10-Q 1 v126407_10q.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
 
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended July 31, 2008
 
or
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from           to
Commission File Number: 000-21287
 
PEERLESS SYSTEMS CORPORATION
(Exact name of Registrant as Specified in its Charter)
 
Delaware
 
95-3732595
(State or Other Jurisdiction
of Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
2381 Rosecrans Avenue, El Segundo, CA
 
90245
(Address of Principal Executive Offices)
 
(Zip Code)
 
(310) 536-0908
(Registrant’s Telephone Number, Including Area Code) 

Indicate by check mark whether the registrant (1) has filed all reports required 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 þ          No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 
 
 
 
 
 
Large accelerated filer o
     
Accelerated filer o
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o Noþ
 
The number of shares of Common Stock outstanding as of September 11, 2008 was 18,419,461.
 
 
 
INDEX
 
 
 
Page No
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4
 
 
 
 
 
 
 
 
 
 
 
 
5
 
 
 
 
 
 
 
 
 
 
 
 
6
 
 
 
 
 
 
 
 
 
 
 
 
7
 
 
 
 
 
 
 
 
 
 
 
14
 
 
 
 
 
 
 
 
 
 
 
23
 
 
 
 
 
 
 
 
 
 
 
23
 
 
 
 
 
 
 
 
       
             
 
 
 
24
 
 
 
 
 
 
 
 
 
 
 
24
 
 
 
 
 
 
 
 
 
 
 
29
 
 
 
 
 
 
 
 
 
 
 
29
 
 
 
 
 
 
 
 
 
 
 
30
 
             
 
 
 
31
  
             
 
 
 
31
  
 


TRADEMARKS

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

FORWARD-LOOKING STATEMENTS

Statements made by us in this report and in other reports and statements released by us that are not historical facts constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management based on our current estimates, expectations, forecasts and projections and include comments that express our current opinions about trends and factors that may impact future operating results. Disclosures that use words such as we “believe,” “anticipate,” “estimate,” “intend,” “could,” “plan,” “expect,” “project” or the negative of these, as well as similar expressions, are intended to identify forward-looking statements. These statements are not guarantees of future performance, rely on a number of assumptions concerning future events, many of which are outside of our control, and involve known and unknown risks and uncertainties that could cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements, expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors throughout this report and specifically under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors” in Part I, Item 2. below and “Risk Factors” in Part II, Item 1A. below. Any such forward-looking statements, whether made in this report or elsewhere, should be considered in the context of the various disclosures made by us about our businesses including, without limitation, the risk factors discussed below. Except as required under the federal securities laws and the rules and regulations of the U.S. Securities and Exchange Commission, we do not have any intention or obligation to update publicly any forward-looking statements, whether as a result of new information, future events, changes in assumptions, or otherwise. The Private Securities Litigation Reform Act of 1995 (the “PSLRA”) provides certain “safe harbor” provisions for forward-looking statements. All forward- looking statements made in this report are made pursuant to the PSLRA. 


 
 
PEERLESS SYSTEMS CORPORATION
(In thousands)
 
 
  
July 31,
  
January 31,
  
 
  
2008
  
2008
  
 
  
 
  
 
  
ASSETS
              
Current assets:
    
   
 
Cash and cash equivalents
  
$
55,139
  
$
23,136
  
Trade accounts receivable, net
    
882
    
2,784
  
Unbilled receivables
    
165
    
845
  
Deferred tax asset
          
4,940
  
Prepaid expenses and other current assets
    
714
    
949
  
Total current assets
    
56,900
    
32,654
  
Property and equipment, net
    
71
    
333
  
Other assets
    
202
    
243
  
Total assets
  
$
57,173
  
$
33,230
  
               
LIABILITIES AND STOCKHOLDERS’ EQUITY 
   
   
    
 
  
               
Current liabilities:
    
   
 
Accounts payable
  
$
106
  
$
289
  
Accrued wages
    
277
    
569
  
Accrued compensated absences
    
226
    
731
  
Accrued product licensing costs
    
2,135
    
1,609
  
Income taxes payable
    
5,083
    
4
  
Other current liabilities
    
759
    
781
  
Deferred revenue
    
682
    
914
  
Total current liabilities
    
9,268
    
4,897
  
Accrued product licensing costs
    
2,522
    
—
 
Other liabilities
    
1,141
    
551
  
Total liabilities
    
12,931
    
5,448
  
Stockholders’ equity:
    
   
 
Common stock
    
18
    
18
  
Additional paid-in capital
    
55,122
    
53,340
  
Accumulated deficit
    
(10,653
)
  
(25,492
)
Accumulated other comprehensive income
    
(7
)
  
29
  
Treasury stock, 216 shares at July 31, 2008 and 150 shares at January 31, 2008
    
(238
)
  
(113
)
Total stockholders’ equity
    
44,242
    
27,782
  
Total liabilities and stockholders’ equity
 
$
57,173
  
$
33,230
  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


PEERLESS SYSTEMS CORPORATION
(In thousands, except share and per share amounts )

   
Three Months Ended
  
Six Months Ended
  
   
July 31,
  
July 31,
  
   
2008
  
2007
  
2008
  
2007
  
Revenues:
    
   
   
   
 
Product licensing
  
$
3,100
  
$
4,415
  
$
3,849
  
$
6,508
  
Engineering services and maintenance
    
241
    
2,526
   
2,726
   
5,179
 
Hardware sales
    
—
    
1
   
—
    
2
 
Total revenues
    
3,341
    
6,942
   
6,575
   
11,689
 
Cost of revenues:
    
   
   
   
 
Product licensing
    
1,548
    
319
   
4,244
   
1,081
 
Engineering services and maintenance
    
109
    
1,838
   
1,505
   
3,618
 
Hardware sales
    
—
    
—
   
—
   
—
 
Total cost of revenues
    
1,657
    
2,157
   
5,749
   
4,699
 
Gross margin
    
1,684
    
4,785
   
826
   
6,990
 
Research and development
    
366
    
1,219
   
1,305
    
2,368
 
Sales and marketing
    
411
    
679
   
1,083
   
1,286
 
General and administrative
    
1,987
    
1,838
   
5,614
    
3,336
 
(Gain) Loss on sale of operating assets
    
3
    
—
    
(32,912
)
  
—
  
Restructuring
    
109
    
—
    
1,197
    
—
  
     
2,876
    
3,736
   
(23,713
)
  
6,990
 
Income (loss) from operations
    
(1,192
)
  
1,049
   
24,539
   
—
 
Other income, net
   
314
    
169
   
496
   
392
 
Income (loss) before income taxes
    
(878
)
  
1,218
   
25,035
   
392
 
Provision (benefit) for income taxes
    
(361
)
  
5
   
10,196
    
8
 
Net income (loss)
  
$
(517
)
$
1,213
  
$
14,839
  
$
384
  
Basic earnings (loss) per share
  
$
(0.03
)
$
0.07
  
$
0.84
 
$
0.02
  
Diluted earnings (loss) per share
  
$
(0.03
)
$
0.07
  
$
0.81
  
$
0.02
  
Weighted average common shares - outstanding — basic
    
18,058
    
17,260
   
17,750
   
17,225
 
Weighted average common shares - outstanding — diluted
    
18,058
    
18,259
   
18,293
   
18,198
 

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


PEERLESS SYSTEMS CORPORATION
(In thousands)
 
 
  
Six Months Ended
  
 
  
July 31,
  
 
  
2008
  
2007
  
 
  
 
  
 
  
Cash flows from operating activities:
    
   
 
Net income
  
$
14,839
  
$
384
  
Adjustments to reconcile net income to net cash provided by operating activities
   
 
         
Depreciation and amortization
    
212
    
414
  
Share-based compensation
    
982
    
506
  
 Deferred income taxes
    
4,940
    
—
 
 Gain on sale of operating assets
    
(32,912
)
  
—
 
 Asset impairment – restructuring
    
112
    
—
 
Other
    
(37
)
  
1
  
Changes in operating assets and liabilities:
    
       
Trade accounts receivables
    
1,902
    
(2,204
)
Unbilled receivables
    
680
    
2,347
  
Prepaid expenses and other assets
    
96
    
7
  
Accounts payable
    
(183
)
  
229
  
Accrued product licensing costs
    
3,048
    
(1,441
)
Deferred revenue
    
(232
)
  
156
  
 Income taxes payable
    
5,079
 
  
—
 
Other liabilities
    
158
    
(616
)
Net cash used by operating activities
    
(1,316
)
  
(217
)
Cash flows from investing activities:
    
       
Purchases of property and equipment
    
(16
)
  
(129
)
Proceeds from sale of operating assets, net of expenses
    
32,723
    
—
 
Purchases of software licenses
    
(63
)
  
(364
)
Net cash provided (used) by investing activities
    
32,644
    
(493
)
Cash flows from financing activities:
    
       
Proceeds from exercise of common stock options
    
800
    
154
  
Purchase of treasury stock
    
(125
)
  
—
 
Net cash provided by financing activities
    
675
    
154
  
Net increase (decrease) in cash and cash equivalents
    
32,003
    
(556
)
Cash and cash equivalents, beginning of period
    
23,136
    
16,378
  
Cash and cash equivalents, end of period
  
$
55,139
  
$
15,822
  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


PEERLESS SYSTEMS CORPORATION

1.
Basis of Presentation:

The accompanying unaudited condensed consolidated financial statements of Peerless Systems Corporation (the “Company” or “Peerless”) have been prepared pursuant to the rules of the Securities and Exchange Commission (the “SEC”) for Quarterly Reports on Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles. The financial statements and notes herein are unaudited, but in the opinion of management, include all the adjustments (consisting only of normal, recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows of the Company. These statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K, for the fiscal year ended January 31, 2008, filed with the SEC on May 12, 2008. The results of operations for the interim periods shown herein are not necessarily indicative of the results to be expected for any future interim period or for the entire year.

2.
Significant Accounting Policies:

Liquidity: As of July 31, 2008, the Company had an accumulated deficit of $10.7 million and cash and cash equivalents of $55.1 million. The Company has no material financial commitments other than those under operating lease agreements. The Company believes the net cash provided by operating activities, and existing cash and cash equivalents, will provide the Company with sufficient resources to meet working capital requirements and other cash needs over at least the next twelve months.

The Company is currently reducing costs and exploring other options to conserve financial resources in order to pursue a strategy of acquisitions and possible merger opportunities. In order to pursue the strategy of acquisitions and mergers it may need to raise additional capital through public or private financing or other arrangements.

Revenue Recognition: The Company recognizes software revenues in accordance with Statement of Position 97-2 “Software Revenue Recognition” as amended by Statement of Position 98-9. For certain of the Company’s multiple element arrangements that do not directly involve licensing, selling, leasing or otherwise marketing of the Company’s software the Company applies the guidance under EITF 00-21 “Revenue Arrangements with Multiple Deliverables.”

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

The Company also enters into engineering services contracts with certain of its OEMs adapting software and supporting electronics to specific OEM requirements. The Company provides engineering support based on a time-and-material basis. Revenues from this support are recognized as the services are performed. The Company has no engineering services contracts that are recognized on a percentage-of completion basis.


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

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

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

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

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

The Company provides an accrual for estimated product licensing costs owed to third party vendors whose technology is included in the products sold by the Company. The accrual is impacted by estimates of the mix of products shipped under certain of the Company’s block license agreements. The estimates are based on historical data and available information as provided by the Company’s customers concerning projected shipments. Should actual shipments under these agreements vary from these estimates, adjustments to the estimated accruals for product licensing costs may be required. In the first quarter of fiscal 2009, the Company had a $2.4 million increase of product licensing expense due to the sale of assets to KMC and the resultant change in mix of technologies available to be delivered against existing block licenses with KMC. The remaining value of the block licenses at the close of the KMC sale was $6.4 million of which $1.4 million was recognized as revenues as part of a $3.0 million block license in the quarter ended October 31, 2006 and $5.0 million recognized in the quarter ending January 31, 2008. Upon the sale of the assets to KMC, the block licenses were modified and KMC will apply only third party vendor technology against the remaining value of the block licenses.

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

The recognition of the Company’s recurring product licensing revenues is dependent, in part, on the timing and accuracy of product sales reports received from the Company’s OEM customers. These reports are provided only on a calendar quarter basis and, in any event, are subject to delay and potential revision by the OEM. Therefore, the Company is required to estimate all of the recurring product licensing revenues for the last month of each fiscal quarter and to further estimate all of its quarterly revenues from an OEM when the report from such OEM is not received in a timely manner. In the event the Company is unable to estimate such revenues accurately prior to reporting financial results, the Company may be required to adjust revenues in subsequent periods. Revenues subject to such estimates were minimal for the six month periods ended July 31, 2008 and 2007.

 
Recent Accounting Pronouncements: In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007) (“SFAS No. 141R”), “Business Combinations” , which replaces SFAS No. 141 and amends several others. The statement retains the purchase method of accounting for acquisitions but changes the way the Company will recognize assets and liabilities. It also changes the way the Company will recognize assets acquired and liabilities assumed arising from contingencies, requires Peerless to capitalize in-process research and development at fair value, and requires Peerless to expense acquisition-related costs as incurred. SFAS No. 141R is effective for the Company on, but not before, February 1, 2009, the beginning of the Company’s fiscal 2010 reporting periods. SFAS No. 141R will apply prospectively to the Company’s business combinations completed on or after February 1, 2009 and will not require Peerless to adjust or modify how the Company recorded any acquisition prior to that date.

In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities”. Under SFAS 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 was effective for us beginning in the first quarter of fiscal 2008 and the Company did not elect the fair value measurement option for any of its financial assets or liabilities. The adoption of SFAS 159 in the first quarter of fiscal 2009 did not impact our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements and is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB FSP 157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Effective February 1, 2008, we adopted SFAS 157 for financial assets and liabilities recognized at fair value on a recurring basis. The adoption of SFAS 157 for financial assets and liabilities did not have a material impact on our consolidated financial position, results of operations or cash flows. As of July 31, 2008, the Company has financial assets that consist of cash and cash equivalents, which are measured at fair value using quoted prices for the identical assets in active market (Level 1 fair value hierchy) in accordance with SFAS 157.

On February 1, 2007, the Company adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The Interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If the tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized — see Note 7.

3. Sale of operating assets to KMC:

On April 30, 2008, the Company consummated the transactions contemplated by that certain Asset Purchase Agreement, dated as of January 9, 2008, between KMC and the Company, pursuant to which the Company sold substantially all of its intellectual property (“IP”) to KMC, transferred to KMC thirty-eight (38) of its employees, licensed the IP back from KMC on a nonexclusive, worldwide, perpetual and royalty free basis subject to certain restrictions, entered into a sublease pursuant to which the Company is subleasing to a subsidiary of KMC 16,409 square feet of office space at the Company’s executive offices for a period of forty (40) months at a monthly rental equal to the allocable portion of the rent and common charges payable by the Company under its lease for the property, and terminated substantially all of the Company’s existing agreements with KMC. As consideration for the sale, KMC assumed approximately $0.4 million of the Company’s liabilities, paid the Company $33.0 million and agreed to escrow an additional $4.0 million relating to potential indemnification obligations that will be released to the Company in two installments of $2.0 million less any holdbacks arising from the transaction. The first and second installments from the escrow funds are scheduled to be disbursed fifteen and twenty-four months, respectively, from the close of the transaction. The Company recorded a pre-tax gain on sale of assets of approximately $32.9 million during the three months ended April 30, 2008 which does not include the $2.4 million of additional licensing costs associated with the restructured license agreements with KMC. The escrow funds, less any holdbacks, will be recorded as a gain in the period that the funds are released and all contingencies for the release of the funds are met.


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

4.  Earnings Per Share:
 
Earnings per share for the three and six months ended July 31, is calculated as follows (in thousands, except for per share amounts):
 
   
2008
  
2007
  
           
Per
          
Per
  
 
  
Net
      
Share
  
Net
      
Share
  
 
  
Income
  
Shares
  
Amount
  
Income
  
Shares
  
Amount
  
Basic EPS for three months ended July 31,
    
 
    
 
    
 
    
 
    
 
    
 
  
Earnings (loss) available to common stockholders
  
$
(517
)
  
18,058
  
$
(0.03
)
$
1,213
    
17,260
  
$
0.07
  
Effect of Dilutive Securities
   
 
    
 
    
 
    
 
    
 
    
 
  
Options
    
—
    
—
    
—
   
—
    
999
    
—
 
Diluted EPS
    
 
    
 
    
 
    
 
    
 
    
 
  
Earnings available to common stockholders with assumed conversions
  
$
(517
)
  
18,058
  
$
(0.03
)
$
1,213
    
18,259
  
$
0.07
  

   
2008
  
2007
  
           
Per
          
Per
  
 
  
Net
      
Share
  
Net
      
Share
  
 
  
Income
  
Shares
  
Amount
  
Income
  
Shares
  
Amount
  
Basic EPS for six months ended July 31,
    
 
    
 
    
 
    
 
    
 
    
 
  
Earnings (loss) available to common stockholders
  
$
14,839
    
17,750
  
$
0.84
  
$
384
    
17,225
  
$
0.02
  
Effect of Dilutive Securities
   
 
    
 
    
 
    
 
    
 
    
 
  
Options
   
—
    
543
    
—
   
—
    
973
    
—
 
Diluted EPS
    
 
    
 
    
 
    
 
    
 
    
 
  
Earnings available to common stockholders with assumed conversions
  
$
14,839
    
18,293
  
$
0.81
  
$
384
    
18,198
  
$
0.02
  

 
5.  Stock-Based Compensation Plans:
 
The Company has several long-term incentive plans which provide for the grant of incentive stock options to employees and non-
statutory stock options, restricted stock purchase awards and stock bonuses to employees, directors and consultants. The terms of stock options granted under these plans generally may not exceed 10 years. Options granted under the incentive plans vest at the rate specified in each optionee's agreement, generally over three or four years. An aggregate of 6.2 million shares of common stock have been authorized for issuance under the various option plans. The Company also grants options outside of these plans.
 
On February 1, 2006, the Company adopted the provisions of SFAS No. 123(R) “Share-Based Payments,” using the modified-prospective method. Under this transition method, compensation expense recognized subsequent to adoption includes: 1) compensation cost for all share-based payments granted prior to, but not yet vested as of adoption, based on values estimated in accordance with the original provisions of SFAS No. 123, and 2) compensation cost of all share-based payments granted subsequent to adoption, based on the grant-date fair values estimated in accordance with the provisions of SFAS No. 123(R). Consistent with the modified-prospective method, our results of operations for prior periods have not been restated.
 
Upon adoption of SFAS 123(R), the Company changed its method of attributing the value of stock-based compensation expense from the multiple-option (i.e., accelerated) approach to the single-option (i.e., straight-line) method. Compensation expense for share-based awards granted through January 31, 2006 will continue to be subject to the accelerated or multiple-option method, while compensation expense for share-based awards granted on or after February 1, 2006 will be recognized using a straight-line, or single-option method. The Company recognizes these compensation costs over the service period of the award, which is generally the option vesting term of three or four years. In determining the fair value of options granted the Company primarily used the Black-Scholes model and then used a binomial model for the calculation of stock-based compensation expense associated with the market triggered equity incentive grant made to the incoming CEO in December 2006. For the Black-Scholes and binomial model calculations, the Company assumed no dividends per year, weighted average expected lives of 3.42 years, expected volatility of 69.7%, and weighted average risk free interest rate of 4.00% for the six months ended July 31, 2008.
 
For the six months ended July 31, 2008, the Company recorded a total of $1.0 million in stock option expense related to stock options and restricted stock awarded after the adoption of SFAS No. 123(R) and for stock options which were not vested by the date of adoption of SFAS No. 123(R). Share-based compensation expense was allocated as follows for the six months ending July 31, 2008: (1) $0.01 million included in research and development expense; (2) $0.01 million included in cost of sales expense; (3) $0.02 million in sales and marketing; and (4) $0.94 million in general and administrative expense. The Company granted approximately 94,000 stock options in the six months ended July 31, 2008.


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

The valuation methodologies and assumptions in estimating the fair value of stock options that were granted in the first two quarters of fiscal 2009 were similar to those used in estimating the fair value of stock options granted in fiscal 2008. The Company uses historical volatility of Peerless' stock price as a basis to determine the expected volatility assumption to value stock options. The Company used its actual stock trading history over a period that approximates the expected term of its options. The expected dividend yield is based on Peerless' practice of not paying dividends. The risk-free rate of return is based on the yield of a U.S. Treasury instrument with terms approximating or equal to the expected life of the option. The expected life in years is based on historical actual stock option exercise experience.

The following represents option activity under the 1992 Stock Option Plan, 1996 Equity  Incentive Plan, 2005 Incentive Award Plan, as amended and restated, and certain employee options issued outside these plans for the six months ended July 31, 2008 (shares and intrinsic value in thousands):
 
 
  
 
  
Weighted
  
Weighted Average
  
 
  
 
  
 
  
Average
Exercise
  
Remaining
 Contractual
  
Aggregate
  
 
  
Shares
  
Price
  
Term (Years)
  
Intrinsic Value
  
Beginning balance
    
3,673
  
$
2.73
    
 
    
 
  
Granted
    
94
  
$
2.01
    
   
 
Exercised
    
(649
)
$
1.24
    
   
 
Canceled or expired
    
(388
)
$
4.89
    
   
 
Ending Balance
    
2,730
  
$
2.86
    
5.95
  
$
982
  
Stock options exercisable at quarter-end
    
1,838
  
$
2.86
    
4.33
  
$
579
  
  
The weighted-average grant date fair value of the options granted during the six months ended July 31, 2008 was $2.01. During the six months ended July 31, 2008, the total intrinsic value of stock options exercised was $0.49 million. Cash received from stock option exercises in the six months ended July 31, 2008 was $0.80 million. The excess tax benefit was negligible for six months ended July 31, 2008. As of July 31, 2008, there was $1.5 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 1992, 1996, and 2005 plans, and certain employee options issued outside these plans. That cost is expected to be recognized over a weighted-average period of 4.01 years.

CEO Restricted Stock and Incentive Stock Option Grant: On September 24, 2007, the CEO of the Company agreed to cancel an option to purchase 400,000 shares of common stock that was granted to him, which was scheduled to vest under certain market conditions, in exchange for 200,000 shares of restricted stock. The weighted-average grant date fair value of the restricted stock was $2.16. As of April 30, 2008 the shares became fully vested due to the KMC transaction.
    
In addition to the restricted stock, in December 2006 the Board of Directors approved an equity incentive grant to the CEO of a time-vested option to purchase 600,000 shares of common stock, which vests over a four-year period, with 25% vesting on the first anniversary of the effective date of the CEO’s employment, and with the remainder vesting in 36 equal monthly installments, subject to the CEO’s continued employment with the Company. This option is included in the table and disclosures above.
    
 The Company’s valuations are based primarily upon the Black-Scholes valuation model and for options vesting at certain market conditions are based upon a binomial valuation model. These option valuation models were developed for use in estimating the fair value of traded-options, which have no vesting restrictions and are fully transferable and negotiable in a free trading market. In addition, option valuation models require input of subjective assumptions, including the expected stock price volatility and expected life of the option. Because the Company’s stock options have characteristics significantly different from those of freely traded options, and changes in the subjective input assumptions can materially affect the Company’s fair value estimates of those options, in the Company’s opinion, existing valuation models are not reliable single measures and may misstate the fair value of the Company’s stock options. Because the Company stock options do not trade on a secondary exchange, recipients can receive no value nor derive any benefit from holding stock options under the plans without an increase, above the grant price, in the market price of the Company’s stock. Such an increase would benefit all stockholders commensurately.

 
6. Concentration of Revenues:

During the second quarter of fiscal year 2009, four customers, Novell Incorporated, Konica Minolta, Seiko Epson, and Okidata, each generated greater than 10% of the revenues of the Company and collectively contributed 96% of such revenues. Perpetual and block licenses for the same time period were 77% of the revenues of the Company. During the second quarter of fiscal year 2008, two customers, Konica Minolta and KMC, each generated greater than 10% of the revenues of the Company and collectively contributed 79% of such revenues. Perpetual and block licenses for the same time period were 52% of the revenues of the Company.
 
7.  Income Taxes:
 
On February 1, 2007, the Company adopted FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109" (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The Interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If the tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized. There was no cumulative effect of adopting FIN 48 to the February 1, 2007 retained earnings balance.

At January 31, 2008, the Company determined that it was more-likely-than-not that the approximately $5.0 million of certain deferred tax assets would be realized in connection with the close of the sale of the Company’s IP to KMC. Accordingly, the Company reversed a portion of its valuation allowance during the fourth quarter of fiscal 2008. The Company realized the deferred tax asset during the six months ended July 31, 2008. At July 31, 2008 the Company continues to maintain a valuation allowance for certain of its foreign deferred taxes assets as the Company is not able to establish that it is more-likely-than-not they will be realized

At July 31, 2007, the Company was not able to establish that it was more-likely-than not its deferred tax assets would be realized and had recorded a full valuation allowance against its net deferred tax assets. For the six months ended July 31, 2007 the Company had minimal provision for income taxes as taxable income was offset by net operating loss carry forwards.
 
8. Restructuring:
 
In connection with the sale of the IP to KMC, the Company formalized a plan directed at reducing operating costs. The plan focused primarily on operational and organizational structures, facilities utilization, and certain other matters. As a result of the plan, the Company recorded approximately $1.2 million of restructuring charges during the six months ended July 31, 2008, of which $0.8 million related to exiting facilities, and $0.2 million was employee severance costs. During the quarter ended July 31, 2008, the Company recorded an additional $0.1 million of asset impairments, $37,000 associated with employee severance and $0.1 million was asset impairments.

A summary of the activities related to these restructuring liabilities are as follows:

(In thousands)
  
Severance
  
Facilities
  
 
            
Balance at February 1, 2008
  
$
—
  
$
—
 
Restructuring Charges
    
238
    
847
  
Payments
    
(119
)
  
(66
)
Balance at July 31, 2008
  
$
119
  
$
781
  
  
The remaining severance and facility payments are expected to be paid out over the next 9 months and 57 months, respectively. At July 31, 2008, $0.3 million is included in other current liabilities and $0.6 million is in long-term liabilities.
  

PEERLESS SYSTEMS CORPORATION
 
This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, including without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on current expectations, estimates, forecasts and projections about the industry in which Peerless operates, our beliefs and assumptions. 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. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Highlights

During the first quarter ended April 30, 2008, we realized a net gain of $32.9 million upon the sale of substantially all of our assets to KMC. We continue to experience a downturn in revenue due to lower demand for the technology we offer from year to year. Consolidated revenues for the second quarter of fiscal year 2009 declined 51.9% from the second quarter of fiscal year 2008 and increased 3.3% from the first quarter of fiscal 2009. Product licensing revenues decreased 29.8% compared to the second quarter of the previous fiscal year as a result of a decrease in block licensing revenue. Engineering services and maintenance revenues declined 90.5%, as 81% of our engineering work force was transferred to KMC as a part of the sale to KMC. The transaction was primarily due to downward pricing pressures arising from an increasingly competitive global market, as well as substantial pressure on our OEM customers to consolidate. The sale to KMC and the financial resources that it has provided is allowing us to pursue opportunities outside the imaging marketplace. These overall decreases in revenues were primarily attributable to declines in the demand for our technologies, third party technologies that we license to sell and the requirement for traditional engineering services.
 
During the first six months of fiscal year 2009, we have experienced a significant number of changes:

 
•
On April 30, 2008, we consummated the transactions contemplated by that certain Asset Purchase Agreement, dated as of January 9, 2008, between KMC and Peerless, pursuant to which we sold substantially all of our IP to KMC, transferred to KMC thirty eight (38) of our employees, licensed the IP back from KMC on a nonexclusive, worldwide, perpetual and royalty free basis subject to certain restrictions, entered into a sublease pursuant to which we are subleasing to a subsidiary of KMC 16,409 square feet of office space at our executive offices for a period of forty (40) months at a monthly rent equal to the allocable portion of the rent and common charges payable by us under our lease for the property, and terminated substantially all of our existing agreements with KMC. As consideration for the sale, KMC assumed certain of our liabilities, and paid us approximately $37.0 million, less a holdback amount of $4.0 million relating to potential indemnification obligations. The cash proceeds generated from the KMC transaction will position us to continue executing our strategic plan.
 
 
 
 
•
As a result of the Asset Purchase Agreement and the proceeds associated with the sale we have announced that we have expanded the parameters of our acquisition strategy to include companies outside the digital content management sector. We are working with our investment bankers to identify enterprises that offer compelling opportunities for growth and profitability and that are annualizing revenue of between $50 million and $150 million.
 
 
•
We are reviewing our staffing requirements to achieve the goals of properly supporting our existing customer base and meeting the requirements of a publicly traded company and have reduced our staffing levels to a total of 16 as of August 31, 2008. This represents a 53% staff reduction from the levels that existed subsequent to the KMC sale.
     
 
•
As result of the review of costs and risks associated with the all-in-one, or AiO, market we have decided to suspend the activities of Cue Imaging Corporation, the subsidiary that was formed in January, 2008. In connection with the suspension of Cue Imaging Corporation, on August 29, 2008 Andrew Lombard, Vice President, Corporate Development and President of Cue Imaging Corporation has been given notice of termination and will be paid severance in accordance with the terms of his employment agreement.
 
 
 
 
•
In 1999, we entered into a PostScript Software Development License and Sublicense Agreement, or the Adobe License Agreement, with Adobe Systems Incorporation, or Adobe, that expanded the application and integration of our respective technologies. The Adobe License Agreement expired on June 30, 2008. The Adobe License Agreement was amended to provide a period of twenty-one months following the expiration of the agreement in which we continue to license and provide services to our existing OEM customers.
 
 
     
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. See “Item 1A. Risk Factors.”

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 our technology. Licensing revenues are also derived from arrangements in which we enable third party technology, such as solutions from Adobe or Novell, to be used with 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 more 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) 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 the imaging software and supporting electronics to specific OEM requirements. Our maintenance revenues are derived from software maintenance agreements. Services and 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.

Our technology 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 2008 and the first two quarters of fiscal year 2009.

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 an acquisitions and mergers strategy. 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 mergers and/or acquisitions.


Liquidity and Capital Resources

Compared to January 31, 2008, total assets at July 31, 2008 increased 72% to $57.2 million and stockholders’ equity increased 59.2% to $44.2 million, primarily the result of the net income. Our cash and cash equivalents at July 31, 2008 was $55.1 million, an increase of 138% from $23.1 million as of January 31, 2008, and the ratio of current assets to current liabilities was 6.1:1, which is a decrease from the 6.7:1 ratio as of January 31, 2008. The decrease was primarily the result of the income taxes payable and additional accrued licensing costs associated with the KMC transaction in the first quarter. Our operations used $1.3 million in cash during the six months ended July 31, 2008, compared to $0.2 million in cash used by operations during the six months ended July 31, 2007.

During the six months ended July 31, 2008, $32.6 million in cash was provided by our investing activities, primarily the result of the sale of operating equipment as a result of the restructuring. We have not historically purchased, nor do we expect to purchase in the future, derivative instruments or enter into hedging transactions.

At July 31, 2008, our principal source of liquidity, cash and cash equivalents was $55.1 million, an increase of $32.0 million from January 31, 2008. We do not have a credit facility. We may require additional long-term capital to finance working capital requirements. See “Risk Factor - Our existing capital resources may not be sufficient and if we are unable to raise additional capital, our business may suffer.”

On April 30, 2008, we consummated the transactions contemplated by that certain Asset Purchase Agreement, dated as of January 9, 2008, between KMC and Peerless, pursuant to which we sold substantially all of our IP to KMC, transferred to KMC thirty eight (38) of our employees, licensed the IP back from KMC on a nonexclusive, worldwide, perpetual and royalty free basis subject to certain restrictions, entered into a sublease pursuant to which we are subleasing to a subsidiary of KMC 16,409 square feet of office space at our executive offices for a period of forty (40) months at a monthly rent equal to the allocable portion of the rent and common charges payable by us under our lease for the property, and terminated substantially all of our existing agreements with KMC. As consideration for the sale, KMC assumed certain of our liabilities, and paid us approximately $37.0 million, less a holdback amount of $4.0 million relating to potential indemnification obligations. The cash proceeds generated from the KMC transaction will position us to continue executing our strategic plan. A certain portion of the net proceeds from the KMC transaction will be used for general corporate purposes, including satisfying our working capital needs and paying our remaining liabilities as they come due, relating to the assets that we retain following the consummation of this transaction, including our rights under our sublicenses with Adobe Systems Incorporated and Novell, Inc. and our customized intellectual property.
 
In addition to the net proceeds that we received from the KMC transaction, as a result of the KMC transaction our operating costs and selling, general and administrative expenses will significantly decrease, freeing up additional capital which will permit us to pursue our long term goal of providing new growth opportunities and a diversified revenue base. We intend to aggressively seek acquisitions leveraged by the infusion of capital resulting from this transaction. Our long term strategy includes diversifying our business to better ensure growth and profitability. We intend to acquire or invest in existing business enterprises to accomplish this goal. We can provide no assurances that it will do so or will ultimately be successful even if any such agreement is consummated.
  
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 Statement of Position 98-9. If VSOE does not exist for the undelivered elements, all revenue for the arrangement is deferred until the earlier of the point at which such VSOE does exist for the undelivered elements or all elements of the arrangement have been delivered, 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. However, product licensing cost increased by $0.4 million during the third quarter of fiscal 2007 as a result of a change in estimate reported by one of our OEM customers, decreased by $0.3 million in the fourth quarter of fiscal 2008 as a result of the settlement of differences arising from a third party licensing agreement review and increased by $2.4 million in the first quarter of fiscal 2009 resulting from the KMC transaction.

At January 31, 2008, we had determined that it was more-likely-than-not that the approximately $5.0 million of certain deferred tax assets would be realized in connection with the close of the sale of the Company’s IP to KMC. Accordingly, we reversed a portion of its valuation allowance during the fourth quarter of fiscal 2008. We realized the deferred tax asset during the six months ended July 31, 2008. At July 31, 2008 we continue to maintain a valuation allowance for certain of our foreign deferred taxes assets as we are not able to establish that it is more-likely-than-not they will be realized.

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.

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 our 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 6. Income Taxes” for further information.

 
Results of Operations
 
Comparison of Quarters Ended July 31, 2008 and 2007
 
 
  
Percentage of
  
Percentage
  
 
  
Total Revenues
  
Change
  
 
  
Three Months
  
Three Months
  
 
  
Ended
  
Ended
  
 
  
July 31,
  
July 31,
  
 
  
2008
  
2007
  
2008 vs. 2007
  
Statements of Operations Data:
  
 
  
 
  
 
  
Revenues:
  
 
  
 
  
 
  
Product licensing
    
93
%
  
64
%
  
(30
)%
Engineering services and maintenance
    
7
    
36
    
(91
)
Hardware sales
    
—
    
—
    
(100
)
Total revenues
    
100
    
100
    
(52
)
Cost of revenues:
              
Product licensing
    
46
    
5
    
385
  
Engineering services and maintenance
    
3
    
26
    
(94
)
Hardware sales
    
—
    
—
    
0
  
Total cost of revenues
    
50
    
31
    
(23
)
Gross margin
    
50
    
69
    
(65
)
               
Research and development
    
11
    
18
    
(70
)
Sales and marketing
    
12
    
10
    
(40
)
General and administrative
    
60
    
26
    
8
  
(Gain) loss on sale of assets
    
—
   
—
   
—
 
Restructuring
3
    
—
   
—
 
     
86
    
54
    
(23
)
                     
Income (loss) from operations
    
(36
)
  
15
    
(214
)
Other income (expense), net
    
9
    
2
    
86
  
Income (loss) before income taxes
    
(26
)
  
18
    
(172
)
Provision (benefit)for income taxes
    
11
 
  
1
    
(7,320
)
Net income (loss)
    
(13
)%
  
17
%
  
(143
)%
 

Net Income
 
Our net loss in the second quarter of fiscal year 2009 was ($0.5) million, or ($0.03) per basic share and( $0.03) per diluted share, compared to a net income of $1.2 million, or $0.07 per basis share and $0.07 per diluted share, in the second quarter of fiscal year 2008.

Revenues
 
Consolidated revenues were $3.3 million for the second quarter of fiscal year 2009, compared to $6.9 million for the second quarter of fiscal year 2008. Licensing revenues decreased $1.3 million in the second quarter of fiscal year 2009 due primarily to a decrease in block licensing revenue resulting from a decline in the demand for our technologies and services. Engineering services and maintenance revenues decreased $2.3 million, primarily as a result of the Asset Purchase Agreement with KMC, resulting in the transfer of engineering and support staff to KMC and the termination of the development efforts being performed for KMC.

Cost of Revenues

Total cost of revenues were $1.7 million in the second quarter of fiscal year 2009, compared to $2.2 million in the second quarter of fiscal year 2008. Product licensing costs increased $1.2 million in the period primarily due to the increased mix of technologies for which we pay license fees to third parties. Engineering services and maintenance costs in the second quarter of fiscal year 2009 decreased $1.7 million compared to the second quarter of fiscal 2008 due to the transfer of employees to KMC.

Gross Margin

Our gross margin decreased to 50% in the second quarter of fiscal year 2009 compared with 69% in the second quarter of fiscal year 2008. The decrease in fiscal year 2009 was due primarily the higher cost of product licensing revenues compared to last year’s second quarter discussed above.

Operating Expenses

Total operating expenses for the second quarter of fiscal year 2009 decreased 23.0% to $2.9 million, compared with $3.7 million for the same period one year ago due mainly to the staffing reductions associated with the KMC transaction.

•
Research and development expenses decreased 70.0% to $0.4 million in the second quarter of fiscal year 2009 from $1.2 million in the comparable quarter of fiscal year 2008. The decrease in staffing that has occurred over the last fiscal year is the primary reason for decline in research and development expense.

•
Sales and marketing expenses decreased 39.5% to $0.4 million in the second quarter of fiscal year 2009 from $0.7 million in the comparable quarter of fiscal year 2008.

•
General and administrative expenses increased 8.2% to $2.0 million in the second quarter of fiscal year 2009 from $1.8 million in the comparable quarter of fiscal year 2008. Costs in the first quarter of fiscal year 2009 were higher as a result of professional services as a result of the efforts surrounding the KMC transaction, and the restructuring of the organization.

•
Restructuring charges were $0.1 million in the second quarter of fiscal year 2009 as a result of reduction in equipment and furnishing associated with reduced staffing levels.

Income Taxes

The effective income tax rate was 41.1% for the second quarter of fiscal year 2009 compared to 0% for the second quarter of fiscal year 2008. The increase in the effective income tax rate is primarily due to the reversal of the valuation allowance in the fourth quarter of fiscal 2008 and the gain on the sale recorded on the KMC transaction in fiscal year 2009. Prior year tax provision was based primarily on the alternative minimum tax as there was net operating loss carryforwards and tax credits sufficient to offset profits, which has minimized income tax expense.


Comparison of Six Months Ended July 31, 2008 and 2007
 
 
  
Percentage of
  
Percentage
  
 
  
Total Revenues
  
Change
  
 
  
Six Months
  
Six Months
  
 
  
Ended
  
Ended
  
 
  
July 31,
  
July 31,
  
 
  
2008
  
2007
  
2008 vs. 2007
  
Statements of Operations Data:
  
 
  
 
  
 
  
Revenues:
  
 
  
 
  
 
  
Product licensing
    
59
%
  
56
%
  
(41
)%
Engineering services and maintenance
    
41
    
44
    
(47
)
Hardware sales
    
—
    
—
    
(100
)
Total revenues
    
100
    
100
    
(44
)
Cost of revenues:
              
Product licensing
    
65
    
9
    
293
  
Engineering services and maintenance
    
23
    
31
    
(58
)
Hardware sales
    
—
    
—
    
0
  
Total cost of revenues
    
87
    
40
    
22
  
Gross margin
    
13
    
60
    
(88
)
               
Research and development
    
20
    
20
    
(45
)
Sales and marketing
    
16
    
11
    
(15
)
General and administrative
    
85
    
29
    
68
  
(Gain) loss on sale of assets
    
(501
)
  
—
    
—
  
Restructuring
    
18
    
—
    
—
  
     
(361
)
  
60
 
  
(439
)
                     
Income from operations
    
373
    
0
    
—
  
Other income, net
    
8
    
3
    
27
  
Income before income taxes
    
381
    
3
    
6,286
  
Provision for income taxes
    
155
    
—
    
—
  
Net income
    
226
%
  
3
%
  
3,764
%

Net Income

Our net income in the first six months of fiscal year 2009 was $15.0 million, or $0.84 per basic share and $0.81 per diluted share, compared to a net income of $0.4 million, or $0.02 per basic share and $0.02 per diluted share, in the first six months of fiscal year 2008.

Revenues
 
Consolidated revenues were $6.6 million for the first six months of fiscal year 2009, compared to $11.7 million for the first six months of fiscal year 2008. Licensing revenues decreased $2.7 million in the first six months of fiscal year 2009 due primarily to a decrease in block licensing revenue resulting from a decline in the demand for the technologies we license. Engineering services and maintenance revenues decreased $2.5 million, primarily as a result of the sale to KMC at the end of the first quarter of fiscal year 2009.

Cost of Revenues

Total cost of revenues was $5.7 million in the first six months of fiscal year 2009, compared to $4.7 million in the first six months of fiscal year 2008. Product licensing costs increased $3.1 million in the current six month period as a result of a $2.4 million increase in the estimate of product licensing costs associated with the restructuring of two block licenses made in conjunction with the KMC sale in the first quarter. The remaining difference was the result of a higher level of third party intellectual property contained in the licenses entered into during the second quarter of this fiscal year. This resulted in a corresponding increase in the percentage of product liability expense to licensing revenue being incurred. Engineering services and maintenance costs in the first six months of fiscal year 2009 were $1.5 million, compared to $3.6 million in the first six months of fiscal year 2008. The decrease was the result of the transfer of engineering resources to KMC with the resultant decrease in services revenues and costs.


Gross Margin

Our gross margin decreased to 13% in the first six months of fiscal year 2009, compared with 60% in the first six months of fiscal year 2008. The decrease in fiscal year 2009 was primarily the result of the $2.4 million increase in product licensing costs and the higher third party licensing cost discussed above.

Operating Expenses

Total operating expenses, excluding the gain of sale of operating assets of $32.9 million,for the first six months of fiscal year 2009 increased 32% to $9.2 million, compared with $7.0 million for the same period one year ago due to increased general and admistrative professional services expenses.

·
Research and development expenses decreased 45% to $1.3 million in the first six months of fiscal year 2009 from $2.4 million in the first six months of fiscal year 2008. The decrease in staffing that has occurred over the last fiscal year is the primary reason for decline in research and development expense.
 
·
Sales and marketing expenses decreased 16% to $1.1 million in the first six months of fiscal year 2009 from $1.3 million in the first six months of fiscal year 2008.
 
·
General and administrative expenses increased 68% to $5.6 million in the first six months of fiscal year 2009 from $3.3 million in the first six months of fiscal year 2008. Expenses were higher as a result of professional services associated with our due diligence efforts in the Prism acquisition and the success fees related to the KMC transaction.
 
·
Restructuring charges were $1.2 million in the first quarter of fiscal year 2009 as a result of the plan directed at reducing operating costs. 

Income Taxes

Our effective income tax rate was 40.7% for the six months ended July 31, 2008 compared to 2.0% for the six months ended July 31, 2007. The increase in the effective income tax rate is primarily due to the KMC transaction in 2008. In the prior year, the tax provision was based primarily on the alternative minimum tax as there was net operating loss carryforwards and tax credits to offset profits, which minimized our income tax expense.



We are exposed to a variety of risks in investments, mainly a lowering of interest rates. The primary objective of our investment activities is to preserve the principal of our investments and to maintain a liquid level of investments to meet short term capital requirements for potential acquisitions and/or mergers, while at the same time maximizing yields without significantly increasing risk. To achieve this objective, from time to time, we maintain our portfolio of cash equivalents in money market funds. Although we are subject to interest rate risks, we believe an effective increase or decrease of 10% in interest rate percentages would not have a material adverse effect on our results from operations.

We have not entered into any derivative financial instruments. Currently all of our contracts, including those involving foreign entities, are denominated in U.S. dollars. We have experienced no significant foreign exchange gains or losses to date. We have not engaged in foreign currency hedging activities to date and have no intention of doing so. Our international business is subject to risks typical of an international business, including but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and to a lesser extent foreign exchange rate volatility. Accordingly, our future results could be materially and adversely affected by changes in these or other factors.  
 

(a)
Evaluation of disclosure controls and procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13(a)-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of the disclosure controls and procedures. Based on the foregoing our principal executive officer and principal financial officer concluded that as of end of the period covered by this report, our disclosure controls and procedures were not effective at ensuring that the information required to be disclosed by us in our reports that we file or submit under the Exchange Act is recorded processed, summarized, and reported as required in applicable SEC rules and forms because of the deficiency in internal controls over financial reporting described below. Management has determined that this deficiency constitutes a material weakness in our internal controls over financial reporting. A material weakness is a deficiency, or a combination of control deficencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

Product Licensing Costs
   
  As a result of substantial efforts associated with the closure of the KMC asset sale and the increased activities associated with the Prism acquisition that was terminated, we did not maintain effective controls over the estimates for product licensing costs for restructured block licenses. Our controls were not adequate to assure that the proper third party license agreement was utilized in the calculation of future license costs. Although this did not result in a material adjustment in the current period, a lack of controls in this area could result in a material misstatement. Management has implemented steps in the current quarter to improve this process including the detailed review by our principal financial officer and our contracts administrator of all product licensing calculations and related agreements.
 
(b)
Changes in internal control over financial reporting 
 
Except as described above, there have been no significant changes in the our internal controls over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 


We are involved in various legal proceedings incidental to the conduct of our business. In accordance with SFAS No. 5, “Accounting for Contingencies,” we record a provision for liability when management believes that it is probable that a liability has been incurred and we can reasonably estimate the amount of loss. We do not believe there is a need for such a provision at this time. We review these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular proceeding.


Our short and long-term success is subject to many factors that are beyond our control. Stockholders and prospective stockholders should consider carefully the following risk factors, in addition to the information contained elsewhere in this Report. This Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements are not guarantees of future performance, rely on a number of assumptions concerning future events, many of which are outside of our control, and involve known and unknown risks and uncertainties that could cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements, expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors below.

As a result of completing the asset sale with KMC, we may encounter difficulties in leveraging our remaining assets and continuing operations at a profitable level. 

Although we intend to continue operations as a licensor of imaging and networking technologies to the digital document market, our primary assets after consummating the transaction with KMC consist of cash and cash equivalents and licenses to use intellectual property owned by others. As a result, we may encounter unanticipated difficulties or challenges in continuing operations and our cash flows and revenues may be materially adversely impacted. If we are unable to address and overcome such difficulties or challenges, we may encounter unexpected requirements for capital resources that may negatively impact our pursuit of possible mergers and/or acquisitions.

We have certain indemnification obligations under the Asset Purchase Agreement with KMC that might result in us not receiving all of the proceeds of the asset sale. 

Under the Asset Purchase Agreement, the $37.0 million purchase price for, among other things, substantially all of our intellectual property, is subject to a holdback amount of $4.0 million relating to potential indemnification obligations. If we are required to indemnify KMC or certain of its affiliates as a result such obligations, we may not receive all of the proceeds from the asset sale.
 
Our current growth strategy depends in part on our ability to successfully invest in and/or acquire the assets or businesses of other companies. Our failure to complete transactions that accomplish these objectives could reduce our earnings and slow our growth. 

We anticipate investing in and/or acquiring the assets or businesses of other companies as part of our current growth strategy. Potential risks involved in such transactions include lack of necessary capital, the inability to satisfy closing conditions, failure to identify suitable business entities for acquisition, the inability to successfully integrate such businesses into our operations, and the inability to make acquisitions on terms that we consider economically acceptable. Our ability to grow through acquisitions and manage growth would require us to continue to invest in operational, financial and management information systems and to attract, retain, motivate and effectively manage our employees. The inability to effectively manage the integration of acquisitions could reduce our focus on subsequent acquisitions and current operations, which, in turn, could negatively impact our earnings and growth. In addition, even if we do invest in or acquire other companies, there is no guarantee that such transactions will be successful in producing revenue or profits.

We may be subject to further government regulation which could adversely affect our operations.
 
Although we are subject to the reporting requirements under the Exchange Act, management does not believe that we are subject to regulation under the Investment Company Act of 1940, as amended (the “Investment Company Act”) at this point in time. If we are required to register as an investment company in the future we could incur significant registration and compliance costs. To date, we have obtained no formal determination from the SEC as to our status under the Investment Company Act and could, therefore, be determined at some later date to be an unregistered investment company, which could subject us to significantly heightened regulatory requirements that would likely, in the aggregate, have material adverse consequences on our business.


The Adobe License Agreement expired on June 30, 2008, and we have a twenty one month extension for the continuation of licensing and support through the end of the extension period. 

The Adobe License Agreement expired on June 30, 2008. The Adobe License Agreement was amended to provide a period of twenty one months following the expiration of the agreement in which we continue to license and provide services to our existing OEM customers. If we fail to replace the revenue derived from the Adobe License Agreement our operating results will be materially adversely impacted. See “Item 1. Financial Statements—Note 6 Concentration of Revenues.”

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

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

During the second quarter of fiscal year 2009, four customers, Novell, Konica Minolta, Seiko Epson, and Okidata each generated greater than 10% of our revenues, and collectively contributed 96% of revenues for the quarter. Perpetual and block licenses for the same time period were 77% of the revenues of the Company. During the second quarter of fiscal year 2008, two customers, Konica Minolta and Kyocera-Mita, each generated greater than 10% of the revenues of the Company and collectively contributed 79% of such revenues. Perpetual and block licenses for the same time period were 52% of the revenues of the Company.

We, as well as our OEM customers and third party technology suppliers face increasingly intense competition within our industry, which is applying significant downward pricing pressure on products and services. As a result, our OEM customers and third party technology suppliers continue to seek lower cost alternatives for their engineering needs. Some of our OEM customers and third party technology suppliers, including Adobe, have developed extensive offshore operations in countries such as India, that are capable of delivering lower cost solutions than we are able to deliver as of today. The ability of our OEM customers and third party technology suppliers to provide the same services at a lower cost may result in them no longer needing our services, as well as being in direct competition with us by providing the same services at a lower cost to our other customers. This may result in us losing some of our customers and may have a material adverse effect on our business, results of operations and future cash flows.

We are involved in a contract dispute, which, if not remedied, could have a material adverse affect on our operating results. 

Effective as of April 1, 2001, we entered into a PostScript sublicense with Canon Inc. The sublicense did not include several terms required to be included in all OEM sublicenses by our license with Adobe. Although Adobe has indicated to us that it has no current intention to pursue claims for alleged breach of the Adobe Peerless PostScript Sublicensing Agreement, Adobe has not agreed to waive the requirement that the missing terms be included in the Canon sublicense. To date, we have been unable to amend the Canon sublicense in a manner acceptable to both Canon and Adobe. Furthermore, there is no assurance that we will be able to resolve the issues in a manner acceptable to both Adobe and Canon. Thus, Adobe may take legal action against us, if it so chooses.

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

We currently sublicense third party technologies to our OEM customers, which sublicenses accounted for $12.2 million and $15.2 million in licensing revenue in fiscal 2008 and 2007, respectively. Such sublicense agreements are non-exclusive. If we are determined not to be in compliance with the agreements between us and our licensors, we may forfeit our right to sublicense these technologies. Likewise, if such sublicense agreements expired, we would lose our right to sublicense the affected technologies. Additionally, the licensing of these technologies has become very competitive, with competitors possessing substantially greater financial and technical resources and market penetration than us. As competitors are pursuing aggressive strategies to obtain similar rights as held by us to sublicense these third party technologies, there is no assurance that we can remain competitive in the marketplace if one or more competitors are successful.

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

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


Our licensing revenue is subject to significant fluctuations which may materially and adversely affect our operating results. 

Our recurring licensing revenue model has shifted from per-unit royalties paid upon OEM shipment of our product and guaranteed quarterly minimum royalties to a model that results in revenues associated with the sale of SDKs and block licenses. The reliance on block licenses has occurred due to aging OEM products in the marketplace, OEM demands in negotiating licensing agreements, reductions in the number of OEM products shipping and a product mix that changed from object code licensing arrangements to SDKs. Revenues may continue to fluctuate significantly from quarter to quarter as the number of opportunities vary, or if the signing of block licenses are delayed or the licensing opportunities are lost to competitors. Any of these factors could have a material adverse effect on our operating results.

Our revenue from engineering services is subject to significant fluctuations. 

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

•
product development delays;
 
•
potential non-recurring engineering reduction for product customization;
 
•
third party delays;
 
•
loss of new engineering services contracts;
 
•
globalization of the engineering workforce; and
 
•
the transfer of certain of our employees and other assets to KMC in connection with the IP sale.

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

The future demand for the products we license is uncertain. 

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

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

We anticipate increasing competition for the color products we license, particularly as new competitors develop and sell competing products. Some of our existing competitors, many of our potential competitors, and virtually all of our OEM customers have substantially greater financial, technical, marketing and sales resources than we have. If price competition increases, competitive pressures could require us to reduce the amount of royalties received on new licenses and to reduce the cost of our engineering services in order to maintain existing business and generate additional product licensing revenues. This could reduce profit margins and result in losses and a decrease in market share. We cannot guarantee that we have the ability to compete favorably with the internal development capabilities of our current and prospective OEM customers or with other third party digital imaging system suppliers and the failure to compete effectively would have a material adverse effect on our operating results.


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

We protect our proprietary rights through a combination of, among other things, trade secret, copyright and trademark laws, as well as the early implementation and enforcement of nondisclosure and other contractual restrictions.

As part of the transaction with KMC, we sold substantially all of our intellectual property, including all of our patents to KMC and executed a license agreement pursuant to which KMC licensed the IP back to us on a nonexclusive, worldwide, perpetual and royalty free basis subject to certain restrictions. Excluded from the IP that was sold to KMC was all of our customized intellectual property that had been previously integrated into products or services licensed or otherwise provided by us to third parties or specifically created for customers of ours after December 7, 2007 other than KMC and, which, in either case, had not also been provided to or integrated into products or services licensed to KMC, or developed pursuant to or in connection with certain agreements with KMC.

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

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

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

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

•
major currency rate fluctuations;
 
•
changes in the economic condition of foreign countries;
 
•
the imposition of government controls;
 
•
tailoring of products to local requirements;
 
•
trade restrictions;
 
•
changes in tariffs and taxes; and
 
•
the burdens of complying with a wide variety of foreign laws and regulations, any of which could have a material adverse effect on our operating results.

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


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

Our success depends to a significant degree upon the continuing contributions of our senior management. Management and other employees may voluntarily terminate their employment with us at any time upon short notice. The loss of key personnel could harm our business. We believe that our future success will depend in part on our ability to retain highly-skilled engineering, managerial and sales personnel. Competition for such personnel is intense, and we may not be successful in retaining such personnel. Failure to retain key personnel could harm our ability to carry out our business strategy. Presently, we have five members of executive management and eleven other employees.

Our stock price may experience extreme price and volume fluctuations. 

Our common stock has experienced price volatility. In the 60-day period ending July 31, 2008, the closing price of our stock ranged from $1.77 per share to $2.10 per share. Such price volatility may occur in the future. Factors that could affect the trading price of our common stock include:
 
•
macroeconomic conditions;
 
•
actual or anticipated fluctuations in quarterly results of operations;
 
•
announcements of new products or significant technological innovations by us or our competitors;
 
•
developments or disputes with respect to proprietary rights;
 
•
losses of major OEM customers;
 
•
general trends in the industry;
 
•
overall market conditions and other factors;
 
•
change in executive management; and
 
•
other risk factors described herein.

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

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

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


If we fail to maintain an effective system of internal control over financial reporting or discover material weaknesses in our internal control over financial reporting or financial reporting practices, we may not be able to report our financial results accurately or detect fraud, which could harm our business and the trading price of our stock. 

Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. We are required to periodically evaluate the effectiveness of the design and operation of our internal controls. These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable. As we previously noted in connection with the material weakness that we disclosed as of January 31, 2007, which was remediated, while management evaluates the effectiveness of our internal controls on a regular basis, we cannot provide absolute assurance that these controls will always be effective or any assurance that the controls, accounting processes, procedures and underlying assumptions will not be subject to revision. There are also inherent limitations on the effectiveness of internal controls and financial reporting practices, including collusion, management override, and failure of human judgment. Because of this, control procedures and financial reporting practices are designed to reduce rather than eliminate business risks. If we fail to maintain an effective system of internal control over financial reporting or if and for so long as management or our independent registered public accounting firm were to discover material weaknesses in our internal control over financial reporting (or if our system of controls and audits results in a change of practices or new information or conclusions about our financial reporting), we may be unable to produce reliable financial reports or prevent fraud and it could harm our financial condition and results of operations and result in loss of investor confidence and a decline in our stock price.
 
As a result of substantial efforts associated with the closure of the KMC asset sale and the increased activities associated with the Prism acquisition that was terminated we did not maintain effective controls over the estimates for product licensing costs for restructured block licenses. Our controls were not adequate to assure that the proper third party license agreement was utilized in the calculation of future license costs. Although this did not result in a material adjustment in the current period, a lack of controls in this area could result in a material misstatement. Management has implemented steps in the current quarter to improve this process including the detailed review by the Chief Financial Officer and our contracts administrator of all product licensing calculations and related agreements.

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

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

None.


 


None.
 

Effective August, 2008 Elliot M. Shirwo, Esq. resigned as General Cousel and Corporate Secretary of the Company.
 
 
EXHIBIT 10.1*
Amendment No. 30 to PostScript Software Development License and Sublicense Agreement dated July 23, 1999, as amended

EXHIBIT 31
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
EXHIBIT 32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
* Confidential treatment has been requested for portions of this exhibit. Portions of this document have been omitted and submitted separately to the Securities Exchange Commission.


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:
 
Peerless Systems Corporation
 
By:  
/s/ William R. Neil
 
William R. Neil
 
Chief Financial Officer
Date: September 18, 2008
 
EXHIBIT INDEX
 
Exhibit Number
  
Description of Exhibit
 
    
 
Amendment No. 30 to PostScript Software Development License and Sublicense Agreement dated July 23, 1999, as amended
     
 
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
    
 
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
* Confidential treatment has been requested for portions of this exhibit. Portions of this document have been omitted and submitted separately to the Securities Exchange Commission.
 
 
 
31