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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   ---------

                                   FORM 10-K
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended                                Commission File Number:
    January 31, 2000                                           000-21287

                                   ---------

                          PEERLESS SYSTEMS CORPORATION
            (Exact name of registrant as specified in its charter)


          Delaware                                    95-3732595
(State or other jurisdiction of                    (I.R.S. Employer
incorporation or organization)                    Identification No.)

                  2381 Rosecrans Avenue, El Segundo, CA 90245
          (Address of principal executive offices, including zip code)

                                 (310) 536-0908
              (Registrant's telephone number, including area code)

       Securities registered pursuant to Section 12(b) of the Acts: None

          Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, $.001 Par Value Per Share

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                               Yes [X]     No[_]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of 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.   [X]

     The approximate aggregate market value of the Common Stock held by non-
affiliates of the Registrant, based upon the last sale price of the Common Stock
reported on the Nasdaq National Market on April 24, 2000 was approximately
$40,021,455.

     The number of shares of Common Stock outstanding as of April 24, 2000 was
14,891,704.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain parts of the Peerless Systems Corporation Proxy Statement relating
to the annual meeting of stockholders to be held on June 20, 2000 (the "Proxy
Statement") are incorporated by reference into Part III of this Annual Report
on Form 10-K.

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                   SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This Report on Form 10-K contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Act of 1934 which are subject to the "safe harbor" created by those sections.
The forward-looking statements include, but are not limited to, statements
related to industry trends and future growth in the markets for digital document
products, embedded imaging systems and enterprise networks; the Company's
strategies for reducing its customers' costs and time-to-market; the Company's
product development efforts; the Company's efforts to secure and protect the
rights to its proprietary technology; the effect of GAAP accounting
pronouncements on the Company's recognition of revenues; market risk; the
Company's future research and development expenditures; the availability of
future rental space; the payment of dividends; and the sufficiency of the
Company's capital resources.  Discussions containing such forward-looking
statements may be found in "Business", "Properties", "Market for Registrant's
Common Equity and Related Stockholder Matters" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".  These forward-
looking statements involve certain risks and uncertainties that could cause
actual results to differ materially from those in such forward-looking
statements. The Company disclaims any obligation to update these forward-looking
statements as a result of subsequent events.  The risks and uncertainties on
pages 21 through 25, among other things, should be considered in evaluating the
Company's prospects and future financial performance.

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                          PEERLESS SYSTEMS CORPORATION

                          2000 FORM 10-K ANNUAL REPORT

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                     Page
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                                                      PART I

<S>                                                                                                  <C>
Item 1.    Business................................................................................   4
Item 2.    Properties..............................................................................  13
Item 3.    Legal Proceedings.......................................................................  13
Item 4.    Submission Of Matters To A Vote Of Security Holders.....................................  13

                                                      PART II

Item 5.    Market For The Registrant's Common Equity Related
           Stockholder Matters.....................................................................  14
Item 6.    Selected Financial Data.................................................................  15
Item 7.    Management's Discussion And Analysis Of Financial
           Condition And Results Of Operations.....................................................  16
Item 8.    Consolidated Financial Statements And Supplementary Data................................  25
Item 9.    Changes In And Disagreements With Accountants On Accounting And Financial Disclosure....  25

                                                      PART III

Item 10.    Directors And Executive Officers.......................................................  26
Item 11.    Executive Compensation.................................................................  27
Item 12.    Security Ownership Of Certain Beneficial Owners And Management.........................  27
Item 13.    Certain Relationships And Related Transactions.........................................  27

                                                      PART IV

Item 14.  Exhibits, Financial Statement Schedules And Reports On
          Form 8-K.................................................................................  28
</TABLE>

                                   TRADEMARKS

Memory Reduction Technology(R) (MRT), PEERLESS SYSTEMS(R), Peerless Powered(R),
WINEXPRESS(R), PeerlessPrint(R) and QuickPrint(R) are registered trademarks of
Peerless Systems Corporation. CPL(TM), PicturePrint(TM), Acceleprint(TM) and
Synthesys(TM) are trademarks of Peerless Systems Corporation and are subjects of
applications pending for registration with the United States Patent and
Trademark Office. Imageworks(TM) and Webworks(TM) are trademarks of Peerless
Systems Corporation.  Peerless Systems (in English and Japanese Katakana),
Peerless (in logo) and P (in logo) are registered service marks with the
Japanese Patent Office. Peerless(TM) (in logo) and P(TM) (in logo), Peerless
Systems(TM), PEERLESSPRINT and PEERLESSPAGE(TM) (all in English and Japanese
Katakana), are trademarks of Peerless Systems Corporation and are subjects of
applications pending for registration with the Japanese Patent Office. This Form
10-K also refers to various products and companies by their trademark names. In
most, if not in all cases, their respective companies claim these designations
as trademarks or registered trademarks.

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PART I

Item 1 -- Business.

  Peerless Systems Corporation ("Peerless" or the "Company"), incorporated
in California in 1982 and reincorporated in Delaware in September 1996, is a
leading provider of software-based embedded imaging and networking systems to
original equipment manufacturers ("OEMs") of digital document products.
Digital document products include monochrome and color printers, copiers, fax
machines and scanners, as well as multifunction products ("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 an embedded imaging system.
Embedded networking systems supply the core software technologies to digital
document products that enable them to communicate over local and wide area
networks and the Internet.  The Peerless Systems family of products and
engineering services provide advanced embedded imaging and networking
technologies that enable the Company's OEM customers and third party developers
for OEM's to develop standalone and networked digital printers, copiers and MFPs
quickly and cost effectively. The Company markets its solutions directly to OEM
customers such as Canon, Hewlett Packard, IBM, Konica Minolta, Ricoh and Seiko
Epson.

  In June 1999, the Company acquired Auco, Inc. ("Auco") a supplier of embedded
networking systems. As a result of the acquisition, Auco became a wholly owned
subsidiary of the Company and was subsequently renamed Peerless Systems
Networking ("PSN").  PSN's low-cost integrated networking capability enables
office peripheral OEMs to provide networking as a standard feature in their
products.  This acquisition gives Peerless the opportunity to improve its
customers' time to market and product performance, including the addition of
critical new capabilities such as Internet connectivity. The acquisition also
brought several key new customers to the Company.

  In December 1999, the Company acquired HDE, Inc ("HDE").  HDE is a developer
of embedded imaging and Internet printing products. As a result of the
acquisition, HDE became a wholly owned subsidiary of the Company and was
subsequently renamed Peerless Systems Imaging Products ("PSIP").  The
acquisition expanded Peerless' presence in the embedded imaging and Internet
printing solutions markets and added important new customers to the Company's
portfolio.  In conjunction with HDE's strategic relationship with Adobe,
Peerless is among the leading embedded Adobe PostScript suppliers to the imaging
market. Further, the Company believes that the combination of its established
network software solutions and PSIP's expertise in Windows 2000 and internet
technologies will put it in the forefront of networking and directory
integration for networked devices.

Industry Background

  Embedded Imaging Systems

  Today's office environment is increasingly dependent on a variety of
electronic imaging products such as printers, copiers, fax machines and
scanners, collectively known as digital document products. These imaging
products also are becoming common in the home environment. Historically, most
electronic imaging products in the office environment have been stand-alone,
monochrome (black-and-white) machines, dedicated to a single print, copy, fax or
scan function. However, with the proliferation of personal computers and color,
desktop publishing software and network computing, documents increasingly are
being created, stored and transmitted digitally, thereby creating the need for
digital document reproduction.

  Digital documents are becoming increasingly complex and may include digital
text, line art or photographic images. In order to process and render these
documents, digital document products rely upon a core set of imaging software
and supporting electronics collectively known as an embedded imaging system. To
date, a majority of embedded imaging systems have been developed and produced
internally by digital document product manufacturers such as Hewlett-Packard
("HP"), Xerox and Canon. The Company estimates the digital document market,
based in part upon data and projections provided by International Data
Corporation ("IDC"), was approximately $41 billion in 1999.

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  Developments in the Digital Document Products Market

  Rapid changes in technology and end-user requirements have created increased
challenges for digital document product manufacturers, particularly in the area
of embedded imaging systems. These changes include increased technical
complexity, the increased role of networking, the emergence of MFPs and the
demand for color imaging driven by the internet. As a result, OEMs are relying
on outside embedded imaging systems suppliers to provide their embedded imaging
system solutions.

  Increased Technical Complexity. Initially, the software written for embedded
imaging systems supported only monochrome, single-function, low-resolution
capabilities. This software was relatively simple and resided on a low-end 8-bit
microprocessor platform. However, as technology and end-user requirements have
evolved, the embedded imaging task has become significantly more complex. Today,
digital imaging engines operate at resolutions of 1,200 dots per inch and
greater, require the support of a variety of document handling options, operate
at increased speeds and are offering high-quality color output. In addition,
computers and application software create increasingly sophisticated documents
that incorporate complex graphical content. The data files for these digital
documents can be very large and, if left in raw form, can overwhelm the memory
and processing power of the digital document product. In response, embedded
imaging systems have evolved from 8-bit to 32-bit platforms that often must
employ special techniques to manage large data files and minimize memory costs.
Most embedded imaging systems use compression techniques to reduce the size of
data files, which can result in reduced image quality. The increased complexity
of digital document products, the rapid pace of technological change and the
increased memory requirements have created increased challenges for digital
document product manufacturers, particularly in the core areas of image
processing and operating system architecture.

  Reliance on Outsourcing. In addition to the engineering challenges generated
by changing technology, digital document product manufacturers are continually
subject to a variety of market pressures. Competition in the marketplace,
coupled with end-user demand for greater performance at reduced cost has created
a growing need to reduce time-to-market and engineering costs. This increased
competition is forcing digital document product manufacturers to outsource some
or all imaging software and supporting electronics design to embedded imaging
systems suppliers in order to include new imaging technologies and minimize
development time and cost.  The increased role of networking, the emergence of
MFPs, the demand for color imaging and the increased technical complexity
associated with products meeting these market changes has enhanced the need for
OEMs to look for cost and value based outsourcing solutions.  Digital output
OEMs are reducing their outsourcing of traditional monochrome printer technology
while growing the outsourcing of new emerging technologies.  Also, OEM internal
resources are focusing on the core competencies in new product systems
development while leaving the quest for product differentiation to a technology
outsourcing function.  Additionally, there has been no established comprehensive
embedded imaging system standard for the digital document product industry since
it is a platform from which competitive differentiation is leveraged. However,
as product market sectors converge and the complexity of imaging technology
intensifies, Peerless believes digital document product manufacturers will
realize significant cost and time-to-market advantages by utilizing a single
open embedded imaging system standard across multiple digital document product
market sectors. See "Competition" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for a discussion of these
forward-looking statements.

  Demand for Color Imaging. Although many office computers have color displays,
and the graphical content available to office users via the Internet and
advanced office applications make heavy use of color, most digital document
products found in today's office environment still generate monochrome output.
In the 1990s, color inkjet printers were introduced into the small office/home
office (SOHO) market and color laser printers were introduced into the office
marketplace. In the SOHO market, most color inkjet printers are typically
limited by output speeds of one or fewer pages per minute. In the office market,
color laser printers have been limited by technology and unit costs that remain
significantly higher than monochrome laser printers.  In addition, the printing
speeds for color continue to be significantly slower than monochrome laser
printers. Furthermore, digital document product manufacturers are developing
tandem engines, which are comprised of multiple imaging stations dedicated to
individual colors used in the printing process. Although these products hold the
promise of raising desktop office color printing speeds to monochrome levels of
performance, cost effective embedded imaging systems that can produce high
quality output from these tandem engines are limited in the market. As a result,
market pressures for

                                       5
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advanced embedding imaging systems that enable high quality and improved
price/performance for both SOHO and office color products remain high. In
addition, the Internet, digital cameras and scanners are creating an intensified
need for photoquality color printing capabilities. Although digital document
engine manufacturers have developed color hardware technology that is now
capable of supporting high speed photoquality color printing, the output
produced by today's digital document products, in many cases, continues to be
limited by existing printing technology. A challenge also exists for embedded
imaging systems as they support the transition from monochrome to color output
because the simultaneous implementation of four planes of color coupled with up
to 8 bits per pixel at increased resolution significantly while increasing the
size of the digital document data stream. As a result, there is a need for
embedded imaging systems that can support the accelerated performance
requirements of high-density color output.

  Emergence of Multifunction Products. The advent of MFPs has eroded the
boundaries between the previously distinct printer, copier, fax and scanner
market sectors. MFPs, ranging from small home products to large office devices,
offer several of these functions for significantly less cost than would
otherwise be incurred by purchasing these products separately.  In the copier
market, the transition from analog to digital technologies is accelerating
demand for mid-range and high-speed MFP devices.  Each of the dominant vendors
in the printer, copier and fax markets have now introduced MFPs, which have
required each of them to broaden their imaging expertise. At the same time, the
need for concurrent processing of multiple digital document product functions
has created the need for real-time, multitasking operating system support.

  Increased Role of Networking. Within the office environment, digital document
products increasingly are deployed in a networked configuration. According to
projections by IDC, 79% of laser printers sold in the United States in 1996 were
estimated to have been connected to enterprise networks, and this percentage is
expected to increase to 83% by 2003.  Because multiple local area network
protocols and network operating systems are deployed in the corporate network
environment, networked digital document products must support a broad array of
networking technologies to maximize accessibility by various user groups. 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 IT environment and the
Internet. In addition, because the majority of office digital document products
are networked, the image processing intelligence may be partitioned and located
anywhere within the network: at the site of document or image origination, at a
server, or, as is typically the case today, inside the digital document product
itself. In some instances, such as when printing to a remote location, it can be
advantageous to perform image pre-processing and compression at the document
origination site prior to transmission over usage-sensitive or congested
facilities. In other instances, such as when printing from a graphics
workstation, it can be advantageous to perform most of the image processing at
the printer in order to offload a host computer that is under a heavy workload.
In order to accommodate the emerging needs of the networked office environment,
an optimal embedded imaging system must employ a modular architecture capable of
serving and managing distributed corporate resources.

     Peerless Products And Solutions

  Peerless is a leading provider of software-based embedded imaging and
networking systems for the digital document product market. The Company's
technology and engineering services provide advanced embedded imaging solutions
that enable the Company's OEM customers to develop digital printers, copiers and
MFPs quickly and cost effectively. The Company delivers its products to its OEM
customers in multiple ways: 1) licensing of the Company's standard Software
Development Kit ("SDK") imaging and networking technology for the OEM's internal
product development; 2) turnkey product development whereby the Company provides
the technology and the additional engineering services necessary to integrate
the appropriate technology into a complete embedded imaging system solution
optimized to the OEM's specific requirements or 3) a co-development relationship
that combines the licensing of Peerless technology with joint Peerless and OEM
engineering resources.

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Products and Services

The Company has designed its embedded imaging technology with a modular
architecture that addresses a broad spectrum of digital document product
solutions tailored to an individual OEM's requirements.

Peerless also offers its OEM customers the flexibility to selectively optimize
solutions for monochrome, color, network connectivity, printer control language,
and various multifunction features for this digital document produced.

  ImageWorks. ImageWorks is a complete object-based imaging system including a
high-performance real-time operating system kernel, printing engine driver,
object-based image processing model, graphics library, font management, hard
disk management, print job management and user control panel interface. The
scaleable nature of the Company's technology enables it to serve both the low
cost and high performance sectors of the market. The multitasking operating
system enables the Company to manage concurrent processing of digital document
product tasks for the MFP marketplace. For added performance and flexibility,
the Company's imaging system may be implemented to operate in a distributed
fashion, allowing for portions of the imaging processing task to take place in
the originating host computer, in the digital document product or elsewhere in
the network. Color extensions to ImageWorks support the unique requirements of
color printers.

  Page Description Languages. The Company provides OEMs with support for the
most widely used and standard page description languages ("PDLs"), Adobe's(R)
PostScript Software and Hewlett-Packard's Printer Control Language ("PCL").
The Company offers PeerlessPrint technology, which emulates Hewlett-Packard's
PCL. The complete range of printing language products includes PeerlessPrint5E,
5C and 6.  PeerlessPrint5E provides compatibility with HP's PCL 5e language
utilized in their LaserJet 5P, 5Si, LJ4000 and LJ5000 laser printer products, as
well as enhancements to support higher resolutions and added paper handling
options. PeerlessPrint5C is designed to provide compatibility with HP's PCL 5C
utilized in its Color LaserJet 4500 and high-end inkjet products. PeerlessPrint6
provides monochrome and color compatibility with HP's latest PCL 6 language. As
a third-party co-developer, the Company provides an optimized, high performance
integration of Adobe(R) PostScript 3 into the PeerlessPage imaging system and
certification services for customers desiring to license Adobe(R) PostScript
from Peerless.

  PC Software. The Company provides a complete set of PeerlessPrint drivers that
optimize the printing process in the Windows 3.1, 95, 98 and the NT 4.0
environments.  Windows NT 5.0 is currently under development and planned for
future release.

  ASICs. The Company designs application specific integrated circuit ("ASIC")
solutions for the office and SOHO sectors of the digital document product
marketplace. These ASICs provide a single chip implementation of key components
of its imaging software. Peerless has licensed these designs to semiconductor
manufacturers, such as IBM Microelectronics, NEC and Motorola who, in turn, have
the right to manufacture and sell these ASICs directly to digital document
product manufacturers. The Company's QuickPrint line of imaging ASIC co-
processors and integrated processors incorporate basic components of the
Company's imaging system into a silicon solution to reduce controller costs and
enhance overall performance. For the high performance sector of the office
market, the Company offers specialized co-processors that accelerate the
Peerless imaging software and incorporate controller functionality and imaging
features to provide both cost savings and performance enhancements. The Company
currently markets the QP 1700, QP 1800, QP 1900 and QP +401 ASICs. The QP +401
is a "system on a chip" solution which integrates the processor and co-processor
on a single chip. Additionally, the Company introduced the QP 1900 family of
ASICs to address tandem color engines for high-speed color printing as well as
very high-speed monochrome printing.

  The 1900 introduced a new business model where Peerless designs and contracts
for the manufacture and distribution of an ASIC semiconductor system.  This
model permits Peerless to offer an integrated solution to its OEM customers.  In
addition, the Company is currently selling the 1900 family of ASICs directly to
its OEM customer base.  Peerless Systems has entered into a distribution
agreement with an effective date of December 14,

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1999 with Maruban Corporation for services provided in our Japan region. A
contract has been negotiated with Arrow Electronic Corporation for similar
distribution services in the United States.

  Networking Technology. Peerless supports a broad array of networking
protocols, allowing its OEM customers to address the majority of end-user
networking requirements. To accommodate the need for remote network management
of digital document products over Local Area Network ("LAN") and across wide
area networks, including intranets, the Company supplies management information
base ("MIB") tables that may be utilized by open industry-standard network
management The PSN embedded network solution eliminates the need for a network
interface card and provides low cost, high speed embedded networking solutions
for cost sensitive market segments.

  Engineering Services. For those OEMs that wish to outsource the development of
some or all of the embedded imaging system for a digital document product, the
Company offers engineering services. This can include controller design and
custom engineering for vendor-specific features that complement the Company's
standard imaging technology. These services can be flexible to the OEMs needs
for hourly time and material support and fixed priced quotations. Peerless
supplies an excellent quality process including project management, the
management of multiple suppliers, design and testing to enable the delivery of a
quality proven product to meet the customers needs.

Solutions

  The Company's technology can be leveraged to provide a wide range of scaleable
solutions:

  Multifunction Solution. The Company's MFP imaging solutions target high-speed
copier-based MFP products lower-cost color inkjet, fax or laser-based workgroup
MFP products. The higher-end solutions combine the Company's networkable imaging
products with MFP-specific extensions to facilitate printing, copying, faxing
and scanning in the same digital document product. The Company's solutions
provide multifunction capability, but the Company does not provide stand-alone
fax or copier solutions.

  Color Solution. The Company's color imaging solutions target OEM requirements
for a broad range of color imaging devices. The Company's proprietary object-
based imaging system reduces Central Processing Unit ("CPU") and resource
requirements for printing color pages while simultaneously accelerating the
document imaging process and increasing print quality.

  Monochrome Solution. The Company's monochrome solution targets are well
recognized in the industry and span copiers and printers in the office
environment from a few pages per minute to units approaching one hundred pages
per minute.

Technology

  The Company develops unique technologies for the embedded imaging systems
marketplace that provide meaningful improvements in performance, cost and time
to market for Peerless' OEMs. The Company's proprietary embedded, object-based
imaging system reduces the size of digital document product imaging files with
virtually no loss of visual quality. This proprietary technology enables the
Company's OEM customers to reduce memory cost and increase print quality and
speed while eliminating or reducing the need for incremental compression
technology. When optimized, this component of the embedded imaging system can
provide significant cost savings and performance differentiation to digital
document product manufacturers. The Company incorporates complimentary
technologies, or makes its technologies compatible with third-party
technologies, in order to provide its customers with a more comprehensive
imaging solution.

  Object-Based Image Processing. Most other embedded imaging systems utilize
similar methods of processing document imaging information. They convert a file
that represents a document page into a bitmap and then process all page elements
as a collection of pixels. Because bitmaps generate large files, the image
processing task can become time-consuming, requiring subsequent document pages
to be stored in memory while previous pages are being processed. To accommodate
memory limitations, file compression technologies are often utilized. These

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compression technologies frequently result in a loss of clarity and detail in
the printed document and require significant processing power.

  Peerless has developed a proprietary approach to the embedded imaging task.
Rather than recognizing a page image as a collection of pixels, the Peerless
object-based image processing technology recognizes basic imaging elements in
the document, differentiating between text, line art and photographs much as the
human eye does. Peerless' software then creates a display list of image objects
as an intermediate representation of the document to be printed. This display
list is a more concise means of representing the imaging information of the
document, enabling complex imaging data to be processed more quickly and with
less memory, typically without resorting to compression techniques that degrade
the image. For high performance applications, the display list can be processed
in real time with assistance from a Peerless-designed graphics co-processor
embedded in the digital document product. Because Peerless technology can enable
the page image to be processed in real time, concurrent with the transmission of
the document print file, memory requirements can be reduced and performance can
be enhanced. Furthermore, the image quality or resolution can be modified to
accommodate limitations in the digital document product's memory, or
progressively enhanced by installation of additional digital document product
memory. The Company's object-based image processing technology provides more
significant benefits as the image processing workload increases, which occurs
with increased resolution or a transition from monochrome to color. The Company
holds six patents in the United States protecting the intellectual property
within certain aspects of its object-based imaging approach.

  Systems Architecture. The Company has developed standardized interfaces for
the Company's family of products that enable the Company's imaging solution to
be ported to a variety of platforms, languages and applications. For example,
the standardized PeerlessPage interface provides the ability to support multiple
printing languages. The PeerlessPage object-based imaging system is both
platform- and device-independent and is able to accommodate a variety of print
engines and controller architectures. The Company has also developed an
applications interface that enables the support of features such as spooling,
stored macros, stored forms, electronic collation and stapling.

  Technology Partners. The Company has established relationships that permit it
to offer to its customers complementary technologies through technology
partners. Adobe has been a development partner with Peerless since 1992 and the
relationship has grown stronger with each joint application of Peerless and
Adobe technologies. On July 23, 1999, Adobe and Peerless entered into a
PostScript Software Development License and Sublicense Agreement which expanded
the technology application and integration of the respective technologies.
Peerless has licensed (for internal development purposes) the right to use
Adobe's PostScript Software to enable the company's products to be used with
Adobe's PostScript Software. The Company's relationship with Adobe permits the
Company to offer a convenient and optimized Adobe PostScript - enabled solution,
as well as directly license PostScript to its OEM customers. With the assumption
of the HDE Adobe direct licensing contract on December 6, 1999 the HDE (now
PSIP) Adobe relationship has significantly expanded the availability of Adobe
embedded PostScript software business to Peerless. In addition, the Company
incorporates font rasterizers into its imaging solution to enable its OEMs to
license font technology from providers such as Agfa and Bitstream. The Company
has also established semiconductor agreements with leading developers and
manufacturers of RISC microprocessors in order to offer integrated processor and
co-processor solutions. The integrated processors combine the Company's basic
imaging sending functionality with an industry-standard microprocessor.

  As a result of the acquisition of Auco in June of 1999, the Company has also
established a strategic partnership with Novell. The partnership covers
networking and device management software licenses for imaging and storage
devices across the Novell NDS server environment, which includes Novell Embedded
NEST Server Software and eDirectory. The agreement enables Peerless to directly
license embedded directory and network services technology for both market
segments. This enables the company to bring greater functionality to all network
devices beginning with digital output systems and other network devices such but
not limited to storage systems.

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Customers and Markets

  Customers

  Peerless markets its imaging networking technology to OEMs manufacturing
digital document products for the high to medium performance sector of the
office market.  In addition, the Company markets its imaging technology to
technology partners, which incorporate certain components of the Company's
technology into integrated product offerings that are ultimately marketed to
digital document OEMs. With the exception of technology partners, such as Adobe
and Novell, the Company has derived substantially all of its revenues in recent
years from direct sales to digital document product OEMs.

  The Company's customers that individually comprised more than 10% of the
Company's total revenues for fiscal 2000 were Canon, Ricoh and Seiko Epson.
Revenues from the Company's top four customers accounted for 47%, 52%, and 49%
of the Company's total revenues for fiscal years 2000, 1999 and 1998,
respectively.  Although the Company has expanded and diversified its customer
base through focused sales efforts and the acquisitions of Auco and HDE, the
Company anticipates that its future revenues may be similarly concentrated with
a limited number of customers.  The Company's 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
licensing arrangements with the Company's customers are provided on a project-
by-project basis, are terminable with limited or no notice, and in certain
instances, and, in a limited number of cases, are not governed by long-term
agreements.

  Markets

  Enterprise Office Market. The office sector of the digital document product
market is characterized by digital document products ranging in price from
approximately $1,000 to in excess of $40,000 each. These products typically
offer high performance differentiated by customized features. In many cases,
digital document product manufacturers demand turnkey, customized embedded
imaging solutions that include imaging software, controller design and network
interface card design. As a result of these unique requirements, Peerless
typically addresses the high performance sector of the digital document product
market via direct OEM relationships with individual digital document product
manufacturers.  The Company's major customers in the office market in the fiscal
year ended January 31, 2000 included Ricoh, Canon, Kyocera, Sharp and Minolta.

  The Company produces a chipset that integrates components of the Company's
imaging software and semiconductor firmware. Peerless has licensed its
technology to Conexant, which has the rights to manufacture and sell a chipset
directly to digital document product manufacturers. Conexant is presently the
Company's primary customer in the SOHO market. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" for discussion on the
Company's dependence on sole source providers.

  International Markets.  Revenues from customers outside the United States
accounted for 72%, 64%, and 52% of the Company's total revenues for fiscal years
2000, 1999 and 1998, respectively. Further, the Company expects that sales to
customers located outside the United States may increase in absolute dollars in
the future. Peerless' international customers are comprised primarily of
companies headquartered in Japan. These Japanese customers sell products
containing Peerless' technology primarily in the North America and European
marketplaces. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" for further discussion on Asian markets.

  All of the Company's contracts with international customers are, and the
Company expects that in the future will be, denominated in U.S dollars.  As a
result, the Company is currently not subject to foreign currency transaction and
translation gains and losses.

                                       10
<PAGE>

Seasonality

  The Company believes that its business may be subject to seasonal trends.  See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for further discussion on seasonality.

Sales and Marketing

  The Company markets its products to the leading OEMs that sell digital
document products into the worldwide market. The Company directs most of its
sales efforts through its headquarters in California and its subsidiary in
Japan. Sales to European digital document product manufacturers are conducted
out of the Company's California headquarters.

  The Company markets directly to OEMs and through focused trade relations and
branding programs. Direct OEM marketing consists of focused public relations
activities and the development of sales collateral, mailers, trade show
attendance and sales support. The Company focuses its time on media read by OEM
customers. The Company directs its branding programs toward building the
Company's brand awareness. These programs consist of public relations and
Peerless product branding on its silicon and software products.


Product Development and Engineering Services

  The Company's product development activities are located at all three of the
sites, namely in El Segundo, California, Redwood City, California and Kent,
Washington. These activities primarily consist predominantly of new product
development, enhancement of existing products, product testing and technical
documentation development.  The Company's engineering personnel are divided into
two primary development areas: research and development, which focuses on
development and enhancement of the Company's core technologies; and engineering
services, which focuses on customized customer design activities.

  The Company's engineering services personnel work closely with OEMs that
desire a turnkey solution, developing customized interfaces and applications
specific to individual OEMs. The Company typically receives a fee for such
engineering services. As part of its corporate strategy, the Company leverages
its engineering services capability to penetrate emerging market sectors where
applications and interfaces have not fully evolved.

Intellectual Property and Proprietary Rights

  The Company's success is heavily dependent upon its proprietary technology. To
protect its proprietary rights, the Company relies on a combination of patent,
copyright, trade secret and trademark laws as well as nondisclosure and other
contractual restrictions. The Company holds six patents issued in the United
States, one of which is also issued in France, Germany and Great Britain. The
issued patents relate to techniques developed by the Company for generating
output for continuous synchronous raster output devices, such as laser printers.
The Company has four applications pending in Japan, three applications pending
in the European Patent Office and three applications pending in the United
States. There can be no assurance that patents held by the Company will not be
challenged or invalidated, that patents will issue from any of the Company's
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 the Company's technology may be sold) to provide
meaningful protection or any commercial advantage to the Company. 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 is not well defined and 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 the Company's technology.

  As part of its confidentiality procedures, the Company generally enters into
nondisclosure agreements with its employees, consultants, OEMs and strategic
partners and limits access to and distribution of its software and other
proprietary information. Despite these efforts, the Company may be unable to
effectively protect its proprietary

                                       11
<PAGE>

rights and, in any event, enforcement of the Company's proprietary rights may be
expensive. The Company's source code also is protected as a trade secret.
However, the Company from time to time licenses its source code to OEMs, which
subjects the Company to the risk of unauthorized use or misappropriation despite
the contractual terms restricting disclosure. In addition, it may be possible
for unauthorized third parties to copy the Company's products or to reverse
engineer or obtain and use the Company's proprietary information.

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

Competition

  The market for embedded 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. The Company competes on the basis of technology expertise, product
functionality, development time and price. The Company's technology and services
primarily compete with solutions developed internally by OEMs. Virtually all of
the Company's OEMs 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 embedded
imaging systems technologies and may implement these systems into their
products, thereby replacing the Company's current or proposed technologies,
eliminating a need for the Company's services and products and limiting future
opportunities for the Company. The Company therefore is required to persuade
these OEMs to outsource the development of their embedded imaging systems and to
provide products and solutions to these OEMs that cost-effectively compete
favorably with their internally developed products. The Company also competes
with software and engineering services provided in the digital document product
marketplace by other systems suppliers to OEMs. In this regard, the Company
competes with, among others, Destiny, Electronics for Imaging, Oak Technologies
and Splash.

  As the industry continues to develop, the Company expects that competition and
pricing pressures will increase from OEMs, existing competitors and other
companies may enter the Company's existing or future markets with similar or
substitute solutions that may be less costly or provide better performance or
functionality. The Company anticipates increasing competition for its color and
multifunction products, particularly as new competitors develop and enter
products in this emerging market. Some of the Company's existing competitors,
many of its potential competitors and virtually all of the Company's OEMs have
substantially greater financial, technical, marketing and sales resources than
the Company. In the event that price competition increases, competitive
pressures could cause the Company to reduce the amount of royalties received on
new licenses and to reduce the cost of its engineering services in order to
maintain existing business and generate additional product licensing revenues,
which could reduce profit margins and result in losses and a decrease in market
share. No assurance can be given as to the ability of the Company to compete
favorably with the internal development capabilities of its current and
prospective OEM customers or with other third-party embedded imaging system
suppliers, and the inability to do so would have a material adverse effect on
the Company's operating results.

                                       12
<PAGE>

Employees

  As of January 31, 2000 the Company had a total of approximately 235 employees
and independent contractors. None of the Company's employees is represented by a
labor union, and the Company has never experienced any work stoppage. The
Company considers its relations with its employees to be good.



Item 2 -- Properties.

  The Company leases its principal facilities in El Segundo, California.  The
operating lease, as amended, expires in March 2007. The Company also leases
office space in Redwood City, California and Mountain View, California for PSN,
in Covington and Kent, Washington for PSIP and in Japan. The Company believes
that suitable additional facilities or alternative space will be available in
the future on commercially reasonable terms as needed.


Item 3 -- Legal Proceedings.

  The Company has filed a lawsuit in January 2000 against Conexant Systems Inc.,
Newport Beach, CA in the Orange County Superior Court regarding the failure and
refusal of Conexant to pay to the Company a portion of a Source License Fee and
guaranteed royalty payments pursuant to an agreement between the parties. The
Company is confident that it will prevail in this matter.

  The Company was sued by a major shareholder, the State of Wisconsin Investment
Board ("SWIB") in the Court of Chancery of the State of Delaware in New Castle
County in December 1999. The Company's former Chief Executive Officer, Edward A.
Gavaldon, has also been named as a defendant. The complaint alleges that
Peerless wrongfully influenced the passage of Proposal 2 (Increase in the Number
of Shares in the Stock Option Plan) at the 1999 Annual Meeting of Shareholders
and provided misleading information to SWIB. Mr. Gavaldon is alleged to have
benefited wrongfully from these actions.

  SWIB seeks to nullify the shareholder approved Amendment and is asking for
unspecified damages. The Company has filed an Answer and Counter-claim and
believes that it will prevail in this matter.

  On March 23, 2000, a lawsuit was filed in the Alameda County Superior Court
against the Company and its wholly owned subsidiary, Peerless Systems
Networking, Inc. (PSN) by Howard Sidorsky, a current employee and Vice President
of Marketing of PSN. Mr. Sidorsky alleges that he is entitled to a commission of
not less than $630,000 for his participation in the 1999 sale to Peerless of
AUCO, Inc., the predecessor of PSN. The Company has not yet responded to the
complaint.  The Company believes that it will prevail in this matter.


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

  No matters were submitted to a vote of the Company's stockholders during the
fourth quarter of fiscal 2000.

                                       13
<PAGE>

PART II

ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters.

     The Company's common stock is traded on the Nasdaq National Market under
the symbol "PRLS". The table below sets forth, during the periods indicated, the
high and low sales price for the Company's common stock as reported on the
Nasdaq National Market.


                                          Year Ended
                  ----------------------------------------------------------
                      January 31, 2000                 January 31, 1999
                  -------------------------        -------------------------
       Quarter       High           Low               High           Low
       ---------  ----------     ----------        ----------     ----------
       First      $   11.000     $    6.000        $   21.250     $   11.000
       Second     $   13.625     $    6.750        $   24.375     $   15.500
       Third      $   15.000     $    7.500        $   21.375     $    2.813
       Fourth     $   12.875     $    4.875        $   10.875     $    6.750



     As of April 5, 2000, there were approximately 150 holders of record of the
Company's common stock.


Dividend Policy

     Prior to its merger with Peerless in December 1999, PSIP, a now wholly-
owned subsidiary of the Company, declared and paid a cash dividend on its common
stock in the amount of $15,000 during the year ended January 31, 1998. The
Company has not declared or paid any other cash dividends on its common stock
during any period for which financial information is provided in this Annual
Report on Form 10-K. The Company currently intends to retain future earnings, if
any, to fund the development and growth of its business and does not anticipate
paying any cash dividends on its common stock in the foreseeable future.

                                       14
<PAGE>

ITEM 6 - Selected Financial Data

     The statement of operations data for the years ended January 31, 2000, 1999
and 1998 and the balance sheet data at January 31, 2000 and 1999, are derived
from, and should be read in conjunction with, the audited consolidated financial
statements and notes thereto included elsewhere in this Form 10-K. The statement
of operations data for the years ended January 31, 1997 and December 31, 1995
and the balance sheet data at January 31, 1998 and 1997 and December 31, 1995
are derived from unaudited consolidated financial statements not included in
this 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 Consolidated Financial Statements and Notes thereto included
elsewhere in this Form 10-K.

<TABLE>
<CAPTION>
                                                                                          Year Ended
                                                         Years Ended January 31, (1)     December 31,
                                                ---------------------------------------
                                                   2000      1999      1998      1997        1995
                                                                              (Unaudited) (Unaudited)
                                                ---------  --------  --------  --------   ----------
Statement of Operations Data:
<S>                                             <C>        <C>       <C>       <C>        <C>
     Net sales                                  $  42,076  $ 41,077  $ 30,958  $ 18,874   $   12,831
     Income (loss) from operations                  4,133     4,647     3,283       632       (1,140)
     Net income (loss)                              3,441     2,462     1,527     2,714       (1,398)
     Basic earnings per share                        0.25      0.19      0.12      0.38        (0.32)
     Diluted earnings per share                      0.22      0.16      0.11      0.22        (0.32)
</TABLE>

<TABLE>
<CAPTION>
                                                          Years Ended January 31, (1)      December 31,
                                                 ---------------------------------------
                                                    2000      1999      1998      1997         1995
                                                                    (Unaudited) (Unaudited) (Unaudited)
                                                 ---------  --------  --------   --------   ----------
Balance Sheet Data:
<S>                                             <C>         <C>       <C>        <C>        <C>
     Total assets                               $  52,565   $ 49,887  $ 42,829   $ 37,842   $  5,251
     Long Term Obligations                          3,165      3,703     1,367      2,617      5,238
     Redeemable preferred stock                       -          -         -          -        5,931
</TABLE>
______________
(1) The Company changed its fiscal year end to January 31, beginning February 1,
1996.


Selected Quarterly Financial Data (Unaudited):
<TABLE>
<CAPTION>
                                   ------------------------------------------   -----------------------------------------
                                          Year Ended January 31, 2000                  Year Ended January 31, 1999
                                   ------------------------------------------   -----------------------------------------
 Quarter                              Fourth    Third     Second     First         Fourth    Third     Second     First
                                   ------------------------------------------   -----------------------------------------
<S>                                <C>          <C>       <C>       <C>         <C>          <C>       <C>       <C>
 Revenues                          $   8,224    $ 11,712  $ 11,400  $  10,740   $  10,649    $ 8,808   $ 10,344  $ 11,276
 Gross Margin                          4,322       8,491     7,914      7,376       7,304      5,190      6,926     7,175
 Gross Margin %                        52.55%      72.50%    69.42%     68.68%      68.59%     58.92%     66.96%    63.63%
 Income from operations            $  (1,485)   $  3,245  $    604  $   1,769   $   2,152    $  (704)  $  1,173  $  2,026
 Net Income                             (772)      2,294       707      1,212       1,415       (902)       518     1,431
 Net Income - Basic                    (0.05)       0.16      0.05       0.09        0.11      (0.07)      0.04      0.12
 Net Income - Diluted                  (0.05)       0.15      0.05       0.08        0.09      (0.07)      0.03      0.09
</TABLE>

                                       15

<PAGE>

ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations.

     This Report on Form 10-K contains forward-looking statements that involve
risks and uncertainties. The statements contained in this report that are not
purely historical are forward-looking statements within 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 the Company's
expectations, beliefs, intentions or strategies regarding the future. All
forward-looking statements included in this document are based on current
expectations, estimates, forecasts and projections about the industry in which
Peerless operates, management's beliefs and assumptions made by management.
These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions which are difficult to predict. Therefore,
actual outcomes and results may differ materially from what is expressed or
forecasted in such forward-looking statements. The Company undertakes no
obligation to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise.

Highlights

     The Peerless solution is based on a combination of software and imaging
ASICs, which together form a cost-effective embedded imaging system that
addresses virtually all sectors of the printing market, from low-end SOHO
inkjets to high end laser digital color copiers and printers. The low-cost,
high-performance printers and MFPs that the Company's imaging solutions drive
are increasingly replacing expensive standalone copiers and printers in
corporate offices. Peerless' target markets are continuing to expand, driven by
the transition from analog to digital in the copier sector, by improving price-
performance, and by the broadening role of color in office printing.

     In June 1999, the Company acquired Auco, Inc. ("Auco") a supplier of
embedded networking systems. The transaction was accounted for as a pooling-of-
interests. As a result of the acquisition, Auco became a wholly owned subsidiary
of the Company and was subsequently renamed Peerless Systems Networking ("PSN").
PSN's low-cost integrated networking capability enables office peripheral OEMs
to provide networking as a standard feature in their products. This acquisition
brought several key new customers to the Company and gives Peerless the
opportunity to improve its customers' time to market and product performance,
including the addition of critical new capabilities such as Internet
connectivity. In addition, PSN is leading the Company's strategic efforts in the
Network Storage area.

     In December 1999, the Company acquired HDE, Inc ("HDE"). HDE is a developer
of embedded imaging and Internet printing solutions. The transaction was
accounted for as a pooling-of-interests. As a result of the acquisition, HDE
became a wholly owned subsidiary of the Company and was subsequently renamed
Peerless Systems Imaging Products ("PSIP"). The acquisition expanded Peerless'
presence in the embedded imaging and Internet printing solutions markets and
added important new customers to the Company's portfolio. As a result of HDE's
strategic relationship with Adobe, Peerless is now the leading embedded Adobe
PostScript supplier to the imaging market. Further, the Company believes that
the combination of its established network software solutions and PSIP's
expertise in Windows 2000 and internet technologies will put it in the forefront
of networking and directory integration for networked devices.

     On July 23, 1999, the Company entered into a distribution license agreement
with Adobe, Inc. for Adobe PostScript 3, PostScript fonts, both roman and double
byte, and certain other Adobe host software applications. This licensing
agreement will allow the Company to directly license Adobe technologies to its
OEMs, resulting in incremental revenues from licensing, recognized both when the
SDKs are delivered and subsequently in the form of recurring licensing revenues
as products utilizing these products are launched. In addition, this new
distribution agreement calls for the Company to remit licensing fees to Adobe
for the first time, which is expected to increase the Company's cost of goods
sold.

In December 1999, PSIP likewise entered into a distribution agreement with
Adobe. While similar in nature to PSCs, PSIP additionally has access to Adobe
Postscript source code. This enables PSIP to meet the special needs Peerless
OEMs seek for product differentiation.

                                       16
<PAGE>

     Traditionally, Peerless provided ASIC (Application Specific Integrated
Circuit) designs to chip foundries that manufactured and distributed the
Company's ASICs to the Company's OEMs. In return, the Company received license
revenue from its chip foundries. As part of the total solution being offered to
its OEMs, the Company is now developing a direct distribution channel for its
ASICs chips. Under this "fabless" model, Peerless will distribute ASIC chips
from the foundry through a third party. The Company will be responsible for
marketing and sale administration, including the billings and collections to and
from its OEMs and distributors, but it is expected that the third party will be
responsible for the coordination of production with the foundry, maintenance of
necessary inventories and providing just-in-time delivery to OEMs and
distributors. The change from licensing ASIC technology to the distribution of
the actual chips will result in higher revenues but lower margin percentages due
to the cost of chips and the costs of distribution and inventory maintenance by
the third party. Peerless is currently finalizing an agreement with a domestic
third party distributor and in December 1999 entered into an international
distribution agreement with Maruban. In the interim, the Company placed its
first ASIC order to the foundry in the third quarter of fiscal 2000. The Company
made its first direct distribution in the first quarter of fiscal year 2001.

     Peerless continues to increase its focus and success in selling its source
code development kits ("SDK"), which allow the OEMs to access Peerless'
technology and perform their own customization. The development kit sales
increase the OEMs commitment to Peerless' embedded imaging technology from a
single point product solution to a broad product platform solution for multiple
printing products.

     The Company continued to invest in research and development which, along
with the recent acquisitions, resulted in an increase in both the breadth and
the depth of its technical product offerings. Among other technologies, the
Company is working on a 100 page per minute (PPM) SDK. Currently, the Company's
highest speed software addresses a 75 PPM machine.

General

     Historically, a limited number of customers have provided a substantial
portion of the Company's revenues. Therefore, new contracts or modifications and
additions to existing contracts with these customers may materially impact the
Company's financial position and results of operations from quarter to quarter.

     The Company's product licensing revenues are comprised of both recurring
licensing revenues and one-time licensing fees for source code or SDKs.
Recurring licensing revenues are derived from per unit fees paid quarterly by
the Company's OEMs upon manufacturing and subsequent commercial shipment of
products incorporating the Company's technology. Recurring licensing revenues
are derived, to a lesser extent, from arrangements in which the Company enables
third-party technology, such as solutions from Adobe, to be used with its
products. The Company often requires minimum royalty commitments from certain
OEMs. These commitments are generally guaranteed quarterly minimum royalty
payments or block license sales, where the OEM purchases a fixed number of
licenses. Payments associated with royalty commitments are generally paid in one
lump sum or over four or more quarters. The Company's development licensing fees
are paid by OEMs for access to the Company's SDKs, which in turn generate
recurring licensing revenues if the software is incorporated into OEM products
that are subsequently developed and commercially shipped.

     The Company also has engineering services revenues that are derived
primarily from adapting the Company's software and supporting electronics to
specific OEM requirements. The Company provides its engineering services to OEMs
seeking a turnkey embedded imaging solution for their digital document products.
The Company's maintenance revenues are derived from software maintenance
agreements. Maintenance revenues currently constitute a small portion of total
revenue.

Over the past several quarters, the Company has experienced a shift in its
business and financial model. The Company generates revenue from its OEMs
through the sale of embedded imaging solutions in either turnkey or software
development kit form. Historically, OEM demand for turnkey solutions has
exceeded demand for SDK solutions. In the last fiscal year, the Company
experienced a shift away from turnkey solutions to the sale of SDKs,
particularly for its monochrome solutions, which incorporate more mature
technology. Additionally, the Company

                                       17
<PAGE>

has expanded its solution offering by incorporating related embedded imaging and
networking technologies licensed from third parties, which in future quarters
could result in incremental SDK, services and royalty revenue streams.

     The shift to SDK sales has resulted in an increase in the products
shipping, as OEMs who utilize Peerless SDKs develop and introduce multiple
products. However, the shift to SDKs will subject the Company to risks
associated with customer delays in funding the purchase of SDKs and starting
their product development utilizing the Company's SDK solution. The Company
expects to continue to provide turnkey solutions in color and MFP where the
technology is certain to evolve and where the turnkey development challenge is
more difficult for OEMs to assume.

Results of Operations

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

<TABLE>
<CAPTION>
                                                                          Percentage of Total Revenues
                                                                      -----------------------------------
                                                                             Years Ended January 31,
                                                                      -----------------------------------
                                                                        2000         1999         1998
                                                                      --------     --------    ----------
          Statement of Operations Data:
<S>                                                                   <C>          <C>         <C>
              Revenues:
                  Product licensing                                         62%          52%           51%
                  Engineering services and maintenance                      38           48            49
                                                                      --------     --------    ----------
                       Total revenues                                      100          100           100
                                                                      --------     --------    ----------

              Cost of revenues:
                  Product licensing                                          2            -             -
                  Engineering services and maintenance                      31           35            34
                                                                      --------     --------    ----------
                       Total cost of revenues                               33           35            34
                                                                      --------     --------    ----------
                              Gross margin                                  67           65            66
                                                                      --------     --------    ----------

              Operating expenses:
                  Research and development                                  23           21            20
                  Sales and marketing                                       15           16            20
                  General and administrative                                14           16            15
                  Other non-recurring costs                                  5            -             -
                                                                      --------     --------    ----------
                       Total operating expenses                             57           53            55
                                                                      --------     --------    ----------
              Income from operations                                        10           12            11
              Interest income, net                                           3            3             4
                                                                      --------     --------    ----------
                 Income before income taxes                                 13           15            15
              Provision for income taxes                                     5            9            10
                                                                      --------     --------    ----------
              Net income                                                     8%           6%            5%
                                                                      ========     ========    ==========
</TABLE>


          Comparison of Fiscal 2000 and 1999

     Fiscal 2000 revenues increased 2% over the previous year. Product licensing
revenues increased 22% in the current year, however, this growth was largely
offset by a 19% decline in engineering services and maintenance revenues from
the previous fiscal year. Product licensing revenues increased due to an
increase in the number of products shipped into the marketplace incorporating
Peerless' imaging and networking technology, an increase in

                                       18
<PAGE>

the market penetration of existing products, and an increase in sales of SDKs.
Additionally, during fiscal 2000, the Company successfully negotiated a contract
modification and extension with a major OEM resulting in the combination of a
new sale and recognition of revenue previously deferred of a total of $1.0
million in product licensing fees. Current year product licensing also benefited
from the sales of block licenses to OEMs and an increase in guaranteed minimum
royalty commitments. Engineering services revenues declined in the current
fiscal year due to a shift in OEM demand from turnkey projects to internally
developed solutions based on Peerless standardized software solutions. Revenues
in the current period further benefited from a one-time cancellation fee of $1.3
million arising from an OEM project that was cancelled due to external technical
challenges.

     The Company's gross margin as a percentage of total revenues increased to
67% in fiscal 2000 from 65% in fiscal 1999. The increase was due to a higher
percentage of licensing fees in the revenue mix. Licensing fees have relatively
low costs associated with the revenues being recognized. The engineering
services margins deteriorated from 27% in fiscal 1999 to 19% in fiscal 2000. The
decline was attributable to additional costs associated with the completion of
product deliveries for customers on fixed-fee arrangements.

     Peerless continues to invest heavily in the future by funding the research
and development of new technology solutions. Research and development expenses
increased 10% in the current year due to increased spending on technical
solutions partially offset by research efforts expended in the prior year on
test tool efforts at PSN ("Auco") that were subsequently terminated. Although
research and development spending increased in the current year, the rate of
growth declined significantly from the 42% growth rate in the prior year. The
decline in the growth rate indicates Peerless is able to leverage off the
existing base of developers and realize economies of scale.

     Although the sales and marketing expenses decreased 2% between fiscal years
2000 and 1999, the Company is still focused on the penetration of new OEM
customers, attendance at industry trade shows and other opportunities to promote
the Company's embedded imaging and network solutions. As a result of this
effort, and the recent acquisitions of Auco and HDE, the Company added several
new strategic OEMs to its customer list during fiscal 2000.

     General and administrative expense for fiscal 2000 decreased 14% from
fiscal 1999. The expense decline in the current year was attributable to
$275,000 in expenses associated with a fiscal year 1999 acquisition for which an
agreement was not achieved. Excluding the one time-item, general and
administrative expenses would have been 13% of total revenues for fiscal 2000
and 16% of total revenues for fiscal 1999.

     Other non-recurring costs of $2.3 million for fiscal 2000 represented
transaction costs, consisting primarily of fees for investment bankers,
attorneys, accountants, consultants, financial printing and other related
charges associated with the June 1999 acquisition of Auco and the December 1999
acquisition of HDE.

     Interest income earned in fiscal years 2000 and 1999 was attributable to
interest and investment income earned on cash and cash equivalents and
investment balances resulting primarily from the $26.3 million in proceeds
received upon the closing of the Company's initial public offering in September
1996.

     The Company's effective tax rate for fiscal 2000 is 36% compared to 59% in
the prior year. The high effective rate for fiscal year 1999 was attributed to
taxes associated with the business combinations.



         Comparison of Fiscal 1999 and 1998

     Fiscal 1999 revenues increased 33% over the previous year. The revenue
growth was driven by a 35% increase in product licensing revenues and a 31%
increase in engineering services and maintenance revenues over the prior fiscal
year. Product licensing revenues increased due to an increase in the number of
products shipped into the marketplace incorporating Peerless' imaging technology
and an increase in the market penetration of existing products. Most of the
increase in recurring license fees can be attributed to an increase in
penetration in the color and multi-function markets. Adding to the product
licensing revenues were strong sales of SDKs. The growth in

                                       19
<PAGE>

engineering services and maintenance revenues was the direct result of an
increase in the dollar value of engineering services design wins in fiscal 1999
over fiscal 1998.

     The Company's gross margin as a percentage of total revenues decreased to
65% in fiscal 1999 from 66% in fiscal 1998. Although fiscal year 1999 revenue
mix included a higher percentage of licensing fees, which have relatively low
costs associated with the revenues being recognized, the margin on engineering
services and maintenance declined in 1999. The deterioration in the engineering
services margins from 31% in fiscal 1998 to 27% in fiscal 1999 was attributable
to a mid-year refocusing of the engineering services department. This change
yielded a record number of product deliveries, but resulted in lower margins as
additional resources were allocated to projects in process in an effort to
reduce the time-to-market.

     Research and development expenses increased 42% between fiscal 1999 and
1998. The expense increases resulted primarily from a growth in the development
staff headcount and the use of outside development partners. The increased
funding was used for, among other things, development programs associated with
the Company's color technology, multi-function technology, application specific
integrated circuit ("ASIC") designs and digital photography technology.

     Sales and marketing expenses increased 6% between fiscal years 1999 and
1998. The increase reflected a growth in the sales and marketing headcount and
an expanded emphasis on penetrating new OEM customers. As a result of this
additional effort, the Company added several new OEMs to its customer list
during fiscal 1999.

     General and administrative expense for fiscal 1999 increased 39% over
fiscal 1998. The expense growth related primarily to an increase in personnel
and expenses necessary to support the growth in the Company's operations, which
included the formation of a corporate development department in support of the
Company's strategy to acquire complementary technology.

     Interest income earned in fiscal years 1999 and 1998 was attributable to
interest and investment income earned on cash and cash equivalents and
investment balances.

     The Company's effective tax rate for fiscal 1999 was 59% compared to 66% in
the prior year. The high effective rates for these two fiscal years is due to
taxes associated with the business combinations.


Liquidity and Capital Resources

     Compared to January 31, 1999, total assets at January 31, 2000 grew 5% to
$52.6 million and stockholders' equity grew 14% to $43.8 million. The Company's
cash and short-term investment portfolio was $25.9 million at January 31, 2000
and the current ratio was 7:1. The Company's operations generated cash of $3.0
million during fiscal 2000 and used $488,000 during fiscal 1999.

     The Company's investing activities during the years ended January 31, 2000
and 1999 generated cash of $3.1 million and $5,000, respectively. Purchases,
sales and maturities of investment securities generated net cash of $5.7 million
in fiscal 2000 and $1.8 million in fiscal 1999. It is the Company's policy to
invest the majority of its unused cash in low risk government and commercial
debt securities. The Company has not historically purchased, nor does it expect
to purchase in the future, derivative instruments or enter into hedging
transactions. During the second quarter of the current fiscal year, the Company
completed the expansion of its El Segundo operating facility to 56,000 square
feet from 30,000 square feet in order to accommodate the growth in operations.
As part of the expansion, the Company made leasehold improvements in the amount
of $818,000 and $1.4 million during 2000 and 1999, respectively. During 2000 and
1999, the Company invested $1.7 million and $.5 million, respectively, in
engineering development tools, computer and network system upgrades.

     Net cash provided by financing activities during fiscal years 2000 and 1999
primarily related to the issuance of common stock under the Company's employee
stock purchase plan and the exercise of common stock options. The Company also
generated $820,000 from the issuance of PSN preferred stock during fiscal 1999.

                                       20
<PAGE>

Risks and Uncertainties

     The following risks and uncertainties, among other things, should be
considered in evaluating the Company's outlook:

     Future Growth Rate and Operating Results: The 2% revenue growth rate in
fiscal 2000 did not approach the 33% level attained in fiscal 1999. Further,
the Company does not expect revenue growth in the first half of fiscal 2001.

     The Company was unprofitable in the fourth quarter of fiscal 2000 and does
not expect to return to a profitable level in fiscal 2001. There can be no
assurance that the Company will be profitable in the future. The factors noted
below may have a material adverse effect on the Company's future revenue growth
and/or results of operations:

     Concentration of Revenues: During fiscal 2000, Canon, Ricoh and Seiko Epson
each generated greater than 10% of the Company's revenues. In the prior fiscal
year, five customers each generated more than 10% of the Company's revenues.
Although recent acquisitions and sales efforts have expanded the Company's
customer base, historically, a limited number of customers have provided a
substantial portion of Peerless' revenues. There presently are only a limited
number of customers in the digital document product market to which the Company
markets its technology and services. Therefore, the ability of the Company to
replace a lost customer or offset a significant decrease in the revenues from a
customer may be significantly limited. A change in business from a customer
providing a significant portion of the Company's revenues could have a material
adverse effect on the Company's operating results. In particular, the Company's
recurring license fees exert a disproportionate influence on profitability and
are often dependent upon end-user demand for OEM products that embed the
Company's technology.

     Shifting OEM Demand for Software Development Kits vs. Turnkey Solutions:
Over the past several quarters, the Company has experienced a shift in OEM
demand from the historically prevailing requirement for a turnkey solution
towards software development kits, or SDKs. Turnkey solutions require the
Company to provide engineering services in order to deliver customized imaging
solutions to an OEM customer, whereas OEMs that opt for an SDK solution choose
to license the Company's embedded imaging technology and perform development
internally using the OEM's in-house engineers. Turnkey design wins result in
engineering services contracts that generate revenue for three to six quarters
prior to product launch. SDK design wins result in development license revenues
that are typically recognized in one quarter and are generally lower in
magnitude than revenue associated with turnkey design wins prior to product
launch but generate higher profitability than engineering services revenues
associated with turnkey design wins. Recurring licensing revenues are generally
the same for both turnkey and SDK products.

     Because the Company has experienced a shift in demand away from turnkey
solutions towards SDKs, engineering services resources were re-deployed to the
research and development department in recent quarters. Should this trend
reverse and turnkey design wins accelerate, the Company may need to transfer
resources back to engineering services. Accordingly, its results of operations
could be negatively affected in the interim.

     Risks in Providing Engineering Services: In the past, the Company has
experienced significant fluctuations in quarterly engineering services results
that have been caused by many factors including: product development delays (see
"Technological Changes" below), third party delays, increases in the estimated
hours to complete particular engineering services projects, delays in the
availability or stability of third-party technology and cancellation or
redirection of engineering services projects by the Company's OEMs. There can be
no assurance that similar factors will not impact future engineering services
results. Further, in the past, the Company has benefited from the inclusion of
cancellation fees in its engineering services agreements. There can be no
assurance that the Company will continue to be able to negotiate these fees into
future engineering services arrangements.

     Shifting of the Recurring License Fee Model: Over the past several
quarters, the Company's recurring licensing fee model has shifted from per unit
royalties paid upon OEM shipment of product to a revenue structure that

                                       21
<PAGE>

includes more revenues associated with guaranteed quarterly minimum royalties
and sales of block licenses. Although the new royalty model benefits the
Company's cash flows and minimizes the Company's risk associated with unexpected
decreases in demand for customer products, the Company's revenues could
fluctuate significantly from quarter to quarter as the number and value of new
royalty commitments changes.

     Recurring Product Licensing Reporting: The recurring product licensing
revenues reported by the Company 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 public announcement of the Company's quarterly results, the Company may
be required to adjust revenues for subsequent periods.

     Technological Changes: Rapidly changing technology, evolving industry
standards and needs, and frequent new product introductions characterize the
market for the Company's products and services. The Company's success will
depend on, among other things: market acceptance of the Company's technology and
the digital document products of the Company's OEM customers; the ability of the
Company and its OEM customers to meet industry changes and market demands in a
timely manner; achievement of new design wins by the Company followed by the
OEMs' development of associated new digital document products; and the regular
and continued introduction of new and enhanced technology and services by the
Company and its OEMs on a timely and cost-effective basis. There can be no
assurance that the products and technology of competitors of the Company or its
OEMs will not render the Company's technology or its OEMs' products
noncompetitive or obsolete. Any failure by the Company or its OEMs to anticipate
or respond adequately to the rapidly changing technology and evolving industry
standards and needs, or any significant delay in development or introduction of
new and enhanced products and services, could result in a loss of
competitiveness or revenues, which could have a material adverse effect on the
Company's operating results.

     Technology Licensing: The Company's larger customers at times have required
that the Company offer new technology directly to them prior to offering it to
other customers and have attempted to restrict the Company from licensing the
technology utilized by these customers to customers developing potentially
competing products. Although the Company has not granted exclusive rights with
respect to its core technologies, the Company has granted exclusive rights in
unusual circumstances with respect to derivative software developed by the
Company in support of a specific customer's proprietary products or
technologies. No assurance can be given, however, that the Company will not, in
the future, grant broader exclusive rights to its technology in order to enter
into a licensing agreement with a customer, or that an unwillingness to grant
such exclusive rights will prevent the Company from entering into such a
licensing agreement.

     Receivables: Although the Company's net trade accounts receivable balances
remained consistent between January 31, 2000 and 1999, the Company's days sales
outstanding increased significantly. Increases in future trade accounts
receivable balance could be caused by increased recurring licensing revenues,
the shift towards the SDK model and the timing of Japanese collections. Much of
the Company's revenue growth in recent years has been fostered by strong
recurring licensing fees, which are not contractually possible to collect prior
to the end of a quarter. The shift towards the SDK model has generated lump-sum
license fees that are billed at the time of delivery. Finally, the Company noted
a trend of slow collections from one of its major Japanese customers. An
increase in accounts receivable has a negative impact on operating cash and
poses inherent collection risks. Although the Company feels that its accounts
receivable reserves are adequate at January 31, 2000, there can be no assurance
regarding this assertion.

     Seasonality: The Company believes that its business may be subject to
seasonal trends. In the digital document product industry, it is not unusual for
vendors to experience an increase in demand in the second calendar quarter
followed by a decrease in the third quarter, as well as an increase in demand in
the fourth calendar quarter followed by a significant decrease in the following
quarter. Although the Company has attempted to manage this risk with the
incorporation of guaranteed minimum royalty commitments, the Company's
predominant shifts in the current year to SDK based revenue negatively impacted
fourth quarter revenues and traditional seasonality. Additionally, the

                                       22
<PAGE>

Company's product licensing revenues may be negatively impacted by seasonality
of unit shipments experienced by its OEMs.

      ASIC Chips: The Company is in the process of developing a "fabless"
distribution model for the sale of ASIC chips. The Company has no direct
distribution experience and will place reliance on third parties to maintain
inventories to address OEM needs, manage manufacturing logistics, and distribute
the product in a timely manner. Additionally, there can be no assurance that the
OEMs will elect to purchase from Peerless as their distributor.

      Dependence on Sole Source Providers: Currently, the Company is dependent
on four independent parties, Motorola, IBM Microelectronics, NEC and Intel, each
of which provides unique application specific integrated circuits ("ASICs")
incorporating the Company's imaging technology to certain of the Company's OEMs.
Additionally, the Company has a set of relationships with Adobe that address
many critical aspects of the Company's OEM customers' needs. The Company has
licensed (for internal development purposes) from Adobe the right to use Adobe's
PostScript Software to enable the Company's products to be used with Adobe's
PostScript Software, has licensed to Adobe several of the Company's technologies
and has developed technologies for Adobe for which the Company receives
royalties and engineering services fees. These sole source providers are subject
to materials shortages, excess demand, reduction in capacity and/or other
factors that may disrupt the flow of goods to the Company's customers and
thereby adversely affect the Company's customer relationships. Any such
disruption could limit or delay production or shipment of the products
incorporating the Company's technology, which could have a material adverse
effect on the Company's operating results.

The Company, through its subsidiary PSN, has entered into contracts with
entities and persons located in Hong Kong, which city is located in a political
district of the People's Republic of China. Through these long term
relationships, the Company operates at favorable cost, schedule and quality of
output advantages. There can be no assurances that the political and business
climates in Hong Kong will remain stable. However, should there be disruption in
the aforesaid relationships, it is not expected to have a materially adverse
affect on the Company, its financial condition or results of financial
operations.

     Costs and Expenses: A substantial portion of the Company's costs and
expenses is related to costs of engineering services and maintenance, product
development, other personnel costs, marketing programs and facilities. The level
of spending for such costs and expenses cannot be adjusted quickly and is based,
in significant part, on the Company's expectations of future revenues and
anticipated OEM commitments. As in the current fiscal year, if such commitments
do not materialize or are terminated or if revenues are below expectations, the
Company's quarterly and annual operating results will be adversely affected.

     Dependence on Key Personnel: The Company is largely dependent upon the
skills and efforts of its senior management and other officers and key
employees. The Company believes that its future success will depend in large
part upon its ability to attract and retain highly skilled managerial,
engineering, sales, marketing and operations personnel, many of whom are in
great demand. Competition for such personnel recently has increased
significantly. The Company only maintains key person life insurance policies for
one executive, Mr. Au. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect on the Company's
operating results.

     International Activities: Peerless is substantially dependent on its
international business activities and the Company expects that sales to
customers located outside the United States may increase in absolute dollars in
the future. The international market for products incorporating the Company's
technology is highly competitive, and the Company expects to face substantial
competition in this market from established and emerging companies and
technologies developed internally by its OEMs. Risks inherent in the Company's
international business activities also include currency 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 the Company's operating results. Although all of the Company's
contracts are, and the Company expects that its future contracts will be,
denominated in U.S. dollars, there can be no assurance that its contracts with

                                       23
<PAGE>

international OEMs in the future will be denominated in U.S. dollars. In the
event that one or more contracts are denominated in foreign currencies, the
Company will be subject to additional risks associated with currency
fluctuations, which could have a material adverse effect on the Company's
operating results.

     During the past few years, the Asian economy has been financially
depressed. As a result, some members of the imaging industry have reported
negative financial impacts attributable to a decrease in demand from Asian
customers. Peerless' Asian customers are comprised primarily of companies
headquartered in Japan. These Japanese customers sell products containing
Peerless' technology primarily in the North American and European marketplaces.
There can be no assurance that revenues from Asian customers will not decline in
future quarters.

     Volatility of Stock Price: The Company's common stock has experienced
significant price volatility and such volatility may occur in the future.
Factors that could affect the trading price of the common stock include
variations in quarterly results of operations, announcements of new products by
the Company or its competitors, developments or disputes with respect to
proprietary rights, general trends in the industry, overall market conditions
and other factors. In addition, the stock market historically has experienced
extreme price and volume fluctuations, which have particularly affected the
market price of securities of many high technology companies and which at times
have been unrelated or disproportionate to the operating performance of such
companies.

     Market Risk: The Company is exposed to various market risks including
changes in interest rates. Market risk is the potential loss arising from
adverse changes in market rates and prices, such as interest rates. The Company
has not been at risk from adverse changes in foreign currency exchange rates as
all transactions have been denominated in U.S. dollars. The Company has not
entered into derivatives or other financial instruments for trading purposes.

     Peerless' exposure to market rate risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company invests its
excess cash in fixed rate debt instruments of the U.S. Government and high-
quality corporate issuers as well as floating rate money market funds. The
Company, by policy, limits the amount of credit exposure to any one issuer.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted due to a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, Peerless' future investment income may fall short
of expectations due to changes in interest rates, or Peerless may suffer losses
in principal if forced to sell securities which have declined in market value
due to changes in interest rates.

     Year 2000: The Company, its subsidiaries, and to its knowledge the
Company's third party suppliers did not experience any problems associated with
its defined exposure areas of its Licensed Products, their Key Transaction
Processing Applications, the Company's Equipment and Facilities and with Key
Suppliers during the transition to the Year 2000. During 1999, the Company spent
approximately $356,000 out of a budget of $400,000 for addressing and preparing
for potential Year 2000 related problems. However, as a result of the work
performed previously and experience in Year 2000 to date, the Company does not
foresee any problems in this area. The Company has determined to maintain a
discrete observation of these potential exposure areas through Year 2000 in the
ordinary course of business. There can be no assurances that such problems,
should they occur, will not have a materially adverse effect on the Company, its
financial condition, or results of operations.

 Future Developments

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives will be recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. SFAS No. 133 is effective for fiscal years beginning after June 15,
1999. The adoption of SFAS No. 133 will not have a material impact on the
Company's results of operations, financial position or cash flows.

                                       24
<PAGE>

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company is currently evaluating the impact of SAB 101 on its
financial statements and related disclosures but does not expect such impact, if
any, will be material. The accounting and disclosures prescribed by SAB 101 will
be effective no later than the second fiscal quarter of the first fiscal year
beginning after December 15, 1999, as amended by.


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.

         On September 20, 1999, the registrant dismissed PricewaterhouseCoopers
LLP ("PwC"), the independent accounting firm which the registrant previously
engaged as the principal accounting firm to audit the registrant's financial
statements. PwC's report on the registrant's consolidated financial statements
for either of the past two years did not contain an adverse opinion or a
disclaimer of opinion, and was not qualified or modified as to uncertainty,
audit scope, or accounting principles. On September 16, 1999, the Audit
Committee of the registrant's Board of Directors approved the decision to
dismiss PwC. During the registrant's two most recent fiscal years and the period
from the end of its most recent fiscal year through the date of dismissal, there
were no disagreements with PwC on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of PwC, would have caused it
to make reference to the subject matter of the disagreements in connection with
its report.

         On September 21, 1999, the registrant engaged Ernst & Young LLP as the
principal accountant to audit the registrant's consolidated financial
statements. The Audit Committee of the registrant's Board of Directors approved
this engagement on September 16, 1999. During the registrant's two most recent
fiscal years and the period from the end of its most recent fiscal year to
September 20, 1999, the registrant did not consult Ernst & Young LLP regarding
either (i) the application of accounting principles to a specified transaction,
either complete or proposed or (ii) the type of audit opinion that might be
rendered on the registrant's consolidated financial statements.

                                       25
<PAGE>

                                   PART III

ITEM 10-- Directors and Executive Officers.

     The information required by this item, insofar as it relates to the
Company's directors, will be contained under the captions "Election of
Directors" and "Section 16 Beneficial Ownership Reporting Compliance" in the
Proxy Statement and is incorporated herein by reference. On April 13, 2000
Edward A. Gavaldon resigned as President, Chief Executive Officer and Chairman
of the Board.  The information covering his resignation will be contained in the
Proxy Statement. The information relating to the Company's executive officers as
of April 13, 2000 is contained in the following table:

<TABLE>
<CAPTION>
Name                       Age              Position
----                       ---              --------
<S>                        <C>              <C>
Robert G. Barrett          55               Chairman of the Board and Director
Howard J. Nellor           61               Interim President and Chief Executive Officer
Carolyn M. Maduza          43               Senior Vice President, Finance and Administration, Chief Financial
                                            Officer
Margaret Turner            36               Vice President, Engineering
Ron Davis                  52               Vice President, Sales
Adam W. Au                 43               Vice President, General Manager, Peerless Systems Networking
</TABLE>

     Robert G. Barrett has been a longstanding member of Peerless' Board of
Directors. He is the founder and a Managing Partner of Battery Ventures, a
venture capital firm, and in that capacity is primarily involved in software
and Internet investments. Prior to forming Battery Ventures, Mr. Barrett was
involved in financing high technology companies as a commercial banker at First
Chicago and an investment banker at Hayden Stone. Mr. Barrett holds a BA degree
in History from Harvard College and an MBA from Harvard Business School.

     Howard J. Nellor has been a consultant to Peerless for four years and has
assisted in the development and delivery process for the Company's products. Mr.
Nellor's consulting work for Peerless has focused on strategic planning,
business process re-engineering, and software product development. His work
experience includes over 20 years with TRW, including internal management
consulting assignments to define the vision and improve the performance of
operating units.  For the past 13 years, he has consulted for a variety of
high-technology firms and health care organizations, primarily to assist in the
management of crisis and turnaround situations. Mr. Nellor's experience also
includes the reversal of declining sales trends and the stabilization of
corporate performance in companies undergoing management changes. At a recent
client engagement in the communications industry, Mr. Nellor reversed a decline
in sales and rebuilt the company's management team after several key executives
left the firm. He holds a Bachelors degree in Engineering and a Master's degree
in Business Administration.

     Carolyn M. Maduza has served the Company as Senior Vice President of
Finance and Administration and Chief Financial Officer since April 1999. Prior
to joining Peerless, Ms. Maduza served for 15 months as the Senior Vice
President, Chief Financial Officer and Treasurer of Smart Technologies, Inc., an
enterprise software and Internet services company located in Austin, Texas.
Prior to that, she served for 21 months as the Senior Vice President, Chief
Financial Officer, Treasurer and Corporate Secretary for Arrowsmith Technologies
Inc., an enterprise software company focused on GPS-based fleet management
software systems. Ms. Maduza has also served as Managing Director for MASI,
Ltd., a member firm of M&A International, which provides global investment
banking advisory services which includes mergers and acquisitions and corporate
finance. Ms. Maduza has over nineteen years of financial and general management
experience in the technology and financials services industries. Ms. Maduza
received a Masters of International Management from the American Graduate School
of International Management and a B.A. in Business Administration from the
University of Wisconsin at Milwaukee. Ms. Maduza is a CPA in the state of
Illinois.

     Margaret Turner joined Peerless as a Project Manager in 1995 and was
promoted to Sr. Project Manager in January 1997. She was promoted once again to
Director, Engineering Services in December 1997 and then to her most current
position of VP, Engineering in February 2000. Margaret has over 15 years
experience in the software technology industry with an emphasis in project
management, future technologies and business group management. Margaret was
employed by Easams, Ltd. from 1987 - 1995 and Software Sciences, ltd. from
1984-1987. Margaret earned her BS from the University of Nottingham, England.

     Ron Davis began with Peerless in 1996 as the Director of Strategic
Planning. Ron received a promotion to Vice President of Sales & Marketing in
March 1999 and then focused attention as VP of Sales effective December 1999.
Prior to Peerless, Ron spent approximately 12 years at Xerox in a number of
functions including program business manager, market and product planning, major
account marketing and market research. Ron also worked for 3M from 1971 to 1984
in several marketing roles. Ron earned his BS in Marketing from the University
on MN and an MBA from the College at St. Thomas, MN.

                                       26
<PAGE>

sales and sales management positions. Mr. Boelig received a B.A in Business
Administration from the University of New Hampshire. Mr. Boelig resigned his
position effective September 17, 1999.

     Adam W. Au has served as the Vice President and General Manager of Peerless
Systems Networking since June 1999. Mr. Au founded Auco, Inc. in May 1994 and
served as the Chairman, President and Chief Executive Officer until the Company
merged with Peerless in June 1999. Prior to founding Auco, Mr. Au spent nine
years at Novell, Inc. His most recent position at Novell was Group Director of
the Corporate Technology Office where he was responsible for overseeing the
company-wide development process and resolving corporate engineering problems.
At Novell, Mr. Au also worked as Group Director of Enterprise Systems where he
was responsible for developing Novell's SNA and remote access products. Mr. Au
has over eighteen years of experience in the technology industry. Mr. Au
received a M.S. in Computer Engineering from the University of Wisconsin at
Madison.


ITEM 11 -- Executive Compensation.

     The information required by this item will be contained in the Proxy
Statement under the caption "Executive Compensation" and is incorporated herein
by reference.

ITEM 12 -- Security Ownership of Certain Beneficial Owners and Management.

     The information required by this item will be contained in the Proxy
Statement under the caption "Security Ownership of Certain Beneficial Owners and
Management" and is incorporated herein by reference.

ITEM 13 -- Certain Relationships and Related Transactions.

     The information required by this item will be contained in the Proxy
Statement under the caption "Certain Transactions" and is incorporated herein by
reference.

                                       27
<PAGE>

                                     PART IV

ITEM 14 -- Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a) Documents filed as a part of this Form 10-K:

(1) Financial Statements

Report of Ernst & Young LLP, Independent Auditors
Report of PricewaterhouseCoopers LLP, Independent Accountants
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements

(2) Financial Statement Schedules:

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

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) Reports on Form 8-K.

No reports on Form 8-K were filed during the last quarter of the fiscal year
ended January 31, 2000.

(c) Exhibits. The following exhibits are filed as part of, or incorporated by
reference into, this Form 10-K.


Exhibit
Number
-------
 3.1(1)      Certificate of Incorporation of the Company.
 3.2(4)      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
                    Norwest Bank Minnesota, N.A., as Rights Agent.
10.1(1)      Form of Indemnity Agreement.
10.2(1)(2)   1992 Stock Option Plan (the "Option Plan"), as amended.
10.3(1)(2)   1996 Equity Incentive Plan.
10.4(1)(2)   Form of Incentive Stock Option.
10.5(1)(2)   Form of Nonstatutory Stock Option.
10.6(1)(2)   1996 Employee Stock Purchase Plan.
10.7(1)      Third Party Development and License Agreement (the "Adobe Third
                    Party License"), dated September 18, 1992, between the
                    Registrant and Adobe Systems Incorporated ("Adobe").
10.8(1)(3)   Reference Post Appendix #2 to the Adobe Third Party License, dated
                    February 11, 1993.
10.9(1)      Amendment No. 1 to the Adobe Third Party License, dated November
                    29, 1993.
10.10(1)(3)  PCL Development and License Agreement (the "PCL License"), dated
                    June 14, 1993, between the Re gistrant and Adobe.
10.11(1)(3)  Amendment No. 1 to the PCL License, dated October 31, 1993.

                                       28
<PAGE>

10.12(1)(3)  Letter Modification to the PCL License, dated August 5, 1994.
10.13(1)(3)  Addendum No. 1 to the PCL License, dated March 31, 1995.
10.14(1)(3)  Letter Modification to the PCL License, dated August 30, 1995.
10.15(1)     Lease Agreement between the Company and Continental Development
                    Corporation, dated February 6, 1992, and Addendum, dated
                    February 6, 1992.
10.16(1)     First Amendment to Office Lease, dated December 1, 1995, between
                    the Company and Continental Development Corporation.
10.18(1)(2)  Employment Agreement with Lauren Shaw.
10.19(1)(2)  Employment Agreement with Edward Gavaldon.
10.20 (5)    Second Amendment to Office Lease, dated April 8, 1997, between the
                    Company and Continental Development Corporation.
10.21(5)     Third Amendment to Office Lease dated, December 16, 1997, between
                    the Company and Continental Development Corporation.
10.22(6)     Fourth Amendment to Office Lease, dated April 22, 1998, between the
                    Company and Continental Development Corporation.
10.23 (7)    Agreement and Plan of reorganization and Merger by and among
                    Peerless Systems Corporation, Auco Merger Sub, and Auco,
                    Inc. dated as of April 6, 1999.
10.24 (7)    Employment Agreement with Adam Au.
10.25        Employment Agreement with Gordon Hanson.
10.26        Maruban Supplier/Distribution Agreement, dated December 14, 1999.
10.27        Lease PSN McKelvy Family Trust (386 Main Street) Standard
                    Industrial/Commercial Single-Tenant Lease-Net, dated March
                    14, 1997
10.28        Lease PSN Terra Bella Inc. and Archie J. Snider dba Terra Snider
                    Joint Venture (1130 Terra Bella) Standard
                    Industrial/Commercial Single-Tenant Lease-Net, dated March
                    16, 2000.
10.29        Lease PSIP Kent Centennial Limited Partnership, dated January 31,
                    1996.
10.30        Lease PSIP Intrarock 1 LLC dated March 15, 2000.
23.1         Consent of Ernst & Young LLP, Independent Auditors
23.2         Consent of Independent Accountants
24.1         Power of Attorney. Reference is made to page 30.
27.1         Financial Data Schedule.
27.2         Restated Financial Data Schedule - Fiscal Year 1999 and 1998
27.3         Restated Financial Data Schedule - Quarters - Fiscal Year 2000
27.4         Restated Financial Data Schedule - Quarters - Fiscal Year 1999
-------------
(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 Confidential Treatment Order.
(4)  Previously filed in the Company's Current Report on Form 8-K, filed October
     8, 1998, 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.

                                       29
<PAGE>

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities 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 25th day of
April, 2000.


                                                    PEERLESS SYSTEMS CORPORATION

                                                 By:    /s/ CAROLYN M. MADUZA
                                                    ----------------------------
                                                         Carolyn M. Maduza
                                        Senior Vice President of Finance and
                                        Administration, Chief Financial Officer,
                                        Secretary and Treasurer
                                          (duly authorized representative)

     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/  ROBERT G. BARRETT         Chairman of the Board,           April 25, 2000
------------------------              Director
       Robert G. Barrett


  /s/  HOWARD J. NELLOR          Interim President and Chief      April 25, 2000
-----------------------              Executive Officer
       Howard J. Nellor          (Principal Executive Officer)


  /s/  ROBERT V. ADAMS           Director                         April 25, 2000
----------------------
       Robert V. Adams


  /s/  ADAM AU                   Director                         April 25, 2000
------------------------
       Adam Au

  /s/  ROBERT L. NORTH           Director                         April 25, 2000
------------------------
       Robert L. North

                                       30
<PAGE>

                          PEERLESS SYSTEMS CORPORATION
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                            Page
                                                                            ----

Report of Ernst & Young LLP, Independent Auditors                           F-2

Report of PricewaterhouseCoopers LLP, Independent Accountants               F-3

Consolidated Statements of Income                                           F-4

Consolidated Balance Sheets                                                 F-5

Consolidated Statements of Stockholders' Equity                             F-6

Consolidated Statements of Cash Flows                                       F-7

Notes to Consolidated Financial Statements                                  F-9

                                      F-1
<PAGE>

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


The Board of Directors and Stockholders
   of Peerless Systems Corporation

We have audited the accompanying consolidated balance sheet of Peerless Systems
Corporation as of January 31, 2000 and the related consolidated statements of
income, stockholders' equity and cash flows for the year then ended. Our audit
also included the financial statement schedule listed in the Index at Item 14
(a) for the year ended January 31, 2000. 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
audit.

We conducted our audit in accordance with auditing standards generally accepted
in the 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 misstatements. 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 audit provides 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, 2000 and the consolidated results of their operations
and their cash flows for the year then ended in conformity with accounting
principles generally accepted the United States. Also, in our opinion, the
related financial statement schedule for the year ended January 31, 2000, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.



                                                     ERNST & YOUNG LLP


Los Angeles, California
March 2, 2000

                                      F-2
<PAGE>

         REPORT OF PRICEWATERHOUSECOOPERS LLP, INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholders of Peerless Systems Corporation

In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated balance sheet and the related consolidated statements
of income, of cash flows and of changes in stockholders' equity present fairly,
in all material respects, the financial position of Peerless Systems Corporation
and its subsidiaries at January 31, 1999, and the results of their operations
and their cash flows for each of the two years in the period ended January 31,
1999, in conformity with accounting principles generally accepted in the United
States. In addition, in our opinion, the financial statement schedule for each
of the two years in the period ended January 31, 1999 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. The
consolidated financial statements and financial statement schedule give
retroactive effect to the mergers of Auco, Inc. in June 1999 and HDE, Inc. in
December 1999 with Peerless Systems Corporation in transactions accounted for as
poolings of interests, as described in Note 2 to the consolidated financial
statements. We did not audit the financial statements of HDE, Inc. which
statements reflect total assets of $1,288,000 at January 31, 1999, and total
revenues of $4,429,000 and $3,834,000 for the years ended January 31, 1999 and
1998, respectively. Those statements were audited by other auditors whose report
thereon has been furnished to us, and our opinion expressed herein, insofar as
it relates to the amounts included for HDE, Inc., is based solely on the report
of the other auditors. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for the opinion expressed above. We have not
audited the consolidated financial statements of Peerless Systems Corporation
for any period subsequent to January 31, 1999.

/s/ PricewaterhouseCoopers LLP

Woodland Hills, CA
March 5, 1999, except as to the pooling of interests with Auco Inc., which is as
of June 10, 1999, and except as to the pooling of interests with HDE, Inc.,
which is as of December 20, 1999.

                                      F-3
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
                       CONSOLIDATED STATEMENTS OF INCOME
                   (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                  Years Ended January 31,
                                                            -----------------------------------
                                                             2000          1999          1998
                                                            -------       -------       -------
<S>                                                         <C>           <C>           <C>
Revenues:
     Product licensing                                      $26,042       $21,305       $15,836
     Engineering services and maintenance                    16,034        19,772        15,122
                                                            -------       -------       -------
          Total revenues                                     42,076        41,077        30,958
                                                            -------       -------       -------
Cost of revenues:
     Product licensing                                          932           139           141
     Engineering services and maintenance                    13,041        14,343        10,404
                                                            -------       -------       -------
          Total cost of revenues                             13,973        14,482        10,545
                                                            -------       -------       -------
          Gross margin                                       28,103        26,595        20,413
                                                            -------       -------       -------
Operating expenses:
     Research and development                                 9,600         8,765         6,152
     Sales and marketing                                      6,366         6,514         6,169
     General and administrative                               5,752         6,669         4,809
     Other non-recurring costs                                2,252             -             -
                                                            -------       -------       -------
          Total operating expenses                           23,970        21,948        17,130
                                                            -------       -------       -------
Income from operations                                        4,133         4,647         3,283
Interest income, net                                          1,209         1,371         1,243
                                                            -------       -------       -------
Income before income taxes                                    5,342         6,018         4,526
Provision for income taxes                                    1,901         3,556         2,999
                                                            -------       -------       -------
          Net income                                        $ 3,441       $ 2,462       $ 1,527
                                                            =======       =======       =======

Basic earnings per share                                    $  0.25       $  0.19       $  0.12
                                                            =======       =======       =======
Diluted earnings per share                                  $  0.22       $  0.16       $  0.11
                                                            =======       =======       =======

Weighted average common shares outstanding - basic           13,890        12,682        12,316
                                                            =======       =======       =======
Weighted average common shares outstanding - diluted         15,483        15,181        14,498
                                                            =======       =======       =======
</TABLE>

                            See accompanying notes

                                      F-4
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
                          CONSOLIDATED BALANCE SHEETS
                                (in thousands)

<TABLE>
<CAPTION>
                                                                                            January 31,
                                                                                      ------------------------
                                                                                        2000            1999
                                                                                      -------          -------
<S>                                                                                   <C>             <C>
                                      ASSETS
Current assets:
       Cash and cash equivalents                                                      $13,620          $ 6,132
       Short term investments                                                          12,329           16,158
       Trade accounts receivable, less allowance for doubtful accounts of $175
            in 2000 and 1999                                                           10,168           10,543
       Unbilled receivables                                                             2,343            2,994
       Income taxes receivable                                                             21                -
       Deferred tax asset                                                                 682            2,766
       Prepaid expenses and other current assets                                          682              639
                                                                                      -------          -------
                Total current assets                                                   39,845           39,232

Long term receivable                                                                    1,500                -
Investments                                                                             2,922            4,605
Property and equipment, net                                                             6,565            5,450
Deferred tax asset                                                                      1,050                -
Other assets                                                                              683              600
                                                                                      -------          -------
       Total assets                                                                   $52,565          $49,887
                                                                                      =======          =======

                     LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
       Accounts payable                                                                 $ 615           $  927
       Income taxes payable                                                                 -              784
       Deferred revenue, current portion                                                  671            2,231
       Note payable to stockholder                                                          -              350
       Other current liabilities                                                        4,320            3,463
                                                                                      -------          -------
                Total current liabilities                                               5,606            7,755
Deferred tax liability                                                                      -              394
Deferred revenue                                                                            -              800
Deferred rent                                                                             366              431
Other tax liabilities                                                                   2,799            2,078
                                                                                      -------          -------
       Total liabilities                                                                8,771           11,458
                                                                                      -------          -------
   Commitments and contingencies

   Stockholders' equity:
   Common stock, $.001 par value, 30,000 shares authorized, 14,724 and 12,838
          shares issued and outstanding in 2000 and 1999, respectively                     15               13
   Additional paid-in capital                                                          47,953           39,360
   Convertible preferred stock Series A, no par value, zero and 3,250 shares
     authorized, zero and 3,228 shares issued and outstanding in 2000 and 1999,
     respectively                                                                           -            3,217
   Convertible preferred stock Series B, no par value, zero and 3,000 shares
     authorized, zero and 1,413 shares issued and outstanding in 2000 and 1999,
     respectively                                                                           -            3,520
   Deferred compensation                                                                 (123)            (188)
   Accumulated deficit                                                                 (4,051)          (7,493)
                                                                                      -------          -------
       Total stockholders' equity                                                      43,794           38,429
                                                                                      -------          -------
       Total liabilities and stockholders' equity                                     $52,565          $49,887
                                                                                      =======          =======
</TABLE>

                            See accompanying notes

                                      F-5
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                (in thousands)

<TABLE>
<CAPTION>
                                                   Convertible         Convertible
                                                 Preferred Stock    Preferred Stock    Additional                          Total
                                Common Stock        Series A            Series B        Paid-In    Deferred    Accumu- Stockholders'
                               --------------    --------------     ----------------                            lated
                               Shares  Amount    Shares   Amount     Shares   Amount    Capital      Comp     (Deficit)    Equity
                               ------  ------    ------   ------     ------   ------    -------      ----     ---------    ------
<S>                            <C>     <C>       <C>      <C>        <C>      <C>      <C>          <C>       <C>         <C>
Balances, January 31, 1997
   as previously reported      10,484   $  10         -    $    -          -    $  -    $ 37,225    $ (346)   $  (8,825)  $ 28,064
Adjustment for poolings
   of interests                 1,707       2     2,500     2,490          -       -          53         -       (2,642)       (97)
                               ------   -----    ------    ------    -------   -----   ---------    ------    ---------   --------
Balances, January 31, 1997     12,191      12     2,500     2,490          -       -      37,278      (346)     (11,467)    27,967
   Issuance of common stock        26       1         -         -          -       -         406         -            -        407
   Exercise of stock options      191       -         -         -          -       -         331         -            -        331
   Issuance of preferred
     stock Series B                 -       -         -         -        400   1,000           -         -            -      1,000
   Conversion of notes payable
     to preferred stock Series
     A and B                        -       -       728       727        685   1,700           -         -            -      2,427
   Amortization of deferred
     compensation                   -       -         -         -          -       -           -        63            -         63
   Cancellation of stock
     options granted                -       -         -         -          -       -          (8)        8            -          -
   Payment of dividends by PSIP     -       -         -         -          -       -           -         -          (15)       (15)
   Net income                       -       -         -         -          -       -           -         -        1,527      1,527
                               ------   -----    ------    ------    -------   -----   ---------    ------    ---------   --------
Balances, January 31, 1998     12,408      13     3,228     3,217      1,085   2,700      38,007      (275)      (9,955)    33,707
   Issuance of common stock        72       -         -         -          -       -         481         -            -        481
   Exercise of stock options      358       -         -         -          -       -         872         -            -        872
   Issuance of preferred
     stock Series B                 -       -         -         -        328     820           -         -            -        820
   Amortization of deferred
      compensation                  -       -         -         -          -       -           -        87            -         87
   Net income                       -       -         -         -          -       -           -         -        2,462      2,462
                               ------   -----    ------    ------    -------   -----   ---------    ------    ---------   --------
Balances, January 31, 1999     12,838      13     3,228     3,217      1,413   3,520      39,360      (188)      (7,493)    38,429
   Issuance of common stock       151       -         -         -          -       -         846         -            -        846
   Exercise of stock options      530       1         -         -          -       -         961         -            -        962
   Conversion of preferred
     stock Series A and B to
     common stock               1,200       1    (3,228)   (3,217)    (1,413) (3,520)      6,736         -            -          -
   Conversion of notes payable
     to common stock                5       -         -         -          -       -          50         -            -         50
   Acquisition adjustment           -       -         -         -          -       -           -         -            1          1
   Amortization of deferred
     compensation                   -       -         -         -          -       -           -        65            -         65
   Net income                       -       -         -         -          -       -           -         -        3,441      3,441
                               ------    -----   ------   -------    -------  ------   ---------    ------    ---------   --------
Balances, January 31, 2000     14,724    $ 15         -   $     -          -  $    -   $  47,953    $ (123)   $   (4051)  $ 43,794
                               ======    =====   ======   =======    =======  ======   =========    ======    =========   ========
</TABLE>

                             See accompanying notes

                                      F-6
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (in thousands)

<TABLE>
<CAPTION>
                                                                                             Years Ended January 31,
                                                                                       ------------------------------------
                                                                                        2000            1999          1998
                                                                                       ------          -------      -------
<S>                                                                                    <C>             <C>          <C>
Cash flows from operating activities:
       Net income                                                                      $ 3,441         $ 2,462      $ 1,527
       Adjustments to reconcile net income to net cash provided (used) by
           operating activities
             Depreciation and amortization                                               1,540           1,289          969
             Amortization of investment discounts and premiums                            (146)           (125)        (247)
             Amortization of deferred compensation                                          65              87           63
             Compensation expense on common stock issued to employees                       48              78            -
             Allowance for bad debt                                                         97              75            -
             Deferred taxes                                                                640            (522)       1,048
             Other                                                                           2               -           21
             Interest expense associated with convertible notes payable                      -               -          363
             Changes in operating assets and liabilities:
                 Trade accounts receivable                                                 278          (4,060)      (2,825)
                 Unbilled receivables                                                      651          (1,608)      (1,023)
                 Income taxes receivable                                                   (21)              -            -
                 Prepaid expenses and other assets                                        (192)            (23)        (717)
                 Long term receivable                                                   (1,500)              -            -
                 Accounts payable                                                         (312)           (513)         855
                 Income taxes payable                                                     (784)            334          372
                 Deferred revenue                                                       (2,360)            257       (2,147)
                 Other liabilities                                                       1,513           1,781        1,603
                                                                                       -------         -------      -------
                    Net cash provided (used) by operating activities                     2,960            (488)        (138)
                                                                                       -------         -------      -------
Cash flows from investing activities:
       Purchases of property and equipment                                              (1,742)           (483)      (1,667)
       Purchases of leasehold improvements                                                (818)         (1,357)      (1,795)
       Purchases of held-to-maturity securities                                              -               -      (24,244)
       Purchases of available-for-sale securities                                      (22,892)        (18,155)      (2,992)
       Maturities of held-to-maturity securities                                         5,500          12,000        7,000
       Proceeds from sales of available-for-sale securities                             23,050           8,000            -
       Purchase of software license                                                        (30)              -            -
                                                                                       -------         -------      -------
                    Net cash provided (used) by investing activities                     3,068               5      (23,698)
                                                                                       -------         -------      -------
Cash flows from financing activities:
       Proceeds from issuance of common stock                                              798             403          407
       Proceeds from exercise of common stock options                                      962             872          331
       Issuance of notes payable                                                             -             200          750
       Repayment of outstanding notes payable                                             (300)           (200)           -
       Issuance of preferred stock Series B                                                  -             820        1,000
       Payment of dividends                                                                  -               -          (15)
                                                                                       -------         -------      -------
                    Net cash provided by financing activities                            1,460           2,095        2,473
                                                                                       -------         -------      -------
                    Net increase (decrease) in cash and cash equivalents                 7,488           1,612      (21,363)
Cash and cash equivalents, beginning of period                                           6,132           4,520       25,883
                                                                                       -------         -------      -------
Cash and cash equivalents, end of period                                               $13,620         $ 6,132      $ 4,520
                                                                                       =======         =======      =======
</TABLE>

                            See accompanying notes

                                      F-7
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
               CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
                                (in thousands)

<TABLE>
<CAPTION>
                                                                                    Years Ended January 31,
                                                                              ---------------------------------
                                                                               2000          1999         1998
                                                                              ------        ------       ------
<S>                                                                          <C>            <C>          <C>
Supplemental disclosure of cash flow information:
   Cash paid during the year for:
      Income taxes                                                           $1,554         $2,332       $   189
                                                                             ======         ======       =======
      Interest                                                               $   15         $   34       $     1
                                                                             ======         ======       =======
Supplemental schedule of noncash investing and financing activities:
   Conversion of preferred stock Series A to common stock                    $3,217         $    -       $     -
                                                                             ======         ======       =======
   Conversion of preferred stock Series B to common stock                    $3,520         $    -       $     -
                                                                             ======         ======       =======
   Conversion of notes payable to common stock                               $   50         $    -       $     -
                                                                             ======         ======       =======
   Common stock issued to employees                                          $   48         $   78       $     -
                                                                             ======         ======       =======
   Tenant improvements paid by the Company's landlord                        $    -         $   41       $   213
                                                                             ======         ======       =======
   Cancellation of stock options granted with exercise prices
      below market on the date of grant                                      $    -         $    -       $     8
                                                                             ======         ======       =======
   Conversion of notes payable to shares of preferred
      stock Series A and B, less issuance costs of $10                       $    -         $    -       $ 2,427
                                                                             ======         ======       =======
</TABLE>

                            See accompanying notes

                                      F-8
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   (in thousands, except per share amounts)



1.   Organization and Summary of Significant Accounting Policies:

     Organization: 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 embedded 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
that perform a combination of these imaging functions. In order to process
digital text graphics, digital document products rely on a core set of imaging
software and supporting electronics, collectively known as the embedded imaging
system. Embedded networking systems supply the core software technologies to
digital document products that enable them to communicate over local area
networks and the Internet.

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

     Business Combinations: All business combinations have been accounted for
under the pooling-of interests method of accounting under Accounting Principles
Board Opinion No. 16. In such cases, the assets, liabilities and stockholders'
equity of the acquired entities were combined with the Company's respective
accounts at recorded values. Prior period financial statements have been
restated to give effect to the mergers.

     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.

     Investments: The Company's investments at January 31, 2000 and 1999
consisted of held-to-maturity and available-for-sale U.S. government debt, state
and local government debt, corporate debt, and other debt securities. Held-to-
maturity securities are carried at amortized cost. Amortization of the purchase
discounts and premiums is included in interest income. Available-for-sale
securities are carried at fair value. Unrealized gains and losses, if material,
are reported as a separate component of stockholders' equity. Realized gains and
losses and declines in value judged to be other than temporary are included in
results of operations. Realized gains and losses are calculated using the
specific identification method and were not material to the Company's results of
operations in any period presented.

     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 equipment          3 to 5 years
          Furniture                        10 years
          Leasehold 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.

     Long-Lived Assets: The Company identifies and records impairment losses on
long-lived assets when events and circumstances indicate that such assets may be
impaired. To date, no such impairment has been recorded.

                                      F-9
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)



     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 revenues in accordance with
Statement of Position 97-2 "Software Revenue Recognition" as amended by
Statement of Position 98-4.

     Development license revenues from the licensing of source code or software
development kits for the Company's standard products are recognized upon
delivery 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,
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 recognized over the course of the development work on a percentage-of-
completion basis. Progress-to-completion under percentage-of-completion is
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.
Maintenance revenues are recognized ratably over the term of the maintenance
contract.

     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. These recurring licensing revenues
are recognized on a per unit basis as products are shipped commercially. In
certain cases, the Company requires customers to pay minimum royalty
commitments. These minimum 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 recurring licensing fee commitments on delivery of
software, when collection of the resulting receivable is probable and when the
fee is fixed and determinable. In cases where the royalty commitments 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 arrangements, values are allocated among the
elements based on vendor specific evidence of fair value ("VSOE"). If VSOE does
not exist, all revenue for the arrangement are deferred until the earlier of the
point at which such VSOE does exist or all elements of the arrangement have been
delivered. If an arrangement includes both software and service elements, a
determination is made as to whether the service element can be accounted for
separately as services are performed.

     Deferred revenue consists of prepayments of recurring licensing royalties,
and payments billed to customers in advance of revenue recognized on engineering
services contracts. Unbilled receivables arise when the revenue recognized on a
contract exceeds billings due to timing differences related to billing
milestones as specified in the contract.

     Research and Development Costs: Research and development costs are expensed
as incurred.

     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.

                                      F-10
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)


     Income Taxes: The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109 ("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.

     Earnings Per Share: Basic earnings per share ("basic EPS") is computed by
dividing net income 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. In addition, in computing the dilutive
effect of convertible securities, the numerator is adjusted to add back the
after-tax amount of interest recognized in the period associated with any
convertible debt. A reconciliation of basic EPS to diluted EPS is presented in
Note 10 to the Company's financial statements.

     Common Stock Options: During 1997, the Company implemented the disclosure
requirements of SFAS No. 123, "Accounting for Stock-Based Compensation." This
statement sets forth alternative standards of recognition of the cost of
stock-based compensation and requires that the Company's financial statements
include certain disclosures about stock-based employee compensation arrangements
regardless of the method used to account for them. As permitted by this
statement, the Company continues to apply Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in recording compensation related to its plans. The supplemental
disclosure requirements and further information related to the Company's stock
option plans are presented in Note 12 to the Company's financial statements.

     Segment Reporting: The Company adopted SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information" for the year ended January
31, 1999. SFAS No. 131 requires that companies report financial and descriptive
information about operating segments and establishes disclosures about products
and services, geographic areas, and major customers. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision-maker in
deciding how to allocate resources and in assessing performance. The Company
believes that it operates in only one reportable business segment, the
development and sale of embedded imaging software and related services. The
Company's adoption of SFAS No. 131 did not affect the results or disclosure of
segment information as the Company's management financial information provides
for only one segment.

     Cash and Cash Equivalents: Cash and cash equivalents represent cash and
highly liquid investments with an original maturity of three months or less.

     Reclassifications: Certain previously reported financial information has
been reclassified to conform to the fiscal 2000 presentation.

                                      F-11
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

     Future Developments: In June 1998, the Financial Accounting Standards Board
issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 133 requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives will be recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. SFAS No. 133
is effective for fiscal years beginning after June 15, 2000, as amended by SFAS
No. 137. The adoption of SFAS No. 133 will not have a material impact on the
Company's results of operations, financial position or cash flows.

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company is currently evaluating the impact of SAB 101 on its
financial statements and related disclosures. While the Company does not expect
the impact on the financial statements and results of operations to be material,
it is not known at this time what the ultimate impact will be. The accounting
and disclosures prescribed by SAB 101 will be effective no later than the second
fiscal quarter of the first fiscal year beginning after December 15, 1999.

2.   Business Developments:

     In June 1999, the Company completed its acquisition of Auco, Inc. ("Auco").
Auco, based in Redwood City, California, develops embedded networking technology
and was privately held prior to the acquisition. As a result of the acquisition,
Auco was renamed Peerless Systems Networking ("PSN") and became a wholly owned
subsidiary of the Company. The Company exchanged 2,500 shares of its common
stock for all outstanding shares of Auco capital stock on a fully diluted basis,
and its convertible note payable. Each share of Auco was exchanged for .2585
shares of Peerless common stock.

     In December 1999, the Company completed its acquisition of HDE, Inc.
("HDE"). HDE, based in Seattle, Washington, develops embedded imaging and
Internet printing solutions and was privately held prior to the acquisition. As
a result of the acquisition, HDE was renamed Peerless Systems Imaging Products
("PSIP") and became a wholly owned subsidiary of the Company. The Company
exchanged 890 shares of its common stock for all of the outstanding shares of
HDE common stock.

     Both the Auco and HDE acquisitions qualified as tax-free exchanges and were
accounted for as poolings-of-interests under Accounting Principles Board Opinion
No. 16. Accordingly, the Company's financial statements have been restated to
include the results of Auco and HDE for all periods presented.

     Prior to the June 1999 merger with Auco, Auco's fiscal year ended on
December 31. In recording the business combination, Auco's prior period
financial statements were not restated to conform to the Company's fiscal year.
Accordingly, the consolidated balance sheet at January 31, 1999 combines the
Peerless balance sheet at January 31, 1999 and the Auco balance sheet at
December 31, 1998. The consolidated statements of income for the 1999 and 1998
fiscal years consist of Peerless' results of operations for the twelve month
periods ended January 31, 1999 and 1998, respectively, and Auco's results of
operations for the twelve month periods ended December 31, 1998 and 1997,
respectively. Beginning in the second quarter of fiscal 2000, Auco's fiscal year
end was changed to conform to Peerless' fiscal year end of January 31.
Accordingly, Auco's results of operations for the month of April 1999 were
excluded from the Company's consolidated operating results. Revenues and net
income of Auco for April 1999 were $463 and $1, respectively, with net income
reflected as an adjustment to retained earnings effective May 1, 1999.

     There were no transactions between Peerless and Auco prior to the
combination. Prior to the acquisition, HDE provided engineering services to the
Company. Transactions between the Company and HDE have been eliminated

                                      F-12
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)


in consolidation. Certain reclassifications were made to the Auco and HDE
financial statements to conform to Peerless' presentations.

     The results of operations for the separate companies and the combined
amounts presented in the consolidated financial statements are as follows:

<TABLE>
<CAPTION>
                                   (Unaudited)   (Unaudited)
                                   Nine Month    Three Month
                                  Period Ended   Period Ended        Years Ended
                                    October 31,    April 30,         January 31,
                                                                  ------------------
                                       1999           1999         1999      1998
                                     --------       --------     -------    -------
     <S>                          <C>            <C>             <C>        <C>
     Revenues:
         Peerless                    $31,065         $ 8,194     $32,583    $25,363
         Auco                             (A)          1,666       4,142      1,878
         HDE                           2,787             880       4,429      3,834
         Eliminations                      -               -         (77)      (117)
                                     -------         -------     -------    -------
            Combined                 $33,852         $10,740     $41,077    $30,958
                                     =======         =======     =======    =======
     Net income (loss):
         Peerless                    $ 4,178         $ 1,091     $ 4,641    $ 4,944
         Auco                             (A)            122        (863)    (2,541)
         HDE                              35              (1)     (1,316)      (876)
                                     -------         -------     -------    -------
            Combined                 $ 4,213         $ 1,212     $ 2,462    $ 1,527
                                     =======         =======     =======    =======
</TABLE>


(A)  Included in Peerless consolidated amounts after merger in June 1999.

                                      F-13
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)



3.   Investments:

     Investments at January 31 consisted of the following:

<TABLE>
<CAPTION>
                                                                     2000         1999
                                                                  ----------   ----------
<S>                                                               <C>          <C>
Held-to-maturity securities:
     Maturities within one year:
          U.S. government debt securities                          $      -     $  5,503
                                                                   --------     --------
                    Total held-to-maturity securities                     -        5,503
                                                                   --------     --------
Available-for-sale securities:
     Maturities within one year:
          U.S. government debt securities                             1,500          979
          State and local U.S. government debt securities               830            -
          Corporate debt securities                                   9,999        4,976
          Other debt securities                                           -        2,000
                                                                   --------     --------
                                                                     12,329        7,955
                                                                   --------     --------
     Maturities after one year through five years:
          U.S. government debt securities                                 -        1,503
          State and local U.S. government debt securities               500            -
          Corporate debt securities                                       -        3,102
                                                                   --------     --------
                                                                        500        4,605
                                                                   --------     --------
     Maturities after ten years:
          U.S. government debt securities                                 -        2,700
          State and local U.S. government debt securities             2,422            -
                                                                   --------     --------
                                                                      2,422        2,700
                                                                   --------     --------
                    Total available-for-sale securities              15,251       15,260
                                                                   --------     --------
Total investments                                                  $ 15,251     $ 20,763
                                                                   ========     ========
</TABLE>

     In February 1999, $2,700 of U.S. government securities with maturities in
excess of ten years was sold and the proceeds were invested in short-term,
available-for-sale securities. Accordingly, the securities have been classified
as current in the 1999 balance sheet.

     The fair value of held-to-maturity securities at January 31, 2000 and 1999
approximated their carrying value (amortized cost). Unrealized gains or losses
on available-for-sale securities were immaterial for all periods presented.


                                      F-14
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

4.   Property and Equipment:

     Property and equipment at January 31 consisted of the following:

                                                  2000          1999
                                                --------      --------
     Computers and other equipment              $  7,129      $  5,507
     Furniture                                       473           390
     Leasehold improvements                        3,044         2,223
                                                --------      --------
                                                  10,646         8,120
     Less, accumulated depreciation               (4,081)       (2,670)
                                                --------      --------
                                                $  6,565      $  5,450
                                                ========      ========

     Depreciation for the years ended January 31, 2000, 1999 and 1998 was
$1,444, $1,149 and $828, respectively.

5.   Liabilities:

     Other current liabilities consisted of the following at January 31,

                                            2000          1999
                                          -------       -------

     Accrued wages                        $ 1,675       $ 1,736
     Accrued compensated absences             895           784
     Accrued warranty costs                   289           100
     Accrued license fees                     645             -
     Other current liabilities                816           843
                                          -------       -------
                                          $ 4,320       $ 3,463
                                          =======       =======

6.   Notes Payable:

     From June 1994 through December 1994, PSN issued 10% Convertible Promissory
Notes ("Convertible Notes") with an aggregate principal amount of $763 to a
shareholder. The Convertible Notes were convertible, at the option of the
holder, to shares of PSN stock at a specified conversion price of $1.00 of
principal amount per share of PSN stock. In November 1997, the principal amount
plus all accrued interest was converted into 598 shares of Convertible Preferred
Stock Series A and into 165 shares of Convertible Preferred Stock Series B. (See
Note 11 for discussion of Convertible Preferred Stock).

     From December 1996 through February 1997, PSN issued 10% Convertible Notes
with an aggregate principal amount of $1,300 to shareholders. The Convertible
Notes had a maturity date of December 31, 1999 and were convertible, at the
option of the holder, to shares of PSN stock at a specified conversion price of
$2.00 of principal amount per share of PSN stock. In November 1997, the
principal amount plus all accrued interest was converted into 130 shares of
Convertible Preferred Stock Series A and into 520 shares of Convertible
Preferred Stock Series B. (See Note 11 for discussion of Convertible Preferred
Stock).

                                     F-15
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

     In December 1997, PSN issued a 10% convertible note with an aggregate
principal amount of $50 to a shareholder. The Convertible Note had a maturity
date of December 31, 1998 and was convertible, at the option of the holder, to
shares of PSN stock at a specified conversion price of $2.50 of principal amount
per share of PSN stock. In June 1999, upon closing of the merger between
Peerless and PSN, the Convertible Note was converted into 5 shares of Peerless
common stock.

     In December 1997, PSN issued 10% Promissory Notes ("Notes") with an
aggregate principal amount of $300 to shareholders. In June 1998, PSN issued
Notes with an aggregate principal amount of $200 to a shareholder. As of January
31, 2000 and 1999, $0 and $300, respectively, in principal amount of the Notes
was outstanding.

7.   Commitments:

     Operating Leases The Company leases its offices and certain operating
equipment under operating leases that expire through 2007. 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. The leases do not specifically provide for renewal options.

     Future minimum rental payments under long-term operating leases are as
follows:

            For the Years
          Ending January 31,
          ------------------
                2001                    $  1,289
                2002                       1,326
                2003                       1,350
                2004                       1,395
                2005                       1,226
                Thereafter                 4,196
                                        --------
                                        $ 10,782
                                        ========

     Total rental expense was $1,403, $1,313 and $1,078 for the years ended
January 31, 2000, 1999 and 1998, respectively.

                                      F-16
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

8.   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, 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, 2000 and 1999, two and three customers
collectively represented 32% and 39% of total trade accounts receivable,
respectively. 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:

<TABLE>
<CAPTION>
                                    2000              1999                1998
                                -------------     ------------       -------------
          <S>                   <C>       <C>     <C>      <C>       <C>       <C>
          Customer A            $ 7,888   19%     $ 6,664  16%       $ 5,444   18%
          Customer B              4,496   11%       5,803  14%         3,544   11%
          Customer C              4,413   10%       4,805  12%         3,216   10%
          Customer D                                4,044  10%         3,134   10%
          Customer E                                3,986  10%         3,084   10%
                                -------           -------            -------
                                $16,797   40%     $25,302  62%       $18,422   59%
                                =======           =======            =======
</TABLE>

     Significant Estimates of Revenues: 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 for
subsequent periods.

     Legal Proceedings: The Company is subject to litigation in the ordinary
course of business. The Company believes that this litigation will not have a
material adverse effect on the financial position, results of operations and
cash flows of the Company.

     The Company filed a lawsuit in January 2000 against Conexant Systems Inc.,
Newport Beach, CA in the Orange County Superior Court regarding the failure and
refusal of Conexant to pay to the Company a portion of a Source License Fee and
guaranteed royalty payments pursuant to an agreement between the parties.
Conexant has filed a cross-complaint alleging misrepresentation of facts
regarding the Company's Intellectual Property. Discovery has been initiated. The
Company is confident that it will prevail in this matter. The Company has not
accrued any liability associated with this lawsuit, as management believes that
the reserve for doubtful accounts at January 23, 2000 is adequate. The
receivable has been reclassified as a long-term receivable in that management
does not expect that the lawsuit will be concluded, and the balance outstanding
to Peerless will be collected, within the next fiscal year.

                                      F-17
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

     The Company was sued by a major shareholder, the State of Wisconsin
Investment Board ("SWIB") in the Court of Chancery of the State of Delaware In
New Castle County in December 1999. The Company's former Chief Executive
Officer, Edward A. Gavaldon, has also been named as a defendant. The complaint
alleges that Peerless wrongfully influenced the passage of a proposal to
increase the number of shares in the stock option plan at the 1999 Annual
Meeting of Shareholders and provided misleading information to SWIB. Mr.
Gavaldon is alleged to have benefited wrongfully from these actions. SWIB seeks
to nullify the shareholder approved Amendment and is asking for unspecified
damages. The Company has filed an Answer and believes that it will prevail in
this matter. Discovery has been undertaken, but no hearing date has been set by
the Court on the matter.

9.   Income Taxes:

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

                                        2000       1999      1998
                                       ------     ------    ------

               Current:
                    Federal            $  232     $2,995    $1,397
                    State                  92        381       462
                    Foreign               937        702        92
                                       ------     ------    ------
                                        1,261      4,078     1,951
                                       ------     ------    ------

               Deferred:
                    Federal               365       (585)      830
                    State                 275         63       218
                                       ------     ------    ------
                                          640       (522)    1,048
                                       ------     ------    ------
                                       $1,901     $3,556    $2,999
                                       ======     ======    ======

                                      F-18
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

     The foreign tax provision is comprised of foreign withholding taxes on
license fees and royalty payments.

     Temporary differences at January 31 which give rise to deferred income tax
assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                           2000        1999
                                                         --------    --------
     <S>                                                 <C>         <C>
     Deferred tax assets:
          Net operating loss carryforwards               $  1,886    $  2,033
          Accrued liabilties                                  483         467
          Allowance for doubtful accounts                      69          75
          Deferred revenue                                    263       2,172
          Deferred expenses                                   133         136
          Tax credit carryforwards                            443         951
          Other                                                 1           2
                                                         --------    --------
                  Total deferred tax assets                 3,278       5,836
                                                         --------    --------
     Deferred tax liabilities:
          Property and equipment                             (409)       (355)
          State taxes                                           -         (39)
                                                         --------    --------
                  Total deferred tax liabilities             (409)       (394)
                                                         --------    --------
          Subtotal                                          2,869       5,442
     Valuation allowance                                   (1,137)     (3,070)
                                                         --------    --------
                  Net deferred income tax asset          $  1,732    $  2,372
                                                         ========    ========
</TABLE>

     The Company periodically evaluates the sufficiency of its deferred tax
asset valuation allowance, which is adjusted as deemed appropriate based on
operating results. The reduction in the valuation allowance in the current year
is primarily due to changes in federal income tax laws which will allow the
company to utilize purchased net operating loss carry forwards acquired through
business combinations.

                                      F-19
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

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

<TABLE>
<CAPTION>
                                                            2000      1999      1998
                                                           ------    ------    ------
<S>                                                        <C>       <C>       <C>
Statutory federal income tax rate                           34.0%     34.0%     34.0%
Foreign provision                                           17.5      11.7       2.0
Nondeductible acquisition expenses                          13.8         -         -
Other nondeductible expenses                                 9.0      20.1      15.9
State tax                                                    4.7       4.7      13.4
Foreign tax and research and experimentation credits       (20.6)    (15.4)     (1.5)
Change in valuation allowance                              (31.2)      3.7      (0.7)
Other                                                        8.4       0.3       3.2
                                                           ------    ------    ------
         Provision for income taxes                         35.6%     59.1%     66.3%
                                                           ======    ======    ======
</TABLE>

     As of January 31, 2000, the Company has net operating loss carryforwards of
approximately $4,815 for federal purposes, which begin to expire in fiscal year
2001.

10.  Earnings Per Share:

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

<TABLE>
<CAPTION>
                                                         2000                         1999                        1998
                                              --------------------------  ---------------------------  -------------------------
                                               Net             Per-Share   Net              Per-Share   Net            Per-Share
                                              Income   Shares   Amount    Income    Shares    Amount   Income  Shares   Amount
                                              ------   ------   ------    ------    ------    ------   ------  ------   ------
<S>                                           <C>      <C>     <C>        <C>       <C>     <C>        <C>     <C>     <C>
Basic EPS
Earnings available to the common
      stockholders                            $3,441   13,890   $ 0.25    $2,462    12,682    $ 0.19   $1,527  12,316   $ 0.12
                                                                ======                        ======                    ======

Effect of Dilutive Securities
Options                                            -    1,115                  -     1,350                  -   1,481
Convertible preferred stock Series A               -      332                  -       834                  -     662
Convertible preferred stock Series B               -      146                  -       315                  -      39
                                              ------   ------             ------    ------             ------  ------

Diluted EPS
Earnings available to common
      stockholders with assumed conversions   $3,441   15,483   $ 0.22    $2,462    15,181    $ 0.16   $1,527  14,498   $ 0.11
                                              ======   ======   ======    ======    ======    ======   ======  ======   ======
</TABLE>

     Options to purchase 970 shares of common stock at $10.13 to $23.13 per
share, 629 shares of common stock at $13.50 to $22.38 per share and 157 shares
of common stock at $14.63 to $18.50 per share were outstanding during the years
ended January 31, 2000, 1999 and 1998, respectively, but were not included in
the computation of diluted EPS because the options' exercise prices were greater
than the average market price of the common shares. In addition, the convertible
note payable was excluded because the impact on earning per share was
antidilutive.

                                      F-20
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)


11.  Convertible Preferred Stock:

     Prior to June 1999, PSN had authorized 10,000 shares of preferred stock, of
which 3,250 were designated as Series A, 3,000 were designated as Series B and
3,750 were undesignated.

     During the year ended January 31, 1999, PSN issued 328 shares of
Convertible Preferred Stock Series B at a price of $2.50 per share in exchange
for $820 of cash. During 1998, PSN issued 400 shares of Convertible Preferred
Stock Series B at a price of $2.50 per share in exchange for $1,000 of cash.

     In June 1999, upon closing of the merger between Peerless and PSN, all
outstanding shares of Convertible Preferred Stock Series A and Convertible
Preferred Stock Series B were converted into 835 and 365 shares of common stock,
respectively.


12.  Stock Option and Purchase Plans:

     Nonstatutory Stock Option Program: During 1992, the Board of Directors
authorized a nonstatutory stock option program for the purpose of granting
options to purchase a total of 222 shares of the Company's common stock to
employees. The Board of Directors reduced the number of shares authorized to 133
during 1994. Options vested annually, pro rata over a five-year period,
retroactive to the date of hire for each recipient. No options were outstanding
and no additional options were authorized under this plan in 2000.

     The following represents option activity for the years ended January 31
under the nonstatutory option plan:

<TABLE>
<CAPTION>
                                                                     1999                               1998
                                                         --------------------------         ---------------------------
                                                                          Weighted                            Weighted
                                                                           Average                             Average
                                                                          Per Share                           Per Share
                                                         Number of        Exercise          Number of         Exercise
                                                          Options           Price            Options            Price
                                                          -------         ---------          -------          ---------
               <S>                                       <C>              <C>               <C>               <C>
               Options outstanding at beginning of year         2           $ 0.20                22            $ 0.50
               Options exercised                               (2)          $ 0.20               (20)           $ 0.53
               Options forfeited                                -                                  -
                                                          -------                            -------
               Options outstanding at year-end                  -                                  2            $ 0.20
                                                          =======                            =======
               Options exercisable at year-end                  -                                  2            $ 0.20
                                                          =======                            =======
               Options available for future grant               -
                                                          =======
</TABLE>

                                      F-21
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

     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 shares of
common stock have been authorized by the Board under this plan.

     The following represents option activity for the years ended January 31
under the 1992 Stock Option Plan:

<TABLE>
<CAPTION>
                                                                   2000                     1999                   1998
                                                         ------------------------  ----------------------  --------------------
                                                                        Weighted                Weighted              Weighted
                                                                         Average                 Average               Average
                                                                        Per Share               Per Share             Per Share
                                                          Number of     Exercise   Number of    Exercise   Number of  Exercise
                                                           Options        Price     Options       Price     Options     Price
                                                        -------------   ---------  ---------    ---------  ---------  ---------
<S>                                                     <C>             <C>        <C>          <C>        <C>        <C>
Options outstanding at beginning of year                          444    $  1.39       683       $  1.33       810     $  1.36
Options granted                                                     -                    -                       -
Options exercised                                                (277)   $  1.42      (202)      $  1.42      (120)    $  1.07
Options forfeited                                                  (3)   $  1.61       (37)      $  1.41        (7)    $  1.02
                                                        -------------              ---------               ---------
Options outstanding at year-end                                   164    $  1.44       444       $  1.43       683     $  1.41
                                                        =============              =========               =========
Options exercisable at year-end                                   158    $  1.40       393       $  1.39       340     $  1.33
                                                        =============              =========               =========
Options available for future grant                                  -
                                                        =============
Weighted average remaining contractual
      life in years                                               4.9
                                                        =============
Range of per share exercise prices for
      options outstanding at year-end                   $0.53 - $1.65
                                                        =============
</TABLE>

     Incentive Plan: In May 1996, the Board adopted the Company's 1996 Stock
Option Plan. The Company's 1996 Equity Incentive Plan (the "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 had authorized and reserved
an aggregate of 1,267 shares of common stock for issuance under the Incentive
Plan. In June 1998, 1,200 additional shares of common stock were authorized and
reserved for issuance under the Incentive Plan.

     The Incentive Plan provides for the grant of incentive stock options to
employees and nonstatutory 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 nonstatutory 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 option agreement.

     During 1994, the PSN 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 PSN plan were
exercisable immediately subject to repurchase rights held by PSN. In June 1999,
upon completion of the merger between Peerless and PSN, the PSN options were
converted to options under the Company's Incentive Plan.

                                      F-22
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)


     The following represents consolidated option activity under the Incentive
Plan for the years ended January 31:

<TABLE>
<CAPTION>
                                                                   2000                     1999                   1998
                                                         ------------------------  ----------------------  --------------------
                                                                        Weighted                Weighted              Weighted
                                                                         Average                 Average               Average
                                                                        Per Share               Per Share             Per Share
                                                          Number of     Exercise   Number of    Exercise   Number of  Exercise
                                                           Options        Price     Options       Price     Options     Price
                                                        -------------   ---------  ---------    ---------  ---------  ---------
<S>                                                     <C>             <C>        <C>          <C>        <C>        <C>
Options outstanding at beginning of year                      1,884     $    7.67     1,256     $    5.67    1,025    $    3.27
Option grants                                                 1,180     $   10.09     1,098     $    8.95      417    $    9.11
Options exercised                                              (253)    $    2.33      (129)    $    4.20      (51)   $    3.17
Options forfeited                                              (474)    $    9.34      (341)    $    4.96     (135)   $    2.73
                                                        -------------              ---------               ---------
Options outstanding at year-end                               2,337     $    8.96     1,884     $    7.67    1,256    $    5.67
                                                        =============              =========               =========
Options exercisable at year-end                                 640     $    6.87       621     $    2.87      571    $    1.36
                                                        =============              =========               =========
Options available for future grant                              765
                                                        =============
</TABLE>

     For various price ranges, weighted average characteristics of outstanding
stock options under the Incentive Plan at January 31, 2000 were as follows:

<TABLE>
<CAPTION>
                                                   Outstanding Options                 Exercisable Options
                                      ------------------------------------------     ------------------------
                                                       Weighted        Weighted                      Weighted
                                                       Average         Average                       Average
                                        Shares        Remaining       Per Share        Shares       Per Share
                                         Under           Life          Exercise         Under        Exercise
Range of Exercise Prices                Option         (Years)          Price          Option         Price
------------------------              ----------     -----------     -----------     ----------     ---------
<S>                                   <C>            <C>             <C>             <C>            <C>
$0.00 to $2.31                              299         5.6            $   0.72            227        $ 0.66
$2.32 to $4.63                              112         6.1            $   3.30             67        $ 3.30
$4.64 to $6.94                              410         6.9            $   5.28             84        $ 5.10
$6.95 to $9.25                              503         9.2            $   8.24             31        $ 8.52
$9.26 to $11.56                             128         7.8            $  10.49             38        $10.99
$11.57 to $13.88                            415         8.4            $  13.07             24        $13.26
$13.89 to $16.19                            348         7.6            $  14.18            119        $14.22
$16.20 to $18.50                             86         5.3            $  17.44             40        $17.36
$18.51 to $20.81                             10         7.6            $  19.44              3        $19.34
$20.82 to $23.13                             26         8.1            $  22.20              7        $22.28
                                      ----------                                     ----------

             Total                        2,337                                            640
                                      ==========                                     ==========
</TABLE>

     Stock Bonuses: During both the years ended January 31, 2000 and 1999, the
Company granted 5 shares of common stock as stock bonuses to certain employees.
The Company recorded $48 and $78 of compensation expense related to these stock
bonuses during the years ended January 31, 2000 and 1999, respectively.

     Deferred Compensation: During the year ended January 31, 1997, the Company
recorded deferred compensation costs of $452 for the difference between the
exercise price and the deemed fair value of the

                                      F-23
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

Company's common stock at the date of grant for options issued under the
Incentive Plan. Of the total deferred expense, the Company recognized $65, $87
and $63 as compensation expense during the years ended January 31, 2000, 1999
and 1998, respectively. The remaining deferred compensation expense will be
amortized over the remaining vesting periods of the options.

     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 shares of the Company's common stock. Under the
Purchase Plan, the Board of Directors may authorize participation by eligible
employees, including officers, in periodic offerings following the adoption of
the Purchase Plan. The offering period for any offering will be no more than 27
months. Plan offering periods have been six months since the inception of the
plan. Employees are eligible to participate if they are employed by the Company
or an affiliate of the Company designated by the Board of Directors and meet
eligibility standards established by the Board of Directors. Employees who
participate 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 will be 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 ends
automatically on termination of employment with the Company and its affiliates.
The Purchase Plan will terminate at the Board of Directors' discretion.

     During the year ended January 31, 2000, 1999 and 1998, employees purchased
146, 87 and 26 shares of common stock at weighted average per share prices of
$5.48, $6.04 and $10.88, respectively.

                                      F-24
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

SFAS 123: The Company applies APB Opinion 25, "Accounting for Stock Issued to
Employees," and related interpretations to account for its stock option plans
and employee stock purchase plan, and therefore does not recognize compensation
expense for grants of stock options or shares sold under the Purchase Plan.
Under SFAS No. 123, compensation cost would be recognized for the fair value of
the employee option rights and shares sold under the employee stock purchase
plan. In determining the fair value, the Company used the Black-Scholes model,
assumed no dividend per year, used expected lives ranging from 2 to 10 years,
expected volatility of 99.5%, 100.0% and 72.6% for the years ended January 31,
2000, 1999 and 1998, respectively, and risk free interest rate of 5.7% for the
year ended January 31, 2000, rates ranging from 4.0% to 5.75% for the year ended
January 31, 1999 and rates ranging from 5.75% to 7.25% for the year ended
January 31, 1998. The weighted average per share fair value of options granted
during the year with exercise prices equal to market price on the date of grant
was $8.83, $8.81 and $10.40 per share for the years ended January 31, 2000, 1999
and 1998, respectively. There were no options granted with exercise prices below
market price on the date of grant during any of the years presented. Had
compensation cost for the Company's grants under stock-based compensation plans
and shares sold under the Purchase Plan been determined consistent with SFAS
123, the Company's net income and earnings per share would have been reduced to
the pro-forma amounts indicated below for the years ended January 31:

<TABLE>
<CAPTION>
                                                            2000              1999               1998
                                                          --------          --------            -------
              <S>                                         <C>               <C>                 <C>
              Net income as reported                      $  3,441          $  2,462            $ 1,527
                                                          ========          ========            =======
              Proforma net income (loss)                  $ (1,881)         $ (2,215)           $   149
                                                          ========          ========            =======
              Earnings per share as reported:
                     Basic                                $   0.25          $   0.19            $  0.12
                                                          ========          ========            =======
                     Diluted                              $   0.22          $   0.16            $  0.11
                                                          ========          ========            =======
              Proforma earnings (loss) per share:
                     Basic                                $  (0.14)         $ (0.17)            $  0.01
                                                          ========          ========            =======
                     Diluted                              $  (0.14)         $ (0.17)            $  0.01
                                                          ========          ========            =======
</TABLE>

13.  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 Norwest Bank Minnesota, N.A., as
rights agent. Pursuant to the Rights Agreement, one Right was issued for each
share of the Company's 11,037 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

                                      F-25
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

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, 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.

14.  Employee Savings Plans:

     The Company and PSN maintain employee savings plans that qualify under
Section 401(k) of the Internal Revenue Code (the "Code") for all of the Peerless
and PSN full-time employees. The plans allow 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 both plans up to a
maximum of $2,000 per employee per year. Company contributions to the Peerless
plan during the years ended January 31, 2000, 1999 and 1998 were $245, $253 and
$192, respectively. The Company contributed $53 to the PSN plan in 2000. No
contributions were made to the PSN plan in 1999 and 1998. Subsequent to January
31, 2000, the PSN plan was terminated and merged into the Peerless plan.

     PSIP maintains a profit sharing plan for all eligible employees. Company
contributions to the profit-sharing plan were $35, $35, and $49 for the years
ended January 31, 2000, 1999 and 1998, respectively. Subsequent to January 31,
2000, the PSIP plan was terminated.

15.  International Operations:

     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:

                              2000        1999       1998
                            --------    --------   --------

      United States         $ 11,864    $ 14,633   $ 14,805
      Japan                   28,537      25,852     16,136
      Other                    1,675         592         17
                            --------    --------   --------
                            $ 42,076    $ 41,077   $ 30,958
                            ========    ========   ========

                                      F-26
<PAGE>

                         PEERLESS SYSTEMS CORPORATION
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                   (in thousands, except per share amounts)

16.  Subsequent Events (Unaudited)

     On March 23, 2000, a lawsuit was filed in the Alameda County Superior Court
against the Company and its wholly owned subsidiary, Peerless Systems
Networking, Inc. (PSN) by Howard Sidorsky, a current employee and Vice President
of Marketing of PSN. Mr Sidorsky alleges that he is entitled to a commission of
not less than $630,000 for his participation in the 1999 sale to Peerless of
AUCO, Inc., the predecessor of PSN. The Company has not yet responded to the
complaint. The Company believes that it will prevail in this matter.

On March 16, 2000 PSN entered into an agreement to lease approximately 12,000
square feet of office space in Mountain View, California. The term of the lease
agreement is seven years. The Company has guaranteed the lease commitment of PSN
and has secured the first twelve months of the agreement with a $742,000 standby
letter of credit, which has been secured by a certificate of deposit of a like
amount. Over the next four years the value of the standby letter of credit shall
be reduced to $594,000, $445,000, $297,000 and $148,000, respectively.

On March 17, 2000, PSIP entered into an agreement to lease approximately 10,000
square feet of office space in Kent, Washington. The term of the lease agreement
is five years and is guaranteed by the Company.

The annual minimum rental payments under these operating leases are as follows:



              For the Years
              Ending January 31,
              ------------------
                2001                        $   562
                2002                            967
                2003                          1,005
                2004                          1,044
                2005                          1,085
              Thereafter                      2,455
                                            -------
                                            $ 7,118
                                            =======

                                     F-27
<PAGE>

                SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
                                (In thousands)

<TABLE>
<CAPTION>
                                                                             Additions
                                                                             Charged
                                                              Balance at     to Costs                      Balance at
                                                              Beginning       and          Deductions         End
          Description                                         of Period      Expenses         (a)           of period
          -----------                                         ---------      --------      ----------      ----------
<S>                                                           <C>            <C>           <C>             <C>
Year Ended January 31, 1998
Reserves deducted from assets to which they apply:
     Allowances for uncollectible accounts receivable            $  100            30          $  (30)         $  100

Year Ended January 31, 1999
Reserves deducted from assets to which they apply:
     Allowances for uncollectible accounts receivable            $  100        $  420          $ (345)         $  175

Year Ended January 31, 2000
Reserves deducted from assets to which they apply:
     Allowances for uncollectible accounts receivable            $  175        $ (248)         $  248          $  175
</TABLE>
------


(a) Accounts written off, net of recoveries

                                      S-1
<PAGE>

                               INDEX TO EXHIBITS

Exhibit
Number
------
3.1(1)         Certificate of Incorporation of the Company.
3.2(4)         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
                    Norwest Bank Minnesota, N.A., as Rights Agent.
10.1(1)        Form of Indemnity Agreement.
10.2(1)(2)     1992 Stock Option Plan (the "Option Plan"), as amended.
10.3(1)(2)     1996 Equity Incentive Plan.
10.4(1)(2)     Form of Incentive Stock Option.
10.5(1)(2)     Form of Nonstatutory Stock Option.
10.6(1)(2)     1996 Employee Stock Purchase Plan.
10.7(1)        Third Party Development and License Agreement (the "Adobe Third
                    Party License"), dated September 18, 1992, between the
                    Registrant and Adobe Systems Incorporated ("Adobe").
10.8(1)(3)     Reference Post Appendix #2 to the Adobe Third Party License,
                    dated February 11, 1993.
10.9(1)        Amendment No. 1 to the Adobe Third Party License, dated November
                    29, 1993.
10.10(1)(3)    PCL Development and License Agreement (the "PCL License"), dated
                    June 14, 1993, between the Registrant and Adobe.
10.11(1)(3)    Amendment No. 1 to the PCL License, dated October 31, 1993.
10.12(1)(3)    Letter Modification to the PCL License, dated August 5, 1994.
10.13(1)(3)    Addendum No. 1 to the PCL License, dated March 31, 1995.
10.14(1)(3)    Letter Modification to the PCL License, dated August 30, 1995.
10.15(1)       Lease Agreement between the Company and Continental Development
                    Corporation, dated February 6, 1992, and Addendum, dated
                    February 6, 1992.
10.16(1)       First Amendment to Office Lease, dated December 1, 1995, between
                    the Company and Continental Development Corporation.
10.18(1)(2)    Employment Agreement with Lauren Shaw.
10.19(1)(2)    Employment Agreement with Edward Gavaldon.
10.20(5)       Second Amendment to Office Lease, dated April 8, 1997, between
                    the Company and Continental Development Corporation.
10.21(5)       Third Amendment to Office Lease dated, December 16, 1997, between
                    the Company and Continental Development Corporation.
10.22(6)       Fourth Amendment to Office Lease, dated April 22, 1998, between
                    the Company and Continental Development Corporation.
10.23 (7)      Agreement and Plan of reorganization and Merger by and among
                    Peerless Systems Corporation, Auco Merger Sub, and Auco,
                    Inc., dated as of April 6, 1999.
10.24 (7)      Employment Agreement with Adam Au.
10.25          Employment Agreement with Gordon Hanson.
10.26          Maruban Supplier/Distribution Agreement, dated December 14, 1999.
10.27          Lease PSN McKelvy Family Trust (386 Main Street)
               Standard Industrial/Commmercial Single-Tenant Lease-Net, dated
                    March 14, 1997.
10.28          Lease PSN Terra Bella Inc. and Archie J. Snider dba Terra Snider
                    Joint Venture (1130 Terra Bella) Standard
                    Industrial/Commercial Single-Tenant Lease-Net, dated March
                    16, 2000.
10.29          Lease PSIP Kent Centennial Limited Partnership, dated January 31,
                    1996.
10.30          Lease PSIP Intrarock 1 LLC dated March 15, 2000.
23.1           Consent of Ernst & Young LLP.
23.2           Consent of PricewaterhouseCoopers LLP.
24.1           Power of Attorney. Reference is made to page 30.
27.1           Financial Data Schedule.
27.2           Restated Financial Data Schedule - Fiscal Year 1999 and 1998
27.3           Restated Financial Data Schedule - Quarters - Fiscal Year 2000
27.4           Restated Financial Data Schedule - Quarters - Fiscal Year 1999
-------------
(1) Previously filed in the Company's Registration Statement on Form S-1 (File
    No. 333-09357), as amended and incorporated herein by reference.
<PAGE>

(2) Management contract or compensatory plan or arrangement.
(3) Subject to Confidential Treatment Order.
(4) Previously filed in the Company's Current Report on Form 8-K, filed
    October 8, 1998, 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.