(17)
            
            Amendment
                No. 1 to Licensed System Agreement No. 7 dated November 1, 2001 by
                and
                between Konica Corporation and Peerless Systems Corporation dated
                January
                1, 2003.10.61(3)(17)
            
            Licensed
                System Agreement Addendum No. 10 to Master Technology License Agreement
                dated January 16, 2000 by and between Konica Corporation and Peerless
                Systems Corporation dated January 17, 2003.10.62(3)(17)
            
            Licensed
                System Addendum #8 to Master Technology License Agreement dated April
                1,
                2000 by and between Seiko Epson Corporation and Peerless Systems
                Imaging
                Products, Inc. effective as of January 6, 2003.10.63(3)(18)
            
            Amendment
                No. 4 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2003.10.64(3)(18)
            
            Amendment
                No. 10 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2003.10.65(3)(19)
            
            Amendment
                No. 5 to Licensed System Addendum No. 4 between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated February 1,
                2002.10.66(3)(19)
            
            Amendment
                No. 8 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 30, 2003.10.67(3)(19)
            
            Amendment
                No. 9 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 15, 2003.10.68(3)(19)
            
            Amendment
                No. 12 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 22, 2003.10.69(20)
            
            Licensed
                Software Addendum No. 14 to Master Technology License Agreements
                dated
                January 16, 2000 and June 12, 1997 by and between Konica Minolta
                Business
                Technologies, Inc. and Peerless Systems Corporation, effective as
                of
                October 31, 200310.70(20)
            
            Amendment
                #2 to the LSA #9 by and between Konica Minolta Business Technologies,
                Inc.
                and Peerless Systems Corporation, effective as of November 1,
                200310.71(20)
            
            Amendment
                No. 5 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of December 16, 2003.10.72(20)
            
            Amendment
                No. 6 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2002.10.73(20)
            
            Amendment
                No. 7 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of May 22,
                2003.




-44-




**Exhibit**
              **Number**10.74(20)
            
            Amendment
                No. 11 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of February 9, 2004.10.75(20)
            
            Amendment
                No. 14 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of December 16, 2003.10.76(20)
            
            Amendment
                No. 15 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 6, 2004.10.77(2)(20)
            
            Change
                in Control Agreement of Chief Executive Officer.10.78(2)(20)
            
            Form
                of Change in Control Agreement of certain members of senior
                management.10.79(2)(20)
            
            Form
                of Transaction Incentive Plan of certain members of senior
                management.10.80(21)
            
            Amendment
                No. 16 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 6, 2004.10.81(21)
            
            Licensed
                Software Addendum #5 to Master Technology License Agreement dated
                April 1,
                1997, entered into as of February 17, 2004.10.82(21)
            
            Amendment
                No. 19 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of April 1, 2004.10.83(22)
            
            Amendment
                to Lease between BIT Holdings Forty-Eight, Inc. and Peerless Systems
                Imaging Products, Inc. as of October 1, 2004.10.84(22)
            
            Amendment
                No. 17 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, Effective as of October 15, 2004.10.85(22)
            
            Silicon
                Valley Bank Loan and Security Agreement between Silicon Valley Bank
                and
                Peerless Systems Corporation dated October 27, 2004.10.86(23)
            
            Memorandum
                of Understanding by and between Kyocera-Mita Corporation and Peerless
                Systems Corporation, effective as of February 1, 2005.10.87(23)
            
            Amendment
                No. 21 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.91(23)
            
            Amendment
                No. 18 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.92(23)
            
            Peerless
                Systems Corporation 2005 Incentive Award Plan10.93(23)
            
            Amendment
                No. 23 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.94(23)
            
            Peerless
                Systems Corporation Amended and Restated Transaction Incentive
                Plan.10.95(24)
            
            Amendment
                No. 22 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 14, 2005.10.96(24)
            
            Amendment
                No. 24 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 14, 2005.10.97(24)
            
            Amendment
                No. 26 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 13,
                2005.




-45-




**Exhibit**
              **Number**10.98(24)
            
            Amendment
                No. 27 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of November 1, 2005.10.99(25)
            
            Development
                Agreement between PMC-Sierra Corporation and Peerless Systems Corporation,
                dated March 27, 2006.10.100(26)(2)
            
            Letter
                of agreement relating to the employment of John V. Rigali as Vice
                President and Chief Financial Officer10.101(27)
            
            Lease
                agreement dated as of August 1, 2006, between Company and Continental
                2361/2381 LLC10.102(28)
            
            Letter
                dated December 7, 2006 from Adobe Systems Incorporated to Peerless
                Systems
                Corporation extending the term of PostScript Software Development
                License
                and Sublicense Agreement10.103(29)(2)
            
            Consulting
                Agreement dated December 15, 2006, between the Company and Howard
                J.
                Nellor10.104(29)(2)
            
            Employment
                Agreement dated as of December 15, 2006, between the Company and
                Richard
                L. Roll10.105(29)(2)
            
            Indemnification
                Agreement dated as of December 15, 2006, between the Company and
                Richard
                L. Roll10.106(29)(2)
            
            Time-Vested
                Option Agreement dated as of December 15, 2006, between the Company
                and
                Richard L. Roll.10.107(29)(2)
            
            Price-Contingent
                Option Agreement dated as of December 15, 2006, between the Company
                and
                Richard L. Roll21
            
            Registrant’s
                Wholly-Owned Subsidiaries.23.1
            
            Consent
                of Independent Registered Public Accounting Firm.24.1
            
            Power
                of Attorney. Reference is made to the signature page to this Annual
                Report
                on Form 10-K.31.1
            
            Certification
                of Principal Executive Officer Pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of Principal Financial Officer Pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.32
            
            Certifications
                of Principal Executive Officer and Principal Financial Officer Pursuant
                to
                Section 906 of the Sarbanes-Oxley Act of 2002.





(1)
            Previously
                filed in the Company’s Registration Statement on Form S-1 (File No.
                333-09357), as amended and incorporated herein by
                reference.





(2)
            Management
                contract or compensatory plan or arrangement.





(3)
            Subject
                to a Confidential Treatment Order.





(4)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed October 13, 1999,
                and incorporated herein by
                reference.





(5)
            Previously
                filed in the Company’s 1998 Annual Report filed on Form 10-K, filed April
                24, 1998, and incorporated herein by
                reference.





(6)
            Previously
                filed in the Company’s 1999 Annual Report filed on Form 10-K, filed April
                26, 1999, and incorporated herein by
                reference.


-46-


(7)
            Previously
                filed in the Company’s Registration Statement on Form S-4 (File No.
                333-77049) as amended and incorporated herein by
                reference.





(8)
            Previously
                filed in the Company’s 2000 Annual Report filed on Form 10-K, filed April
                28, 2000, and incorporated herein by
                reference.





(9)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed July 2, 2001, and
                incorporated herein by reference.





(10)
            Previously
                filed in the Company’s Registration Statement on Form S-8 (File No.
                333-73562), filed November 16, 2001, and incorporated herein by
                reference.





(11)
            Previously
                filed in the Company’s Registration Statement on Form S-8 (File No.
                333-57362), filed March 21, 2001, and incorporated herein by
                reference.





(12)
            Previously
                filed in the Company’s Amendment No. 4 to its Registration Statement on
                Form S-3 (File No. 333-60284), filed July 27, 2001, and incorporated
                herein by reference.





(13)
            Previously
                filed in the Company’s 2001 Annual Report filed on Form 10-K, filed May 1,
                2001, and incorporated herein by
                reference.





(14)
            Previously
                filed in the Company’s 2002 Annual Report on Form 10-K, filed May 1, 2002,
                and incorporated herein by
                reference.





(15)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2002, filed September 16, 2002, and incorporated herein by
                reference.





(16)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2002, filed December 16, 2002, and incorporated herein by
                reference.





(17)
            Previously
                filed in the Company’s 2003 Annual Report on Form 10-K filed May 1, 2003,
                and incorporated herein by
                reference.





(18)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2003, filed September 15, 2003, and incorporated herein by
                reference.





(19)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2003, filed December 15, 2003, and incorporated herein by
                reference.





(20)
            Previously
                filed in the Company’s 2004 Annual Report on Form 10-K filed April 30,
                2004, and incorporated herein by
                reference.





(21)
            Previously
                filed in the Company’s Quarterly Report for the period ended April 30,
                2004, filed June 14, 2004, and incorporated herein by
                reference.





(22)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2004, filed December 15, 2004, and incorporated herein by
                reference.





(23)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2005, filed December 15, 2004, and incorporated herein by
                reference.





(24)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2005, filed December 15, 2004, and incorporated herein by
                reference.


-47-


(25)
            Confidential
                treatment has been requested with respect to the omitted portions
                of this
                Exhibit, which portions have been filed separately with the Securities
                and
                Exchange Commission. Previously filed in Amendment No. 1 to the Company’s
                2006 Annual Report on Form 10-K for the year ended December 31, 2006,
                filed October 26, 2006.





(26)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2006, filed September 14, 2006, and incorporated herein by
                reference.





(27)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2006, filed December 14, 2006, and incorporated herein by
                reference.





(28)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed December 18,
                2006, and incorporated herein by
                reference.





(29)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed December 19,
                2006, and incorporated herein by reference.


-48-


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, as amended, the Registrant has duly caused this Report to be signed on
      its
      behalf by the undersigned, thereunto duly authorized, on the 13th day of April,
      2007.





Peerless
      Systems Corporation




By: /s/ JOHN
      V.
      RIGALI


John
      V.
      Rigali


*Vice
      President of Finance and* *Chief
      Financial Officer*




KNOW
      ALL PERSONS BY THESE PRESENTS, that each person whose signature
      appears below constitutes and appoints Richard L. Roll and John V. Rigali,
      his/her attorneys-in-fact, each with the power of substitution, for him/her
      in
      any and all capacities, to sign any amendments to this Annual Report on Form
      10-K, and to file the same, with Exhibits thereto and other documents in
      connection therewith with the Securities and Exchange Commission, hereby
      ratifying and confirming all that each of said attorneys-in-fact, or substitute
      or substitutes may do or cause to be done by virtue hereof.




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the date indicated.





**Signature**
            
            **Title**
            
            **Date**/s/RICHARD L. ROLL
            
            Chief
                Executive Officer & President
            
            April
                13, 2007Richard
                L. Roll
            
            (Principal
                ExecutiveOfficer)/s/Robert
                G. Barrett
            
            Director
            
            April
                13, 2007Robert
                G. Barrett/s/Louis C. Cole
            
            Director
            
            April
                13, 2007Louis
                C. Cole/s/Howard
                J. NELLOR
            
            Director
            
            April
                13, 2007Howard
                J. Nellor/s/JOHN
                V. RIGALI
            
            Vice
                President of Finance and ChiefFinancial
                Officer
            
            April
                13, 2007John
                V. Rigali
            
            (PrincipalFinancial
                and Accounting Officer)





-49-




**PEERLESS
      SYSTEMS CORPORATION**





**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Page**Report
                of Independent Registered Public Accounting
                Firm
            F-2Consolidated
                Statements of Operations
            F-3Consolidated
                Balance Sheets
            F-4Consolidated
                Statements of Stockholders’
                Equity
            F-5Consolidated
                Statements of Cash Flows
            F-6Notes
                to Consolidated Financial
                Statements
            F-7





F-1




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM**






The
      Board
      of Directors and Stockholders of Peerless Systems Corporation




We
      have
      audited the accompanying consolidated balance sheets of Peerless Systems
      Corporation as of January 31, 2007 and January 31, 2006, and the related
      consolidated statements of operations, stockholders’ equity, and cash flows for
      each of the three years in the period ended January 31, 2007. Our audits also
      included the financial statement schedule listed in the index at Item 15(a).
      These financial statements and schedule are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these financial
      statements and schedule based on our audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Peerless Systems
      Corporation at January 31, 2007 and January 31, 2006, and the consolidated
      results of its operations and its cash flows for each of the three years in
      the
      period ended January 31, 2007, in conformity with U.S. generally accepted
      accounting principles. Also, in our opinion, the related financial statement
      schedule, when considered in relation to the basic financial statements taken
      as
      a whole, presents fairly in all material respects the information set forth
      therein.




As
      discussed in Note 1 to the consolidated financial statements, Peerless Systems
      Corporation adopted Statement of Financial Accounting Standards No. 123(R)
      on
      February 1, 2006.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Peerless Systems
      Corporation’s internal control over financial reporting as of January 31, 2007,
      based on criteria established in Internal Control-Integrated Framework issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission and our
      report dated April 10, 2007 expressed an unqualified opinion on management’s
      assessment and an adverse opinion on the effectiveness of internal control
      over
      financial reporting.






/s/
      Ernst
& Young LLP





Los
      Angeles, California


April
      10,
      2007


F-2




**PEERLESS
      SYSTEMS CORPORATION**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





**Years
                Ended January 31,****2007**
            
            **2006**
            
            **2005****(In
                thousands, except per share amounts)**Revenues:Product
                licensing
            
            $
            21,758
            
            $
            21,021
            
            $
            18,163Engineering
                services and maintenance
            
            
            11,232
            
            
            11,921
            
            
            2,664Hardware
                sales
            
            
            393
            
            
            3,215
            
            
            2,251Total
                revenues
            
            
            33,383
            
            
            36,157
            
            
            23,078Cost
                of revenues:Product
                licensing
            
            
            4,612
            
            
            6,499
            
            
            4,318Engineering
                services and maintenance
            
            
            8,768
            
            
            8,085
            
            
            3,353Hardware
                sales
            
            
            670
            
            
            2,464
            
            
            1,142Total
                cost of revenues
            
            
            14,050
            
            
            17,048
            
            
            8,813Gross
                margin
            
            
            19,333
            
            
            19,109
            
            
            14,265Operating
                expenses:Research
                and development
            
            
            6,706
            
            
            5,728
            
            
            11,723Sales
                and marketing
            
            
            3,040
            
            
            3,481
            
            
            3,668General
                and administrative
            
            
            6,746
            
            
            5,553
            
            
            4,551Total
                operating expenses
            
            
            16,492
            
            
            14,762
            
            
            19,942Income
                (loss) from operations
            
            
            2,841
            
            
            4,347
            
            
            (5,677
            )Interest
                income (expense), net
            
            
            468
            
            
            (4
            )
            
            23Income
                (loss) before provision for income taxes
            
            
            3,309
            
            
            4,343
            
            
            (5,654
            )Provision
                for income taxes
            
            
            23
            
            
            29
            
            
            151Net
                income (loss)
            
            $
            3,286
            
            $
            4,314
            
            $
            (5,805
            )Basic
                earnings (loss) per share
            
            $
            0.19
            
            $
            0.26
            
            $
            (0.37
            )Diluted
                earnings (loss) per share
            
            $
            0.17
            
            $
            0.23
            
            $
            (0.37
            )Weighted
                average common shares outstanding — basic
            
            
            17,100
            
            
            16,496
            
            
            15,891Weighted
                average common shares outstanding — diluted
            
            
            18,912
            
            
            18,465
            
            
            15,891






The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-3




**PEERLESS
      SYSTEMS CORPORATION**




**CONSOLIDATED
      BALANCE SHEETS**





**January
                31,****2007**
            
            **2006****(In
                thousands)****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            16,378
            
            $
            13,220Trade
                accounts receivable, less allowance for doubtful accounts of $19
                and $168
                in 2007 and 2006, respectively
            
            
            1,748
            
            
            2,128Unbilled
                receivables
            
            
            4,011
            
            
            3,032Inventory
            
            
            62
            
            
            —Prepaid
                expenses and other current assets
            
            
            685
            
            
            559Total
                current assets
            
            
            22,884
            
            
            18,939Property
                and equipment, net
            
            
            558
            
            
            904Other
                assets
            
            
            159
            
            
            191Total
                assets
            
            $
            23,601
            
            $
            20,034**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            233
            
            $
            479Accrued
                wages
            
            
            637
            
            
            693Accrued
                compensated absences
            
            
            932
            
            
            872Accrued
                product licensing costs
            
            
            3,035
            
            
            4,325Other
                current liabilities
            
            
            1,315
            
            
            743Deferred
                revenue
            
            
            807
            
            
            708Total
                current liabilities
            
            
            6,959
            
            
            7,820Other
                liabilities
            
            
            459
            
            
            275Total
                liabilities
            
            
            7,418
            
            
            8,095CommitmentsStockholders’
                equity:Common
                stock, $.001 par value, 30,000 shares authorized, 17,303 and 17,041
                shares
                issued and outstanding in 2007 and 2006, respectively
            
            
            17
            
            
            17Additional
                paid-in capital
            
            
            51,908
            
            
            50,939Accumulated
                deficit
            
            
            (35,639
            )
            
            (38,925
            )Accumulated
                other comprehensive income
            
            
            10
            
            
            21Treasury
                stock, 150 shares in 2007 and 2006
            
            
            (113
            )
            
            (113
            )Total
                stockholders’ equity
            
            
            16,183
            
            
            11,939Total
                liabilities and stockholders’ equity
            
            $
            23,601
            
            $
            20,034


The
        accompanying notes are an integral part of these consolidated financial
        statements.  F-4




**PEERLESS
      SYSTEMS CORPORATION**




**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’
EQUITY**





**Accumulated****Additional**
            
            
            
            **Other**
            
            **Total****Common
                Stock**
            
            **Treasury
                Stock**
            
            **Paid-In**
            
            **Accumulated**
            
            **Comprehensive**
            
            **Stockholders’****Shares**
            
            **Amount**
            
            **Shares**
            
            **Amount**
            
            **Capital**
            
            **Deficit**
            
            **Income**
            
            **Equity****(In
                thousands)**Balances,
                January 31, 2004
            
            
            15,866
            
            
            15
            
            
            150
            
            
            (113
            )
            
            49,295
            
            
            (37,434
            )
            
            38
            
            
            11,801Issuance
                of common stock
            
            
            251
            
            
            1
            
            
            —
            
            
            —
            
            
            337
            
            
            —
            
            
            —
            
            
            338Exercise
                of stock options
            
            
            55
            
            
            —
            
            
            —
            
            
            —
            
            
            39
            
            
            —
            
            
            —
            
            
            39Non-employee
                stock option grants and modifications
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            66
            
            
            —
            
            
            —
            
            
            66Issuance
                of common stock warrants
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            24
            
            
            —
            
            
            —
            
            
            24Comprehensive
                loss:Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (5,805
            )
            
            —
            
            
            (5,805
            )Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1
            
            
            1Total
                comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,804
            )Balances,
                January 31, 2005
            
            
            16,172
            
            
            16
            
            
            150
            
            
            (113
            )
            
            49,761
            
            
            (43,239
            )
            
            39
            
            
            6,464Issuance
                of common stock
            
            
            335
            
            
            —
            
            
            —
            
            
            —
            
            
            440
            
            
            —
            
            
            —
            
            
            440Exercise
                of stock options
            
            
            509
            
            
            1
            
            
            —
            
            
            —
            
            
            738
            
            
            —
            
            
            —
            
            
            739Exercise
                of common stock warrants
            
            
            25
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Comprehensive
                income:Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            4,314
            
            
            —
            
            
            4,314Foreign
                currency translation adjustment
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (18
            )
            
            (18
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            4,296Balances,
                January 31, 2006
            
            
            17,041
            
            $
            17
            
            
            150
            
            $
            (113
            )
            $
            50,939
            
            $
            (38,925
            )
            $
            21
            
            $
            11,939Issuance
                of common stock
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Exercise
                of stock options
            
            
            262
            
            
            —
            
            
            —
            
            
            —
            
            
            357
            
            
            —
            
            
            —
            
            
            357Share-based
                compensation expense
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            612
            
            
            —
            
            
            —
            
            
            612Comprehensive
                income:Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            3,286
            
            
            —
            
            
            3,286Foreign
                currency translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (11
            )
            
            (11
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,275Balances,
                January 31, 2007
            
            $
            17,303
            
            $
            17
            
            
            150
            
            $
            (113
            )
            $
            51,908
            
            $
            (35,639
            )
            $
            10
            
            $
            16,183




The
        accompanying notes are an integral part of these consolidated financial
        statements.  F-5




**PEERLESS
      SYSTEMS CORPORATION**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**




**Years
                Ended January 31,****2007**
            
            **2006**
            
            **2005****(In
                thousands)**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            3,286
            
            $
            4,314
            
            $
            (5,805
            )Adjustments
                to reconcile net income (loss) to net cash provided (used) by operating
                activitiesDepreciation
                and amortization
            
            
            906
            
            
            1,332
            
            
            1,567Share-based
                compensation
            
            
            612
            
            
            —
            
            
            —Other
            
            
            (11
            )
            
            (5
            )
            
            67Changes
                in operating assets and liabilities:Trade
                accounts receivable
            
            
            380
            
            
            (91
            )
            
            4,109Unbilled
                receivables
            
            
            (979
            )
            
            (2,080
            )
            
            (952
            )Inventory
            
            
            (62
            )
            
            688
            
            
            (686
            )Prepaid
                expenses and other assets
            
            
            (84
            )
            
            63
            
            
            268Accounts
                payable
            
            
            (246
            )
            
            (391
            )
            
            (27
            )Accrued
                product licensing costs
            
            
            (1,290
            )
            
            1,961
            
            
            (470
            )Deferred
                revenue
            
            
            99
            
            
            (189
            )
            
            (426
            )Other
                liabilities
            
            
            760
            
            
            531
            
            
            (376
            )Net
                cash provided (used) by operating activities
            
            
            3,371
            
            
            6,133
            
            
            (2,731
            )Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (217
            )
            
            (210
            )
            
            (230
            )Purchases
                of available-for-sale securities
            
            
            —
            
            
            —
            
            
            (400
            )Proceeds
                from sales of available-for-sale securities
            
            
            —
            
            
            1,384
            
            
            3,344Purchases
                of software licenses
            
            
            (353
            )
            
            (385
            )
            
            (285
            )Net
                cash provided (used) by investing activities
            
            
            (570
            )
            
            789
            
            
            2,429Cash
                flows from financing activities:Proceeds
                from issuance of common stock
            
            
            —
            
            
            440
            
            
            338Proceeds
                from exercise of common stock options
            
            
            357
            
            
            739
            
            
            39Payments
                for deferred costs for financing arrangement
            
            
            —
            
            
            —
            
            
            (45
            )Net
                cash provided by financing activities
            
            
            357
            
            
            1,179
            
            
            332Net
                increase in cash and cash equivalents
            
            
            3,158
            
            
            8,101
            
            
            30Cash
                and cash equivalents, beginning of period
            
            
            13,220
            
            
            5,099
            
            
            5,069Cash
                and cash equivalents, end of period
            
            $
            16,378
            
            $
            13,200
            
            $
            5,099Supplemental
                disclosure of cash flow information:Cash
                paid during the year for:Income
                taxes
            
            $
            54
            
            $
            30
            
            $
            613






The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-6




**PEERLESS
      SYSTEMS CORPORATION**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**






**1.**
            **Organization,
                Business and Summary of Significant Accounting
                Policies:**





*Organization
      and Business:* Peerless
      Systems Corporation (“Peerless” or the “Company”) was incorporated in the state
      of California in April 1982 and reincorporated in the state of Delaware in
      September 1996. Peerless develops and licenses software-based digital imaging
      and networking systems and supporting electronic technologies and provides
      custom engineering services to Original Equipment Manufacturers (“OEMs”) of
      digital document products located primarily in the United States and Japan.
      Digital document products include printers, copiers, fax machines, scanners
      and
      color products, as well as multifunction products (“MFP”) that perform a
      combination of these imaging functions. In order to process digital text and
      graphics, digital document products rely on a core set of imaging software
      and
      supporting electronics, collectively known as a digital imaging system. Network
      interfaces supply the core technologies to digital document products that enable
      them to communicate over local area networks and the Internet.





*Liquidity:* Historically, the Company has incurred losses from operations and has reported
      negative operating cash flows. As of January 31, 2007, the Company had an
      accumulated deficit of $35.6 million and cash and cash equivalents of $16.4
      million. The Company has no material financial commitments other than those
      under operating lease agreements. The Company believes that its existing cash
      and short-term investments, and any cash generated from operations will be
      sufficient to fund its working capital requirements, capital expenditures and
      other obligations through the next twelve months.





On
      March
      1, 2005, the Company entered into a binding Memorandum of Understanding or
      MOU
      with Kyocera-Mita Corporation (“Kyocera-Mita”) to provide a range of
      non-exclusive engineering services and product development services. Pursuant
      to
      the MOU, Kyocera-Mita has agreed to pay the Company an aggregate of $24.0
      million, which will be paid in $2.0 million quarterly payments over the initial
      three-year term of the MOU. The long term liquidity of the Company is dependent
      upon this MOU. Should the MOU be terminated and Kyocera-Mita and the Company
      not
      enter into definitive agreements, the Company’s cash flow assumptions would be
      materially affected, and the Company would need to scale its operations to
      match
      the decrease in cash flows and may need to raise additional capital. The Company
      currently does not have a credit facility. The Company did not renew its credit
      facility with its bank, Silicon Valley Bank, which expired on October 26, 2005,
      and generally only provided coverage for short-term working capital needs.
      Long
      term, the Company may face significant risks associated with the successful
      execution of its business strategy and may need to raise additional capital
      in
      order to fund more rapid expansion, to expand its marketing activities, to
      develop new or enhance existing services or products, and to respond to
      competitive pressures or to acquire complementary services, businesses, or
      technologies. If the Company is not successful in generating sufficient cash
      flow from operations, it may need to raise additional capital through public
      or
      private financing, strategic relationships, or other arrangements (see Note
      14).





*Principles
      of Consolidation and Basis of Presentation:* The
      consolidated financial statements include the accounts of the Company and its
      subsidiaries. All significant intercompany accounts and transactions have been
      eliminated.





*Use
      of Estimates:* The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenues and expenses during the reporting periods.
      Actual results could differ from those estimates.





The
      Company provides an accrual for estimated product licensing costs owed to third
      party vendors whose technology is included in the products sold by the Company.
      The accrual is impacted by estimates of the mix of products shipped under
      certain of the Company’s block license agreements. The estimates are based on
      historical data and available information as provided by the Company’s customers
      concerning projected shipments. Should actual shipments under these agreements
      vary from these estimates, adjustments to the estimated accruals for product
      licensing costs may be required.


F-7




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


The
      Company grants credit terms in the normal course of business to its customers.
      The Company continuously monitors collections and payments from its customers
      and maintains allowances for doubtful accounts for estimated losses resulting
      from the inability of any customers to make required payments. Estimated losses
      are based primarily on specifically identified customer collection issues.
      If
      the financial condition of any of the Company’s customers, or the economy as a
      whole, were to deteriorate, resulting in an impairment of their ability to
      make
      payments, additional allowances may be required. Actual results have
      historically been consistent with management’s estimates.





The
      Company’s recurring product licensing revenues are dependent, in part, on the
      timing and accuracy of product sales reports received from the Company’s OEM
      customers. These reports are provided only on a calendar quarter basis and,
      in
      any event, are subject to delay and potential revision by the OEM. Therefore,
      the Company is required to estimate all of the recurring product licensing
      revenues for the last month of each fiscal quarter and to further estimate
      all
      of its quarterly revenues from an OEM when the report from such OEM is not
      received in a timely manner. In the event the Company is unable to estimate
      such
      revenues accurately prior to reporting financial results, the Company may be
      required to adjust revenues in subsequent periods.





*Reclassifications:* Certain
      2005 and 2006 amounts have been reclassified to conform to 2007
      presentation.





*Cash
      and Cash Equivalents:* Cash and
      cash equivalents represent cash and highly liquid investments, which mature
      within three months of purchase.





*Fair
      Value of Financial Investments:* Cash and
      cash equivalents, accounts receivable, accounts payable, and accrued liabilities
      are carried at cost, which management believes approximates fair value due
      to
      the short term maturity of these instruments.





*Inventory:* Inventory, which consists of raw materials, is accounted for on a specific
      identification basis. Inventory is carried at lower of cost or realizable
      value.





*Property
      and Equipment:* Property
      and equipment are stated at cost, less accumulated depreciation. Depreciation
      on
      property and equipment is calculated using the straight-line method as
      follows:





Computers
                and other equipment
            3
                to 5 yearsFurniture
            10
                yearsLeasehold
                improvements
            Shorter
                of useful life or lease term





Maintenance
      and repairs are expensed as incurred, while renewals and betterments are
      capitalized. Upon the sale or retirement of property and equipment, the accounts
      are relieved of the cost and the related accumulated depreciation, and any
      resulting gain or loss is included in results of operations.


F-8




**PEERLESS
          SYSTEMS CORPORATION**
  **NOTES
          TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


*Long-Lived
      Assets:* The
      Company currently evaluates long-lived assets, including intangible assets,
      for
      impairment when events or changes indicate, in management’s judgment, that the
      carrying value of such assets may not be recoverable. The determination of
      whether an impairment has occurred is based upon management’s estimate of
      undiscounted future cash flows attributable to the assets as compared to the
      carrying value of the assets. If an impairment has occurred, the amount of
      the
      impairment recognized is determined by estimating the fair value of the assets
      and recording a write-down to reduce the related asset to its estimated fair
      value.





*Capitalization
      of Software Development Costs:* The
      Company follows the working model approach to determine technological
      feasibility of its products. Costs that are incurred subsequent to establishing
      technological feasibility are immaterial and, therefore, the Company expenses
      all costs associated with the development of its products as such costs are
      incurred.





*Revenue
      Recognition:* The
      Company recognizes software revenues in accordance with Statement of Position
      97-2 “Software Revenue Recognition” as amended by Statement of Position
      98-9.





Development
      license revenues from the licensing of source code or software development
      kits
      (“SDKs”) for the Company’s standard products are recognized upon delivery to and
      acceptance by the customer of the software if no significant modification or
      customization of the software is required and collection of the resulting
      receivable is probable. If modification or customization is essential to the
      functionality of the software, the development license revenues are recognized
      over the course of the modification work.





The
      Company also enters into engineering services contracts with certain of its
      OEMs
      to provide a turnkey solution, adapting the Company’s software and supporting
      electronics to specific OEM requirements. Revenues on such contracts are
      generally recognized over the course of the engineering work on a
      percentage-of-completion basis. Progress-to-completion under
      percentage-of-completion is generally determined based on direct costs,
      consisting primarily of labor and materials, expended on the arrangement. The
      Company provides for any anticipated losses on such contracts in the period
      in
      which such losses are first determinable. At January 31, 2007 and 2006 the
      Company had no significant loss contracts. The Company also provides engineering
      support based on a time-and-material basis. Revenues from this support are
      recognized as the services are performed.





Recurring
      licensing revenues are derived from per unit fees paid by the Company’s
      customers upon manufacturing and subsequent commercial shipment of products
      incorporating Peerless technology and certain third party technology, of which
      the Company is a sub-licensor. These recurring licensing revenues are recognized
      on a per unit basis as products are shipped commercially. The Company sells
      block licenses, that is, specific quantity or dollar amounts of licensed units
      that may be shipped in the future, or the Company may require the customer
      to
      pay minimum royalty commitments. Associated payments are typically made in
      one
      lump sum or extend over a period of four or more quarters. The Company generally
      recognizes revenues associated with block licenses and minimum royalty
      commitments on delivery and acceptance of software, when collection of the
      resulting receivable is probable, when the fee is fixed and determinable, and
      when the Company has no future obligations. In cases where block licenses or
      minimum royalty commitments have extended payment terms and the fees are not
      fixed and determinable, revenue is recognized as payments become due. Further,
      when earned royalties exceed minimum royalty commitments, revenues are
      recognized on a per unit basis as products are shipped
      commercially.





For
      fees
      on multiple element software arrangements, values are allocated among the
      elements based on vendor specific objective evidence of fair value (“VSOE”). The
      Company generally establishes VSOE based upon the price charged when the same
      elements are sold separately. When VSOE exists for all undelivered elements,
      but
      not for the delivered elements, revenue is recognized using the “residual
      method” as prescribed by Statement of Position 98-9. If VSOE does not exist for
      the undelivered elements, all revenue for the arrangement is deferred until
      the
      earlier of the point at which such VSOE does exist for the undelivered elements
      or all elements of the arrangement have been delivered.





For
      certain of the Company’s multiple element arrangements that do not directly
      involve licensing, selling, leasing or otherwise marketing of the Company’s
      software (including its MOU with Kyocera-Mita), the Company


F-9




**PEERLESS
          SYSTEMS CORPORATION**
  **NOTES
          TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


applies
      the guidance under EITF 00-21 *“Revenue
      Arrangements with Multiple Deliverables”* .
      With
      respect the Kyocera-Mita MOU, the Company applied the provisions of EITF 00-21
      and determined that there were two elements that required separate accounting:
      a) engineering services for over the three year term of the MOU and b) future
      maintenance services. The Company determined the fair value of future
      maintenance services to be $400 thousand based upon stand alone sales of the
      maintenance agreements and used the residual method to allocate the remaining
      portion of the $24 million service fee to the engineering services element.
      The
      Company had deferred the value of the future maintenance and is recognizing
      the
      remainder of the $24 million fee over the three year term of the
      arrangement.





The
      Company derived revenues from the sale of controllers for MFP devices. The
      Company recognized this revenue in accordance with Securities and Exchange
      Commission (SEC) Staff Accounting Bulletin 104, “Revenue Recognition in
      Financial Statements” (SAB 104). SAB 104 requires that four basic criteria must
      be met before revenue can be recognized: (1) persuasive evidence of an
      arrangement exists; (2) delivery has occurred or services rendered; (3) the
      fee
      is fixed and determinable; and (4) collectibility is reasonably assured.
      Peerless sold its controllers to certain OEM dealers for distribution to end
      users. Because it was a relatively new product, the Company was unable to
      establish a history regarding returns of product shipped. Therefore, the Company
      recognizes revenue only upon sales through to end users based on meeting the
      revenue recognition criteria under Statement of Financial Accounting Standards
      (SFAS) No. 48, “Revenue Recognition When Right of Return Exists.” The sale of
      these controllers was discontinued during the quarter ended January 31,
      2006.





Deferred
      revenue consists of prepayments of licensing fees, payments billed to customers
      in advance of revenue recognized on engineering services or support contracts,
      and shipments of controllers that have not been sold to end users. Unbilled
      receivables arise when the revenue recognized on engineering support or block
      license contracts exceeds billings due to timing differences related to billing
      milestones as specified in the contract.





*Research
      and Development Costs:* Research
      and development costs are generally expensed as incurred. Costs to purchase
      software from third-parties for research and development that have identifiable
      alternative future uses (in research and development projects or otherwise)
      are
      capitalized as intangible assets and amortized over their expected useful life.
      Such intangible assets were fully amortized at January 31, 2007 and 2006.
      Amortization expense associated with these intangible assets was $321 thousand
      and $550 thousand for the years ending January 31, 2006 and 2005,
      respectively.





*Advertising
      Costs:* Advertising costs are expensed as incurred in accordance with Statement of
      Position 93-7 “Reporting on Advertising Costs.” Advertising expenses are
      recorded in sales and marketing expense and were immaterial to the results
      of
      operations for all periods presented.





*Income
      Taxes:* The
      Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
      for Income Taxes.” Under this method, deferred income taxes are recognized for
      the tax consequences in future years resulting from differences between the
      tax
      bases of assets and liabilities and their financial reporting amounts at each
      year-end based on enacted tax laws and statutory rates applicable to the periods
      in which the differences are expected to reverse. Valuation allowances are
      established, when necessary, to reduce deferred income tax assets to the amount
      expected to be realized. Income tax provision is the tax payable for the period
      and the change during the period in net deferred income tax assets and
      liabilities.





*Comprehensive
      Income (Loss):* In
      accordance with SFAS No. 130, “Reporting Comprehensive Income,” all components
      of comprehensive income (loss), including net income (loss), are reported in
      the
      financial statements in the period in which they are recognized. Comprehensive
      income (loss) is defined as the change in equity during a period from
      transactions and other events and circumstances from non-owner sources. The
      Company’s accumulated other comprehensive income (loss) for fiscal years January
      31, 2007, 2006 and 2005 consisted of foreign currency translation gains and
      is
      reported in stockholders’ equity.





*Earnings
      Per Share:* Basic
      earnings per share (“basic EPS”) is computed by dividing net income (loss)
      available to common stockholders (the numerator) by the weighted average number
      of common shares outstanding (the denominator)
      during the period. The computation of diluted earnings per share (“diluted EPS”)
      is similar to the computation of basic EPS except that the denominator is
      increased to include the number of additional common shares that would have
      been
      outstanding if dilutive potential common shares had been issued. Potential
      common shares include outstanding options under the Company’s employee stock
      option plan (which are included under the treasury stock method) and any
      outstanding convertible securities. A reconciliation of basic EPS to diluted
      EPS
      is presented in Note 7 to the Company’s financial statements.





F-10




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**





*Foreign
      Currency Translation:* The
      financial statements of the Company’s non-U.S. subsidiary are translated into
      U.S. dollars in accordance with SFAS No. 52, “Foreign Currency Translation.” The
      assets and liabilities of the Company’s non-U.S. subsidiary whose “functional”
currencies are other than the U.S. dollar are translated at current rates of
      exchange. Revenue and expense items are translated at the average exchange
      rate
      for the year. The resulting translated adjustments are recorded directly into
      accumulated other comprehensive income (loss). Transaction gains and losses
      are
      included in net income in the period they occur. Foreign currency translation
      and transaction gains and losses have not been significant in any period
      presented.





*Recent
      Accounting Pronouncements:* In May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”,
      which changes the accounting for and the reporting of voluntary changes in
      accounting principles. SFAS No. 154 requires changes in accounting principles
      to
      be applied retrospectively to prior period financial statements, where
      practicable, unless specific transition provisions permit alternative transition
      methods. SFAS No. 154 was effective for fiscal years beginning after December
      15, 2005. The Company’s adoption of SFAS No. 154 did not have a material impact
      on the Company’s results of operations, financial position or cash
      flows.





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108).
      Due
      to diversity among registrants, SAB 108 expresses SEC staff views regarding
      the
      process by which misstatements in financial statements are evaluated for
      purposes of determining whether financial statement restatement is necessary.
      SAB 108 is effective for fiscal years ending after November 15, 2006. The
      adoption of SAB 108 had no impact on the Company’s consolidated financial
      statements.





In
      September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
      statement defines fair value, establishes a framework for measuring fair value
      in generally accepted accounting principles, and expands disclosures about
      fair
      value measurements. SFAS No. 157 is effective for fiscal years beginning after
      November 15, 2007. The Company does not expect the adoption of SFAS No. 157
      will
      have a material impact on its consolidated financial statements.





In
      June
      2006, the FASB issued Interpretation No. 48, “Accounting for Income Taxes (FIN
      48)”, to create a single model to address accounting for uncertainty in tax
      positions. FIN 48 clarifies the accounting for income taxes, by prescribing
      a
      minimum recognition threshold a tax position is required to meet before being
      recognized in financial statements. FIN 48 also provides guidance on
      derecognition, measurement, classification, interest and penalties, accounting
      in interim periods, disclosure, and transition. FIN 48 is effective for fiscal
      years beginning after December 15, 2006. The Company is currently evaluating
      the
      impact of the adoption of FIN 48 and therefore cannot estimate the impact the
      adoption will have on the Company’s financial position and results of
      operations.





In
      June
      2005, the FASB issued SFAS No. 123(R), “Share-Based Payment”. The Company
      adopted this statement on February 1, 2006 (see Note 2).


F-11




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**
   **2.**
              **Stock
                  Option and Purchase
                  Plan**





The
      Company has several long-term incentive plans which provide for the grant of
      incentive stock options to employees and non-statutory stock options, restricted
      stock purchase awards and stock bonuses to employees, directors and consultants.
      The terms of stock options granted under these plans generally may not exceed
      10
      years. Options granted under the incentive plans vest at the rate specified
      in
      each optionee’s agreement, generally over three or four years. An aggregate of
      6.2 million shares of common stock have been authorized for issuance under
      the
      various option plans.




On
      February 1, 2006 the Company adopted the provisions of Statement of Financial
      Accounting Standards SFAS No. 123(R) “Share-Based Payments,” using the
      modified-prospective method. Under this transition method, compensation expense
      recognized subsequent to adoption includes: a) compensation cost for all
      share-based payment granted prior to, but not yet vested as of adoption, based
      on values estimated in accordance with the original provisions of SFAS No.
      123,
      and b) compensation cost of all share-based payments granted subsequent to
      adoption, based on the grant-date fair values estimated in accordance with
      the
      provisions of SFAS No. 123(R). Consistent with the modified-prospective method,
      our results of operations for prior periods have not been restated.




Upon
      adoption of SFAS 123(R), the Company changed its method of attributing the
      value
      of stock-based compensation expense from the multiple-option (i.e., accelerated)
      approach to the single-option (i.e., straight-line) method. Compensation expense
      for share-based awards granted through January 31, 2006 will continue to be
      subject to the accelerated or multiple-option method, while compensation expense
      for share-based awards granted on or after February 1, 2006 will be recognized
      using a straight-line, or single-option method. The Company recognizes these
      compensation costs over the service period of the award, which is generally
      the
      option vesting term of three or four years. In determining the fair value of
      options granted during fiscal 2007 the Company primarily used the Black-Scholes
      model, assumed no dividends per year, weighted average expected lives of 4.40
      years, expected volatility of 76.7%, and weighted average risk free interest
      rate of 4.78%.




For
      fiscal 2007, the Company recorded a total of $612 thousand in stock option
      expense related to stock options awarded after the adoption of SFAS No. 123(R)
      and for stock options which were not vested by the date of adoption of SFAS
      No.
      123(R). The impact of the adoption of SFAS No. 123(R) was a reduction of $0.04
      on basic and $0.03 reduction on diluted net income per share for year ended
      January 31, 2007.




The
      valuation methodologies and assumptions in estimating the fair v alue
      of
      stock options that were granted in fiscal 2007 were similar to those used in
      estimating the fair value of stock options granted in fiscal 2006. The Company
      uses historical volatility of Peerless’ stock price as a basis to determine the
      expected volatility assumption to value stock options. The Company used its
      actual stock trading history over a period that approximates the expected term
      of its options. The expected dividend yield is based on Peerless’ practice of
      not paying dividends. The risk-free rate of return is based on the yield of
      a
      U.S. Treasury instrument with terms approximating or equal to the expected
      life
      of the option. The expected life in years is based on historical actual stock
      option exercise experience. The Company had historically estimated forfeitures
      at the time of grant and the adoption of SFAS No. 123(R) had no material impact
      on forfeitures.




Prior
      to
      the adoption of
      SFAS
      No. 123(R), in fiscal 2007, the Company accounted for its stock option plans
      in
      accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees”
and included pro forma disclosures for stock compensation under the provisions
      of SFAS 123, “Accounting for Stock Based Compensation.” Under APB Opinion No.
      25, no compensation expense is recognized if the exercise price of the Company’s
      employee stock options equaled the market price of the underlying stock at
      the
      date of the grant. No compensation expense related to employee stock options
      was
      recorded in fiscal 2006 or in prior years.




The
      following table illustrates the effect on net income and earnings (loss) per
      share if the Company had applied the fair value recognition provisions of SFAS
      No. 123:


F-12




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


**Year
                Ended**
              **January
                31, 2006**
              **(In
                thousands,**
              **except
                per share**
              **amounts)**
            
            **Year
                Ended**
              **January
                31, 2005**
              **(In
                thousands,**
              **except
                per share**
              **amounts)**Net
                income as reported
            
            $
            4,314
            
            $
            (5,805
            )Stock-based
                compensation, net of taxes
            
            $
            (466
            )
            $
            (465
            )Pro
                forma net income
            
            $
            3,848
            
            $
            (6,270
            )Basic
                earnings per share as reported
            
            $
            0.26
            
            $
            (0.37
            )Pro
                forma basic earnings per share
            
            $
            0.24
            
            $
            (0.39
            )Diluted
                earnings per share as reported
            
            $
            0.23
            
            $
            (0.37
            )Pro
                forma diluted earnings per share
            
            $
            0.21
            
            $
            (0.39
            )





In
      determining the fair value for the pro forma disclosure the Company used the
      Black-Scholes model, assumed no dividends per year, used expected lives ranging
      from 2 to 10 years, expected volatility of 77.3% and 75.0% for the years ended
      January 31, 2006 and 2005, respectively, and weighted average risk free interest
      rates of 4.10% and 3.47% for the years ended January 31, 2006 and 2005,
      respectively.





*1992
      Stock Option Plan:* During
      1992, the Board of Directors authorized the 1992 Stock Option Plan for the
      purpose of granting options to purchase the Company’s common stock to employees,
      directors and consultants. The Board of Directors determines the form, term,
      option price and conditions under which each option becomes exercisable. Options
      to purchase a total of 1,055 thousand shares of common stock have been
      authorized by the Board under this plan.





*1996
      Incentive Plan:* In May
      1996, the Board of Directors adopted the Company’s 1996 Stock Option Plan. The
      Company’s 1996 Equity Incentive Plan (the “1996 Incentive Plan”) was adopted by
      the Board of Directors in July 1996 as an amendment and restatement of the
      Company’s 1996 Plan. At that time, the Board of Directors had authorized and
      reserved an aggregate of 1,267 thousand shares of common stock for issuance
      under the 1996 Incentive Plan. Additional shares of common stock were authorized
      and reserved for issuance under the 1996 Incentive Plan in June 1998, June
      1999,
      June 2001, and June 2003 in the amounts of 1,200 thousand, 750 thousand, 750
      thousand, and 700 thousand shares, respectively.





During
      1994, the Auco, Inc. Board of Directors authorized the 1994 Stock Option Plan.
      The terms and conditions of this plan were generally the same as those of the
      Peerless Incentive Plan except options issued under the Auco plan were
      exercisable immediately subject to repurchase rights held by Auco. In June
      1999,
      upon completion of the merger between Peerless and Auco, the Auco options were
      converted to options under the Company’s Incentive Plan.





*2005
      Incentive Stock Option Plan:* In June
      2005 shareholders approved the Company’s 2005 Equity Incentive Plan. The Board
      authorized and reserved 500 thousand shares together with the 289 thousand
      shares remaining under the 1996 Incentive Plan which was terminated as
      authorized by the shareholders.





The
      2005
      Incentive Plan provides for the grant of incentive stock options to employees
      and non-statutory stock options, restricted stock purchase awards and stock
      bonuses to employees, directors and consultants. The terms of stock options
      granted under the Incentive Plan generally may not exceed 10 years. The exercise
      price of options granted under the Incentive Plan is determined by the Board
      of
      Directors, provided that the exercise price for an incentive stock option cannot
      be less than 100% of the fair market value of the common stock on the date
      of
      the option grant and the exercise price for a non-statutory stock option cannot
      be less than 85% of the fair market value of the common stock on the date of
      the
      option grant. Options granted under the Incentive Plan vest at the rate
      specified in each optionee’s agreement, which is generally over 1 to 4
      years.


F-13




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


The
      following represents option activity under the 1992 Stock Option Plan, 1996
      Incentive Plan, 2005 Incentive Plan, and certain employee options issued outside
      these plans for the years ended January 31:





**Options**
            
            **Weighted**
              **Average
                Exercise**
              **Price**
            
            **Weighted
                Average**
              **Remaining
                Contractual**
              **Term
                (Years)**
            
            **Aggregate**
              **Intrinsic
                Value**(In
                thousands, except per share amounts)Beginning
                outstanding balance at January 31, 2004
            
            
            3,102
            
            $
            2.70Granted
            
            
            963
            
            $
            1.33Exercised
            
            
            (55
            )
            $
            0.73Canceled
                or expired
            
            
            (237
            )
            $
            3.83Balance
                outstanding January 31, 2005
            
            
            3,773
            
            $
            2.32Granted
            
            
            145
            
            $
            3.52Exercised
            
            
            (508
            )
            $
            1.46Canceled
                or expired
            
            
            (100
            )
            $
            2.85Balance
                outstanding January 31, 2006
            
            
            3,310
            
            $
            2.47Granted
            
            
            1,356
            
            $
            3.79Exercised
            
            
            (262
            )
            $
            1.36Canceled
                or expired
            
            
            (220
            )
            $
            4.79Balance
                outstanding January 31, 2007
            
            
            4,184
            
            $
            2.85
            
            
            6.72
            
            $
            2,267Options
                exercisable, January 31, 2007
            
            
            2,433
            
            $
            2.72
            
            
            4.88
            
            $
            1,874




The
      weighted-average grant date fair value of the options granted during the years
      ended January 31, 2007, 2006, and 2005 were $2.35, $1.60 and $0.81,
      respectively. During the twelve months ended January 31, 2007, the total
      intrinsic value of stock options exercised was $1,552 thousand. Cash received
      from stock option exercises in the twelve months of fiscal 2007 was $357
      thousand. The excess tax benefit was negligible for year ended January 31,
      2007.
      As of January 31, 2007, there was $2.4 million of total unrecognized
      compensation cost related to nonvested share-based compensation arrangements
      granted under the 1992, 1996, 2005, and certain employee options issued outside
      these plans. That cost is expected to be recognized over a weighted-average
      period of 4.38 years. The Company issues shares of common stock reserved for
      such plans upon the exercise of stock options.




*CEO
      Incentive Stock Option Grant:* In
      December 2006, the board of directors approved an equity incentive grant for
      the
      incoming CEO. The grant included 400 thousand options which vest at certain
      market conditions. The first 200 thousand options vest upon the share closing
      price reaching $10 per share and staying at or above that price for 90 days.
      The
      second 200 thousand options vest upon the share closing price reaching $14
      per
      share and staying at or above that price for 90 days. These options were
      included in the table and disclosures above.




*Other
      Stock Options:* During
      fiscal year 2005, the Company granted stock options to two non-employees of
      the
      Company in connection with an agreement with the non-employees to provide
      services to the Company. The stock options are for the purchase of 25 thousand
      shares at an exercise price of $3.27 and 25 thousand shares at an exercise
      price
      of $4.27. The options are fully vested and expire on May 24, 2014. The fair
      value of the options was recorded as an operating expense at the time of grant.
      The fair value of the options was $31 thousand and was determined using the
      Black-Scholes method.




*Employee
      Stock Purchase Plan:* In July
      1996, the Company’s Board of Directors approved the Employee Stock Purchase Plan
      (the “Purchase Plan”) covering an aggregate of 300 thousand shares of the
      Company’s common stock. An additional 500 thousand shares were approved by the
      stockholders in June 2000, with an additional 1.0 million shares approved in
      June 2002. Under the Purchase Plan, the Board of Directors authorized
      participation by eligible employees, including officers, in periodic offerings
      following the adoption of the Purchase Plan. Plan  F-14


**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


offering
      periods have been six months since the inception of the plan. Employees were
      eligible to participate if they were employed by the Company or an affiliate
      of
      the Company designated by the Board of Directors and met eligibility standards
      established by the Board of Directors. Employees who participated in an offering
      can have up to 15% of their earnings withheld pursuant to the Purchase Plan
      and
      applied, on specified dates determined by the Board of Directors, to the
      purchase of shares of common stock. The price of common stock purchased under
      the Purchase Plan was equal to 85% of the lower of the fair market value of
      the
      common stock on the commencement date or the purchase date of each offering
      period. Employees may end their participation in the offering at any time during
      the offering period, and participation ended automatically on termination of
      employment with the Company and its affiliates. In November 2005, the Board
      elected to terminate the Purchase Plan.





Under
      the
      Purchase Plan, during the years ended January 31, 2006 and 2005, employees
      purchased 335 thousand and 251 thousand shares of common stock at weighted
      average per share prices of $1.32 and $1.35, respectively.





**3.**
            **Property
                and Equipment:**





Property
      and equipment at January 31 consisted of the following:





**2007**
            
            **2006**(In
                thousands)Computers
                and other equipment
            
            $
            8,635
            
            $
            8,419Furniture
            
            
            502
            
            
            502Leasehold
                improvements
            
            
            2,379
            
            
            2,37911,516
            
            
            11,300Less,
                accumulated depreciation and amortization
            
            
            (10,958
            )
            
            (10,396
            )$
            558
            
            $
            904





Property
      and equipment depreciation and amortization for the years ended January 31,
      2007, 2006, and 2005 was, $563 thousand, $672 thousand and $829 thousand,
      respectively.





**4.**
            **Other
                Current Liabilities**





Other
      current liabilities at January 31 consisted of the following:





**2007**
            
            **2006**(In
                thousands)Professional
                Service Fees
            
            $
            793
            
            $
            180Restructuring
                Charges
            
            
            358
            
            
            —Other
            
            
            164
            
            
            563Total
                other current liabilities
            
            $
            1,315
            
            $
            743





In
      January 2007, the Company implemented a restructuring program to better match
      the Company’s resources with the current level of contract activity. The
      reduction in workforce affected approximately 20 positions company -wide. The
      Company recorded a charge of approximately $358 thousand in expenses for
      one-time termination benefits. This resulted in a $200 thousand charge to cost
      of sales; $101 thousand to research and development; $9 thousand to sales and
      marketing; and $48 thousand to general and administrative expense. This amount
      is expected to be paid during the first quarter of fiscal 2008 and is recorded
      in other current liabilities.





**5.**
            **Deferred
                Revenues:**





The
      Company may bill or receive payments from its customers for fees associated
      with
      product licensing, engineering services, or maintenance agreements in advance
      of
      the Company’s completion of its contractual obligations. Such billings or
      payments, in accordance with the Company’s revenue recognition policies, are
      deferred, and are recognized as revenue when the Company has performed its
      contractual obligations related to the billings or payments


F-15




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


Deferred
      revenues consisted of the following at January 31:





**2007**
            
            **2006**(In
                thousands)Product
                licensing
            
            $
            180
            
            $
            25Engineering
                services and maintenance
            
            
            626
            
            
            622Other
            
            
            1
            
            
            61$
            807
            
            $
            708





**6.**
            **Income
                Taxes:**





The
      income tax provision for the years ended January 31 consisted of:





**2007**
            
            **2006**
            
            **2005**Current:
            
            (In
                thousands)Federal
            
            $
            —
            
            $
            —
            
            $
            —State
            
            
            14
            
            
            26
            
            
            1Foreign
            
            
            9
            
            
            3
            
            
            150$
            23
            
            $
            29
            
            $
            151





The
      foreign tax provision was comprised of foreign withholding taxes on license
      fees
      and royalty payments. On July 1, 2004, a new tax treaty between Japan and the
      United States went into effect. The new treaty generally eliminates the
      requirement of the Company’s Japanese customers to withhold income taxes on
      royalty payments due to Peerless. The impact was to nearly eliminate the
      Company’s provision for income taxes in the period since the treaty went into
      effect.





Temporary
      differences for the years ended January 31, consisted of:





**2007**
            
            **2006**Deferred
                tax assets:
            
            (In
                thousands)Net
                operating loss carryforwards
            
            $
            1,816
            
            $
            4,196Accrued
                liabilities
            
            
            462
            
            
            445Allowance
                for doubtful accounts
            
            
            5
            
            
            61Property
                and equipment
            
            
            740
            
            
            659Inventory
            
            
            72
            
            
            65Deferred
                expenses
            
            
            231
            
            
            190Tax
                credit carryforwards
            
            
            9,479
            
            
            7,222Other
            
            
            294
            
            
            3Total
                deferred tax assets
            
            
            13,099
            
            
            12,841Deferred
                tax liabilities:State
                income taxes
            
            
            1
            
            
            (1
            )Subtotal
            
            
            13,100
            
            
            12,840Valuation
                allowance
            
            
            (13,100
            )
            
            (12,840
            )Net
                deferred income tax asset
            
            $
            —
            
            $
            —





The
      Company established a valuation allowance on its net deferred tax assets as
      based on the uncertainty with respect to the Company’s ability to continue to
      generate future taxable income, it is unlikely that the deferred tax assets
      will
      be realized. With a change in management’s assessment of the uncertainty, the
      valuation allowance will be adjusted accordingly.


F-16




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


The
      provision for income taxes for the years ended January 31, differed from the
      amount that would result from applying the federal statutory rate as
      follows.




**2007**
            
            **2006**
            
            **2005**Statutory
                federal income tax rate
            
            
            34.0
            %
            
            34.0
            %
            
            (34.0
            )%Foreign
                provision
            
            
            0.3
            %
            
            0.1
            %
            
            2.7Other
                nondeductible expenses
            
            
            0.4
            %
            
            0.4
            %
            
            0.3State
                tax
            
            
            4.6
            %
            
            5.8
            %
            
            (5.8
            )Change
                in valuation allowance
            
            
            (36.0
            )%
            
            (37.3
            )%
            
            50.9Other
            
            
            (2.6
            )%
            
            (2.4
            )%
            
            (11.4
            )Provision
                for income taxes
            
            
            0.7
            %
            
            0.7
            %
            
            2.7
            %





As
      of
      January 31, 2007, the Company had net operating loss carryforwards available
      to
      reduce future federal and state income of approximately $5,187 thousand and
      $1,152 thousand respectively, which will begin to expire in fiscal years 2025
      for federal and 2009 for state. In addition, as of January 31, 2007, the Company
      had tax credit carryforwards available to reduce future income tax liabilities
      of approximately $11,648 thousand which will begin to expire in fiscal year
      2008. Utilization of the net operating loss and tax carryforwards will be
      subject to an annual limitation if a change in the Company’s ownership should
      occur as defined by Section 382 and Section 383 of the Internal Revenue
      Code.





**7.**
            **Earnings
                (Loss) Per Share:**





Earnings
      (loss) per share for the years ended January 31, is calculated as
      follows:





**2007**
            
            **2006**
            
            **2005****Net**
              **Income**
            
            **Shares**
            
            **Per**
              **Share**
              **Amount**
            
            **Net**
              **Income**
            
            **Shares**
            
            **Per**
              **Share**
              **Amount**
            
            **Net**
              **Loss**
            
            **Shares**
            
            **Per**
              **Share**
              **Amount**(In
                thousands, except per share amounts)**Basic
                EPS**Earnings
                (loss) available to common stock holders
            
            $
            3,286
            
            
            17,100
            
            $
            0.19
            
            $
            4,314
            
            
            16,496
            
            $
            0.26
            
            $
            (5,805
            )
            
            15,891
            
            $
            (0.37
            )**Effect
                of Dilutive Securities**Options
            
            
            —
            
            
            1,813
            
            
            —
            
            
            —
            
            
            1,969
            
            
            —**Diluted
                EPS**Earnings
                (loss) available to common stockholders with assumed
                conversions
            
            $
            3,286
            
            
            18,912
            
            $
            0.17
            
            $
            4,314
            
            
            18,465
            
            $
            0.23
            
            $
            (5,805
            )
            
            15,891
            
            $
            (0.37
            )





The
      Company had 472 thousand, 314 thousand, and 1,434 thousand common stock options
      that are not included in the calculation of diluted earnings (loss) per share
      in
      fiscal years 2007, 2006, and 2005, respectively. Additionally, 31 thousand
      warrants were not included in fiscal year 2005. These common stock options
      and
      warrants were not included because the effects are anti-dilutive.





**8.**
            **Shareholder
                Rights Plan:**





In
      October 1998, the Board of Directors of the Company adopted a stockholder rights
      plan, as set forth in the Rights Agreement, dated as of October 7, 1998, by
      and
      between the Company and Wells Fargo Shareowner Services, a division of Wells
      Fargo Bank Minnesota, N.A., formerly known as Norwest Shareowner Services,
      as
      rights agent. Pursuant to the Rights Agreement, one right was issued for each
      share of the Company’s 11,037 thousand outstanding shares of common stock as of
      October 15, 1998. Each of the Rights entitles the registered holder to purchase,
      from the Company, one one-thousandth of a share of Series A Junior Participating
      Preferred Stock at a price of $35.50 per one one-thousandth of a share. The
      Rights generally will not become exercisable unless and until, among other
      things, any person or group not approved by the Board of Directors acquires
      beneficial ownership of 15% or more of the Company’s outstanding common stock or
      commences a tender offer or exchange offer which would result in a person or
      group beneficially owning 15% or more of the Company’s outstanding common stock.
      Upon the occurrence of certain events, each holder of a Right, other than such
      person or group,


F-17




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


would
      thereafter have the right to purchase, for the then exercise price of the Right,
      shares of common stock of the Company or a corporation or other entity acquiring
      the Company, having a value equal to two times the exercise price of the Right.
      The Rights are redeemable by the Company under certain circumstances at $0.01
      per Right and will expire, unless earlier redeemed or extended, on October
      15,
      2008.





**9.**
            **Employee
                Savings Plan:**





The
      Company maintains an employee savings plan that qualifies under Section 401(k)
      of the Internal Revenue Code (the “Code”) for all of the Peerless full-time
      employees. The plan allows employees to make specified percentage pretax
      contributions up to the maximum dollar limitation prescribed by the Code. The
      Company has the option to contribute to the plan up to a maximum of $2,000
      per
      employee per year. Company contributions to the plan during the years ended
      January 31, 2007, 2006, and 2005 were $193 thousand, $178 thousand, and $163
      thousand, respectively.





**10.**
            **Segment
                Reporting:**





The
      Company operates in one reportable business segment, Imaging. Peerless provides
      software-based digital imaging and networking technology for digital document
      products and provides directory and management software for networked storage
      devices and integrates proprietary software into enterprise networks of original
      equipment manufacturers.





The
      Company’s long-lived assets are located principally in the United States. The
      Company’s revenues for the years ended January 31, which are transacted in U.S.
      dollars, are derived based on sales to customers in the following geographic
      regions:





**Years
                Ended January 31,****2007**
            
            **2006**
            
            **2005**(In
                thousands)United
                States
            
            $
            3,055
            
            $
            3,550
            
            $
            3,384Japan
            
            
            30,309
            
            
            31,596
            
            
            19,673Australia
            
            
            —
            
            
            751
            
            
            —Other
            
            
            19
            
            
            260
            
            
            21$
            33,383
            
            $
            36,157
            
            $
            23,078





**11.**
            **Commitments:**





*Operating
      Leases:* The
      Company leases its offices and certain operating equipment under operating
      leases that expire in fiscal year 2017. The principal operating leases covering
      the Company’s office space contain certain predetermined rent increases
      calculated at the inception of the lease based on the lessor’s estimate of
      expected increases in the fair market value of the leased space. These leases
      provide for renewal options of one to five years, at then fair rental value.
      Future minimum rental payments under long-term operating leases for the years
      ending January 31 are as follows:





**Operating**
              **Leases**(In
                thousands)2008
            
            $
            1,4252009
            
            
            1,4642010
            
            
            1,4952011
            
            
            1,4092012
            
            
            1,397Thereafter
            
            
            6,633$
            13,823





Total
      rental expense, net of sublease income, was $1,431 thousand, $1,189 thousand,
      and $1,369 thousand for the years ended January 31, 2007, 2006, and 2005,
      respectively.


F-18




**PEERLESS
        SYSTEMS CORPORATION**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**


*Purchase
      Orders:* The
      Company has outstanding purchase orders of approximately $31 thousand for
      materials and services at the end of fiscal year 2007.





**12.**
            **Risks
                and Uncertainties:**





*Concentration
      of Credit Risk:* The
      Company had cash and certificates of deposit on deposit at banks at certain
      times throughout the year that was in excess of federally insured
      limits.





The
      Company’s credit risk in accounts receivable (trade and unbilled), which are
      generally not collateralized, is concentrated with customers which are OEMs
      of
      laser printers and printer peripheral technologies. The financial loss, should
      a
      customer be unable to meet its obligation to the Company, would be equal to
      the
      recorded accounts receivable. At January 31, 2007, two customers collectively
      represented 70% of total accounts receivable and at January 31, 2006, four
      customers collectively represented 80%. For the years ended January 31 the
      following customers, not necessarily the same from year to year, represented
      greater than ten percent of total revenues:





**2007**
            
            **2006**
            
            **2005**(In
                thousands)Customer
                A
            
            $
            15,766
            
            
            47
            %
            $
            11,070
            
            
            31
            %
            $
            6,567
            
            
            28
            %Customer
                B
            
            
            7,654
            
            
            23
            %
            
            7,037
            
            
            19
            %
            
            2,984
            
            
            13
            %Customer
                C
            
            
            —
            
            
            —
            
            
            3,651
            
            
            10
            %
            
            2,653
            
            
            12
            %Customer
                D
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2,400
            
            
            10
            %$
            23,420
            
            
            70
            %
            $
            21,758
            
            
            60
            %
            $
            14,604
            
            
            63
            %





A
      significant portion of the Company’s revenue is generated from the sale of block
      licenses. Block license revenue represented 50%, 44%, and 56% of total revenue
      for the fiscal years 2007, 2006, and 2005.





*Litigation:* The
      Company is involved from time to time in various claims and legal actions
      incident to its operations, either as plaintiff or defendant. In the opinion
      of
      management, after consulting with legal counsel, no claims are currently
      expected to have a material adverse effect on the Company’s financial position,
      operating results, or cash flows.





**13.**
            **Related
                Party Transactions:**





In
      fiscal
      years 2006 and 2005, the Company engaged a marketing consulting firm controlled
      by a consultant who later became an officer of the Company in sales and
      marketing. Sales and marketing expenses for the years ended January 31, 2006
      and
      2005 included $5 thousand and $115 thousand, respectively, for the services
      performed by this related entity. No significant balances were owed to the
      entity at January 31, 2006.





**14.**
            **Subsequent
                Events**




On
      April
      10, 2007, Kyocera-Mita Corporation advised us that they had executed definitive
      agreements for the development, licensing and maintenance of some of the new
      technologies currently being developed under the MOU. We are currently awaiting
      receipt of these agreements. These agreements are currently under review by
      management and legal counsel and we hope to execute these documents in the
      very
      near term.


F-19




**SCHEDULE
      II — VALUATION AND QUALIFYING
      ACCOUNTS**




**Allowances
                for uncollectible accounts receivable:**
            
            **Balance
                at**
              **Beginning**
              **of
                Period**
            
            **Additions**
              **Charged
                to**
              **Costs
                and**
              **Expenses**
            
            **Deductions(a)**
            
            **Balance
                at**
              **End
                of**
              **Period****(In
                thousands)**Year
                Ended January 31, 2005Reserves
                deducted from assets to which they apply:Allowances
                for uncollectible accounts receivable
            
            $
            141
            
            $
            15
            
            $
            (31
            )
            $
            125Year
                Ended January 31, 2006Reserves
                deducted from assets to which they apply:Allowances
                for uncollectible accounts receivable
            
            $
            125
            
            $
            62
            
            $
            (19
            )
            $
            168Year
                Ended January 31, 2007Reserves
                deducted from assets to which they apply:Allowances
                for uncollectible accounts receivable
            
            $
            168
            
            $
            19
            
            $
            (168
            )
            $
            19





(a)
            Accounts
                written off, net of recoveries.




S-1




**EXHIBIT
      INDEX**




**Exhibit**
              **Number**3.1(1)
            
            Certificate
                of Incorporation of the Company.3.2(9)
            
            Amended
                and Restated Bylaws of the Company.4.1
            
            Instruments
                defining the rights of security holders. Reference is made to Exhibits
                3.1
                and 3.2.4.2(4)
            
            Rights
                Agreement, dated October 7, 1998, between the Company and Wells Fargo
                Shareowner Services, a division of Wells Fargo Bank Minnesota, N.A.,
                formerly known as Norwest Shareowner Services, as Rights
                Agent.10.1(10)(2)
            
            1996
                Equity Incentive Plan, as amended and form of stock option agreements
                thereunder.10.2(11)(2)
            
            1996
                Employee Stock Purchase Plan, as amended.10.3(1)(3)
            
            Reference
                Post Appendix No. 2 to the Adobe Third Party License dated February
                11,
                1993.10.4(1)
            
            Amendment
                No. 1 to the Adobe Third Party License dated November 29,
                1993.10.5(1)(3)
            
            PCL
                Development and License Agreement (the “PCL License”) dated June 14, 1993,
                between the Registrant and Adobe.10.6(1)(3)
            
            Amendment
                No. 1 to the PCL License dated October 31, 1993.10.7(1)(3)
            
            Letter
                Modification to the PCL License dated August 5, 1994.10.8(1)(3)
            
            Addendum
                No. 1 to the PCL License dated March 31, 1995.10.9(1)(3)
            
            Letter
                Modification to the PCL License dated August 30, 1995.10.10(1)
            
            Lease
                Agreement between the Company and Continental Development Corporation
                dated February 6, 1992, and Addendum, dated February 6,
                1992.10.11(1)
            
            First
                Amendment to Office Lease dated December 1, 1995, between the Company
                and
                Continental Development Corporation.10.12(5)
            
            Second
                Amendment to Office Lease dated April 8, 1997, between the Company
                and
                Continental Development Corporation.10.13(5)
            
            Third
                Amendment to Office Lease dated December 16, 1997, between the Company
                and
                Continental Development Corporation.10.14(6)
            
            Fourth
                Amendment to Office Lease dated April 22, 1998, between the Company
                and
                Continental Development Corporation.10.15(7)
            
            Agreement
                and Plan of reorganization and Merger by and among Peerless Systems
                Corporation, Auco Merger and Auco, Inc. dated as of April 6,
                1999.10.16(8)
            
            Marubun
                Supplier/Distribution Agreement dated December 14,
                1999.10.17(8)
            
            Lease
                PSN McKelvy Family Trust (386 Main Street) Standard Industrial/Commercial
                Single-Tenant dated March 14, 1997.10.18(8)
            
            Lease
                PSIP Kent Centennial Limited Partnership dated January 31,
                1996.10.19(2)(12)
            
            Form
                of Indemnification Agreement, effective as of March 12,
                2001.10.20(13)
            
            Settlement
                Agreement and Mutual Release dated April 11, 2001 between Peerless
                Systems
                Corporation and Gordon L. Hanson.10.21(9)
            
            Settlement
                Agreement and Mutual Release, effective as of April 27, 2001, by
                and among
                the State of Wisconsin Investment Board, Peerless Systems Corporation
                and
                Edward A. Gavaldon.10.22(14)
            
            Series
                A Preferred Stock Purchase Agreement dated January 29, 2002 by and
                among
                Netreon, Inc., a Delaware corporation, Netreon, Inc., a California
                corporation and each of the several purchasers named
                therein.10.23(14)
            
            Series
                A Preferred Stock Contribution Agreement dated January 29, 2002 by
                and
                between Netreon, Inc., a Delaware corporation and Peerless Systems
                Corporation.









**Exhibit**
              **Number**10.24(3)(15)
            
            Postscript
                Software Development License and Sublicense Agreement between Adobe
                Systems Incorporated and the Company effective as of July 23,
                1999.10.25(3)(15)
            
            Custom
                Sales Agreement between the Company and International Business Machines
                effective as of April 23, 2001.10.26(3)(15)
            
            Master
                Technology License Agreement dated January 16, 2000 between Konica
                Corporation and Peerless Systems Corporation.10.27(3)(15)
            
            License
                Software Addendum #1 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 16,
                2000.10.28(3)(15)
            
            License
                Software Addendum #2 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 19,
                2000.10.29(3)(15)
            
            License
                Software Addendum #3 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of July 21,
                2000.10.30(3)(15)
            
            License
                Software Addendum #4 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of March 1,
                2001.10.31(3)(15)
            
            License
                Software Addendum #5 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of July 1,
                2001.10.32(3)(15)
            
            License
                Software Addendum #7 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.10.33(3)(15)
            
            License
                Software Addendum #8 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.10.34(3)(15)
            
            License
                Software Addendum #9 to Master Technology License Agreement by and
                between
                Konica Corporation and the Company effective as of January 1,
                2002.10.35(15)
            
            Master
                Technology License Agreement dated April 1, 1997 between Kyocera
                Corporation and Peerless Systems Corporation.10.36(3)(15)
            
            Licensed
                Software Addendum #1 to Master Technology License Agreement by and
                between
                Kyocera Corporation and the Company effective as of December 28,
                1999.10.37(3)(15)
            
            Amendment
                #3 to Licensed Software Addendum #1 to Master Technology License
                Agreement
                by and between Kyocera Corporation and the Company effective as of
                September 28, 2001.10.38(3)(15)
            
            Licensed
                Software Addendum #3 to Master Technology License Agreement by and
                between
                Kyocera-Mita Corporation and the Company effective as of May 1,
                2002.10.39(3)(15)
            
            Master
                Technology License Agreement between Oki Data Corporation and Peerless
                Systems Imaging Products, Inc.10.40(3)(15)
            
            Licensed
                System Addendum No. 1 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products,
                Inc.10.41(3)(15)
            
            Licensed
                System Addendum No. 2 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products,
                Inc.10.42(3)(15)
            
            Licensed
                System Addendum No. 3 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products, Inc. effective
                as
                of August 25, 2000.10.43(3)(15)
            
            Attachment
                #1 to Licensed System Addendum #3 by and between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated March 1,
                2001.10.44(3)(15)
            
            Attachment
                #2 to Licensed System Addendum #3 by and between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated July 1,
                2001.10.45(3)(15)
            
            Licensed
                System Addendum No. 4 to Master Technology License Agreement between
                Oki
                Data Corporation and Peerless Systems Imaging Products, Inc. effective
                as
                of February 1, 2002.









**Exhibit**
              **Number**10.46(15)
            
            Master
                Technology License Agreement dated April 1, 2000 between Seiko Epson
                Corporation and Peerless Systems Imaging Products, Inc.10.47(3)(15)
            
            Licensed
                System Addendum #1 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                dated
                April 1, 2000.10.48(3)(15)
            
            Licensed
                System Addendum #2 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products,
                Inc.10.49(3)(15)
            
            Licensed
                System Addendum #3 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products,
                Inc.10.50(3)(15)
            
            Attachment
                #1 to Licensed System Addendum #3 by and between Seiko Epson Corporation
                and Peerless Systems Imaging Products, Inc. dated May 1,
                2001.10.51(3)(15)
            
            Attachment
                #2 to Licensed System Addendum #3 by and between Seiko Epson Corporation
                and Peerless Systems Imaging Products, Inc. dated July 23,
                2001.10.52(3)(15)
            
            Licensed
                System Addendum #4 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of October 19, 2001.10.53(3)(15)
            
            Licensed
                System Addendum #5 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of December 1, 2001.10.54(3)(15)
            
            Licensed
                System Addendum #6 to Master Technology License Agreement by and
                between
                Seiko Epson Corporation and Peerless Systems Imaging Products, Inc.
                effective as of April 30, 2002.10.55(3)(15)
            
            Nest
                Office SDK Development and Reseller Agreement Statement of Work 8
                to BDA
                No. N-A-1 between and Novell, Inc. and Peerless Systems Networking
                effective as of August 17, 1999.10.56(3)(15)
            
            Amendment
                No. 1 to Nest Office SDK Development and Reseller Agreement Statement
                of
                Work 8 to BDA No. N-A-1 between and Novell, Inc. and Peerless Systems
                Networking effective as of August 17, 1999.10.57(15)
            
            Business
                Development Agreement by and between Novell and Auco, Inc effective
                as of
                September 6, 1996.10.58(16)
            
            Amendment
                No. 4 to Licensed System Addendum No. 4 dated February 1, 2002 by
                and
                between Oki Data Corporation and Peerless Systems Imaging Products,
                Inc.
                dated September 1, 2002.(15)10.59(16)
            
            Amendment
                No. 3 to Postscript Software Development Agreement by and between
                Adobe
                Systems Incorporated and the Company dated October 25,
                2002.10.60(3)(17)
            
            Amendment
                No. 1 to Licensed System Agreement No. 7 dated November 1, 2001 by
                and
                between Konica Corporation and Peerless Systems Corporation dated
                January
                1, 2003.10.61(3)(17)
            
            Licensed
                System Agreement Addendum No. 10 to Master Technology License Agreement
                dated January 16, 2000 by and between Konica Corporation and Peerless
                Systems Corporation dated January 17, 2003.10.62(3)(17)
            
            Licensed
                System Addendum #8 to Master Technology License Agreement dated April
                1,
                2000 by and between Seiko Epson Corporation and Peerless Systems
                Imaging
                Products, Inc. effective as of January 6, 2003.10.63(3)(18)
            
            Amendment
                No. 4 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2003.10.64(3)(18)
            
            Amendment
                No. 10 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2003.10.65(3)(19)
            
            Amendment
                No. 5 to Licensed System Addendum No. 4 between Oki Data Corporation
                and
                Peerless Systems Imaging Products, Inc. dated February 1,
                2002.









**Exhibit**
              **Number**10.66(3)(19)
            
            Amendment
                No. 8 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 30, 2003.10.67(3)(19)
            
            Amendment
                No. 9 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 15, 2003.10.68(3)(19)
            
            Amendment
                No. 12 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of September 22, 2003.10.69(20)
            
            Licensed
                Software Addendum No. 14 to Master Technology License Agreements
                dated
                January 16, 2000 and June 12, 1997 by and between KonicaMinolta Business
                Technologies, Inc. and Peerless Systems Corporation, effective as
                of
                October 31, 200310.70(20)
            
            Amendment
                #2 to the LSA #9 by and between KonicaMinolta Business Technologies,
                Inc.
                and Peerless Systems Corporation, effective as of November 1,
                200310.71(20)
            
            Amendment
                No. 5 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of December 16, 2003.10.72(20)
            
            Amendment
                No. 6 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of July 31, 2002.10.73(20)
            
            Amendment
                No. 7 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of May 22, 2003.10.74(20)
            
            Amendment
                No. 11 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of February 9, 2004.10.75(20)
            
            Amendment
                No. 14 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of December 16, 2003.10.76(20)
            
            Amendment
                No. 15 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 6, 2004.10.77(2)(20)
            
            Change
                in Control Agreement of Chief Executive Officer.10.78(2)(20)
            
            Form
                of Change in Control Agreement of certain members of senior
                management.10.79(2)(20)
            
            Form
                of Transaction Incentive Plan of certain members of senior
                management.10.80(21)
            
            Amendment
                No. 16 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 6, 2004.10.81(21)
            
            Licensed
                Software Addendum #5 to Master Technology License Agreement dated
                April 1,
                1997, entered into as of February 17, 2004.10.82(21)
            
            Amendment
                No. 19 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of April 1, 2004.10.83(22)
            
            Amendment
                to Lease between BIT Holdings Forty-Eight, Inc. and Peerless Systems
                Imaging Products, Inc. as of October 1, 2004.10.84(22)
            
            Amendment
                No. 17 to the Postscript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, Effective as of 15 October,
                2004.









**Exhibit**
              **Number**10.85(22)
            
            Silicon
                Valley Bank Loan and Security Agreement between Silicon Valley Bank
                and
                Peerless Systems Corporation dated October 27, 2004.10.86(23)
            
            Memorandum
                of Understanding by and between Kyocera-Mita Corporation and Peerless
                Systems Corporation, effective as of February 1, 2005.10.87(23)
            
            Amendment
                No. 21 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.91(23)
            
            Amendment
                No. 18 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.92(23)
            
            Peerless
                Systems Corporation 2005 Incentive Award Plan10.93(23)
            
            Amendment
                No. 23 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of January 1, 2005.10.94(23)
            
            Peerless
                Systems Corporation Amended and Restated Transaction Incentive
                Plan.10.95(24)
            
            Amendment
                No. 22 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 14, 2005.10.96(24)
            
            Amendment
                No. 24 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 14, 2005.10.97(24)
            
            Amendment
                No. 26 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of October 13, 2005.10.98(24)
            
            Amendment
                No. 27 to the PostScript Software Development License and Sublicense
                Agreement between Adobe Systems Incorporated and Peerless Systems
                Corporation, effective as of November 1, 2005.10.99(25)
            
            Development
                Agreement between PMC-Sierra Corporation and Peerless Systems Corporation,
                dated March 27, 2006.10.100(26)(2)
            
            Letter
                of agreement relating to the employment of John V. Rigali as Vice
                President and Chief Financial Officer10.101(27)
            
            Lease
                agreement dated as of August 1, 2006, between Company and Continental
                2361/2381 LLC10.102(28)
            
            Letter
                dated December 7, 2006 from Adobe Systems Incorporated to Peerless
                Systems
                Corporation extending the term of PostScript Software Development
                License
                and Sublicense Agreement.10.103(29)(2)
            
            Consulting
                Agreement dated December 15, 2006, between the Company and Howard
                J.
                Nellor10.104(29)(2)
            
            Employment
                Agreement dated as of December 15, 2006, between the Company and
                Richard
                L. Roll10.105(29)(2)
            
            Indemnification
                Agreement dated as of December 15, 2006, between the Company and
                Richard
                L. Roll10.106(29)(2)
            
            Time-Vested
                Option Agreement dated as of December 15, 2006, between the Company
                and
                Richard L. Roll.10.107(29)(2)
            
            Price-Contingent
                Option Agreement dated as of December 15, 2006, between the Company
                and
                Richard L. Roll21
            
            Registrant’s
                Wholly-Owned Subsidiaries.23.1
            
            Consent
                of Independent Registered Public Accounting
                Firm.









**Exhibit**
              **Number**24.1
            
            Power
                of Attorney. Reference is made to the signature page to this Annual
                Report
                on Form 10-K.31.1
            
            Certification
                of Principal Executive Officer Pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of Principal Financial Officer Pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.32
            
            Certifications
                of Principal Executive Officer and Principal Financial Officer Pursuant
                to
                Section 906 of the Sarbanes-Oxley Act of 2002.





(1)
            Previously
                filed in the Company’s Registration Statement on Form S-1 (File No.
                333-09357), as amended and incorporated herein by
                reference.





(2)
            Management
                contract or compensatory plan or arrangement.





(3)
            Subject
                to a Confidential Treatment Order.





(4)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed October 13, 1999,
                and incorporated herein by
                reference.





(5)
            Previously
                filed in the Company’s 1998 Annual Report filed on Form 10-K, filed April
                24, 1998, and incorporated herein by
                reference.





(6)
            Previously
                filed in the Company’s 1999 Annual Report filed on Form 10-K, filed April
                26, 1999, and incorporated herein by
                reference.





(7)
            Previously
                filed in the Company’s Registration Statement on Form S-4 (File No.
                333-77049) as amended and incorporated herein by
                reference.





(8)
            Previously
                filed in the Company’s 2000 Annual Report filed on Form 10-K, filed April
                28, 2000, and incorporated herein by
                reference.





(9)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed July 2, 2001, and
                incorporated herein by reference.





(10)
            Previously
                filed in the Company’s Registration Statement on Form S-8 (File No.
                333-73562), filed November 16, 2001, and incorporated herein by
                reference.





(11)
            Previously
                filed in the Company’s Registration Statement on Form S-8 (File No.
                333-57362), filed March 21, 2001, and incorporated herein by
                reference.





(12)
            Previously
                filed in the Company’s Amendment No. 4 to its Registration Statement on
                Form S-3 (File No. 333-60284), filed July 27, 2001, and incorporated
                herein by reference.





(13)
            Previously
                filed in the Company’s 2001 Annual Report filed on Form 10-K, filed May 1,
                2001, and incorporated herein by
                reference.





(14)
            Previously
                filed in the Company’s 2002 Annual Report on Form 10-K, filed May 1, 2002,
                and incorporated herein by
                reference.





(15)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2002, filed September 16, 2002, and incorporated herein by
                reference.





(16)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2002, filed December 16, 2002, and incorporated herein by
                reference.





(17)
            Previously
                filed in the Company’s 2003 Annual Report on Form 10-K filed May 1, 2003,
                and incorporated herein by
                reference.





(18)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2003, filed September 15, 2003, and incorporated herein by
                reference.





(19)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2003, filed December 15, 2003, and incorporated herein by
                reference.





(20)
            Previously
                filed in the Company’s 2004 Annual Report on Form 10-K filed April 30,
                2004, and incorporated herein by
                reference.





(21)
            Previously
                filed in the Company’s Quarterly Report for the period ended April 30,
                2004, filed June 14, 2004, and incorporated herein by
                reference.





(22)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2004, filed December 15, 2004, and incorporated herein by
                reference.





(23)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2005, filed December 15, 2004, and incorporated herein by
                reference.





(24)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2005, filed December 15, 2004, and incorporated herein by
                reference.





(25)
            Confidential
                treatment has been requested with respect to the omitted portions
                of this
                Exhibit, which portions have been filed separately with the Securities
                and
                Exchange Commission. Previously filed in Amendment No. 1 to the Company’s
                Annual Report for the year ended December 31, 2006, filed October
                26,
                2006.





(26)
            Previously
                filed in the Company’s Quarterly Report for the period ended July 31,
                2006, filed September 14, 2006, and incorporated herein by
                reference.





(27)
            Previously
                filed in the Company’s Quarterly Report for the period ended October 31,
                2006, filed December 14, 2006, and incorporated herein by
                reference.





(28)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed December 18,
                2006, and incorporated herein by
                reference.





(29)
            Previously
                filed in the Company’s Current Report on Form 8-K, filed December 19,
                2006, and incorporated herein by reference.