Summary of PEERLESS SYSTEMS CORP

Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations.

Highlights

Product licensing revenues of $1,065,000 for the six months ended July 31, 2012 decreased by $1,051,000 or 49.7% compared to revenues of $2,116,000 for the six months ended July 31, 2011. Pretax income for the six months ended July 31, 2012 was $270,000 a 27.2% decrease from pretax income for the six months ended July 31, 2011 of $371,000. We recorded $190,000 and $52,000 of net realized gains on sales of marketable securities during the six months ended July 31, 2012 and July 31, 2011, respectively.

As a result of our staffing and cost reductions, operating expenses were reduced by 27.6%, to $929,000 for the six months ended July 31, 2012 compared to $1,284,000 for the six months ended July 31, 2011.

General

We continue to generate revenue from our original equipment manufacturer ("OEM") customers through the licensing of technology related to imaging solutions. Our product licensing revenues are comprised of recurring per unit and block licensing revenues and perpetual licenses. 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 Novell, to be used with our OEM customers' 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. Perpetual licenses allow OEMs to ship products using licensed technology without the further payment of licensing fees. Payment schedules for these licenses are negotiable and payment terms are often dependent on the size and other terms and conditions of the 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 and perpetual licenses is recognized in accordance with provisions of ASC 985-605, Software - Revenue Recognition and ASC 605-25, Revenue Recognition - Multiple-Element Arrangements, 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.

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 technology offered by us has continued to decline since fiscal 2008. The document imaging industry has changed. Lower cost of development and production overseas as well as increasing complexity of imaging requirements makes us unable to effectively compete in this environment. As a result, we sold our imaging and networking technologies and certain other assets to KYOCERA Document Solutions Inc. (formerly Kyocera Mita Corporation) in April 2008. As part of the transaction we retained the right, subject to certain restrictions, to continue licensing 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.

Our inability to implement our strategy to enhance stockholder value as well as the declining sales trend of our existing licenses, downward price pressure on the technologies we license, downward price pressure on OEM products and the anticipated consolidation of the number of OEMs in the marketplace, may have a material adverse effect on our business and financial results. See "Forward-Looking Statements" above.

Liquidity and Capital Resources

Our total assets at July 31, 2012 were $15.0 million, a decrease of 18.5% from $18.4 million as of January 31, 2012. Cash and cash equivalents decreased from $10.4 million at January 31, 2012 to $9.3 million at July 31, 2012. Stockholders' equity at July 31, 2012 was $12.9 million, a decrease of 13.4% from $14.9 million as of January 31, 2012 which was primarily related to unrealized losses on investments in marketable securities.

At July 31, 2012, our principal source of liquidity, cash and cash equivalents, was $9.3 million; a decrease of $1.1 million from January 31, 2012. The decrease is primarily due to the prepayment of estimated federal and state taxes because of anticipated realization of gains on its investment in ModusLink Global Solutions, Inc. ("ModusLink"), which has not occurred, the payments of other liabilities and the purchase of the Company's common stock pursuant to its stock repurchase plan, partially offset by the realization of a $0.2 million gain on the sales of marketable securities.

Critical Accounting Policies

We describe our significant accounting policies in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended January 31, 2012. There has been no change in our significant accounting policies since the end of fiscal 2012.

Results of Operations

Revenues

Revenues were $1,065,000 for the six months ended July 31, 2012, compared to $2,116,000 for the six months ended July 31, 2011, representing a 49.7% decline. Revenues for the six months ended July 31, 2012 decreased due to (i) an $800,000 block license that was sold during the six months ended July 31, 2011, with no such license sold during the six months ended July 31, 2012 and
(ii) an overall decrease of per-unit licensing revenue.

Revenues were $451,000 for the three months ended July 31, 2012, compared to $358,000 for the three months ended July 31, 2011, representing a 26.0% increase. Revenues for the three months ended July 31, 2011 were lower due to disruptions in a customer's business resulting from impacts of an earthquake and resulting catastrophes in Japan experienced during that period.

Cost of Revenues

Total cost of revenues was $44,000 for the six months ended July 31, 2012, compared to $578,000 for the six months ended July 31, 2011, reflecting a decline in license revenues and a positive adjustment of $26,000 related to adjustments to estimates of prior period costs. Product licensing costs were higher for the six months ended July 31, 2011, primarily due to the third party license fees associated with the $800,000 block license sold during that period.

Total cost of revenues was ($8,000) for the three months ended July 31, 2012, compared to ($12,000) for the three months ended July 31, 2011. Product licensing costs were negative in both periods primarily due to the adjustments to estimates of prior period costs.

Gross Margin

Our gross margins were 95.9% and 72.7% for the six months ended July 31, 2012 and July 31, 2011, respectively. Gross margins for the six months ended July 31, 2012 were higher due to a favorable customer mix in the current period, higher costs in the prior period associated with the block license sale and adjustments to estimated costs in prior periods.

Our gross margins were 101.8% and 103.4% for the three months ended July 31, 2012 and July 31, 2011, respectively. We had adjustments to the estimated cost of revenue, due to adjustments to estimated costs in prior periods, resulting in a credit to the cost of revenue in both periods.

Operating Expenses

Total operating expenses decreased 27.6% to $929,000 for the six months ended July 31, 2012, from $1,284,000 for the six months ended July 31, 2011. Sales and marketing costs remained comparable in both periods. General and administrative expenses decreased 29.0% to $867,000 for the six months ended July 31, 2012 from $1,221,000 for the six months ended July 31, 2011. The decrease was due to lower stock-based compensation costs and the Company's continued reduction of costs in general.

Total operating expenses decreased 19.6% to $493,000 for the three months ended July 31, 2012, from $613,000 for the three months ended July 31, 2011. Sales and marketing costs remained comparable in both periods. General and administrative expenses decreased 20.8% to $462,000 for the three months ended July 31, 2012 from $583,000 for the three months ended July 31, 2011. The decrease was primarily attributed to lower stock-based compensation costs and the Company's continued reduction of costs in general.

Other Income, Net

Other income, net increased by 52.1% to $178,000 for the six months ended July 31, 2012 from $117,000 for the six months ended July 31, 2011. This increase was primarily attributable to realized gains on sales of marketable securities. Other income, net decreased to a loss of $431,000 for the three months ended July 31, 2012, from income of $4,000 for the three months ended July 31, 2011, due to losses realized on sales of marketable securities in the current period.

Income Taxes

The Company reported a tax expense of $127,000 and $159,000 for the six months ended July 31, 2012 and 2011, respectively. The effective tax rate was 47.0% and 42.9% for the six months ended July 31, 2012 and 2011, respectively. The effective tax rate of 47% for the six months ended July 31, 2012 reflects a discrete expense of $20,000 related to a state tax assessment on a previously filed tax return filed for the fiscal year ending January 31, 2009. The Company does not agree with such assessment and is exploring its options related thereto.

The Company reported tax benefits of $162,000 and $101,000 for the three months ended July 31, 2012 and 2011, respectively. The effective tax rate was 34.8% and 42.3% for the three months ended July 31, 2012 and 2011, respectively.

Net Income

Our net income for the six months ended July 31, 2012 was approximately $143,000, or $0.04 per basic share and diluted share, compared to a net income of approximately $212,000, or $0.07 per basic share and $0.06 per diluted share, for the six months ended July 31, 2011.

Our net loss for the three months ended July 31, 2012 was approximately $303,000, or $0.09 per basic share and diluted share, compared to a net loss of approximately $138,000, or $0.04 per basic and diluted share, for the three months ended July 31, 2011. The Company had 3.3 million and 3.2 million weighted average shares of common stock outstanding during the quarters ending July 31, 2012 and July 31, 2011, respectively.