Highlights

During the first quarter ended April 30, 2009, we showed the results of our restructuring efforts made after the sale of substantially all of our assets in the KMC transaction. Expenses have been reduced as a result of the reduction in staffing and the termination of the facility lease obligations both in El Segundo, California and Kent, Washington. Staffing costs have been reduced approximately 74% and facility costs have been reduced 95%. We continue to maintain an organization that is capable of meeting the requirements of our customers and the obligations of a public company.

During the quarter, we amended a third party license agreement that resulted in a gain of approximately $2.6 million.

In connection with the KMC transaction, $4.0 million of consideration payable from KMC to the Company was held in escrow. In May 2009, the Company negotiated for the early release of these escrow funds, subject to a discount payable to KMC. The Company received a sum of approximately $3.8 million on May 29, 2009. The Company will record a gain associated with the release of funds in the quarter ending July 31, 2009.

Consolidated revenues for the first quarter of fiscal year 2009 were $0.9 million, a 71.9% decline from the first quarter of fiscal year 2009 and a 59.1% decline from the fourth quarter of fiscal 2009. Product licensing revenues decreased 1.7% as a result of a decrease in licensing revenue from the first quarter of fiscal year 2009. Engineering services and maintenance revenues decreased 93.5% primarily due to the sale to KMC of the engineering work force from the first quarter of fiscal year 2009. These overall decreases in revenues were primarily attributable to declines in the demand for our technologies, third party technologies we are licensed to sell and the requirement for traditional engineering services.

We acquired 416,800 shares of common stock of Highbury Financial, Inc. ("Highbury"), recorded at fair value of approximately $1.1 million as of April 30, 2009. We held 1,112,148 shares of Highbury common stock and warrants to acquire 1,449,621 shares of Highbury common stock recorded at fair value of approximately $4.4 million as of June 9, 2009.

Our inability to implement our acquisition plan as well as the declining sales trend of our existing licenses, downward price pressure on the technologies we license, uncertainty surrounding third party license revenue sharing agreements, downward price pressure on OEM products and the anticipated consolidation of the number of OEMs in the marketplace, may have a material adverse effect on our business and financial results.

General

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

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

Revenue received for block licenses is recognized in accordance with SOP 97-2, which requires that revenue be recognized after the following conditions have been met: (1) delivery has occurred; (2) fees have been determined and are fixed; (3) collection of fees is probable; and (4) and evidence of an arrangement exists. For block licenses that have a significant portion of the payments due within twelve months, revenue is generally recognized at the time the block license becomes effective assuming all other revenue recognition criteria have been met.

We also have engineering services revenues that are derived primarily from adapting our software and supporting electronics to specific OEM requirements. Our maintenance revenues are derived from software maintenance agreements. Maintenance revenues currently constitute a small portion of total revenue.

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

The technology we license has addressed the worldwide market for monochrome printers (21-69 pages per minute) and multifunction printers ("MFP") (21-110 pages per minute). This market has been consolidating, and the demand for the monochrome technology and products offered by us declined throughout fiscal year 2009 and fiscal year 2008.

The document imaging industry has changed. Lower cost of development and production overseas increasing complexity of imaging requirements has resulted in us not being able to effectively compete in this environment. As a result, we sold our intellectual property and transferred 38 of our engineers and support personnel to KMC. Although as a part of the transaction we have retained the right, subject to certain restriction, to continue licensing and supporting the imaging technology that we had previously developed and continue to license third party imaging technologies, we are currently pursuing other potential investment opportunities. The strategy calls for aligning our cost structure with our current and projected revenue streams, maximizing the value of our licensed back technologies and expanding our business through investment opportunities.

Liquidity and Capital Resources

Compared to January 31, 2009, total assets at April 30, 2009 decreased 2.5% to $50.3 million and stockholders' equity increased 3.3% to $46.0 million, primarily the result of the net income generated by the reversal of the product licensing cost related to a licensing agreement amendment. Our cash and investment portfolio at April 30, 2009 was $43.4 million, a decrease of 2.9% from $44.7 million as of January 31, 2009, and the ratio of current assets to current liabilities was 17.5:1, which is an increase from the 9.2:1 ratio as of January 31, 2009. The increase was primarily the result of the reduction to accrued licensing cost for which the reduced amount has been disbursed in the current quarter and a reversal for technologies licensed by the Company to a customer due to an agreement amending a third party technology license agreement. Our operations used $1.1 million in cash during the three months ended April 30, 2009, compared to $0.3 million in cash used by operations during the quarter ended April 30, 2008.

During the three months ended April 30, 2009, $114,000 in cash was generated by our investing activities, mainly due to interest income. We have not historically purchased, nor do we expect to purchase in the future, derivative instruments or enter into hedging transactions.

At April 30, 2009, our principal source of liquidity, cash and cash equivalents was $42.3 million; a decrease of $2.4 million from January 31, 2009. The decrease is primarily due to the increase in marketable securities of $1.1 million. The Company in the current quarter purchased exchanged traded marketable securities. As of April 30, 2009, the Company has purchased 416,800 of Highbury common stocks. We do not have a credit facility and may require additional long-term capital to finance an acquisition or merger.

Critical Accounting Policies

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

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

We account for our software revenues in accordance with Statement of Position, or SOP, 97-2, "Software Revenue Recognition", as amended by SOP 98-9, Staff Accounting Bulletin No. 104, "Revenue Recognition", and Emerging Issues Task Force 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." Over the past several years, we entered into block license agreements that represent unit licenses for products that will be licensed over a period of time. In accordance with SOP 97-2, revenue is recognized when the following attributes have been met: 1) an agreement exists between us and the OEM selling product utilizing our intellectual property and/or a third party's intellectual property for which we are an authorized licensor; 2) delivery and acceptance of the intellectual property has occurred; 3) the fees associated with the sale are fixed and determinable; and 4) collection of the fees are probable. Under our accounting policies, fees are fixed and determinable if 90% of the fees are to be collected within a twelve-month period, in accordance with SOP 97-2. If more than 10% of the payments of fees extend beyond a twelve-month period, they are recognized as revenues when they are due for payment, in accordance with SOP 97-2.

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

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

We provide an accrual for estimated product licensing costs owed to third party vendors whose technology is included in the products sold by us. The accrual is impacted by estimates of the mix of products shipped under certain of our block license agreements. The estimates are based on historical data and available information as provided by our customers concerning projected shipments. Should actual shipments under these agreements vary from these estimates, adjustments to the estimated accruals for product licensing costs may be required. Such adjustments have historically been within management's expectations.

As of April 30, 2009, we had tax credit carry-forwards available to reduce future income tax liabilities of approximately $5.5 million which begin to expire in fiscal year 2011. The realization of these assets is based upon management's estimates of future taxable income. We have provided a valuation allowance for the remaining of our net deferred tax assets, primarily foreign tax credits, because of the uncertainty with respect to our ability to generate future taxable income to realize the deferred tax assets. With a change in management's assessment of the uncertainty, the valuation allowance will be adjusted accordingly.

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

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

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

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

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

On February 1, 2007, we adopted FIN 48. See "Item 1. Financial Statements - Note
8. Income Taxes" for further information.

Results of Operations

Comparison of Quarters Ended April 30, 2009 and 2008

                                           Percentage of           Percentage
                                          Total Revenues             Change
                                           Three Months           Three Months
                                               Ended                 Ended
                                             April 30,             April 30,
                                        2009         2008        2009 vs. 2008
Statements of Operations Data:
Revenues:
Product licensing                           82 %          23 %               59 %
Engineering services and maintenance        18            77               (59)
Total revenues                             100           100                  -
Cost of revenues:
Product licensing                        (263)            83              (346)
Engineering services and maintenance         9            43               (34)
Total cost of revenues                   (254)           126              (380)
Gross margin                               354          (26)                380
Operating expenses:
Research and development                     -            29               (29)
Sales and marketing                         23            21                  2
General and administrative                  62           112               (50)
Gain on sale                                 -       (1,018)              1,018
Restructuring expense                        -            34               (34)
Total operating expenses                    85         (822)                907
Income from operations                     269           796              (527)
Other income, net                           13             5                  8
Income before income taxes                 282           801              (519)
Provision for income taxes                 113           326                  *
Net income                                 169 %         475 %            (306) %

* Percentage not meaningful

Net Income

Our net income in the first quarter of fiscal year 2010 was $1.5 million, or $0.09 per basic share and $0.09 per diluted share, compared to a net income of $15.4 million, or $0.87 per basis share and $0.84 per diluted share, in the first quarter of fiscal year 2009, which included the $32.9 million gain associated with the KMC transaction.

Revenues

Consolidated revenues were $0.9 million for the first quarter of fiscal year 2010, compared to $3.2 million for the first quarter of fiscal year 2009. Engineering services and maintenance revenues decreased $3.1 million, primarily as a result of the sale of our intellectual properties to KMC.

Cost of Revenues

Total cost of revenues were $(2.3) million in the first quarter of fiscal year 2010, compared to $4.1 million in the first quarter of fiscal year 2009. Product licensing costs decreased $5.1 million in the period primarily due to a reversal of accrued licensing costs for technologies licensed by the Company to a customer due to an agreement amending a third party technology license agreement and the $2.4 million of additional product licensing costs associated with the restructured license agreements with KMC recorded during the quarter ended April 30, 2008. Engineering services and maintenance costs in the first quarter of fiscal year 2010 decreased $0.6 million compared to the first quarter of fiscal 2009 mainly due to the transfer of 38 employees to KMC as a part of the KMC transaction.

Gross Margin

Our gross margin increased to 354% in the first quarter of fiscal year 2010 compared with (26)% in the first quarter of fiscal year 2009. The increase was primarily the result of the reduction to accrued licensing cost for which the reduced amount has been disbursed in the current quarter and a reversal for technologies licensed by the Company to a customer due to an agreement amending a third party technology license agreement.

Operating Expenses

Total operating expenses for the first quarter of fiscal year 2010 increased 907% to $0.77 million, compared with $(26.6) million for the same period one year ago due mainly to the KMC transaction.

• Research and development expenses decreased 100% to $0 in the first quarter of fiscal year 2010 from $0.9 million in the comparable quarter of fiscal year 2009. The decrease was attributable to the transfer of engineers to KMC and the discontinuance of the product development efforts subsequent to the KMC transaction.

• Sales and marketing expenses decreased 70% to $0.2 million in the first quarter of fiscal year 2010 from $0.7 million in the comparable quarter of fiscal year 2009. The decrease was due the reduction of staffing which was no longer required in the sale of current product offerings.

• General and administrative expenses decreased 85% to $0.6 million in the first quarter of fiscal year 2010 from $3.6 million in the comparable quarter of fiscal year 2009. The decrease was due to lower staffing levels and a lower level of professional fees which were expended in support of the KMC transaction and the due diligence efforts associated with a transaction that was not completed.

Income Taxes

Our $1.0 million tax provision for the first quarter of fiscal 2010 was primarily due to the gain associated with the amended third party license agreement. Our tax provision for the first quarter of fiscal year 2009 was primarily due to the KMC transaction.