20-F 1 pnidigital20f130930.htm ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2013 Filed by e3 Filing, Computershare 1-800-973-3274 - PNI Digital Media Inc. - Form 20-F

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

FORM 20-F

[   ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 

[ X ]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2013

 

OR

 

[   ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________
 
OR
 

[   ]

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of event requiring this shell company report ________

 

Commission file number 0-30148

PNI DIGITAL MEDIA INC
(Exact name of Registrant specified in its charter)

Not Applicable
(Translation of Registrant’s name into English)

BRITISH COLUMBIA, CANADA
(Jurisdiction of incorporation or organization)

590 – 425 Carrall Street
Vancouver, British Columbia, Canada V6B 6E3
(Address of principal executive offices)

Cameron Lawrence, 604 893 8955, clawrence@pnimedia.com
(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

Title of Each Class Name of each exchange on which registered
None Not applicable

 

Securities registered or to be registered pursuant to Section 12(g) of the Act

Common Shares without Par Value
(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. None





Number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of business of the period covered by the annual report.

34,299,472 Common Shares Without Par Value
(See item 3.A below)

Indicate by check mark if the Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.

Yes [   ] No [ X ]

If this report is an annual or transition report, indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Yes [   ] No [ X ]

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

Yes [ X ] No [   ]

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

Large Accelerated Filer [   ] Accelerated Filer [   ] Non Accelerated Filer [ X ]

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP [   ] International Financial Reporting Standards as issued by the International Accounting Standards Board [ X ] Other [   ]

If “Other” has been checked in response to the previous question, Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 [   ] Item 18 [ X ]

If this is an annual report, indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b 2 of the Exchange Act):

Yes [   ] No [ X ]

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether Registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Not applicable.

(End of Cover Page)

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TABLE OF CONTENTS

  Page
PART I 2
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 2
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 2
ITEM 3. KEY INFORMATION 2
ITEM 4. INFORMATION ON THE COMPANY 21
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 32
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 45
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 55
ITEM 8. FINANCIAL INFORMATION 57
ITEM 9. THE OFFER AND LISTING 58
ITEM 10. ADDITIONAL INFORMATION 61
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 66
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 69
PART II 69
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 69
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS  70
ITEM 15. CONTROLS AND PROCEDURES 70
ITEM 16. [RESERVED] 71
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 71
ITEM 16B. CODE OF ETHICS 73
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 74
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 74
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED  
PURCHASERS 75
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT. 75
ITEM 16G. CORPORATE GOVERNANCE. 75
ITEM 16H. MINE SAFETY DISCLOSURE 75
PART III 75
ITEM 17. FINANCIAL STATEMENTS 75
ITEM 18. FINANCIAL STATEMENTS 75
ITEM 19. EXHIBITS 123

 

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PART I

We have made forward-looking statements in this annual report that are subject to risks and uncertainties. Forward-looking statements include information concerning our possible or assumed future results of operations. Also, when we use such words as “believe,” “expect,” “anticipate,” “plan,” “could,” “intend” or similar expressions, we are making forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks are discussed in Item 3.D “Risk Factors.” In particular, the statements contained in Item 4.B “Business Overview”, Item 5 “Operating and Financial Review and Prospects” and Item 11 “Quantitative and Qualitative Disclosures About Market Risk” are inherently subject to a variety of risks and uncertainties. Given these uncertainties, we caution readers not to place undue reliance on such forward-looking statements.

We expressly disclaim any obligation or undertaking to provide an update or revision to any forward looking statement contained herein to reflect any change in our expectations or any change in events, conditions or circumstances on any which any statement is based, except as required by applicable law. You should carefully review the cautionary statements and risk factors contained in this and other documents that we file from time to time with the Securities and Exchange Commission.

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not Applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected financial data

 

The following tables sets forth selected financial information for PNI Digital Media Inc. (the “Company”) for the fiscal years ended September 2009 and 2010 under Pre-Changeover Canadian GAAP and U.S. GAAP as well as for the fiscal years ended September 2011, 2012 and 2013 prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. The information for the last three fiscal years ended September 30, 2013, 2012 and 2011 have been extracted from the Company’s audited consolidated financial statements and related notes included herein and should be read in conjunction with such financial statements appearing in Item 18 – Financial Statements and with the information appearing in Item 5 - Operating and Financial Review and Prospects. As required by the Canadian Accounting Standards Board, the Company adopted IFRS on October 1, 2010 and the Company’s financial information for 2011 has been prepared on a retrospective basis to comply with IFRS. Information prior to the transition date has not been adjusted and is not comparable to financial information prepared in accordance with IFRS. The consolidated financial statements included in Item 18 in this Annual Report are prepared under IFRS. The selected financial data as at September 30, 2009 and 2010 and for the fiscal years ended

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September 30, 2009 and 2010 was extracted from the audited financial statements of the Company not included in this Annual Report.

The data is expressed in Canadian dollars (“CDN$”), unless otherwise described. We refer readers to “Currency and Exchange Rates” below for a history of exchange rates between the Canadian dollar and the U.S. dollar.

Reported under IFRS

  For the years ended September 30th
Item 2013 2012 2011
Revenue $ 20,899,204 $ 22,712,805 $ 23,686,351
Total comprehensive (loss) income for the period $ (7,120,997) $ (4,293,609) $ 1,073,208
Basic net profit (loss) per common share $ (0.22) $ (0.12) $ 0.03
Fully diluted net profit (loss) per common share $ (0.22) $ (0.12) $ 0.03
Total assets $ 14,751,232 $ 19,964,896 $ 22,472,894
Net assets (liabilities) $ 7,838,579 $ 14,819,212 $ 18,904,362
Share capital $ 66,881,748 $ 66,817,352 $ 66,420,572
Weighted average number of
Common Shares - basic (1)
34,299,471 34,178,165 33,927,659
Weighted average number of
Common Shares - diluted (1)
34,299,471 34,178,165 33,985,271

 

(1) See Item 3.A.

 

Reported under Pre-Changeover Canadian GAAP and U.S. GAAP

 
  For the years ended September 30th
Item 2010 2009
Revenue (Pre-Changeover Canadian GAAP) $25,356,570 $24,446,569
Revenue (U.S. GAAP) $25,356,570 $24,446,569
Total comprehensive (loss) income for the period (Pre-Changeover Canadian GAAP) $6,341,652 ($2,422,327)
Total comprehensive (loss) income for the period (U.S. GAAP) $7,183,193 ($2,399,796)
Basic net profit (loss) per common share (Pre-Changeover Canadian GAAP) $0.20 ($0.05)
Basic net profit (loss) per common share (U.S. GAAP) $0.23 ($0.05)
Fully diluted net profit (loss) per common share (Pre-Changeover Canadian GAAP) $0.20 ($0.05)
Fully diluted net profit (loss) per common share (U.S. GAAP) $0.23 ($0.05)
Total assets (Pre-Changeover Canadian GAAP) $23,520,358 $21,136,975

 

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Total assets (U.S. GAAP) $30,980,573 $27,648,038
Net assets (liabilities) (Pre-Changeover Canadian GAAP) $17,129,478 $10,192,534
Net assets (liabilities) (U.S. GAAP) $24,589,693 $16,703,597
Share capital (Pre-Changeover Canadian GAAP) $66,200,215 $66,017,456
Share capital (U.S. GAAP) $66,199,666 $65,909,296
Weighted average number of Common Shares - basic (1) (Pre-Changeover Canadian GAAP and U.S. GAAP) 33,804,338 33,610,843
Weighted average number of Common Shares - diluted (1) (Pre-Changeover Canadian GAAP and U.S. GAAP) 33,908,352 33,610,843
(1) See Item 3. A.

 

Currency and Exchange Rates

Unless otherwise indicated, all references to dollar amounts are to Canadian dollars. The rate of exchange for the U.S. dollar, expressed in Canadian dollars, as of November 29, 2013, was 0.9422, based on the daily noon rate as published by the Bank of Canada. Exchange rates published by the Bank of Canada are available on its website, www.bankofcanada.ca, are nominal quotations – not buying or selling rates – and are intended for statistical or analytical purposes.

The following table sets forth the high and low exchange rates for each month during the previous six months, based on the noon rate as published by the Bank of Canada:

Previous Six Months

  June July August September October November
  2013 2013 2013 2013 2013 2013
Low Rate 0.95 0.9445 0.9493 0.9480 0.9527 0.9445
High Rate 0.9835 0.9736 0.9714 0.9803 0.9716 0.96

 

The following table sets forth:

  • The rates of exchange for the U.S. dollar, expressed in Canadian dollars, in effect at the end of each of the periods indicated;

  • The average of the exchange rates in effect on the last day of each month during such periods; and

  • The high and low exchange rate during such periods, in each case based on the noon rate as published by the Bank of Canada.

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Years ending September 30

  2013 2012 2011 2010 2009
Rate at end of Period 0.9706 0.9837 1.0389 1.0298 1.0722
Average Rate During Period 1.0342 1.0074 0.9866 1.0407 1.1804
High Rate 0.9732 1.0604 1.0389 1.0845 1.3000
Low Rate 0.9702 0.9710 0.9449 0.9961 1.0609

 

B. Capitalization And Indebtedness

 

Not applicable.

 
C. Reasons for the offer and use of proceeds

 

Not applicable.

 

D. Risk Factors

 

Our business operations and our securities are subject to a number of substantial risks, including those described below. Any person who is not in a position to lose the entire amount of any investment should not invest in our securities. You should carefully consider the risks described below and the other information in this Annual Report on Form 20F before investing in our common shares. The risks and uncertainties described below are not the only ones we may face. Additional risks and uncertainties that we are unaware of, or that we currently deem to be immaterial, may also become important factors that affect us. If any of these or other risks actually occur, our business, financial condition and operating results, as well as the trading price or value of our securities could be materially and adversely affected.

Risks Relating to the Business

The Following Risks Relate to Our Business Operations

We are currently dependent on a limited number of key customers, the loss of which could materially and adversely affect our business.

We generate a significant portion of our revenue from a small number of customers. During fiscal 2013, we earned CDN$19,113,626 from four customer groups, representing 91% of our total revenue for the year. While we are working to expand our customer base, there can be no assurance we will be able to reduce our reliance on these key customers. If our existing customers do not elect to renew their contracts with us at the expiry of their current term, our recurring revenue base will be reduced, which could have a material adverse effect on our results of operations.

If we are unable to respond to rapid technological change and improve our products, our business could be materially and adversely affected.

The market for our service is characterized by:

  • rapidly changing technology;

  • evolving industry standards; and

  • frequent introduction of new services which may be comparable or superior to our services.

Our success will depend upon acceptance by our retailer customers and their end users of our existing solution and our ability to enhance these solutions and introduce new solutions and features to meet changing customer demands. We cannot assure that we will be successful in identifying, developing and marketing new solutions or enhancing our existing solutions. We may introduce unsatisfactory solutions to the market, negatively impacting our ability to generate sales. In the fourth quarter of 2013, the Company recorded an impairment charge of $594,851

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(2012: $77,382) in the European cash-generating unit (“CGU”), resulting in the write down of the full amount of the carrying value of goodwill. No further write down in CGU considered necessary as the remaining assets all liquid and at fair value. The impairment charge was recorded in cost of sales on the consolidated statements of operations and comprehensive (loss) income. We also recognized impairment losses of $540,736 in fiscal 2012 primarily due to underperforming revenues associated with previously capitalized internal use software associated with our social stationery product offering. We can provide no assurance that similar charges will not be recorded in the future. In addition, we cannot assure that solutions or technologies developed by others will not render our solutions or technologies non-competitive or obsolete.

To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our solutions and our network services. The Internet and the e-commerce industry are characterized by rapid technological change, changes in user and customer requirements and preferences, frequent new product and service introductions embodying new technologies and the emergence of new industry standards and practices that could render our existing online operations, network services and proprietary technology and systems obsolete. Our success will depend, in part, on our ability to license leading technologies useful in our business, enhance our existing services, develop new services and technology that address the varied needs of our existing and prospective customers and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. The development of our solutions, the network services and other proprietary technology entails significant technical, financial and business risks. There can be no assurance that we will successfully implement or develop new technologies or adapt our solutions, network services, proprietary technology and transaction-processing systems to customer requirements or emerging industry standards. If we are unable to adapt in a timely manner in response to changing market conditions or customer requirements for technical, legal, financial or other reasons, our business could be materially adversely affected.

In order to remain competitive, we must continually invest in improving our solutions, and adding new products and services. We may need to expend significant resources in order maintain our competitive position. The cost to improve our solutions and add new products and services may adversely affect our financial results.

Failure by our retail partners to market products that are sold over our platform for sale could impact future growth potential or cause our revenue to decline.

There can be no assurance that any increase in marketing and sales efforts will result in a larger market or increase in market acceptance for our services. If the market fails to develop, develops more slowly than expected or becomes saturated with competitors, or if our proposed services do

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not achieve or sustain market acceptance, our proposed business, results of operations and financial condition will be materially and adversely affected.

While we assist retailers with their marketing programs, we cannot be assured that retailers will continue to market our service or that their marketing efforts will be successful in attracting and retaining end user customers. The failure to attract and retain end user customers will adversely affect our business. In addition, if our service does not generate revenue for the retailer, we may lose retailers as customers, which would adversely affect our revenue.

We compete with others who provide products comparable to our products. If we are unable to compete with current and future competitors, our business could be materially and adversely affected.

Demand for our products and services are sensitive to price slow economic growth and consumer conservatism. Many external factors, including our production and personnel costs, consumer sentiment and our competitors’ pricing and marketing strategies, can significantly impact our pricing strategies. If we fail to meet our customers’ price expectations, we could lose customers, which would harm our business and results of operations. Changes in our pricing strategies have had, and may continue to have, a significant impact on our net revenues and net income.

Our success is dependent upon our ability to maintain our current customers and obtain additional customers. Digital imaging services are provided by a wide range of companies. Competitors in the market for the provision of digital print services for retailers include Snapfish (a Hewlett-Packard (“HP”) service), American Greetings’ Webshots brand, Vistaprint, SmugMug, LifePics and Storefront.com Online Inc. In addition, end users have a variety of ways in which to obtain their prints, including through kiosk services provided by our competitors at many retailers, online services such as Snapfish and Shutterfly, Internet portals and search engines such as Yahoo!, AOL and Google that offer digital photography solutions, and home printing solutions offered by Hewlett Packard, Epson, Canon and others. Many of our competitors have:

  • longer operating histories;

  • significantly greater financial, technical and marketing resources;

  • greater name and product recognition; and

  • larger existing customer bases.

As potential competitors introduce competing solutions we may encounter additional and more intense competition. We may experience delays or difficulties in introducing new functionalities into our services, allowing competitors to exploit opportunities in the market. We cannot be certain that we will be able to compete successfully against current and future competitors. If we are unable to do so it will have a material adverse effect on our business, results of operations and financial condition.

Certain competitors have the ability to offer discounted printing services. While in the majority of our agreements we are not directly affected by discounts in the price charged to consumers by our customers, consumers may determine not to print their photos through our retail customers’ services, resulting in fewer transactions through such retailers, and reduced revenue to us. However, under certain agreements we are directly affected by discounts in the price charged to consumers by the retailer where we are responsible for the fulfillment of print orders, the provision of certain consumer deliverables and other media to the retailer’s end consumer. Under this type of arrangement, we pay the retailer a commission for the use of their website and other services provided by the retailer.

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As we increase the number of service offerings that we make available to retailers through areas such as business printing and social stationery, we may find ourselves operating in new segments of the retail market and encounter competition from entities that we have not been required to compete against before. These entities may have competitive advantage over the Company through longer operating history, an established market presence or superior financial resources.

To remain competitive, we may have to reduce our pricing. Depending on the price-elasticity of demand for our products, the pricing and quality of competitive products, and other economic and competitive conditions, such as price reductions may have an adverse impact on our revenue and profit. If we’re unable to compensate for price reductions with increased sales volume, our results of operations could be adversely affected.

If new products currently being developed by the Company are not accepted in the marketplace, our business could be adversely impacted.

A significant amount of time and effort has been focussed towards the development of new service offerings such as business printing and social stationery which will be offered across our platform to both existing and new customers. There can be no assurance that the market for our new services in these areas will emerge to a profitable level or be sustainable. Failure by the us to sell these services to either new or existing customers may result in future internal growth targets not being achieved and the cost of developing these new services becoming unrecoverable. Focus on these areas means that we may have foregone alternative market opportunities, which could result in a loss of market share and harm our business, financial condition, and results of operations.

We are reliant on a single service provider for our new custom social stationery, and have a contractual commitment which limits the use of a different service provider without consent. Should our relationship with the exclusive provider terminate, we may face restrictions on supplying the custom social stationery and to any new customers.

Our operating results are affected by consumer preferences for digital photography and their desire to create physical products from their digital images

As the Company’s operations predominantly relate to hosting retailers online photo centers, and our revenue model is principally based on the volume of orders placed through such photo centers, should consumer preferences for digital photography change, our revenues may be significantly affected.

If our business does not continue to grow at previously seen rates, our business could be materially and adversely affected.

There can be no assurance that our services will continue to grow at the pace seen over the last ten years, or that our new services will receive widespread market acceptance. Even if our services continue to grow and attain widespread acceptance, there can be no assurance we will be able to meet the demands of our customers on an ongoing basis. Our operations may be delayed or halted as a result of failure to perform as described. Such delays or failure would seriously harm our reputation and future operations. If our products do not continue to be accepted in the market place, our business could be materially and adversely affected.

We face many risks, uncertainties, expenses and difficulties relating to increasing our market share and growing our business.

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To address the risks and uncertainties of increasing our market share and growing our business, we must do the following:

  • maintain and increase the size of our customer base;

  • maintain and enhance our brands;

  • enhance and expand our products and services;

  • successfully execute our business and marketing strategy;

  • continue to develop and upgrade our technology and information processing systems;

  • continue to enhance our service to meet the needs of a changing market;

  • provide superior customer service;

  • respond to competitive developments; and

  • attract, integrate, retain and motivate qualified personnel.

We may be unable to accomplish one or more of these requirements, which could cause our business to suffer. Accomplishing one or more of these requirements might be very expensive, which could harm our financial results.

We rely on our ability to attract and retain customers. If we are unable to maintain reliability of our network, kiosk solutions and mobile applications we may lose both present and potential customers.

Our ability to attract and retain customers depends on the performance, reliability and availability of our network infrastructure, kiosk services, and mobile applications. We may experience periodic service interruptions caused by temporary problems in our own systems or software or in the systems or software of third parties upon whom we rely to provide such services. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins and similar events could damage these systems and interrupt our services. Computer viruses, electronic break-ins or other similar disruptive events also could disrupt our services. System disruptions could result in the unavailability or slower response times of the websites we host for our customers, which would lower the quality of the consumers’ experiences. Service disruptions could adversely affect our revenues and if they were prolonged, would seriously harm our business and reputation. This risk is heightened in the fourth calendar quarter, as we experience significantly increased traffic to our network during the holiday season. Any interruption that occurs during such time would have a disproportionately negative impact than if it occurred during a different quarter. We do not carry business interruption insurance to compensate for losses that may occur as a result of these interruptions. Our customers depend on Internet service providers and other website operators for access to our network. These entities have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. Moreover, the Internet network infrastructure may not be able to support continued growth. Any of these problems could adversely affect our business.

The infrastructure relating to our services are vulnerable to unauthorized access, physical or electronic computer break-ins, computer viruses and other disruptive problems. Internet service

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providers have experienced, and may continue to experience, interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees and others. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. Security breaches relating to our activities or the activities of third-party contractors that involve the storage and transmission of proprietary information could damage our reputation and relationships with our customers and strategic partners. We could be liable to our customers for the damages caused by such breaches or we could incur substantial costs as a result of defending claims for those damages. We may need to expend significant capital and other resources to protect against such security breaches or to address problems caused by such breaches. Security measures taken by us may not prevent disruptions or security breaches.

If our security measures are breached, our products and services may be perceived as not being secure, end users and our customers may curtail or stop using our products and services, and we may incur significant legal and financial exposure.

Our products and services involve the storage and transmission of end users of our customers and our customers’ personal and proprietary information on our equipment and networks. Security breaches expose us to a risk of loss of this information, litigation, remediation costs, increased costs for security measures, loss of revenue, damage to our reputation, and potential liability. The data of end users of our customers contained in our networks and security measures may in the future be breached due to the actions of outside parties (including cyber attacks), employee error, malfeasance, a combination of these, or otherwise, allowing an unauthorized party to obtain access to our data or that of the end users of our customers or our customers’ data. Additionally, outside parties may attempt to fraudulently induce employees, users, or customers to disclose sensitive information in order to gain access to our data or that of the end users of our customers or our customers’ data.

Any breach or unauthorized access could result in significant legal and financial exposure, increased remediation and other costs, damage to our reputation and a loss of confidence in the security of our products, services and networks that could potentially have an adverse effect on our business. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently or may be designed to remain dormant until a predetermined event and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose end users of our customers and our customers.

We may divert our resources to develop new product lines, which may result in fluctuations in our expenditures.

In order to remain competitive, we must continually develop new product lines for our customers. We expect to continue developing new product lines, such as online printing of business and social stationery which were launched during fiscal 2012, business printing which was launched during fiscal 2013, and expand current product lines. The development of new product lines may result in increased expenditures during the development and implementation phase, which could negatively impact our results of operations. In addition, we are a small company with limited resources and diverting these resources to the development of new product lines may result in reduced customer

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service turn-around times and delays in deploying new customers. These delays could adversely affect our business and results of operations.

We may undertake acquisitions to expand our business, which may pose risks to our business and dilute the ownership of existing shareholders.

We may pursue acquisitions of businesses, technologies or services. Integrating newly acquired businesses, technologies or services may be expensive and time consuming. To finance any acquisitions, it may be necessary to raise additional funds through public or private financings. Additional funds may not be available on terms favourable to us and, in the case of equity financings, would result in additional dilution to our existing shareholders. If we do complete any acquisitions, we may be unable to operate the acquired businesses profitably. If we are unable to integrate any newly acquired entities, technologies or services effectively, our business and results of operations may suffer. The time and expense associated with finding suitable and compatible businesses, technologies or services could also disrupt our ongoing business and divert management’s attention. Future acquisitions by us could result in large and immediate write-offs or assumptions of debt and contingent liabilities, any of which could substantially harm our business and results of operations.

Our ability to realize the anticipated benefits of any acquisitions will depend on successfully integrating the acquired businesses.

The integration of acquired business operations could disrupt our business by causing unforeseen operating difficulties, diverting management’s attention from day-to-day operations and requiring significant financial resources that would otherwise be used for the ongoing development of our business. The difficulties of integration could be increased by the necessity of coordinating geographically dispersed organizations, integrating personnel with disparate business backgrounds and combining different corporate cultures. In addition, we could be unable to retain key employees or customers of any combined businesses. We could face integration issues pertaining to the internal controls and operational functions of any acquired companies and we also could fail to realize cost efficiencies or synergies that we anticipated when selecting our acquisition candidates. As a result of these and other risks, if we are unable to successfully integrate acquired businesses, we may not realize the anticipated benefits from any acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses and technologies could seriously harm our business.

Our net revenues, operating results and cash requirements are affected by the seasonal nature of our business.

Our business is seasonal, with a significant proportion of our recurring revenues net income and operating cash flows generated during our first fiscal (fourth calendar) quarter. As a result, any stoppages or interruptions in the provision of our network to our customers during our first fiscal (fourth calendar) quarter could have an adverse effect on our operating results and our relationships with our customers. In addition, our growth in past years may have overshadowed seasonal or cyclical fluctuations in the economy which might have influenced our business to date; accordingly, our past performance may not reflect the true seasonal nature of our business, or the effect of general economic conditions on our business.

Our quarterly results may fluctuate, which may lead to volatility in our stock price.

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Our future revenues and operating results may vary significantly from quarter to quarter due to a number of factors, some of which are outside of our control. Factors that could cause our quarterly results to vary include:

  • demand for services, including seasonal and holiday demand, and reduction in demand as a result of general market or economic conditions;

  • the ability of our customers to attract and retain visitors to their websites;

  • the ability of our customers to encourage repeat purchases from their customers;

  • the pricing and marketing strategies of our customers;

  • the cost of expanding or enhancing the services we provide to our customers;

  • volatility in our stock price, which may lead to higher stock based compensation expense for future stock option grants; and

  • improvements in the quality, cost and convenience of desktop printing of digital pictures and products.

Based upon the factors cited above, quarter to quarter comparisons of our operating results may not be a good indication of our future performance. It is possible that in one or more future quarters, our operating results may be below the expectations of public market analysts and investors, which may result in a decline in the market price of our common shares.

In the past we have relied on the proceeds of financings to fund our operations. In the past, we had negative cash flows from operations, including up to the year ended September 30, 2013. We achieved positive cash flows from operations for the years ended September 30, 2009, 2010, 2011, and 2012 and while we believe we will generate sufficient cash flow to meet our expected cash requirements for fiscal 2014, if we are unable to continue to generate positive cash flow from operations or continue to raise funds, we may be required to limit or curtail operations in the future.

At September 30, 2013, had an accumulated deficit of CDN$78,802,351. The successful implementation of our business strategy depends on numerous factors including economic, competitive and other conditions and uncertainties, the ability to hire and retain qualified personnel, the ability to obtain financing for continued development and commercialization of our products. Adverse economic or competitive conditions or the failure to hire and retain qualified personnel or obtain financing if required could affect our operations in the future.

During the year ended September 30, 2013 we recorded a loss before income tax of CDN$4,844,813, and during the same period recorded cash outflows from operations of CDN$2,916,385. In addition, we are currently generating sufficient revenues to cover our operating expenses. However, if our revenue growth slows or declines and our expenses do not slow or decline at an equal or greater rate we may be unable to continue to generate positive cash flows. If we are unable to generate positive cash flow from operations or raise the funds necessary to continue existing operations, we may be required to either limit or curtail operations.

As of September 30, 2013, we had cash and cash equivalents of approximately CDN$2,425,106. The cash available, along with anticipated positive cash flow from operations are expected to meet our requirements for fiscal 2014. See “Item 5 – Operating and Financial Review and Prospects – B. Liquidity and Capital Resources”.

Ongoing economic uncertainty and macroeconomic trends may negatively affect our business in the future.

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Our financial performance depends on general economic conditions. The North American economy is experiencing a slow economic recovery from a deep recession, concerns about inflation, low consumer confidence, high unemployment rate and other adverse business conditions. Fluctuations in the U.S. and Canadian economies such as the recent recession could cause, among other adverse business conditions, a prolonged decline in consumer spending and an increase in the cost of labor and materials. Weak economic conditions, low consumer spending and decreased consumption may harm our operating results. If the economic climate does not improve, end users of our customers or potential customers could delay, reduce or forego their use of our products and services, which could impact our business in a number of ways, including lower prices for our products and services and reduced sales. In addition, adverse economic conditions may lead to price increases by our suppliers or increase our operating expenses due to, among others, higher costs of labor, energy, equipment and facilities. A prolonged and slow economic recovery or a renewed recession may also lead to additional restructuring actions and associated expenses. Due to reduced consumer spending and increased competitive pressures in the current economic environment, we may not be able to pass these increased costs on to our customers. The resulting increased expenses and/or reduced income would negatively impact our operating results. If the economic recovery continues to be slow, or if the economy experiences a prolonged period of decelerating or negative growth, our results of operations may be further harmed.

We may have difficulty in managing our growth.

Expected rapid growth in all areas of our business may place a significant strain on our operational, technical and management resources. As a result of such growth, we expect that operating expenses and staffing levels may increase in the future. To manage our growth, we must expand our operational and technical capabilities and manage our employee base, while effectively administering multiple relationships with various third parties, including affiliates. We cannot assure that we will be able to effectively manage our growth. The failure to effectively manage our growth could result in an inability to meet our customer demands, leading to customer dissatisfaction and loss. Loss of customers could adversely affect our operating results. There is no guarantee that the expansion of our operations will result in an increase in revenue.

Our business is increasingly focussing on foreign markets and our results becoming subject to significant exposure to foreign exchange rates, which may adversely impact our business.

Until 2007 we had been focused on the Canadian marketplace. Since that time we have added a number of large new customers in the United States marketplace, including but not limited to, Costco USA, SAMS Clubs USA, Walgreens Co., CVS/pharmacy, Tesco and Fred Meyer. As a result of this we are now more concentrated in the United States marketplace. The United States marketplace for our services offers approximately ten times the size of the Canadian marketplace and due to our recent success in the United States market, a substantial portion of our operations is based on sales and services rendered to customers in the United States. Further, with our acquisition of Pixology in July 2007 and our acquisition of WorksMedia in March 2009, we have expanded into the United Kingdom. Although Pixology has lost customers since this acquisition and may lose additional customers going forward, we continue to expect a significant portion of our sales and services will be rendered to customers in the United Kingdom. Finally, during the past four fiscal years we have begun expanding the delivery of our service to customers outside of Canada, the United States and the United Kingdom to countries such as Australia, South Africa and other parts of Europe; however our financial performance will not be materially affected by fluctuations in the value of the Canadian dollar against the currencies in the other jurisdictions as

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we currently invoice customers in Canadian dollars, U.S. dollars, Euros or United Kingdom pounds. We record the financial results for the operations of our UK subsidiary, and U.S. subsidiary in United Kingdom pounds and U.S. dollars, respectively, and also undertake certain transactions with our United States customers in U.S. dollars. Sales to other jurisdictions around the world are conducted either in United Kingdom pounds, Canadian dollars or United States dollars.

Our consolidated financial results are reported in Canadian dollars. As a result, our earnings and financial position are affected by foreign exchange rate fluctuations in a number of ways. First, the Company is subject to translation risk. Translation risk is the risk that an entity’s financial statements for a particular period, or at a certain date, depend on the prevailing exchange rate of the local currencies in which its foreign subsidiaries operate against the Canadian dollar. Second, the Company is subject to transaction risk. Transaction risk is the risk that the exchange rate at which a transaction is initially recorded will be different from the rate at which it is settled. Finally, as a significant amount of the Company’s revenue is now in either US dollars or British pounds, any weakening in these exchange rates relative to the Canadian dollar will impact the revenue that is recorded by the Company. In extreme cases, this could eliminate the impact of underlying growth being experienced within the industry and result in a situation where the Company’s revenue declines even though the level of activity taking place through its platform is increasing.

At the present time, we have no plan or policy to utilize forward contracts or currency options to minimize or hedge this exposure, and even if these measures are implemented there can be no assurance that such arrangements will be available, be cost effective or be able to fully offset such future currency risks.

If we are not able to reliably meet our data storage and management requirements, customer satisfaction and our reputation could be harmed. Interruptions to our customers’ website, information technology systems, print production processes or customer service operations could damage our reputation and substantially harm our business and results of operations.

The satisfactory performance, reliability and availability of our customer’s websites, information technology systems, printing production processes and customer service operations are critical to our reputation, and our ability to attract and retain customers and maintain adequate customer satisfaction. Any interruptions that result in the unavailability of customer’s websites or reduced order fulfillment performance or customer service could result in negative publicity, damage our reputation and brands and cause our business and results of operations to suffer. This risk is heightened in our first quarter, as we experience significantly increased traffic to our customer’s website during the holiday season.

Our ability to provide our service depends on the uninterrupted operation of our computer and communications systems. If we are not able to reliably meet our data storage and management requirements, we could have disruptions in services which could impair customer satisfaction and our reputation and lead to reduced net revenues and increased expenses. Moreover, if the cost of meeting these data storage and management requirements exceeds our expectations, our results of operations would be harmed.

If the facilities where our computer hardware are located failed, our business and results of operations would be harmed.

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Our computer hardware necessary to operate our service is primarily located in a third-party hosting facilities located in Toronto, Ontario. Our systems and operations could suffer damage or interruption from human error, fire, flood, power loss, telecommunications failure, break-ins, terrorist attacks, acts of war and similar events. As the result of the two facilities, though we do have redundant systems in multiple locations, we do not have all customers hosted in each location; therefore, if one facility failed it may take days to get customers resident on the failed system live in the other facility. Further, we do not have business interruption insurance to compensate us for losses that may occur in relation to a failed facility(ies). In addition, the impact of any of these disasters on our business may be exacerbated by the fact that we do not have a disaster recovery plan in place.

We may not be able to protect and enforce our intellectual property rights, which could result in the loss of our rights, loss of business or increased costs.

Our success and ability to compete largely depends on our current technology and future technology that we may develop or license from third parties. To protect our technology, we have used the following:

  • confidentiality agreements;

  • retention and safekeeping of source codes; and,

  • duplication of such for backup.

Despite these precautions, it may be possible for unauthorized third parties to copy or otherwise obtain and use our technology or proprietary information. In addition, effective proprietary information protection may be unavailable or limited in certain foreign countries. Litigation may be necessary in the future to:

  • enforce our intellectual property rights;

  • protect our trade secrets; or,

  • determine the validity and scope of the proprietary rights of others.

Such misappropriation or litigation could result in substantial costs and diversion of financial and management resources and the potential loss of intellectual property rights, which could impair our financial and business condition.

If we become involved in intellectual property litigation we could incur substantial costs, expenses or liability, lose our exclusive rights or be required to stop certain of our business activities.

Third parties may sue us for infringing their intellectual property rights. Such claims may involve internally developed technology or technology and enhancements that we may license from third parties. Moreover, although we sometimes may be indemnified by third parties against such claims related to technology that we have licensed, such infringements against the proprietary rights of others and indemnity there from may be limited, unavailable, or, where the third party lacks sufficient assets or insurance, ineffectual. Any such claims could require us to spend time and money defending against them, and, if they were decided adversely to us, could cause us to:

  • pay damages;

  • be subject to injunctions; or,

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  • halt deployment of our network and products while we re-engineer them or seek licenses to the necessary technology, which necessary licenses may increase our costs and might not be available on reasonable terms.

Any of these factors could have a material and adverse effect on our financial condition and business. See ITEM 8. FINANCIAL INFORMATION A. Consolidated Statements and Other Financial Information - Legal Proceedings.

If we are unable to adequately control the costs associated with operating our business, our results of operations will suffer.

The primary costs in operating our business are related to compensating our personnel, acquiring equipment and technology and leasing facilities. If we are unable to keep these costs aligned with the level of revenues that we generate, our results of operations would be harmed.

The loss of any of our executive officers, key personnel or contractors would likely have an adverse effect on our business.

We are dependent upon our management, employees and contractors for meeting our business objectives. In particular, members of the senior management team play key roles in our executive management and technical development. A lack of management continuity could result in operational and administrative inefficiencies and added costs, which could adversely impact our results of operations and stock price and may make recruiting for future management positions more difficult. We do not carry key man insurance coverage to mitigate the financial effect of losing the services of any of these key individuals. Loss of any of these key individuals would likely have an adverse effect on our business.

In addition, we may require additional capabilities. We cannot assure that we will be successful in attracting personnel of the appropriate calibre or we may be required to pay increased compensation to do so. Our failure to attract and retain qualified personnel could impair our ability to implement our business plan.

We rely on third parties for the development and maintenance of the Internet and the availability of increased bandwidth to users.

The success of our business will rely on the continued improvement of the Internet as a convenient means of consumer interaction and commerce. Our business will depend on the ability of our customers’ consumers to use the network without significant delays or aggravation that may be associated with decreased availability of Internet bandwidth and access to our services. This will depend upon the maintenance of a reliable network with the necessary speed, data capacity and security, as well as timely development of complementary products such as high speed modems for providing reliable Internet access and services. The failure of the Internet to achieve these goals may reduce our ability to generate significant revenue.

Our penetration of a broader consumer market will depend, in part, on continued proliferation of high speed Internet access. The Internet has experienced, and is likely to continue to experience, significant growth in the number of users and amount of traffic. As the Internet continues to experience increased numbers of users, increased frequency of use and increased bandwidth requirements, the Internet infrastructure may be unable to support the demands placed on it. In addition, increased users or bandwidth requirements may harm the performance of the Internet. The Internet has experienced a variety of outages and other delays and it could face outages and

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delays in the future. These outages and delays could reduce the level of Internet usage as well as the level of traffic, and could result in the Internet becoming an inconvenient or uneconomical source of products and services, which would cause our revenue to decrease. The infrastructure and complementary products or services necessary to make the Internet a viable commercial marketplace for the long term may not be developed successfully or in a timely manner.

Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by us to comply with these regulations could substantially harm our business and results of operations.

We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property use and ownership, sales and other taxes, fraud, libel and personal privacy apply to the Internet and e-commerce as the vast majority of these laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues raised by the Internet or e-commerce. Those laws that do reference the Internet are only beginning to be interpreted by the courts and their applicability and reach are therefore uncertain. The costs of compliance with regulations that govern the Internet and e-commerce may increase in the future as a result of changes in such regulations or the interpretation of them. Further, any failures on our part to comply with such regulations may subject us to significant liabilities. Those current and future laws and regulations or unfavorable resolution of these issues may substantially harm our business and results of operations.

Our technology may contain undetected errors that could result in limited capacity or an interruption in service.

Our technology may contain undetected errors or design faults which may cause our service to fail and result in the loss of, or delay in, acceptance of our services. If the design fault leads to an interruption in the provision of our services or a reduction in the capacity of our services, we would lose revenue. In future, we may encounter scalability limitations that could seriously harm our business. A failure of our services could lead to a loss of customers, the erosion of our reputation, and serious harm to our business.

In the past we have identified deficiencies with our internal controls and there remain areas of our internal and disclosure controls that require improvement. If we fail to maintain an effective system of internal controls, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our common shares may be adversely impacted.

We are subject to reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in the company’s annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In the fiscal years ended September 30, 2007 and 2008, we concluded that our disclosure controls and procedures and our internal controls over our financial reporting were not effective. The deficiencies

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identified related to management’s application of certain complex accounting requirements. Following the identification of these deficiencies, we undertook remedial steps and plan to continue to take additional remedial steps to improve our internal and disclosure controls. There can be no guarantee that the measures taken will be sufficient to ensure accurate financial reporting in the future. A failure to provide accurate financial results may result in loss of investor confidence and may adversely impact the price of our common shares. In addition, our failure to maintain adequate internal and disclosure controls could lead to sanctions by the Securities and Exchange Commission and other regulatory bodies under the applicable legislation, including the Foreign Corrupt Practices Act of 1977.

Maintaining and improving our financial controls and the requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.

As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002, Canadian securities laws and the rules and regulations of the TSX. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act contains various provisions applicable to the corporate governance functions of public companies. Additional or new regulatory requirements may be adopted in the future. The requirements of existing and potential future rules and regulations will likely continue to increase our legal, accounting and financial compliance costs, make some activities more difficult, time-consuming or costly and may also place undue strain on our personnel, systems and resources.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and effective internal control over financial reporting. Significant resources and management oversight are required to design, document, test, implement and monitor internal control over relevant processes and to remediate any deficiencies. As a result, management’s attention may be diverted from other business concerns, which could harm our business, financial condition and results of operations. These efforts also involve substantial accounting related costs.

The Following Risks Relate To The Market For Our Common Shares

There may not be an active, liquid market for our common shares.

There is no guarantee that an active trading market for our common shares will be maintained on the OTC Bulletin Board or the TSX. Shareholders may not be able to sell their shares quickly or at the latest market price if trading in our common shares is not active.

Our common shares may experience extreme price and volume volatility which may result in losses to our shareholders.

On September 30, 2013, our common shares closed at a price of CDN$0.49 on the TSX and US$0.47 on the OTC Bulletin Board. During the period from October 1, 2012 to September 30, 2013, the adjusted high and low trading prices of our common shares on the TSX were CDN$0.58 and CDN$0.20, respectively, with a total reported trading volume of 4,362,800 shares. For the same period, the adjusted high and low trading prices of our common shares on the OTC Bulletin Board were US$0.49 and US$0.19, respectively, with a total reported trading volume of approximately 2,710,000 shares. The trading volume of our shares on the OTC Bulletin Board may not be representative of actual trading volume due to double ticketing of orders that may have occurred on one or more days of the period analyzed.

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Daily trading volume on the TSX of our common shares for the period from October 1, 2012 to September 30, 2013 has fluctuated, with a high of 216,000 shares and a low of zero shares, averaging approximately 17,400 shares. Daily trading volume on the OTC Bulletin Board in our common shares for the period from October 1, 2012 to September 30, 2013 has fluctuated with a high of 221,300 and a low of zero, averaging approximately 10,800. Accordingly, the trading price of our common shares may be subject to wide fluctuations in response to a variety of factors including announcement of material events by us such as the status of required regulatory approvals for our products, competition by new products or new innovations, fluctuations in our operating results, general and industry-specific economic conditions and developments pertaining to patent and proprietary rights. The trading price of our common shares may be subject to wide fluctuations in response to a variety of factors and/or announcements concerning such factors, including:

  • actual or anticipated period-to-period fluctuations in financial results;

  • litigation or threat of litigation;

  • failure to achieve, or changes in, financial estimates by securities analysts;

  • new or existing products or services or technological innovations by us or our competitors;

  • comments or opinions by securities analysts or major shareholders;

  • significant acquisitions, strategic partnerships, joint ventures or capital commitments;

  • additions or departures of key personnel;

  • sales of our common shares, or securities convertible into our common shares;

  • economic and other external factors or disasters or crises;

  • limited daily trading volume; and

  • developments regarding our patents or other intellectual property or that of our competitors.

In addition, the securities markets in the United States and Canada have recently experienced high levels of price and volume volatility, and the market price of securities of technology companies have experienced wide fluctuations in price which have not necessarily been related to the operating performance, underlying asset values or prospects of such companies. It is expected that such fluctuations in price and limited liquidity will continue in the foreseeable future which may make it difficult for a shareholder to sell shares at a price equal to or above the price at which the shares were purchased.

At present, there is a limited market for our common shares in the United States. If a substantial and sustained market for our common shares does not develop in the United States, our US shareholders' ability to sell their shares may be materially and adversely affected.

During the year ended September 30, 2011 our common shares traded in Canada on the TSX Venture Exchange (“TSX-V”). Subsequent to September 30, 2011 the Company’s application to the Toronto Stock Exchange (“TSX”) was approved and effective October 18, 2011 the Company’s shares were de-listed from the TSX-V and began trading on the TSX. In the United States the Company’s common shares are traded on the OTC Bulletin Board, however, at present there is a limited trading market in the United States for our common shares and such is unlikely to develop further while we are quoted on the OTC Bulletin Board. There can be no assurance that our securities will ever qualify for listing on any other stock market or stock exchange in the U.S. or elsewhere. Accordingly, there can be no assurance that any U.S. market for our securities will continue.

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If there are substantial sales of our common shares, the market price of our common shares could decline.

Sales of substantial numbers of our common shares could cause a decline in the market price of our common shares. Any sales by existing shareholders or holders of options or warrants may have an adverse effect on the market price of our common shares.

Our stock is a penny stock. Trading of our stock may be restricted by the SEC's penny stock regulations which may limit a stockholder's ability to buy and sell our stock.

Our stock is a penny stock. The SEC has adopted Rule 15g-9 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000, not including any equity in that person’s or person’s spouse’s primary residence, or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer's account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer's confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.

FINRA sales practice requirements may also limit a stockholder's ability to buy and sell our stock.

In addition to the “penny stock” rules promulgated by the SEC, the Financial Industry Regulatory Authority (FINRA) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock.

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We have no history of paying dividends, do not intend to pay dividends in the foreseeable future and may never pay dividends.

Since incorporation, we have not paid any cash or other dividends on our common shares and do not expect to pay such dividends in the foreseeable future as all available funds will be invested to finance the growth of our business.

ITEM 4. INFORMATION ON THE COMPANY

 

Summary

We are a company incorporated under the Business Corporations Act (British Columbia). Our principal and registered offices are located at Suite 590, 425 Carrall Street, Vancouver, British Columbia, V6B 6E3. We also have an office in Southampton, England and Austin, Texas.

We provide software and technology to retailers, Internet portals and web sites, and telecommunication service providers (including mobile phone companies). Our principal service is the PNI Digital Media Platform. The PNI Digital Media Platform consists of digital imaging technology which we provide to retailers who provide, or wish to provide, photo print, photo gift stationery and business card print services, professional and commercial photo processing labs, image content owners, and targeted portal services (collectively, the “Retailer”). The PNI Digital Media Platform enables the Retailer to provide digital photo and personalized product services from desktops, kiosks, and mobile phones, through the Internet to end user customers. End user customers upload their digital images through the Internet via the Retailer’s website, or at a retail outlet through an in-store kiosk for printing and storage by the Retailer. The Retailer controls the process from image upload to final delivery of the end product. We act as a platform intermediary in the process, and as a “white label” solution are not visible to the end user customer unless the Retailer chooses to disclose us as the provider of their solution.

A. History and development of the Company

 

We were incorporated on December 1, 1995 pursuant to the laws of British Columbia, Canada under the name InMedia Presentations Inc. We changed our name on July 14, 1999 to PhotoChannel Networks Inc., and on June 8, 2009 we changed our name to PNI Digital Media Inc.

On July 2nd, 2007, we acquired Pixology Plc (“Pixology”), a company with offices based in the United Kingdom and a sales office in the United States. On March 11th 2009, we acquired WorksMedia Ltd. (“WorksMedia”), a United Kingdom-based software company with offices in Southampton, England.

On April 11th, 2013 we acquired Quarterhouse Software, Inc. (“Quarterhouse”), a software company based in Austin, Texas.

As of September 30, 2013, we had 34,299,471 common shares outstanding.

Our principal executive office is located at 590-425 Carrall Street, Vancouver, British Columbia, Canada V6B 6E3, our telephone number is 604-893-8955 and our website can be accessed at www.pnimedia.com.

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Important Events In the Development of Our Business

Important events in the development of our business are provided under Item 4.B., below, and in other sections of this filing.

Principal Capital Expenditures And Divestitures

We continue to develop, change and enhance our software and product offerings. Since October 1, 1999, the only capital divestiture has been the filing by our US operating subsidiary, PhotoChannel, Inc., under Chapter 7 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Connecticut, on November 1, 2001. The only capital expenditures have been for computer equipment, software and furniture and leaseholds, which occurred in the normal course of our operations. Our total capital expenditures were approximately $1,560,779 compared with $2,181,069 for the year ended September 30, 2012, and $2,399,316 for the year ended September 30, 2011. Prior to 2009 we financed capital expenditures primarily by issuing common shares. All expenditures subsequent to the year ended September 30, 2009 have been financed through cash flows generated from operations or financed through equipment leases. Further details applicable to our anticipated capital expenditures and funding sources are detailed in Liquidity and Capital Resources in Item 5.B.

Principal Capital Expenditures And Divestitures Currently in Process

As of December 1, 2013 there were no capital expenditures or divestitures in process outside of the normal course of business.

Public Takeover Offers

There have been no public takeover offers by third parties in respect of our shares.

Acquisitions of subsidiaries

Acquisition of Pixology

The Company acquired Pixology on July 2, 2007. Pixology had two principal product offerings –in-store kiosk technology and an online digital printing solution called the Pixology Online Photo Center, which is similar to our PNI Digtial Media Platform offering. Pixology’s focus was in the delivery of software for in-store kiosks, which enable customers in retail stores to upload their pictures for printing within such retail store, and for ordering gift items for future delivery. We acquired all of the outstanding shares of Pixology pursuant to a take-over offer, for a total purchase price of approximately $17,650,000 before direct costs associated with the acquisition, based on exchange rates at the time of take-up. We completed the acquisition of all of the outstanding shares of Pixology, and converted Pixology to a non-public company under the laws of the United Kingdom on October 27, 2007.

Acquisition of WorksMedia

On February 25, 2009, the Company acquired 100% of the issued and outstanding share capital of WorksMedia Ltd., a company based in Southampton, England. Under the terms of the Agreement, we paid the shareholders of WorksMedia Ltd. the Sterling equivalent of $2.1 million based upon the exchange rate published by the Bank of England on February 25, 2009 in thirteen equal monthly instalments and issued to the shareholders of WorksMedia 750,000 common

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shares of PNI Digital Media Inc. which were released to the former WorksMedia Ltd. shareholders in three equal instalments of 250,000 common shares after 12, 24, and 36 months after closing of the purchase, for all the issued and outstanding shares of WorksMedia Ltd.

WorksMedia Ltd. was a provider of software for in-store kiosks, with an existing deployment of WorksMedia software to more than 3000 kiosks.

Acquisition of Quarterhouse

On April 11, 2013, the Company acquired 100% of the outstanding shares of privately-held QS Quarterhouse Software, Inc. (“Quarterhouse”), a company based in Austin Texas. Quarterhouse is a leading developer of web-based-print on demand software for commercial printers and distributors. Quarterhouse earned approximately $430,000 in revenues in their most recent financially completed year. Under the terms of the Agreement, we purchased all outstanding shares for $500,000 in cash and up to $500,000 in earn out payments may be made over the 13 months following closing upon achievement of various milestones. These milestones are related to functionality designed software solution advances designed to benefit our entry into new revenue producing areas. As of September 30, 2013, $50,000 in earn out payments have been made. Subsequent to September 30, 2013, an additional $75,000 in earn out payments have been made.

B. Business Overview

 

Overview

The Company operates the PNI Digital Media Platform, which provides transaction processing and order routing services for major retailers. The PNI Digital Media Platform connects consumer ordered digital content, whether from in-store kiosks, online sites, desktop software or mobile devices, with retailers that have on-demand manufacturing capabilities for the production of merchandise such as photos and business documents. The Company successfully generates and routes millions of transactions each year for a range of retailers enabling thousands of locations worldwide.

The Company’s customers include some of the largest retailers on a worldwide basis, including, Costco, Walmart Canada, SAM’s Club, Blacks, Walgreens Co., CVS/Pharmacy, Tesco, Rite Aid and Fujifilm among others. In fiscal 2013, the Company won Office Depot and Samsung as new customers.

The Company’s core value proposition is to provide an effective and dynamic technology platform to allow its customers to transact and transport photo and digital media orders from the consumer, whether via a website over the internet, from an in-store kiosk or from a mobile device, to the retailers’ production facilities. The technology that delivers this end to end service is generically known as the PNI Digital Media Platform (the “Platform” or “Network”). The Company earns revenue through multiple channels, including recording transaction fees for all such orders that pass through the Network.

The Company’s goal is to provide leading retailers who have digital manufacturing facilities with the ability to produce merchandise on-demand from digital orders received via the internet or kiosk, including being able to support and enable one-hour photo operations.

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The Company has built its current business around the conversion of photography from film-based to digital-based and has positioned itself to be one of the most significant providers of internet infrastructure that facilitates the delivery of digital imaging from order origination to fulfillment through our relationships with large retailers.

The Company has invested in, and focused on building a future towards, enabling e-commerce for all types of digital content for the retailers’ ‘Media Center’. Up to fiscal 2011, the PNI Digital Media Platform was limited to providing transaction processing and order routing services associated with photo print and photo related gift products. During fiscal 2012, the Company completed its platform development to enable the launch of its business printing and social stationery initiatives in November 2011 and February 2012 respectively. The dollar value of online transactions processed over the Platform has increased by 5.3% due to our investments in mobile technologies. With the latest mobile Platform release and launch of the industry’s first full HTML 5 site, the Company believes it has leapt ahead of the competition. This is expected to enrich the end-customer experience, resulting in increased transactions.

The Company’s business is seasonal, with a significant proportion of the Company’s recurring revenues net income and operating cash flows generated during the first fiscal (fourth calendar) quarter. As a result, any stoppages or interruptions in the provision of the Company’s Platform to its customers during the first fiscal (fourth calendar) quarter could have an adverse effect on the Company’s operating results and its relationships with its customers.

Company Update

In November 2013, the Company announced it had launched the first generation HTML5 stationery, collage, and canvas solutions with select major retailers. HTML5 applications are important to PNI’s mobile strategy as they work across all mobile and tablet devices as opposed to the previous industry standard Adobe® Flash®. Providing applications that work across the mobile market, especially on tablets, is important for the Company’s future growth. According to a May 2013 forecast from the International Data Corporation (IDC) Worldwide Quarterly Tablet Tracker, tablet shipments are expected to grow 58.7% year over year in 2013 reaching 229.3 million units, up from 144.5 million units in 2012. IDC now predicts tablet shipments will exceed those of portable PCs in 2013. In addition, IDC expects tablet shipments to outpace the entire PC market (portables and desktops combined) by 2015.

Effective September, 1, 2013, PNI has successfully transitioned the last of its retailer agreements that based PNI”s compensation on a legacy image upload model to the Company’s preferred transaction revenue share model. The Company continues to see the photo-market moving from traditional prints to higher order value products such as photo books created with customer content pulled from cloud and social networks such as Dropbox, Facebook, Instagram, Google+ Photos, Google Drive, Flickr and SkyDrive which are all integrated to the PNI Platform through the Company’s API. With a transaction fee model, PNI is now better positioned to participate in the revenue growth our retailers continue to see in the overall photo market. The Company has been actively engaged in transitioning legacy contracts where compensation was based on the number of images uploaded, to a participation model which will allow PNI to share in the revenue growth its retailers are seeing in the photo market.

In October 2013, the Company announced it had signed a definitive two year agreement with Samsung Information Systems America Inc. (“Samsung”) to provide its mobile photo printing services as an embedded application on Samsung devices sold in the United States. This application will enable Samsung customers to route photos taken on their Samsung handset for

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printing at over 30,000 retail locations in the United States connected to the Platform, including major retailers such as Costco US, CVS, Rite Aid, Sam’s Club, Walgreens, and Wal-Mart US. PNI launched the beta version of the application in the fall of 2013, with PNI earning a fee on each transaction processed. The Company has also announced it has integrated the Wal-Mart US Photo API technology to the PNI Platform via the PNI Photo Services API. As a result, apps and solutions, along with apps and products from third parties subscribed to the PNI platform, can directly submit photo prints and products to more than 8,000 Wal-Mart locations nationwide, often ready for pick up in as little as one hour.

As of September 2013, PNI has launched either standalone mobile photo app or apps bundled within the retailer’s master app for Costco, CVS, Rite Aid, Tesco and Wal-Mart. From our first app deployment in July 2012 to September 2013, mobile revenue as a percentage of overall retailer revenue has increased from 0.6% to 7.2%.

In September 2013, the Company announced it has integrated the Walgreens QuickPrints Photo API technology to the PNI Platform via the PNI Photo Services API. As a result, apps and solutions, along with apps and products from third parties subscribed to the PNI platform, can directly submit photo prints and products to more than 8,000 Walgreens locations nationwide, often ready for pick up in as little as one hour.

In August 2013, the Company announced it had signed a definitive three year agreement with Office Depot to license the Platform to help grow their successful Copy and Print Depot services. Office Depot represents a new customer win for PNI and the Company expects to provide Platform technology and services for over 1,100 Office Depot Copy & Print locations by early calendar 2014.

In July 2013, the Company released its new PNI Mobile Photo Software Developer Kit (“SDK”), offering any app developer the ability to add PNI’s full featured mobile photo application within their own mobile app and instantly interface with PNI’s Platform. The SDK builds on the Company’s series of technical innovations to expand its web-to-store innovations, which includes the Platform API launched in February 2013 and further entrenches our position as the industry leader in this technology.

In June 2013, the Company further expanded its supported cloud capabilities by adding access to Microsoft SkyDrive to the Platform, enabling end-users to access content stored on SkyDrive and send for printing. Access to SkyDrive builds on the Company’s existing cloud capabilities which include Dropbox, Facebook, Instagram, Google+ Photos, Google Drive and Flickr. Access to these cloud sites improves the library from which end-users can pull content and is part of our strategy to grow our mobile channel.

In April 2013, the Company acquired all of the outstanding shares of privately-held QS Quarterhouse Software, Inc. (“Quarterhouse”), an Austin, Texas based company that is a leading developer of web-based-print on demand software for commercial printers and distributors. The initial focus will be on business printing. The Company expects the highly customizable content management systems and automation tools from Quarterhouse will enable the Company to realize operational improvements and allow us to target retailers of all sizes including varying regional retailers and multi-outlet franchisees. In return for $500,000 in cash, the Company acquired 100% of Quarterhouse outstanding shares upon closing. Up to $500,000 in earn out payments may be made over the 12 months following completion of the acquisition upon the achievement of various milestones related to advancing the software solution with functionality designed to

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benefit the Company’s entry into new revenue producing areas. Quarterhouse earned revenues of approximately $430,000 in their most recently completed fiscal year.

In April 2013, the Company launched the next generation of the PNI Platform with the implementation of a new photo site for Costco at www.costcophotocenter.com. This site is the first in the next-generation of technologies that PNI is investing in, including new photobook builders, and integration with cloud media providers such as Facebook, Dropbox and Picasa, new HTML5 uploaders, better product displays, improved user experiences and our next generation of content management systems.

In February 2013, the Company announced and deployed the new PNI Photo Services API that enables developers to add print-to-store features to their mobile or web apps and enable their users to submit photo print orders directly over the PNI Digital Media Platform for in-store printing in as little as one hour. The PNI Photo Services API provides a direct connection over the PNI Digital Media Platform to in-store print services across PNI’s retailer network and the ability for app developers to display store lists, locations, hours of service, real time product pricing. The Company has signed several partners to the API already including Smartphoto, Aperion, Wrappz, Gartner Studios, Skinit, and Case Mate.

Products

The PNI Digital Media Platform

On May 10, 2001 the first retail Platform members outfitted with their own branded Internet sites were activated onto our PNI Digital Media Platform. These retailers accept the upload of images that originate within digital cameras or mobile phones or have been uploaded from the in-store kiosk environment to sites we create and host. Our Platform is a transparent component to the consumer, existing solely as the technology backbone of the retailer’s digital imaging strategy. The service enables retailers to offer a variety of products to their customers, from standard 4x6 prints to various gift items as well as certain non-photographic based products such as business cards and stationery. The service is designed to prompt end users to purchase gift items in addition to their 4x6 prints, thus increasing sales for our customers and increasing our revenues.

Utilizing the capabilities of our Platform, we are an internet infrastructure company that owns retail relationships and manages a Platform environment that today is focused on delivering digital imaging and personalized product creation from order origination to fulfillment. We have developed a fully syndicated white branded site that allowed for orders to be placed online and then routed to a remote location for printing for ultimate pick up by the consumer at the store location of their choice.

Transactions being handled over our Platform has continued to increase significantly:

FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY2013
7.6 million 14.6 million 17.1 million 18.4 million 19.1 million 20.1 million

 

Our Platform is not restricted to the provision of digital imaging services. We can provide a range of personalized products that can be created, ordered and routed over the PNI Digital Media Platform to our customers. In 2008, we extended the PNI Digital Media Platform to include creation and on-demand ordering and routing of greeting cards from a website. This extension of the PNI Digital Media Platform has been populated across some of our existing retailers, and has

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also been used to acquire new retailer customers. The Company has recently directed a portion of its resources at investigating and developing other personalized products and services that can be offered over the Platform. After careful consideration of a number of options, the two areas chosen for development were small business printing and social stationery which were launched in the first and second quarter of fiscal 2012, respectively. Small business printing services allow the Company’s customers to offer an online service allowing consumers to order business collateral such as business cards, copies, flyers, letterhead and bound reports from their home or office and pick up the finished products in as little as the same day or next day from the retailer’s store location. Social stationery services allow the Company’s retailers to offer an online service providing personalised invitations and correspondence focused on life events such as weddings, birthdays, baby announcements etc.

In fiscal 2013, we launched the next generation of the Platform with the implementation of a new photo site for Costco, which includes integrations with cloud media providers such as Facebook, Dropbox, Picasa, new HTML5 uploaders, better product displays, improved user experiences, and out next generation of content management systems for better site merchandising. We partnered with Aperion Inc. to create rich libraries of themes and designs to be used as part of the Platform. We also launched the new PNI Mobile Photo SDK, which instantly connects to part of our Platform to any retailer who wants to drive profitable photo revenue as part of their mobile strategy. On October 15th, 2013, we announced our partnership with Samsung to connect users to retail photo printing solutions through their mobile phones on the PNI Digital Media Platform.

Pixology Kiosk Technology

With the acquisition of Pixology on July 2, 2007, we added kiosk software to our product offering. Pixology was focused exclusively on the photo product market and had developed software and networks that enable equipment manufacturers and retailers of photo products to substitute the analogue film environment with new digital infrastructure. Pixology’s customers were principally companies located in the United States, Japan and the United Kingdom, and include Costco in the United States.

Pixology had two principal product offerings – in store kiosk technology and an online digital printing solution which is similar to our Network offering. Pixology’s focus was in the delivery of software for in store Kiosks, which enable customers in retail stores to upload their pictures for printing within such retail store, and for ordering gift items for future delivery. In some instances, Pixology would also take on the responsibility for fulfilling the customer orders through the use of third party suppliers. Pixology had been providing this service in the retail environment for four years prior to our acquisition. We have taken over this service and provide it to a number of retail customers including Tesco and Costco. During the year ended September 2008 Jessops gave notice that they would not renew their contract at the end of its term in August 2009. In the last two fiscal years we have realized lower revenues in the former Pixology business resulting from changing fee structures of certain key customers while maintaining the same level if not higher services as well as the change in the kiosk operations..

WorksMedia Software Technology:

With the acquisition of WorksMedia Ltd on February 25th, 2009, we further extended the capabilities of the PNI Digital Media Platform by adding extensible rich-media software to kiosks, desktop software and online websites. The principal deployment of the WorksMedia software has been on in-store kiosks. This software differs from the solution acquired with Pixology, in that it is focused on rich-media experiences for the end user, and is highly portable

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across almost any medium, including mobile phones. Furthermore, the software, given the nature of its flexibility, can support the creation of personalized photo gifts or other personalized products beyond simple photo prints in a kiosk environment, thereby creating another “on ramp” to the PNI Digital Media Platform for personalized products.

WorksMedia provided the software solution to a range of retailers and resellers including Blacks Photography Corporation, Fujifilm UK, and others. On April 30th, 2009, we deployed the WorksMedia Software, now branded as the PNI Connected Kiosk(tm), with in-store kiosks in Fred Meyer grocery chains in the USA. On July 9th, 2009, we announced the addition of a series of resellers of the WorksMedia Software including Retail Imaging Management Group and Photo Gift World Ltd. The PNI Connected Kiosk is currently predominantly sold through distributor agreements in various countries around the world, including the United Kingdom, the United States, Canada, Australia, South Africa, Israel and Continental Europe.

PNI Photo Services Application Programming Interface

In February 2013, the Company announced and deployed its PNI Photo Services Application Programming Interface (“API”). The API enables developers to add a direct connection over the Platform to in-store print services across our retailer network.

Quarterhouse Software Technology

With the acquisition of QS Quarterhouse Software, Inc. on April 11th, 2013, we added capabilities for our business printing services. Quarterhouse develops highly customizable content management systems and automation tools that we expect will enable us to realize operational improvements and target retailers of all sizes. After this acquisition, we entered into a definitive agreement with AlphaGraphics of the Palm Beaches, for their use of the Quarterhouse software in their south Florida locations. The software will allow AlphaGraphics to offer its customers a new online business printing service that directly connects to its in-store printing capabilities. Additionally, we signed a definitive three year license agreement with Office Depot to provide Platform technology and services for over 1,100 Office Depot Copy & Print locations by early 2014.

Updated PNI Platform

In April 2013, we launched the new generation of our PNI Platform in implementing a new photo site for Costco. The new site provides an improved user experience and our next generation of content management systems by including new photo builders, integrating with cloud media providers, and providing better product displays and new HTML5 uploaders.

Expanded Cloud Capabilities

In June 2013, we further expanded our cloud capabilities by adding access to Microsoft SkyDrive to the Platform. This builds on our existing cloud capabilities and adds to the current library from which end-users can pull content to send for printing by including access to content stored on SkyDrive.

PNI Mobile Software Developer Kit

In July, 2013 we released our new PNI Mobile Software Developer Kit (“SDK”) offering any app developer the ability to add our full mobile photo application within their own mobile app. The

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SDK builds on our recent series of technical innovations to expand our web-to-store capabilities. We also launched an all-new Tesco Photo Prints mobile app for Android for Tesco. The new app allows Tesco customers to upload photos from their mobile device for printing in as little as one hour from 120 participating Tesco photo centers nationwide.

Summary of Gross Revenues

During the three years ended September 30, 2013 our revenue was generated as follows:

  For the Year ended September 30,
  2013 2012 2011
Canadian based operations $19,206,634 92% $18,920,053 83% $18,742,467 79%
United Kingdom based operations 1,692,570 8% 3,792,752 17% 4,943,884 21%
Total Revenue $20,899,204   $22,712,805   $23,686,351  

 

Competition

The digital photography market is intensely competitive with a wide range of companies competing for market share through various avenues. PNI does not have a consumer facing business model, instead positioning itself behind the established brand names of major retail partners. By positioning itself in such a manner, the Company is able to reduce some of its business risk as it is able to reduce reliance on one particular market segment or geographic concentration and does not have to concentrate on building consumer brand awareness of its own.

Direct competitors in the market who also provide digital print services on behalf of retailers include Snapfish (a division of Hewlett Packard), LifePics, and Storefront.com Online Inc.. The competition for in-store kiosk software is provided by companies such as Hewlett Packard, Lucidiom, Storefront.com Online Inc., Kodak, DNP Photo Imaging and Fujifilm. Although there continues to be an increased trend of business being conducted over the internet and away from the traditional store environment, a significant portion of photo and photo related business is still conducted in-store through kiosk interfaces and the Company believes there remains significant business potential to increase market share and revenue by connecting kiosk-based interfaces to the PNI Digital Media platform.

Online photo print services

Internet photography service providers offer different services, some associated with photo products, personalized photo gifts, stationery and small business printing collateral, others with archiving and sharing, and some provide a comprehensive photo community service. The following are the common services provided:

  • Content - the ability to offer uploading of digital images through various devices, as well as image enhancing options. Internet portals can charge for the uploading service or provide it free of charge. Some companies offer the content for online photography community sites, promoting photographic education via articles and photo-magazine subscriptions or via a chat platform and lectures with professional photographers.

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  • Sharing/Albums - via the creation of albums and archives, many of the sites offer the ability to view and share photos.

  • Photofinishing - is generated through prints, reprints, enlargements, gift items and sales of photo hardware and supplies.

  • Community - communities offer an interactive location where the user can find a one-stop- shop catering to photography.

We offer all of these services, except community and related content/education, through our syndicated websites.

Printing of Digital Images

We provide an open, scalable and secure network for the retailers in the print-on-demand product industry. Some companies like Shutterfly and Snapfish provide both online consumer websites that compete with Retailers, while also providing technology services to Retailers. Our kiosk business model going forward is one of connecting with our Platform to offer a online and in-store digital imaging solution. This solution will provide the same look and feel to the consumer whether they are ordering prints online or in-store from the kiosk. It will permit the consumer to access their online account from the in-store kiosk. This advantage will allow consumers to order prints and gifting products from their online albums while in the store or upload digital images from the kiosk into their online album(s) saving all in one step. We believe consumers, as with the automated banking machines, will continue to utilize the in-store kiosk even as the use of online becomes more common practice.

Our most significant online competitor is HP’s Snapfish. Prior to HP’s acquisition of Snapfish in 2005, Snapfish was focused on a pure business to consumer model, competing with Kodak’s Ofoto (at the time) and Shutterfly. During 2005, Snapfish entered the distributed printing model (as used by us) when it signed Costco USA. Immediately thereafter it was purchased by HP for an undisclosed amount. Although Snapfish now competes with us under a distributed printing model for retailers they continue to operate their business to consumer (“mail order”) model, which is in essence a competitor to the retailers that they aspire to contract with.

While Shutterfly’s direct to consumer model differs from ours, they do compete directly with our retailers for market share of the online photo print services market. Shutterfly also offers its products and services as an affiliate or vendor provider to our Retailers.

Our most significant kiosk competitor is Kodak with more kiosks in the marketplace today than any other manufacturer. We believe that going forward we will have an advantage over Kodak with an integrated online/kiosk solution, at which time our main competitor may become HP as it too has a kiosk technology similar to ours but still mandates that the retailer buy kiosk hardware to get the HP software experience. Other kiosk manufacturers are Fujifilm, Lucidiom, DaiNippon Print (DNP), HP and Beaufort.

Retailers offering photo products are our key customers, however, in some instances we provide services to the ultimate customer through an arrangement whereby we pay the retailer a fee for the use of their website and take on the responsibility for the fulfillment of print orders, the provision of certain consumer deliverables and other media through the use of third party suppliers. Organizations such as Kodak, Fujifilm, Hewlett Packard and DaiNippon also compete with our service in varying manners, but all also work with retailers in terms of providing

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equipment to scan silver halide images to digital, digital print equipment and some provide online storage and web site hosting. We believe that we can co-exist in many retail environments with these other industry players without directly competing with them, as our services are independent of the type of digital imaging hardware the retailer prefers to use. We also believe that we can deliver the secure network component and lab broker system of delivering print orders from outside parties without having to compete on the equipment, hosting and storage business. Some larger retailers have created internal networks, however, such networks are restricted to that retailer’s stores.

One of our strengths is that we offer a complete solution that creates a secure and open network and kiosk software, both of which are agnostic to the brand of digital minilabs and kiosk hardware being utilized by the digital imaging retailer. This allows different retailers and web properties to do business together if they so desire. Our business model allows us to create a multi-dimensional digital image solution.

Our current customers, when given the alternative of “white labelling”, have gravitated quickly toward our solutions of technology coupled with our private label branding, service and flexibility. Retailers offering photo products need innovative digital imaging goods and services.

We believe that one of differentiating factors is the advantage of being a small and efficient organization to make speedy and informed decisions. This flexibility means the retailer or their customer does not have to go through levels of bureaucracy to get a decision, act upon it and have a solution implemented. We believe that the principal factors enabling us to compete, include: a complete solution service; strategic market positioning; channel distribution; and the functionality of our technologies. The relative importance of each of these factors depends upon the specific customer involved.

C. Organizational structure

 

We have four (4) wholly owned subsidiaries, PNI Digital Media Ltd (formerly Pixology Limited). PNI Digital Media Europe Ltd. (formerly Pixology Software Limited), and QS Quarterhouse Software, Inc. are all active and WorksMedia Limited is dormant. We acquired Pixology Limited and Pixology Software Limited in connection with the acquisition of Pixology Plc that was completed in July 2007. We acquired WorksMedia Limited as part of the acquisition of the WorksMedia business that was completed in March 2009. Our U.K. and kiosk operations are operated out of PNI Digital Media Europe Ltd. Finally, we acquired all outstanding shares of QS Quarterhouse Software, Inc. in April 2013.

 
D. Property, plant and equipment

 

Our executive offices are located at Suites 590 and 100 – 425 Carrall Street, Vancouver, British Columbia, Canada, V6B 6E3. The premises currently comprise approximately 20,477 square feet in an office building and are leased from an unaffiliated party. The company’s main lease expires in July 2023. The base monthly rent is approximately $25,206.

Our Platform equipment is located at TELUS Corporation’s co-located hosting facilities, which are located at 73 Laird Drive, East York, Ontario, Canada. The premises are under contract from an unaffiliated party for a period of forty-seven months. The lease expires on November 20, 2015. The base monthly rent in Toronto, including prepaid monthly bandwidth usage of 400 Mbps, is approximately $158,378.

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Our United Kingdom offices are located at Suite 4, Medina Chambers, Town Quay, Southampton, SO142AQ UK. The premises are shared with another company which is part owned by an officer of the company and comprise a total of 3,350 square feet in an office building. Our UK operations use approximately 50% of this space. The lease agreement for the premises is held by the related party directly with the owners of the building and we reimburse the related party for our share of the monthly rental costs in accordance with a services agreement that was put in place at the time of acquiring WorksMedia. The base monthly rent is approximately $4,800.

Our United Kingdom data base and network equipment is located in two data facilities: Redbus, Sovereign House – Interhouse, 227 Marsh Wall, London E14 9SD; and Telehouse Docklands, Coriander Avenue, London E14 2AA. The premises are under contract from unaffiliated parties for a period of thirty-six months expiring February 2009. Subsequent to the expiration of this three-year agreement, the Company is continuing to use the data facilities on a month-to-month basis. The base monthly rent is approximately $14,200.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

General

This section contains forward-looking statements involving risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under Item 3.D – Risk Factors. In this section, we explain our consolidated financial condition and results of operations for each of the years ended September 30, 2013, 2012 and 2011. As readers read this section, they may find it helpful to refer to our consolidated financial statements included in Item 18 of this annual report and the information contained in the section entitled “Selected Financial Data” in Item 3 of Part I of this annual report.

As required by the Canadian Accounting Standards Board, the Company adopted IFRS on October 1, 2010 and the Company’s financial information for 2011 has been prepared on a retrospective basis to comply with IFRS.

Critical Accounting Policies

The significant accounting policies used in the preparation of these consolidated financial statements are as follows:

a) Intangible Assets

 

(i) Identifiable intangible assets

 

Intangible assets acquired in a business combination that meet the specified criteria for recognition, apart from goodwill, are initially recognized and measured at fair value. Intangible assets with finite useful lives, including acquired software, software developed for internal use and customer relationships, are amortized on a straight-line basis over their estimated useful lives as follows:

 

Acquired software 3 years
 
Customer relationships 3 years

 

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Internal use software 1-3 years

 

Amortization of intangible assets is included within cost of sales. The amortization methods and estimated useful lives of intangible assets are reviewed annually or earlier if events and circumstances change.

 
(ii) Software development costs

 

Software development costs includes the costs to customize aspects of the Company's PNI Network software for specific customers as well as the cost of generating the Company's software used in the PNI Network and software sold to customers. For costs incurred to generate software used in the PNI Network or sold to customers, the Company classifies costs into a research phase and a development phase. Costs incurred during the research phase are expensed when incurred as the Company is not able to demonstrate that the software will generate future economic benefits. Costs incurred during the development phase are recognized as intangible assets only if the Company can demonstrate the asset meets the criteria laid out under the relevant standards.

During the year ended September 30, 2013, no internal development costs were capitalized as these costs did not meet the criteria for capitalization (2012: $508,806, 2011: $186,426), based on lack of certainty over the achieving future economic benefits from these activities.

. During the year ended September 30, 2013, the Company expensed $9,907,590 in software development expenses (2012: $9,678,638, 2011: $9,439,423). These costs principally consist of staff and consulting costs associated with the day to day operations of the Company including customizing aspects of the Company’s PNI Network software for specific customers, generating and maintaining the Company’s software used in the PNI Network and exploring new initiatives.

(iii) Goodwill

 

Goodwill represents the excess of the purchase price of an acquired enterprise over the fair values assigned to the identifiable net assets of the acquired enterprise at the date of acquisition. Goodwill is allocated to each cash-generating unit (“CGU”) or group of CGUs that are expected to benefit from the related business combination. The allocation of goodwill to cash generating units reflects how goodwill is monitored for internal management purposes. A group of CGUs represents the lowest level within the entity at which the goodwill is monitored for internal management purposes, which is not higher than an operating segment. The Company’s CGUs are PNI Canada (its Canadian operations) and PNI Europe (its European operations). Goodwill is not amortized, and is carried at cost less accumulated impairment losses, if any. Management reviews the performance of its cash generating units based on geography, which is also at the operating segment level. Irrespective of any indication of impairment, the recoverable amount of the cash generating unit or group of cash generating units to which goodwill has been allocated is tested annually for impairment or more frequently if there is an indication that the goodwill may be impaired in accordance with “impairment of non-financial assets.” The carrying value of goodwill is compared to the recoverable amounts, which is the higher of the value in use and the fair value less costs to sell. Any impairment is recognized in expense immediately and is not subsequently reversed.

 
b) Impairment of non-financial assets

Property and equipment and intangible assets are tested for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Long lived assets that

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are not amortized are subject to an annual impairment test. For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows (CGUs). The recoverable amount is the higher of:

  • An asset’s fair value less costs to sell; and

  • Value in use (being the present value of the expected future cash flows of the relevant asset or CGU).

The impairment test methodology is based on a comparison between the higher of fair value less costs to sell and value-in-use of each of the Company's CGUs and the net asset carrying values, including goodwill, of the Company's CGUs. An impairment loss is recognized if the carrying amount of a CGU exceeds its estimated recoverable amount. Value in use is determined as the present value of the future cash flows expected to be derived from an asset or cash generating unit. Estimated future cash flows are calculated using estimated future prices, operating and capital costs.

An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount.

The Company evaluates impairment losses, other than goodwill, for potential reversals when events or circumstances warrant such consideration.

It is possible that some of our tangible or intangible long-lived assets or goodwill could become impaired in the future and that any resulting write-downs could be material.

c) Current and deferred income taxes

 

Income tax comprises current and deferred tax. Income tax is recognized in the statement of operations and comprehensive loss except to the extent that it relates to items recognized directly in other comprehensive income or directly in equity, in which case the income tax is also recognized directly in other comprehensive income (loss) or equity, respectively.

Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted, at the end of the reporting period, and any adjustment to tax payable in respect of previous years. As at September, 2013, the Company has not incurred any taxes payable (2012: $nil, 2011: $nil).

Deferred tax is recognized, using the balance sheet liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for operating losses or tax credits. Deferred income tax is determined on a non-discounted basis using tax rates and laws that have been enacted or substantively enacted at the balance sheet date and are expected to apply when the deferred tax asset is realized or liability is settled. Deferred tax assets are recognized to the extent that it is probable that future taxable profit will be available against which the deductible temporary differences can be utilized.

Deferred income tax assets and liabilities are presented as non-current.

Revenue

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    The Company provides online and in-store digital media solutions to retailers. These solutions are primarily provided through the PNI Digital Media Network services (Network Services). The Company also provides professional services and sells software products to retailers either directly or through license and distribution agreements. The products sold do not have any general rights of return except under arrangements whereby the Company provides the product to the ultimate customer.

    Through Network Services, the Company’s customers obtain access to the PNI Digital Media Platform (Platform) which provides the technology which delivers media transactions between retailers and content providers and their consumers. The Platform provides a transaction and order routing tier which delivers orders placed either through online sites, mobile devices or kiosks to the production facilities of the Company’s customers for production and delivery to end consumers. Through the Platform, customers are able to store, edit, archive, distribute and print photographs and other personalized products. The Company does not produce the content, but may act as an agent for certain retailers for some consumer deliverables. The Network Services provided by the Company may include the software, hosting, storage and archiving facilities, ongoing development up to a specified threshold of hours, initial integration of the software into the customer’s environment, technical support, maintenance services and hardware. Fees for these services are paid through fixed and variable fees. The variable fees are based on different factors and may be based on the number of physical locations connected to the Network, the number of transactions processed through the Platform, the number of images uploaded through the Platform, a percentage of revenue earned by its customers and the amount of storage capacity used in excess of minimums provided in the contract. The Company accounts for the Network Services as a single unit of accounting.

    In some instances, the Company provides services to the ultimate customers who access the PNI

    Network through a retailer’s website. These services include taking on the responsibility for the fulfillment of print orders, the provision of certain consumer deliverables and other media. The Company pays the retailer a commission for the use of their website and other services provided by the retailer. The Company is responsible for fulfilling the ultimate customers’ orders and fulfills its obligations through the use of third party suppliers who ship the products directly to the customer. Revenue is recognized when the product is shipped, net of estimated returns, as the Company has transferred the significant risks and rewards of ownership to the customer at that time. The Company estimates the provision for returns based on historical experience and adjusts to actual returns when determinable.

    The Company provides professional services in addition to the initial integration services to make changes to the customer’s website and branded environment and to provide email marketing programs to customers. Revenue is considered realized or realizable and earned when all of the following criteria are met: (i) Persuasive evidence of a sales arrangement exists; (ii) Delivery has occurred or services have been rendered; (iii) The price is fixed or determinable; and (iv) Collectability is reasonably assured.

    Cash received from customers prior to the related revenue being recognized is recorded as deferred revenue. In addition to this general policy:

    • Fees earned for software licenses relate to the sale of software either directly to retailers or to distributors for resale to retailers for use in-store, allowing end users to edit and order prints and other photo-related items from digital images. Revenue from these arrangements that involve multiple elements are reviewed to determine whether a delivered item(s) has value to the customer on a stand-alone basis and whether there is objective and reliable evidence of the fair

    35





    value of the undelivered item(s). If these criteria are met, the Company allocates revenue using the relative fair value of each element within the contract that has stand-alone value, such as software products, post contract customer support and maintenance. In instances, where the Company has evidence of the fair value of each element within a multiple deliverable arrangement, revenue is recognized upon the delivery or rendering of service(s) with respect to each section as there is no general right of return. Revenue for perpetual software licenses is recognized upon delivery, as the license holder is not obligated to pay maintenance for the ongoing use of the license. Maintenance fees are recognized on a straight line basis over the term of the maintenance service period. If the fair value of the delivered item is not obtainable, the Company allocates revenue using the residual method in instances where the fair value of the undelivered item is verifiable. The Company does not currently have any multiple deliverable arrangements which require the use of the residual approach.

    • Installation fees are fixed upfront fees related to Network Services which are deferred and recognized on a straight-line basis over the life of the agreement, or where the agreement with the customer is on a month-to-month basis, over the estimated life of the customer relationship period. The customer relationship period is assessed annually, and has been estimated to be 24 to 48 months.

    • Monthly fixed fees per connected location are recognized monthly and are included in membership fees.

    • Fees for storing and archiving digital images for customers in excess of the minimums provided in the agreement are based upon our customers storage capacity needs, and are recognized as the storage is provided and are included in archive fees.

    The Company offers volume and other rebates and discounts to certain customers which are recognized as a reduction of revenue at the date the related revenue is recognized or the date the offer is made for previously recognized revenue. The amount of rebates is based on estimates of the expected rebates to be paid based on historical and expected trends or on the maximum potential rebates that could be earned by a customer if the Company is unable to reasonably estimate the expected rebate. The Company accounts for cash consideration offered to customers, including annual volume discounts, as a reduction in sales revenue. All revenues are reported net of sales and value added taxes.

    Trade accounts receivable balances are shown net of allowances for doubtful accounts.

    Cost of sales

    Cost of sales is comprised of costs associated with providing hosting services to our customers, customer support provided on behalf of our customers, and costs of products sold as it relates to instances where the Company is responsible for fulfillment of certain items sold. Hosting services include costs for renting our data centers, personnel costs associated with maintaining and monitoring the performance of our network, personnel and consulting costs associated with maintaining our customer’s sites and third party software licenses used in maintaining the performance of our network and platform. In addition, cost of sales includes amortization associated with property and equipment used in our data centers, amortization associated with acquired software, customer relationships and internal use software relating to generating revenue.

    Share-based payment

    36





      The Company’s share-based awards may take the form of stock options, Performance Share Units (“PSU”), and Restricted Share Units (“RSU”) which are granted to directors and certain employees of the Company as an element of compensation. The cost of the service received as consideration is measured based on an estimate of fair value at the date of the grant. The grant-date fair value is recognized as compensation expense over the related service period with a corresponding increase in contributed surplus. If graded awards are granted, each vesting tranche is accounted for as a separate award. Compensation expense is recognized for awards expected to vest over the applicable vesting period with a corresponding increase in contributed surplus.

      On exercise of stock options, the Company issues common shares from treasury and the consideration received together with the compensation expense previously recorded to contributed surplus is credited to share capital. On vesting of PSUs and RSUs, the Company issues common shares from treasury and the compensation expense previously recorded to contributed surplus is credited to share capital. All awards are equity settled.

      The Company uses the Black-Scholes option pricing model to estimate the fair value of each stock option. The Black-Scholes option pricing model requires the Company to estimate the expected term of the options granted, the volatility of the Company’s common shares, forfeitures, and an expected dividend yield. The Company estimates the expected term of the options granted by considering the Company’s historical experience involving stock option exercise; cancellations and expiries; volatility is estimated with reference to historical volatility data; forfeitures are estimated with reference to historical forfeiture data. The Company does not currently anticipate paying any cash dividends in the foreseeable future and therefore has used an expected dividend yield of zero as detailed in note 15b. The Black-Scholes model also requires the Company to input a risk-free interest rate and the Company uses the Bank of Canada marketable bond rates.

      The fair value of each PSU and RSU awarded is based upon the quoted price of the Company’s stock on the date of grant. All PSU and RSU awards are equity settled. As it relates to PSUs and RSUs, the Company estimates the expected forfeiture rate and no value is attributed to awards that the employee is expected to forfeit as a result of not achieving the service or performance conditions. The expected forfeiture rate is adjusted for actual forfeitures when they occur.

      A. Operating results

       

      Operational Highlights for 2013

      • We processed a record 20.1 million transactions during fiscal 2013, as compared to 19.1 million during fiscal 2012. In addition, we processed $248.7 million in online transactions over our platform on behalf of our retail partners, as compared to $236.2 million during fiscal 2012, evidencing the continued growth of the online photo business across our platform.

      • Revenue for fiscal 2013 was $20.9 million, as compared to $22.7 million in fiscal 2012, an 8% decrease. The decrease in revenues as compared to the prior year is due in part to the renegotiation and three year extension of our agreement with our largest UK based retail partner, which has also been the fastest growing photo business across our customer base. These new terms came into effect in July 2012. Also impacting revenues were lower upload fees from customers where we are compensated on an upload model, and reduced revenues from ASDA Stores Ltd. for whom we no longer provide online photo services. Effective September 1, 2013, all customers contracts in which we had previously been compensated on the basis of each image uploaded the PNI Platform had been transitioned to a transaction fee model.

      37





      • Transaction fees represented 78% of total revenue, as compared to 78% during the same period of fiscal 2012.

      • Cash was $2.4 million at September 30, 2013, as compared to $4.6 million at September 30, 2012.

      • Generated loss before taxes for fiscal 2013 of $4.8 million, as compared to a loss before taxes of $2.3 million in fiscal 2012.

      • Non-IFRS adjusted EBITDA1 for fiscal 2013 resulted in a loss of $1,692,970, compared to a non-IFRS adjusted EBITDA of $1,464,784 during the fiscal 2012. The reduced adjusted EBITDA in the current period is a reflection of the lower revenues earned as well as higher personnel costs, higher legal and accounting fees, and higher one-time direct costs associated with the reprinting of certain items sold. In addition, the year ended September 30, 2012 $695,232 of personnel costs were capitalized as internal use software, whereas no comparable costs were capitalized in the year ended September 30, 2013. Also negatively impacting adjusted EBITDA in the year were higher legal costs associated with the acquisition of Quarterhouse as well as legal fees associated with defense of certain patent infringement claims, one of which was settled during the year.

      1 – Adjusted EBITDA is a non-IFRS financial measure which the Company defines as net profit plus amortization, impairment, interest expense, tax expense, share-based compensation expense and un-realized foreign exchange loss (gain).

      Selected Information

      The following table sets forth selected consolidated annual financial information of the Company for, and as of the end of, each of the last three fiscal years. The selected consolidated financial information should be read in conjunction with the consolidated financial statements of the Company:

            September 30,    
        2013   2012   2011
        IFRS   IFRS   IFRS
        $   $   $
      Net (loss) income (7,667,330 ) (4,122,653 ) 1,099,600
      Net (loss) income per share (0.22 ) (0.12 ) 0.03
      Total cash and cash equivalents 2,425,106   4,611,824   3,936,176
      Working capital 1,211,166   4,779,791   5,397,594
      Total assets 14,751,232   19,964,896   22,472,894
      Total liabilities 6,912,653   5,145,684   3,568,532
      Shareholders’ equity 7,838,579   14,819,212   18,904,362

       

      Year Ended September 30, 2013

      For the year ended September 30, 2013, the Company had a net loss of $7, 667,330 or $0.22 per share compared to a net loss of $4,122,653 or $0.12 per share with the corresponding period in 2012.

      38




      Revenues

      Revenues for the year ended September 30, 2013 were $20,899,204 reflecting a decline of $1,813,601 or 8% from revenues generated in the year ended September 30, 2012 of $22,712,805.

      The decrease in revenue, despite increased transactions over the Platform, was due to $2,100,182 lower transaction revenue generated in the United Kingdom, which is predominantly the result of the renegotiation and three-year extension with our largest UK based retail partner which became effective in July of 2012, and reduced revenues from ASDA Stores Ltd. for whom we no longer provide online photo services.

      Also impacting the lower transaction revenue in the current periods were lower upload fees from customers where we are compensated on an upload model, offset by higher revenues generated from mobile devices.

      Cost of sales decreased to $10,401,693 for the year ended September 30, 2013, from $10,458,022 for the year ended September 30, 2012, a decrease of $56,329, or less than 1%, due to lower property and equipment amortization, intangible asset amortization, offset by higher employee expenses, and licensing costs.

      In 2013, the Company recorded an impairment charge of $594,851 (2012: $77,382) which arose in the European CGU, resulting in the carrying amount if the CGU written down to its recoverable amount and included the full write off of the goodwill amount. No further write down in CGU considered necessary as the remaining assets all liquid and at fair value. The impairment charge was recorded in cost of sales on the consolidated statements of operations and comprehensive (loss) income. In 2012, the Company recorded a non-cash intangible asset impairment loss of $540,736 primarily due to underperforming revenues associated with previously capitalized internal use software in our Canadian operating segment.

      Operating expenses

      Software development expenses increased to $9,907,590 for the year ended September 30, 2013, from $9,678,638 for year ended September 30, 2012. The increase of $228,952, or 2%, was mainly driven by $695,232 of capitalized personnel costs associated with the development of internal use software in fiscal 2012. If these costs had not been capitalized last year, current period total software development expenses would have decreased over the prior year by $466,279 as compared to 2012. This decrease is due to lower employee expenses. During 2013 we completed some of our major initiatives in mobile, cloud media, HTML5, and our API, which we anticipate will help drive a return to growth in the 2013 holiday season. As a result, we have begun scaling back our outsourced development teams.

      General and administration expenses decreased to $3,591,014 for the year ended September 30, 2013, as compared to $3,768,203 for the year ended September 30, 2012. The decrease of $177,189, or 5%, was mainly due to lower employee expenses, including stock based compensation, lower board fees, and lower bad debt expense, offset by increased legal costs associated with the acquisition of Quarterhouse as well as legal fees associated with defense of certain patent infringement claims, one of which was settled during 2013.

      39





      Sales and marketing expenses increased to $1,474,749 for the year ended September 30, 2013, from $1,038,374 for the year ended September 30, 2012. The increase of $436,375, or 42%, was due to higher personnel costs, including severance.

      Other income and expenses

      During the year ended September 30, 2013, the Company recorded an unrealized foreign exchange loss of $542,234, and a realized foreign exchange gain of $58,621. The unrealized loss arose primarily as a result of the translation of intercompany balances between the UK subsidiaries and the Canadian parent, while the realized gain was the result of favorable changes in Canadian dollar between the time sales invoices were raised and the receipt of funds.

      Income Taxes

      During the year September 30, 2013, the Company recorded an income tax expense in the amount of $2,822,517 compared to the recognition of an income tax expense during the year ended September 30, 2012 of $1,814,221. The Company’s net deferred tax asset as at September 30, 2013 is $2,214,519. The Company also recorded a net deferred tax liability of $502,250 associated with the Quarterhouse acquisition. Company expects to utilize the net deferred tax asset through a combination of retaining existing customers and closely monitoring controllable cash costs. The Company expects to utilize the majority of the net deferred income tax asset over the next five to seven years.

      Year Ended September 30, 2012

      For the year ended September 30, 2012, the Corporation had a net loss of $4,122,653 or $0.12 per share compared to a net profit of $1,099,600 or $0.3 per share with the corresponding period in 2011.

      Revenues for the year ended September 30, 2012 were $22,712,805 as compared to $23,686,351 for the year ended September 30, 2011.

      Income tax expenses for the year ended September 30, 2012 were $1,814,221 as compared to a an income tax recovery in the amount of $1,299,025 for the year ended September 30, 2011.

      Total expenses and cost of sales for the year ended September 30, 2012 were $24,943,237 as compared to $23,755,029 in the corresponding period of 2011. The increase was predominantly due to our continued investment in social stationery and business printing in order to meet our planned roll out of our new offerings with additional customers.

      Critical Accounting Estimates

      The Company prepares its financial statements in accordance with International Financial Reporting Standards (“IFRS”). The preparation of consolidated financial statements in conformity with IFRS 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 period. Estimates are based upon historical experience and various other assumptions that are believed to be reasonable under the circumstances. These estimates are evaluated on an ongoing basis and form the basis for making judgments regarding the carrying values of assets

      40





      and liabilities and the reported amount of revenues and expenses. Actual results may differ from these estimates under different assumptions.

      Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods, if the revision affects both current and future periods.

      Refer to Critical Accounting policies for Estimated Impairment of Goodwill, Recoverability of Deferred Income Tax Assets and Share Based Payments.

      Estimated impairment of goodwill

      The Company tests annually whether the goodwill has suffered impairment, in accordance with the accounting policy states in note 2. The recoverable amount of the cash generating unit have been determined based on the higher of the value in use calculations and the fair vale less costs to sell.

      The Company assessed the carrying values of goodwill, which is allocated to the Company’s European operating segment. An impairment charge of $594,851 (2012: $77,382) arose in the European CGU, resulting in the carrying amount if the CGU written down to its recoverable amount and included the full write off of the goodwill amount. No further write down in CGU considered necessary as the remaining assets all liquid and at fair. The impairment charge was recorded in cost of sales on the consolidated statements of operations and comprehensive loss.

      The impairment test was based on the value in use or fair value as applicable. The impairment test methodology is based on a comparison between the higher of fair value less costs to sell and value-in-use and the net asset carrying values, including goodwill. An impairment loss is recognized if the carrying amount exceeds its estimated recoverable amount. Estimates used to determine value in use are reviewed annually and updated based on facts and circumstances. The calculation of value in use was based on the following key assumptions:

      • Cash flows were projected based on past experience, actual operating results and planned results for the near term. Terminal value calculations for the cash generating unit were extrapolated using a constant growth rate of 3%.

      • The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. Risks specific to the assets of these units have not been included within the calculation of the discount rates used, but have been factored into the cash flow projections.

      • The net present value of the future expected cash flows was compared to the carrying value of the Company’s investment in these units, including goodwill, at year-end.

      Share-based payments

      The Company’s share-based awards may take the form of stock options, Performance Share Units (“PSU”), and Restricted Share Units (“RSU”) which are granted to directors and certain employees of the Company as an element of compensation. The cost of the service received as consideration is measured based on an estimate of fair value at the date of the grant. The grant-date fair value is recognized as compensation expense over the related service period with a

      41





      corresponding increase in contributed surplus. If awards are granted, each vesting tranche is accounted for as a separate award. Compensation expense is recognized for awards expected to vest over the applicable vesting period with a corresponding increase in contributed surplus.

      On exercise of stock options, the Company issues common shares from treasury and the consideration received together with the compensation expense previously recorded to contribute surplus is credited to share capital. On vesting of PSUs and RSUs, the Company issues common shares from treasury and the compensation expense previously recorded to contributed surplus is credited to share capital. All awards are equity settled.

      The Company uses the Black-Scholes option pricing model to estimate the fair value of each stock option. The Black-Scholes option pricing model requires the Company to estimate the expected term of the options granted the volatility of the Company’s common shares, forfeitures, and any expected dividend yield. The Company estimates the expected term of the options granted by considering the Company’s historical experience involving stock option exercise; cancellations and expiries; volatility is estimated with reference to historical volatility data; forfeitures are estimated with reference to historical forfeiture data. The Company does not currently anticipate paying any cash dividends in the foreseeable future and therefore has used an expected dividend yield of zero as detailed in note 14b of the Company’s financial statements. Black-Scholes model also requires the Company to input a risk-free interest rate and the Company uses the Bank of Canada marketable bond rates.

      The fair value of each PSU and RSU awarded is based upon the quoted price of the Company’s stock on the date of grant. All PSU and RSU awards are equity settled. As it relates to PSUs and RSUs, the Company estimates the expected forfeiture rate and no value is attributed to awards that the employee is expected to forfeit as a result of not achieving the service or performance conditions. The expected forfeiture rate is adjusted for actual forfeitures when they occur.

      Recoverability of deferred income tax assets

      The amount recognised as deferred tax is generally determined utilising undiscounted cash flows aligned with estimates used in assessing the impairment of goodwill. Management considers all factors that could affect the probability that future taxable profits will be available. The factors include profitability of operations, estimate of terminal value, which is calculated consistently with the terminal value used to assess the carrying value of long-term assets, and customer renewal rates. The amount recognised is sensitive to the loss of certain key customers.

      Based on management’s analysis, the Company reduced the value of its deferred tax assets in its Canadian and European operations totalling $2,822,517 (2012: $1,814,221). This change is a result of lower projected revenues as the company experiences certain challenges from certain customers in the form of changing fee structures while maintaining the same level of services if not higher. Certain of these contracts were renegotiated in the current year which gave rise to the changes in management’s estimates and the resulting reduction of the deferred tax asset.

      B. Liquidity and Capital Resources

       

      Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with its financial liabilities that are settled by delivery of cash or other financial assets. The Company's approach to managing liquidity risk is to ensure it has sufficient cash available to manage the payment of its financial liabilities. The Company has the Revolving Demand Facility in place to help manage its liquidity position, thus its liquidity position is not solely dependent on

      42





      its overall volume of business activity and its ability to manage the collection and payment of its accounts receivable and accounts payable through cash flow management techniques.

      During the year ended September 30, 2013 its working capital decreased to $1,211,166. The Company's liquidity position may fluctuate during the year due to a number of factors which could include unanticipated changes to its volume of business, credit losses and the extent of capital expenditure in the year. The Company's liquidity position may also be adversely impacted by the seasonal nature of its business with the Company's busiest period of activity typically during the first quarter of the fiscal year. As the Company has a concentration of business with select key customers, its liquidity position would be adversely impacted if one of its key customer relationships was discontinued.

      The Company primarily monitors its liquidity position through forecasting expected cash flows based on the timing of expected receipts and payments. Management monitors its cash balances and projections on a weekly and monthly basis. The starting point for its analysis is based upon the contractual maturity date of its liabilities and its expected collection period for its receivables. The Company has a positive working capital position of $1,211,166 at September 30, 2013 and it manages the payment of its financial liabilities based on available cash and matching the settlement of its financial liabilities to realized financial assets. The Company also monitors its debtor collection as described in the credit risk note below. As the Company's revenues are primarily collectible within 30 days of invoicing, which is performed weekly for some customers and monthly for others, the Company aims to be able to collect its accounts receivable more promptly than it settles its third party accounts payable. However, as certain of the Company's operating expenses such as its payroll obligations are contractually due at least monthly, the Company’s working capital level could periodically change depending on the timing of the maturity of its accounts receivable and accounts payable and accrued liabilities.

      The Company’s activities are being funded out of its operating cash flow, the Company’s line of credit, and lease facility. Previously the Company has not encountered any difficulties doing so, however if negative operating results continue in future periods there is a risk that the Company would not be able to meet all of its contractual commitments when due. The Company has in place a revolving demand facility with its bank which, subject to certain criteria being met, could provide the Company with additional funds of up to $1,500,000 as well as a $1,250,000 lease facility.

      C. Software development, patents and licenses, etc.

      During the fiscal year ended September 30, 2013 we expended $9,907,590 (2012 - $9,678,638) on software development related to our Network and kiosk software.

      Proprietary Protection - Trademarks, Copyrights, Etc.

      We rely on a combination of contractual rights, trade secrets, copyrights, non-disclosure agreements and technical measures to establish and protect our proprietary rights. There can be no assurance, however, that the steps taken by us will be adequate to prevent misappropriation of the technology or independent development by others of software products with features based upon, or otherwise similar to, those provided by us. In addition, although we believe that our technology has been independently developed, there can be no assurance that our technology does not, and will not, infringe proprietary rights of others or that third parties will not assert infringement claims against us in the future. In the case of infringement, we would, under certain circumstances, be required to modify our products or obtain a license and any failure to do so

      43





      could have a material adverse effect on us. In addition, there can be no assurance that we will have the necessary resources to defend or pursue any infringement actions.

      See ITEM 8. FINANCIAL INFORMATION A. Consolidated Statements and Other Financial Information Legal Proceedings for further discussion of legal matters.

      D. Trend Information

       

      We continue to see significant organic increase in the usage from our existing customers’ connected to our PNI Digital Media Platform, however due to additional factors that have to be taken into account, including but not limited to currency fluctuations, and changes in product mix from prints to non-print merchandise such as photo books, photo cards, and the number of prints made from images uploaded through one of our retail customer’s sites, the Company’s results may not always mirror the overall transaction level growth seen within the wider industry.

      In recent years, the shift in product mix away from traditional print items and towards more creative products has accelerated. As a result of the way in which some of our contracts with customers are set up we earn more money (represented as a % of the retail value of the sale) when print items are sold than when non-print products are sold. This move away from print items can therefore result in us recognizing lower revenue, even though the overall number of orders placed though our platform remains consistent or in some cases increases.

      This trend in product mix continued in fiscal 2013. Revenue for fiscal 2013 was $20.9 million, as compared to $22.7 million in fiscal 2012, a 7.8% decrease. The decrease in fees as compared to the prior year is due in part to the renegotiation and three year extension of our agreement with our largest UK based retail partner, which has also been the fastest growing photo business across our customer base. These new terms came into effect in July 2012. Also impacting revenues were lower upload fees from customers where we are compensated on an upload model, and reduced revenues from ASDA Stores Ltd. for whom we no longer provide online photo services. Effective September 1, 2013, all customers contracts in which we had previously been compensated on the basis of each image uploaded the PNI Platform had been transitioned to a transaction fee model. Throughout this period, the overall volume of orders placed over our platform grew by 5% and totalled 20.1 million.

      Effective September 1, 2013, the Company has successfully transitioned the last of its significant retailer agreements that based the Company’s compensation on a legacy image upload model to its preferred transaction revenue share model. With a transaction fee model, the Company is now better positioned to participate in the revenue growth its retailers continue to see in the overall photo market.

      The Company has continued developing its social stationery and business printing service offerings throughout fiscal 2013. In August 2013, the Company announced it had signed a definitive three year agreement with Office Depot to license the Platform to help grow their successful Copy and Print Depot services. Office Depot represents a new customer win for the Company and it expects to provide Platform technology and services for over 1,100 Office Depot Copy & Print locations by early calendar 2014.

      In November 2013, the Company announced it had launched the first generation HTML5 stationery, collage, and canvas solutions with select major retailers. HTML5 applications are important to the Company’s mobile strategy as they work across all mobile and tablet devices as opposed to the previous industry standard Adobe® Flash®. Providing applications that work

      44





      across the mobile market, especially on tablets, is important for the Company’s future growth. According to a May 2013 forecast from the International Data Corporation (“IDC”) Worldwide Quarterly Tablet Tracker, tablet shipments are expected to grow 58.7% year over year in 2013 reaching 229.3 million units, up from 144.5 million units in 2012. IDC now predicts tablet shipments will exceed those of portable PCs in 2013. In addition, IDC expects tablet shipments to outpace the entire PC market (portables and desktops combined) by 2015.

      E. Off-Balance Sheet Arrangements

       

      Not Applicable

       

      F. Tabular Disclosure of Contractual Obligations

       

          Payments due by period    
        Total Less than 1 1-3 years 3-5 years
          year    
      Accounts payable and accrued liabilities 3,037,371 3,037,371 - -
      Other short-term debt obligations 1,401,070 1,401,070 - -
      Equipment leases 966,861 371,131 595,730 -
      Property leases 2,737,744 584,988 1,137,535 1,051,221
      Purchase consideration payable 343,279 343,279      
       

      8,486,325

      5,737,839 1,733,265 1,051,221  
       

       

             

       

      ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

       

      A. Directors and Senior Management

       

      The names, residences, ages, positions with us, principal occupations and beneficial ownership of our securities of each of our directors and executive officers as at December 1, 2013 are as follows. All Directors serve until the next Annual General Meeting of our Shareholders.

       
              Percentage
      Name and Residence   Positions with Company and Securities Beneficially of
      (If a Director, period such   Principal Occupations Owned, Directly or Outstanding
      position held) Age During the Last 5 Years Indirectly(4) Shares(5)
      Peter Fitzgerald (1) (2) (3)
      Herts, United Kingdom
       
      Director (July 2001 - present)
      65 March 2005 to September 2008:
      President & CEO of the Company
      Chairman of the Company
      1,830,113
      Common Shares(6)
      4.84%
      Kyle Hall
      Vancouver, BC, Canada

      Director (March 2009 to present)
      48

      October 2008 to Present: Chief
      Executive Officer; March 13, 2003 – October 4, 2004: Corporate Secretary of the Company;
      June 5, 2002 to September 30, 2008:
      Executive Vice President, Business
      Development of the Company

      439,733(7)
      Common Shares
      (*)
      Rob Chase (1) (2) (3)
      Vancouver, BC
      Director (March 2013 to present)
      44 COO of Absolute Software
      Corporation;
      320,940(8)
      Common Shares
      (*)
      Dave Jaworski (1) (2) (3) 53 CEO of Meta Media Partners LLC; 44,440(9) (*)

       

      45





              Percentage
      Name and Residence   Positions with Company and Securities Beneficially of
      (If a Director, period such   Principal Occupations Owned, Directly or Outstanding
      position held) Age During the Last 5 Years Indirectly(4) Shares(5)
      Franklin, TN
      Director (March 2013 to present)
        COO of Lifebook Company LLC;
      Netsteps LLC, Vice President of Sales and marketing; board member
      of 2xGlobal.
      Common Shares  
      Josef Vejvoda (1) (2) (3)
      Waterloo, ON
      Director (March 2013 to present)
      48 President of Jove Capital Inc. 89,440(10)
      Common Shares
      (*)
      Karl Oertel
      Surrey, UK
      46 July 2007 to Present: VP UK
      Operations of the Company; August 2006 to July 2007: Pixology
      Ltd. VP UK Operations; July 1997 to August 2006: ITEBA
      Ltd. – Operations Manager
      7,100
      Common Shares
      (*)
      Chris Egan
      Vancouver, BC, Canada
      37 December 2012 to Present: VP,
      Product Management
      December 2011 to December 2012:
      VP Business Services
      January 2003 to December 2011: various roles, the last of which was as the Director of Business Technology and Integration
      38,330(11)
      Common Shares
      (*)
      Cameron Lawrence
      Vancouver, BC
      34 August 2012 to Present: CFO
      October 2008 to June 2012: various
      roles the last of which was Senior
      Director of Finance and Principal
      Accounting Officer of OncoGenex
      Pharmaceuticals, Inc.
      September 2003 to October 2008: Manager of PricewaterhouseCoopers
      LLP
      125,333(12)
      Common Shares
      (*)
      Simon Cairns
      Vancouver, BC
      42 December 2012 to Present: VP
      Business Development of the
      Company; April 2009 to December
      2012: Director of Corporate
      Development.
      46,866(13)
      Common Shares
      (*)
      Paul Thomas
      Port Moody, BC
      41 December 2012 to Present: VP of
      Technology at the Company; August 2008 to December 2012 various roles,
      the last of which was as Director of
      Technology with the Company and
      Enterprise Architect.
      47,366(14)
      Common Shares
      (*)
      Roger Canann
      Cedar Park, TX
      44 April 2013 to Present: VP, US
      Development; Founder and Director
      of Quarterhouse.
      0
      Common Shares
      (*)

       

      (1)

      Member of the Audit Committee.

      (2)

      Member of the Compensation Committee.

      (3)

      Member of the Corporate Governance Committee.

      46





      (4)

      Information regarding shares beneficially owned or controlled is as of December 1, 2013 (the “Determination Date”) and has been furnished by the respective individuals. As such, we assume no responsibility for its accuracy or completeness. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities including warrants and stock options for which the individual has the right to exercise within 60 days of the Determination Date. We believe that the beneficial owners of shares of our common shares listed above have sole investment and voting power with respect to such shares, subject to community property laws where applicable.

      (5)

      Based on 34,326,154 common shares issued and outstanding as of December 1, 2013.

      (6)

      Includes 169,440 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (7)

      Includes 283,333 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (8)

      Includes 175,700 shares held by Mr Chase’s spouse, which shares are deemed to be indirectly owned by Mr. Chase, and 44,440 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (9)

      Includes 44,400 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (10)

      Includes 44,440 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (11)

      Includes 33,333 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (12)

      Includes 33,333 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (13)

      Includes 41,666 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (14)

      Includes 25,000 shares held by Mr Thomas’ spouse which shares are deemed to be indirectly owned by Mr. Thomas, and 16,666 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

      (*)

      Denotes beneficial ownership of less than 1% of the issued and outstanding common shares of our Company.

       
      B. Compensation

       

      During the fiscal year ended September 30, 2013, the aggregate amount of compensation paid by us and our subsidiaries to all directors and officers as a group for services in all capacities was $1,929,755.

      Our Company may grant, pursuant to the policies of the TSX, stock options to directors, officers and employees of, and consultants to, our Company or a subsidiary of our Company, or to employees of a company providing management services to our Company or any of our subsidiaries. We have adopted a stock option plan that is more fully described in Item 6.E of this annual report.

      During the fiscal year ended September 30, 2013 neither us nor our subsidiaries set aside or accrued any amount to provide pension, retirement or similar benefits for directors and officers pursuant to any existing plan provided or contributed to by us or our subsidiaries. The term “plan” includes all plans, contracts, authorizations or arrangements, whether or not set forth in any formal document.

      The following table sets out all compensation paid to our Chief Executive Officer and our three most highly compensated executive officers other than the Chief Executive Officer during the fiscal periods indicated.

      47





              Long Term
          Annual Compensation  - Compensation
                 Stock    Common Shares
       Name and  Fiscal  Salary  Bonus Benefits  Options   Total Under-
                    Lying Options and
      Principal Year ($) ($) ($) ($)(11)   Performance Share
                    Units Granted
      Position        -  -  - (Number)
      Kyle Hall (1)
      CEO
      2013
      2012
      265,000
      265,000
      -
      -
      2,302
      4,175
      47,980
      20,107
      315,282
      289,282
      175,000
      400,000
      Patrick Nangle
      Former COO(2)
      2013
      2012
      55,385
      46,875
      -
      -
      542
      369
      (6,365)
      6,365
      49,562
      53,609
      -
      200,000
      Cameron Lawrence
      CFO(3)
      2013
      2012
      165,625
      15,385
      10,000
      -
      4,694
      52
      14,802
      -
      195,121
      15,437
      275,000
      -
      Aaron Rallo
      Former President(4)
      2013
      2012
      Nil
      56,250
      Nil
      -
      Nil
      171,100
      Nil
      (9,363)
      Nil
      217,987
      Nil
      -
      Simon Bodymore(5)
      Former CFO
      2013
      2012
      Nil
      174,167
      Nil
      -
      Nil
      2,759
      Nil
      2,625
      Nil
      179,551
      Nil
      -
      Harley Ware,
      Former EVP, In-Store Retail
      Systems (6)
      2013
      2012
      16,667
      200,000
      -
      -
      66,839
      2,317
      (7,023)
      8,373
      76,483
      210,690
      -
      200,000
      Simon Cairns
      VP, Business Development
      2013 150,000 - 1,164 10,676 161,840 150,000
      Chris Egan
      VP, Product Management
      2013 150,000 -l 2,268 14,801 167,069 100,000
      Paul Thomas
      VP, Technology
      2013 143,250 - 2,289 10,320 155,859 150,000
      Roger Canann
      Cedar Park, TX
      2013 61,442 - 10,570 428 72,440 15,000
      Karl Oertel
      Surrey, UK
      2013
      2012
      126,813
      119,774
      -
      -l
      25,394
      8,821
      1,664
      3,075
      153,871
      131,670
      15,000
      -
      Kevin Jampole
      Richmond BC
      2013 175,000 17,100 100,701 - 292,801 -

       

      (1)

      On March 9, 2001, Kyle Hall, formerly VP Sales and Business Development for our US subsidiary, PhotoChannel, Inc., became our President and Chief Operating Officer, as well as a director. On June 5, 2002, Mr. Hall resigned as a director and as President and Chief Operating Officer and assumed the role of Executive Vice President of Business Development. On March 13, 2003, Mr. Hall assumed the role of Corporate Secretary, a position he held until October 4, 2004. On October 1, 2008, Mr. Hall assumed the role of Chief Executive Officer.

        (2)

      On July 17, 2012 the Company announced the appointment of Patrick Nangle as Chief Operating Officer and held this position until January 2, 2013.

        (3)

      On September 11, 2012 the Company announced the appointment of Cameron Lawrence as Interim Chief Financial Officer. Compensation for 2012 relates to the period of September 11, 2012 to September 30, 2012.

         

      Mr. Lawrence was subsequently appointed CFO on December 10, 2012.

        (4)

      On November 8, 2004, Aaron Rallo was appointed Chief Technical Officer. On July 2, 2007, Mr. Rallo also assumed the role of Chief Operating Officer and on October 1, 2008 Mr. Rallo assumed the role of President.

      48





       

      Effective December 31, 2011 Mr. Rallo ceased being an employee and is no longer the President and Chief Operating Officer of the Company.

        (5)

      On December 17, 2008, Simon Bodymore, formerly Director of Finance became VP Finance. On March 26, 2009 Mr. Bodymore was appointed Chief Financial Officer. Effective August 9, 2012 Mr. Bodymore ceased being an employee and is no longer the Chief Financial Officer of the Company.

        (6)

      On March 11, 2009 upon the acquisition of WorksMedia Ltd., Harley Ware joined the PNI Digital Media group and was appointed Managing Director – Europe. On November 13, 2010, Mr. Ware took on the role of EVP In-Store Retail Systems. Effective October 31, 2012 Mr. Ware ceased being an employee and is no longer the EVP In-Store Retail Systems of the Company.

      (7)

      On December 10, 2012, Simon Cairns was appointed Vice President, Business Development.

      (8)

      On December 10, 2012, Chris Egan was appointed Vice President, Product Management.

      (9)

      On December 10, 2012, Paul Thomas was appointed Vice President, Technology.

      (10)

      Compensation expense recorded in accordance with IFRS 2 Share Based Payment.

       
      C. Board Practices

       

      Our articles provide that our Board of Directors shall consist of a minimum of three directors. Directors can be either elected annually by the shareholders at the annual meeting of the shareholders or, subject to our articles and applicable law, be appointed by the Board of Directors between annual meetings. Each director holds office until the close of the next annual meeting of shareholders or until he or she ceases to be a director by operation of law or until his or her resignation becomes effective. None of the directors have a service contract with us to provide for benefits upon termination of his or her directorship.

      Committees Of The Board

      Our Board of Directors has formed three committees.

      The Audit Committee consists of four directors. Subsequent to March 14, 2013, this committee consists of Rob Chase (Chairman), Peter Fitzgerald, Josef Vejvoda and David Jaworski. Prior to March 14, 2013, the committee consisted of Robert Chisholm (Chairman), Peter Scarth, Thomas Nielson and Peter Fitzgerald. This committee is responsible for all relationships between our independent external auditor, including the approval of all work and related fees and for actively engaging in a dialog with that auditor with respect to any disclosed relationships or services that may impact the objectivity and independence of the auditor. This Committee also oversees and establishes procedures concerning our systems of internal accounting and auditing controls.

      The Compensation Committee consists of four directors. Subsequent to March 14, 2013, the committee consists of Josef Vejvoda (Chairman), Robert Chase, Peter Fitzgerald and David Jaworski. Prior to March 14, 2013, the committee consisted of Cary Deacon (Chairman), Robert Chisholm and Peter Fitzgerald. This committee is responsible for recommending salary levels and granting of options and deferred share units for our executive officers.

      The Corporate Governance Committee consists of four directors. This committee is responsible for corporate governance. Subsequent to March 14, 2013, this committee consists of David Jaworski (Chairman), Rob Chase, Peter Fitzgerald and Josef Vejvoda. Prior to March 14, 2013 this committee consisted of Cary Deacon, Thomas Neilson, Peter Scarth, Peter Fitzgerald, and Robert Chisholm.

      49





      D. Employees

       

      We currently have one hundred forty seven (147) permanent full-time employees, four (4) permanent part-time employees and five (5) consultants we retain for regular engagements. None of our staff are unionized.

      We currently have the following salaried employees in our Vancouver office:

      Executive Officers 5
      Finance/Administration 8, includes 3 executive officers.
      Technology and Operations 125, includes 2 executive officers.
      Sales, and Business Development 6

       

      We currently have the following salaried employee in our Southampton, UK office:

       

      Executive Officers 1
      Finance/Administration 2
      Technology and Operations 3, includes 1 executive officer.

       

      We currently have the following salaried employees in our Austin, TX office:

       
      Executive Officers 1
      Technology and Operations 4, includes 1 executive officer.
      Sales, and Business Development 1

       

      E. Share Ownership

       

      As disclosed in Item 6.A, each of our current directors and executive officers has reported to us the number of common shares he or she beneficially owned in our Company as of December 1, 2013. To determine beneficial ownership for these purposes, each director or executive officer is deemed to be the beneficial owner of securities over which he or she exercises voting or investment power; and of securities that he or she has the right to acquire within sixty days, pursuant to such events as the exercise of a stock option, warrant or right, or through the conversion of a security, or through the power to revoke a trust or the automatic termination of a trust. Based on the information provided by our current and former directors and executive officers, they as a group beneficially owned a total of 2,989,621 common shares (including an aggregate of 710,971 common shares that are reserved for issuance pursuant to stock options that are all exercisable within sixty days).

      As of December 1, 2013, options to purchase an aggregate of 2,600,000 common shares had been granted and were outstanding, as follows:

      Number of Exercise Price Expiration
      Common Shares Per Common Share Date
      150,000 $1.48 March 25, 2014
      25,000 $1.50 August 6, 2014

       

      50





      150,000 $1.55 October 4, 2015
      341,654 $0.27 May 17, 2016
      341,662 $0.27 May 17, 2017
      600,000 $0.46 July 12, 2017
      200,000 $0.44 October 24, 2017
      50,000 $0.32 February 7, 2018
      741,684 $0.27 May 17, 2018

       

      As of December 1, 2013, a total of 2,205,000 common shares were subject to options held by our directors and executive officers as a group. The following table sets forth particulars of the options held by each of our directors and executive officers:

      51





      Name Grant Date Exercise
      Price
      Expiration
      Date
      Total Number
      of Options
      Peter Fitzgerald 25-Mar-09 $1.48 25-Mar-14 50,000
      Director, Chairman 04-Oct-10 $1.55 04-Oct-15 25,000
        12-Jul-12 $0.46 12-Jul-17 50,000
        17-May-13 $0.27 17-May-18 100,000
      Cory Kent 25-Mar-09 $1.48 25-Mar-14 50,000
      Corporate Secretary 04-Oct-10 $1.55 04-Oct-15 25,000
        12-Jul-12 $0.46 12-Jul-17 50,000
      Kyle Hall
      25-Mar-09 $1.48 25-Mar-14 50,000
      Director & Chief Executive Officer 04-Oct-10 $1.55 04-Oct-15 100,000
        12-Jul-12 $0.46 12-Jul-17 400,000
        17-May-13 $0.27 17-May-15 175,000
        17-May-13 $0.27 17-May-16 58,333
        17-May-13 $0.27 17-May-18 58,334
      Cameron Lawrence 25-Oct-12 $0.44 25-Oct-17 100,000
        17-May-13 $0.27 17-May-15 58,333
        17-May-13 $0.27 17-May-16 58,333
        17-May-13 $0.27 17-May-18 58,334
      Simon Cairns 06-Aug-09 $1.50 06-Aug-14 25,000
        24-Oct-12 $0.44 24-Oct-17 50,000
        17-May-13 $0.27 17-May-15 33,333
        17-May-13 $0.27 17-May-16 33,333
        17-May-13 $0.27 17-May-18 33,334
      Chris Egan 12-Jul-12 $0.46 12-Jul-17 100,000
        17-May-13 $0.27 17-May-15 33,333
        17-May-13 $0.27 17-May-16 33,333

       

      52





        17-May-13 $0.27 17-May-18 33,334
      Paul Thomas 24-Oct-12 $0.44 24-Oct-17 50,000
        17-May-13 $0.27 17-May-15 33,333
        17-May-13 $0.27 17-May-16 33,333
        17-May-13 $0.27 17-May-18 33,334
      Karl Oertel 17-May-13 $0.27 17-May-15 5,000
        17-May-13 $0.27 17-May-16 5,000
        17-May-13 $0.27 17-May-18 5,000
      Roger Canann 17-May-13 $0.27 17-May-15 5,000
        17-May-13 $0.27 17-May-16 5,000
        17-May-13 $0.27 17-May-18 5,000
      Rob Chase 17-May-13 $0.27 17-May-18 100,000
      David Jaworski 17-May-13 $0.27 17-May-18 100,000
      Josef Vejvoda 17-May-13 $0.27 17-May-18 100,000

      Stock Option Plan

      Our Company initially adopted a stock option plan in 1997. At our Company’s annual general meeting held on March 10, 2004, our shareholders approved an increase in the number of common shares reserved for issuance under the plan to 18,000,000 common shares (as so amended, the “2004 Plan”).

      At our Company’s annual general meeting held on March 6, 2006, our shareholders approved a stock option plan (the “2006 Plan”) which provides for a “rolling” number of underlying shares rather than a “fixed” number of shares. Specifically, the 2006 Plan provided that the maximum number of common shares reserved for issuance upon exercise of any options granted under the 2006 Plan shall be equal to 10% of the issued and outstanding common shares of our Company at the time the options are granted, less the number of shares reserved for issuance under any outstanding options. This will mean that there can never be more than 10% of our Company’s issued and outstanding common shares reserved for issuance under the 2006 Plan at any point in time. The 2006 Plan was amended by shareholders at the annual general meetings held on March 6, 2007, March 25, 2009 and March 10, 2010.

      As the Company is now listed on the TSX the Board deems it to be in the best interests of the Company to adopt a new option plan to accommodate TSX policies concerning option plans. On February 22, 2012 the Board authorized the adoption of a new form of share option plan dated for reference February 22, 2012 (the “2012 Plan”). The 2012 Plan provides for a maximum of 10% of the issued and outstanding Common Shares of the Company at the time an option is granted,

      53





      less Common Shares reserved for issuance under all other Share Compensation Arrangements of the Company, to be reserved for options to be granted at the discretion of the Board or the compensation committee of the Board, to eligible optionees (“Optionees”). Existing outstanding options will be rolled into and governed by the 2012 Plan.

      Eligible Optionees

      Options to purchase Common Shares may be granted hereunder to Service Providers from time to time by the Board. Service Providers that are corporate entities will be required to undertake in writing not to effect or permit any transfer of ownership or option of any of its shares, nor issue more of its shares (so as to indirectly transfer the benefits of an Option), as long as such Option remains outstanding, unless the written permission of the TSX and the Company is obtained.

      Material Terms of the 2012 Plan

      The following is a summary of the material terms of the 2012 Plan:

      (a)

      all options granted under the 2012 Plan are non-assignable and non-transferable and are exercisable for a period of up to 10 years from the date of grant;

        (b)

      if the expiry date for an option falls within a blackout period, or within nine (9) business days following the expiration of a blackout period, such expiry date will be automatically adjusted without any further act or formality to that day which is the 10th business day after the end of the blackout period, such 10th business day to be considered the expiry date for such option for all purposes under the 2012 Plan;

        (c)

      the minimum exercise price of an option granted under the 2012 Plan must not be less than the Market Price calculated the day before the grant being an exercise price which is no less than the five day volume weighted average trading price (“VWAP”) at the date of grant. VWAP is calculated by dividing the total value of the Common Shares traded for the relevant period on the TSX by the total volume of shares;

        (d)

      for stock options granted to employees or service providers (including directors, officers, management company employees and consultants), the Company must ensure that the proposed optionee is a bona fide employee or service provider (including directors, officers, management company employees and consultants), as the case may be, of the Company or any subsidiary;

        (e)

      if an Optionee ceases to be employed by the Company (other than as a result of termination with cause) or ceases to act as a director or officer of the Company or a subsidiary of the Company, any option held by such Optionee which has vested may be exercised within 90 days after the date such Optionee ceases to be employed or act as an officer or director, as the case may be, or for such other period as may be specified in any agreement with the Optionee or otherwise approved by the Board;

        (f)

      if an Optionee dies, any vested option held by him at the date of death will become exercisable by the Optionee’s lawful personal representatives, heirs or executors until the earlier of one year after the date of death of such Optionee and the date of expiration of the term otherwise applicable to such option;

      54





        (g)

      in the case of an Optionee being dismissed from employment or service for cause, such Optionee’s options, whether or not vested at the date of dismissal, will immediately terminate without right to exercise same;

        (h)

      vesting of options shall be at the discretion of the Board;

        (i)

      all options which have not then vested shall immediately vest upon a change of control; and

        (j)

      the Board reserves the right in its absolute discretion to terminate the 2012 Plan with respect to all 2012 Plan shares in respect of options which have not yet been granted hereunder.

      Restricted Share and Performance Share Unit Plan

      At our Company’s Annual General Meeting held on March 10, 2010, the Shareholders approved a Restricted Share Unit Plan, with the purpose of the plan to attract and retain highly qualified officers, directors, key employees and consultants, to motivate such officers, directors, key employees and consultants to serve the Company and to encourage the continued employment and service of, and maximum efforts by, officers, key employees and directors of the Company by offering those persons an opportunity to acquire or increase a direct proprietary interest in the operations and future success of the Company.

      A restricted share unit (“RSU”) is a right granted to a unit holder to receive on common share of the Company. The RSU’s vest over a three (3) year period from the award grant date (1/3 upon the first anniversary of the grant, 1/3 upon the second anniversary of grant and 1/3 upon the third anniversary of grant). In addition, the RSU’s awarded to executive officers will be subject to performance requirements and will be earned only if performance goals over the performance periods established by or under the direction of the Compensation Committee are met (referred to as “PSU’s”). The RSU will be terminated to the extent the performance objectives are not met.

      ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

       

      A. Major Shareholders

      To the knowledge of our directors and senior officers, as of December 1, 2013, no person or corporation beneficially owns, directly or indirectly, or exercises control or direction over 5% or more of our outstanding common shares, except as noted below. Our directors and officers, as a group, control us by reason of their positions with us and their ownership of common shares and common share options. As a group, they beneficially own, directly or indirectly, 2,989,621 common shares, representing about 8.5% of our presently issued and outstanding common shares (including an aggregate of 710,971 common shares that are reserved for issuance pursuant to stock options that are all exercisable within 60 days).

      Pursuant to the policies of the TSX, where an issuance of securities may result in the creation of a new control person of an issuer (which is a person holding greater than 20% of the outstanding securities of an issuer is deemed to be), the issuance must be approved by the disinterested shareholders of the company. To the knowledge of our directors and senior officers, as of December 1, 2013, no person or corporation owned or had the intent of acquiring 20% or greater of our securities.

      55





      Peter Fitzgerald is our Chairman and is a significant shareholder and investor in us. Currently, Mr. Fitzgerald owns 1,660,673 shares of our common stock or 4.84% of our outstanding common shares. Mr. Fitzgerald also holds 169,440 common share options that are all exercisable within sixty days and if he were to exercise all of these options and assuming no other common shares of us are issued prior to such exercise, Mr. Fitzgerald could own 1,830,113 shares of our common stock, representing 5.22% of our then outstanding securities, as of December 1, 2013.

      Invesco Canada Ltd. (previously Invesco Trimark Ltd.) is an institutional investor that currently has control or direction over 5,960,500 shares of our common stock or 17.4% of our outstanding common shares.

      As of December 1, 2013, our shareholders’ register listed approximately 110 registered shareholders holding an aggregate of 34,326,154 common shares. A total of 68 of these registered shareholders were shown to be residents of Canada, owning 26,757,021shares representing 77.95% of our issued and outstanding common shares. A total of 28 of these registered shareholders were shown to be residents of the United States, owning 7,382,489 shares representing 21.51% of our issued and outstanding common shares.

      B. Related Party Transactions

      During the year ended September 30, 2013, the Company incurred legal fees of $201,682 (2012: $156,204), for services provided by McMillan LLP, a law firm of which the Corporate Secretary of the Company is a partner. Accounts payable and accrued liabilities at September 30, 2013 included $19,687 (2012: $41,245) related to these services.

      During the year ended September 30, 2013, the Company incurred consulting fees of $60,741 (2012: $59,678), respectively, for services provided by Digital Photoworks, a company of which a Director of the Company controls. The Company does not have any outstanding accounts payable or accrued liabilities as at September 30, 2013 related to this company (2012: $nil).

      During the year ended September 30, 2013, the Company incurred employment expenses of $2,543 (2012 – $nil) paid to a relative of an Officer of the Company for services performed in the ordinary course of business.

      The Company shares its UK premises with another company, Works Unit Ltd., of which a former Officer is a director. During the year ended September 30, 2013, the Company was recharged its proportional share of office running costs totalling $191,575 (2012: $209,850) by this related party. During the year ended September 30, 2013, the Company did not incur expenses relating to the use of the software development services of this company (2012: $105,560). The Company does not have any outstanding accounts payable as at June 30, 2013 (2012: $nil) related to these services and cost recharges.

      During the year ended September 30, 2013, the Company generated revenue of $6,141 (2012: $7,683) relating to transaction fees, software license and installation fees, and membership fees from a customer, Extrafilm, of which a Director of the Company controls. Accounts receivable as at September 30, 2013 included $299 (2012: $2,581) related to these services.

      Key management includes the Company’s directors, and members of the executive team. Compensation awarded to key management included:

      56





              Year Ended    
          September 30,   September 30,   September 30,
      Description    2013     2012     2011  
      Salaries, director fees and short-term employee benefits $ 1,637,564 $ 1,462,547 $ 1,587,219
      Share-based payments   125,524   93,723   434,149
      Compensation expense in connection with acquisition of WorksMedia Limited   -   53,826   142,373
      Termination benefits    166,667      168,750      87,500  
      Total $ 1,929,755   $ 1,778,846   $ 2,251,241  

      All amounts charged were recorded at their exchange amount, which is the amount of consideration established and agreed to by the related parties and having normal trade terms.

      C. Interests of Experts and Counsel

      Not Applicable.

      ITEM 8. FINANCIAL INFORMATION

       

      A. Consolidated Statements and Other Financial Information

      The consolidated financial statements of the Company for the years ended September 30, 2013, 2012, and 2011 have been prepared in accordance with IFRS, as issued by the International Accounting Standards Board, or IASB, and are included under Item 18 of this annual report. The consolidated financial statements including related notes are accompanied by the report of the Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP.

      Legal Proceedings.

      As of the date of this Annual Report, in the opinion of our management, we are not currently a party to any litigation or legal proceedings which are material, either individually or in the aggregate, and, to our knowledge, no legal proceedings of a material nature involving us currently are contemplated by any individuals, entities or governmental authorities. We may become involved in claims litigation arising in the ordinary course of business. In the opinion of management, the outcome of such claims litigation, if decided adversely, could have an effect on the operating results or cash flows when resolved in a future period. However, in the opinion of management, these matters would not materially affect our consolidated financial position.

      From time to time the Company may be involved in various litigation matters. In addition, the Company has contractual indemnification obligations as part of certain of our retailer agreements. Any losses that may arise as a result of these binding legal arrangements may be material to the consolidated financial statements.

      On March 7, 2013, CreateAds LLC filed a complaint for alleged patent infringement against various customers of PNI filed in the U.S. District Court for the District of Delaware. The complaint asserts infringement of U.S. Patent No. 5,535,320, which claim among others things a method of generating a representation of a visual design and applying it to various advertising materials. Subsequent to September 30, 2013, PNI settled the complaint on behalf of all

      57





      customers for US$105,000, in exchange for the plaintiffs dismissing all claims against the Company and its customers which was included in cost of sales.

      On January 4, 2013, Express Card Systems, LLC filed a complaint for alleged patent infringement against various customers of PNI in the Eastern District of Texas, Tyler Division. The complaint asserts infringement of U.S. Patents Nos., 5,748,484 and 5,552,994. PNI settled the complaint on behalf of all customers for US$122,500, in exchange for the plaintiffs dismissing all claims against the Company and its customers which was included in cost of sales.

      On November 27, 2013, the Company received a letter from Bloom Stationers LLC “Bloom” alleging certain violations of the terms of our Amended and Restated Master Development & Services by and between Bloom and the Company (the “Bloom Agreement”). The complaint asserts that PNI violated the terms of the Bloom Agreement by launching HTML5 based stationery builders in November 2013 with certain retailers and advertising our abilities to provide stationery solutions to new customers. The Company believes the allegations are completely without merit.

      During the year ended September 30, 2010, the Company received notice from a former customer that a possible patent infringement had been brought to their attention regarding software which in previous years had been sold by one of our subsidiaries and which is unrelated to the PNI Platform and to the Company’s kiosk software. During the year ended September 30, 2011, the Company received notice from its former customer that a settlement had been reached between it and the entity that had been making the claims of patent infringement. As a result, the Company’s former customer requested that the Company pay a portion of the settlement amount under an indemnification clause included in the contract that was in place during the previous relationship. After considering all of the available facts, including the expected legal costs of disputing the matter, the Company agreed to pay a contribution of the settlement charge, up to a maximum amount of US$100,000. The Company has now concluded negotiations over the final allocation of the settlement charge with the former customer and made a contribution of US$80,000 during the year ended September 30, 2011All amounts charged were recorded at their exchange amount, which is the amount of consideration established and agreed to by the related parties and having normal trade terms.

      B. Significant Changes

      Since the date of the audited consolidated financial statements, there have been no significant changes other than as detailed, if applicable, in Liquidity and Capital Resources in Item 5.B and in Business Overview in Item 4.B.

      ITEM 9. THE OFFER AND LISTING

      Not applicable except for Item 9A(4) and Item 9C.

      A. (4). Price History

      Market and Trading Prices

      During the year ended September 30, 2012 the Company’s application to the TSX was approved, and effective October 18, 2011 the Company’s shares were de-listed from the TSX-V and began trading on the TSX under the trading symbol “PN”. Our shares were first listing for trading on the Montreal Exchange (“ME”), in Montreal, Quebec, Canada, which merged with the Canadian

      58





      Venture Exchange (“CDNX”) in September 2001 and effective October 1, 2001 we began trading on the CDNX. Subsequently the CDNX was acquired by the TSX in 2002 and on April 1, 2002 we were listed for trading on the TSX-V. The following table sets forth the reported high and low sale prices of our common shares as reported by the TSX-V, and where applicable the TSX for the periods indicated.

          Sales Prices (CDN$)
          High Low
      Common Shares      
      Annual Data 2013 0.52 0.20
        2012 0.98 0.40
        2011 1.80 0.80
        2010 1.95 1.30
        2009 2.29 1.00
        2008 4.50 1.90
        2007 5.77 2.31
         
      Quarterly data 2013
        September 30, 2013 0.52 0.20
        June 30, 2013 0.35 0.23
        March 31, 2013 0.40 0.27
        December 31, 2012 0.48 0.30
         
        2012 0.73 0.34
        September 30, 2012 0.74 0.40
        June 30, 2012 0.60 0.48
        March 31, 2012 0.72 0.52
        December 31 2011 0.98 0.65
         
      Monthly data September 2013 0.50 0.38
          August 2013 0.42 0.20  
        July 2013 0.27 0.20
        June 2013 0.28 0.20
        May 2013 0.30 0.25
        April 2013 0.35 0.29

      Our common shares are also listed on the OTC Bulletin Board in the United States under the trading symbol PNDMF, however, we do not presently have an active market maker in the United States. The following table sets forth the high and low sales prices for the common shares on the OTC BB the periods indicated.

          Sales Prices (US$)
            High Low
      Common Shares      
      Annual Data 2013 0.49 0.20
          2012 0.98 0.40
        2011 1.77 0.80
        2010 1.87 1.28  

       

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          Sales Prices (US$)
          High Low
        2009 2.05 0.89
        2008 4.65 1.84
        2007 4.88 2.52
             
      Quarterly Data 2013
        September 30 2013 0.49 0.19
        June 30, 2013 0.35 0.20
        March 31, 2013 0.41 0.26
        December 31, 2012 0.47 0.28
             
        2012
        September 30, 2012 0.73 0.40
        June 30, 2012 0.59 0.40
        March 31, 2012 0.70 0.51
        December 31 2011 0.98 0.61
              
      Monthly data September 2013 0.49 0.36
        August 2013 0.36 0.19
        July 2013 0.22 0.20
        June 2013 0.27 0.20
        May 2013 0.29 0.25
        April 2013 0.35 0.28

      Our common share register indicates that, as of December 1, 2013, 28 of our registered shareholders are residents of the United States, owning 7,382,489 shares representing 21.5% of our issued and outstanding common shares. We have no information and express no opinion regarding the identities, addresses or holdings of the beneficial owners of these securities.

      B. Plan of Distribution

      Not Applicable.

      C. Markets

      See Item 9.A(4) above.

      D. Selling Shareholders

      Not Applicable.

      E. Dilution

      Not Applicable.

      F. Expenses of the Issue

      Not Applicable.

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      ITEM 10.

      ADDITIONAL INFORMATION
       
      A. Share Capital

      Not Applicable.

      B. Memorandum and Articles of Association

      Our charter documents consist of our Notice of Articles and our Articles. Our corporation number, as assigned by the British Columbia Ministry of Consumer and Commercial relations, is 509287.

      In March 2004, the Company Act (British Columbia) (the “BCCA”) was replaced by the Business Corporations Act (British Columbia) (the “BCA”). All companies incorporated under the BCCA were required complete a transition application under the BCA by March 29, 2006. We have been successfully transitioned under the BCA. We filed a Notice of Articles in June 2005. At our annual general meeting held on March 24, 2005, our shareholders adopted a new set of Articles which is intended to take advantage of the increased flexibility afforded by the BCA with respect to certain provisions of our Charter Documents. Details of our Notice of Articles and Articles were disclosed in our annual report on Form 20-F for the fiscal year ended September 30, 2005, as filed with the Securities and Exchange Commission. A copy of our Articles was filed as an exhibit to our annual report on Form 20-F for the fiscal year ended September 30, 2005. There have been no changes to the Notice of Articles or Articles since that time.

      C. Material Contracts

      The following summary of our material agreements, some of which have been previously filed with the SEC, does not purport to be complete and is subject to, and is qualified in its entirety by reference to, all the provisions of those agreements. There are no material contracts, other than those contracts entered into in the ordinary course of business, currently in place or to which we or any member of our group is a party, from the two years immediately preceding the publication of this annual report, except as follows:

      1.

      The OEM Revenue Sharing Agreement with Samsung Information Systems America, Inc., effective August 23, 2013 for a period of two years. The term will automatically extend for one-year periods unless either party provides written notice to the other at least 120 days prior to the end of the current term.

         

       

      2.

      The Internet Services Agreement with Office Depot, Inc. dated June 28, 2013. The initial term expires June 28, 2016, with consecutive one-year terms renewed automatically unless written notice is provided by either party to the other at least 60 days prior to the end of the current term.

         

       

        3.

      The Share Purchase Agreement with QS Quarterhouse Inc. dated April 11, 2013.

         

       

        4.

      The Internet Services Agreement with Tesco Stores Ltd. to provide services. This agreement is effective July 1, 2012 and continues in full force and effect until July 1, 2015 or until terminated by either Tesco giving PNI no less than three months’ written notice of termination, or PNI giving Tesco no less than six months’ written notice of termination.

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      5.

      The Toronto and Vancouver Co-Located Hosting Agreement with TELUS Communications Inc., dated December 20, 2011. This agreement is for a 47 month period commencing December 20, 2011.

       

       

       

      6.

      The Services and Software Agreement with CVS Pharmacy, Inc. (“CVS”), dated April 1, 2011. This Agreement is for a period of three years, expiring March 31, 2014 (the “Term”) and automatically renews for a perpetual rolling Term, cancellable at any time upon at least ninety (90) days prior written notice by either party.

       

       

       

      7.

      An Amended and Restated Master Development and Services Agreement with Bloom Stationers LLC (“Bloom”), a New York based designer of social stationery products, dated March 11, 2011. Under this Agreement, we agreed to develop and host an online software solution for Bloom to permit end users to purchase Bloom’s suite of business and personal stationery products Bloom’s website, co-branded websites and through retail partners. The agreement is for a five year term from the date the Bloom system is launched with a national retailer, and automatically renews for additional five year terms. Pursuant to this agreement, we are obligated to develop and host the Bloom solution, provide all services necessary to connect the Bloom solution to retailers and co-branded sites who contract for the Bloom solution, and provide Bloom with a mirror site in the event of a termination of this agreement, in consideration for which we are to receive a share of revenue generated from the sale of Bloom products through the such co-branded sites and retail partners. The agreement provides that all work product created by PNI for Bloom will be owned by Bloom. We have covenanted to use our best efforts to enter into agreements with our retailer partners to make the Bloom products available through our retailer partners, and have agreed that we will not during the term of the agreement and for a period of 60 months after its termination, provide services which compete with the Bloom solution, other than (i) non-customizable services for retailers for which we provided services as of the date of the agreement with Bloom (“Pre-existing Retailers”), and (ii) after the expiry of twelve months from the date the Bloom system is launched, customizable services for Pre-existing Retailers. The agreement may be terminated by either party in the event of a material default by the other party or upon the bankruptcy or insolvency of the other party. The agreement may also be terminated by PNI in the event of a change of control of Bloom, which includes an event where certain officers of Bloom cease to be officers of Bloom. Bloom may also terminate the agreement in the event of a change of control of PNI, which includes any event where Kyle Hall ceases to be the Chief Executive Officer of PNI, or if PNI becomes a provider of services materially similar to or competing with the Bloom products in violation of the agreement, or if PNI fails to defend a claim that either the Bloom solution infringes any intellectual property rights, or that the intellectual property rights in the Bloom solution are being infringed.

       

       

       

      8.

      The Internet Photo Services Agreement with Costco Wholesale Canada Ltd., dated November 1, 2010, including the First Amendment Internet Photo Services Agreement dated April 29, 2011. This agreement is for a period of approximately five years, expiring June 4, 2016 (the “Term”) and may be extended by Costco for one year periods if written notice is provided by Costco at least ninety (90) days prior to the end of the Term or the then current renewal term.

       

       

       

      9.

      The Share Purchase Agreement amongst PhotoChannel Networks Inc., as Purchaser and Vendors in relation to the sale and purchase of the whole of the issued share capital of WorksMedia Limited, dated February 25, 2009.

       

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      10. The Amended and Restated Services Agreement with Wal-Mart Canada Corp., dated January 31, 2008. This Agreement is for a period of two years, expiring January 31, 2010 (the “Term”) and automatically renews for one year periods unless written notice is provided by one party to the other not less than thirty (30) days prior to the end of the Term or the then current renewal term
           
      11. The Services Agreement with Sam’s West Inc., dated January 23, 2008. This Agreement is for a period of two years, expiring January 23, 2010 (the “Term”) and automatically renews for one year periods unless written notice is provided by one party to the other prior to the end of the Term or the then current renewal term.
           
        12. The Internet Photo Services Agreement with Costco Wholesale Corporation, dated April 29, 2008, including the First Amendment Internet Photo Services Agreement dated February 16, 2011, the Second Amendment Internet Photo Services Agreement dated July 16, 2013, and Third Amendment Internet Photo Services Agreement dated September 2, 2013. This Agreement is for a period of approximately five years, expiring June 4, 2016 (the “Term”) and may be extended by Costco for one year periods if written notice is provided by Costco at least ninety (90) days prior to the end of the Term or the then current renewal term.

       

      D. Exchange Controls

      We incorporated pursuant to the laws of the Province of British Columbia, Canada. There is no law or governmental decree or regulation in Canada that restricts the export or import of capital, or affects the remittance of dividends, interest or other payments to a non-resident holder of Common Shares, other than withholding tax requirements. Any such remittances to United States residents are generally subject to withholding tax, however no such remittances are likely in the foreseeable future. See “Taxation”, below.

      There is no limitation imposed by the laws of Canada or by our charter on the right of a non-resident to hold or vote our shares, other than as provided in the Investment Canada Act (Canada) (the “Investment Act”). The following discussion summarizes the material features of the Investment Act for a non-resident who proposes to acquire a controlling number of Great our common shares. It is general only, it is not a substitute for independent advice from an investor’s own advisor, and it does not anticipate statutory or regulatory amendments. We do not believe the Investment Act will have any effect on us or on our non-Canadian shareholders due to a number of factors including the nature of our operations and our relatively small size.

      The Investment Act generally prohibits implementation of a “reviewable” investment by an individual, government or agency thereof, corporation, partnership, trust or joint venture (each an “entity”) that is not a “Canadian” as defined in the Investment Act (i.e. a “non-Canadian”), unless after review the Minister responsible for the Investment Act is satisfied that the investment is likely to be of net benefit to Canada. An investment in our common shares by a non-Canadian (other than a “WTO Investor” as that term is defined in the Investment Act and which term includes entities which are nationals of or are controlled by nationals of member states of the World Trade Organization) when we were not controlled by a WTO Investor, would be reviewable under the Investment Act if it was an investment to acquire control of the Company and the value of our assets, as determined in accordance with the regulations promulgated under the Investment Act, was over $5 million, or if an order for review was made by the federal cabinet on the grounds that the investment related to Canada’s cultural heritage or national identity, regardless of the value of our assets. An investment in our common shares by a WTO

      63





      Investor, or by a non-Canadian when the Company was controlled by a WTO Investor, would be reviewable under the Investment Act if it was an investment to acquire control of the Company and the value of our assets, as determined in accordance with the regulations promulgated under the Investment Act, was not less than a specified amount, which for 2005 exceeds $265 million. A non-Canadian would acquire control of the Company for the purposes of the Investment Act if the non-Canadian acquired a majority of the common shares. The acquisition of less than a majority but one-thirds or more of the common shares would be presumed to be an acquisition of control unless it could be established that, on the acquisition, we were not controlled in fact by the acquiror through the ownership of the common shares.

      Certain transactions relating to the common shares would be exempt from the Investment Act, including

       

      (a)

      an acquisition of the common shares by a person in the ordinary course of that person’s business as a trader or dealer in securities,

       

       

       

      (b)

      an acquisition of control in connection with the realization of security granted for a loan or other financial assistance and not for a purpose related to the provisions of the Investment Act, and

       

       

       

      (c)

      an acquisition of control by reason of an amalgamation, merger, consolidation or corporate reorganization following which the ultimate direct or indirect control in fact of the Company, through the ownership of the common shares, remained unchanged.

       

      E. Taxation

      The following summary is not exhaustive, but is materially complete.

      A brief description of certain provisions of the tax treaty between Canada and the United States is included below, together with a brief outline of certain taxes, including withholding tax provisions, to which United States security holders are subject under existing laws and regulations of Canada. The consequences, if any, of provincial, state and local taxes are not considered.

      The following information is general and security holders are advised to seek the advice of their own tax advisors, tax counsel or accountants with respect to the applicability or effect on their own individual circumstances of the matters referred to herein and of any provincial, state, or local taxes.

      Certain Canadian Federal Income Tax Consequences

      The discussion under this heading summarizes the principal Canadian federal income tax consequences of acquiring, holding and disposing of shares of our common stock for any of our shareholders who is not a resident of Canada but is a resident of the United States and who will acquire and hold shares of our common stock as capital property for the purposes of the Income Tax Act (Canada) (the “Canadian Tax Act”). This summary does not apply to a shareholder who carries on business in Canada through a “permanent establishment” situated in Canada if the shareholder’s holding in our stock is effectively connected with such permanent establishment. Nor does the summary apply to a shareholder who is an employee and who holds such shares as a consequence of his employment. This summary is based upon the provisions of the Canadian Tax

      64





      Act including the regulations thereunder (the “Regulations”) in force as of the date hereof and Counsels’ understanding of the current published administrative and assessing practices and policies of the Canada Revenue Agency (the “CRA”). Except for specifically proposed amendments (the “Proposed Amendments”) to the Tax Act and the Regulations that have been publicly announced by or on behalf of the federal Minister of Finance prior to the date hereof, this summary does not take into account or anticipate changes in the income tax law, whether by legislative, governmental or judicial action, nor any changes in the administrative practices and policies of the CRA. There can be no assurance that the Proposed Amendments will be enacted in their present form, or at all. This summary is not exhaustive of all Canadian federal income tax considerations nor does it take into account any provincial, territorial or foreign tax considerations arising from the acquisition, ownership or disposition of the Securities. This discussion is general only and is not a substitute for independent advice from a shareholder’s own Canadian and U.S. tax advisors.

      The provisions of the Canadian Tax Act are subject to income tax treaties to which Canada is a party, including the Canada-United States Income Tax Convention (1980), as amended (the “Convention”).

      Dividends on Common Shares and Other Income

      Under the Canadian Tax Act, a non-resident of Canada is generally subject to Canadian withholding tax at the rate of 25 percent on dividends paid or deemed to have been paid to him or her by a corporation resident in Canada. The Convention limits the rate to 15 percent if the shareholder is a resident of the United States and the dividends are beneficially owned by and paid to such shareholder, and to 5 percent if the shareholder is also a corporation that beneficially owns at least 10 percent of the voting stock of the payor corporation.

      The amount of a stock dividend (for tax purposes) would generally be equal to the amount by which our paid up or stated capital had increased by reason of the payment of such dividend. We will furnish additional tax information to shareholders in the event of such a dividend.

      The Convention generally exempts from Canadian income tax dividends paid to a religious, scientific, literary, educational or charitable organization or to an organization constituted and operated exclusively to administer or provide a pension, retirement or employee benefit fund or plan, if it is a resident of the United States and is exempt from income tax under the laws of the United States.

      Interest paid or deemed to be paid on the Corporation’s debt securities held by non-Canadian residents may also be subject to Canadian withholding tax, depending upon the terms and provisions of such securities and any applicable tax treaty. However, in general, interest paid to holders of debt securities who are resident in the United States is not subject to Canadian nonresident withholding tax and rather is taxable only in the United States.

      Dispositions of Common Shares

      Under the Canadian Tax Act, a taxpayer’s capital gain or capital loss from a disposition of a share of our common stock is the amount, if any, by which his or her proceeds of disposition exceed (or are exceeded by, respectively) the aggregate of his or her adjusted cost base of the share and reasonable expenses of disposition. The capital gain or loss must be computed in Canadian currency using a weighted average adjusted cost base for identical properties. The capital gains net of losses realized and included in income are at 50%. The amount by which a shareholder’s

      65





      capital loss exceeds the capital gain in a year may be deducted from a capital gain realized by the shareholder in the three previous years or any subsequent year, subject to certain restrictions in the case of a corporate shareholder.

      Under the Canadian Tax Act, a non-resident of Canada is subject to Canadian tax only on taxable capital gains, net of allowable capital losses, realized on a disposition of “taxable Canadian property.” In general, shares of our common stock should not constitute taxable Canadian property. Consequently, in general, nonresidents of Canada should not be taxable in Canada in respect of gains arising on a disposition of our shares.

      F. Dividends and Paying Agents

      Not Applicable.

      G. Statements by Experts

       

      Not Applicable.

      H. Documents on Display

      The documents concerning us which are referred to in this annual report may be inspected at our offices located at 590 – 425 Carrall Street, Vancouver, British Columbia V6B 6E3.

      We are required to file reports and other information with the securities commission in British Columbia, Alberta, Ontario and Quebec. Readers are invited to read and copy any reports, statements or other information, other than confidential filings, that we file with the provincial securities commission. These filings are also electronically available for the Canadian System for Electronic Document Analysis and Retrieval (SEDAR) (www.sedar.com), the Canadian equivalent of the SEC’s electronic document gathering and retrieval system (EDGAR).

      I. Subsidiary Information

      For information about our subsidiaries, please see “Item 4. Information On The Company; Organizational Structure.”

      ITEM 11.

      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      We are exposed to a number of risks related to changes in foreign currency exchange rates, interest rates, collection of accounts receivable, settlement of liabilities and management of cash and cash equivalents. We manage these risks through internal risk management policies.

      Many of our strategies are based on historical trading patterns and correlations and our management’s expectations of future events. However, these strategies may not be fully effective in all market environments or against all types of risks. Unexpected market developments may affect our risk management strategies during this time, and unanticipated developments could impact our risk management strategies in the future. If any of the variety of instruments and strategies we utilize are not effective, we may incur losses.

      Credit risk

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      Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and accounts receivable. The Company aims to protect its cash and cash equivalents from undue risk by holding them with various high credit quality financial institutions located in Canada and the United Kingdom. In circumstances where a bank in which the Company holds a deposit has any significant decline in its credit rating, the Company carefully monitors the extent of any credit risk net of government deposit guarantees and, where appropriate, would take remedial action to minimise the risk of any potential credit loss. Of the amounts held with financial institutions on deposit, $100,000 is covered by the Canada Deposit Insurance Corporation, leaving $2,325,106 at risk should the financial institutions with which the deposits are held cease trading.

      The Company's accounts receivable are all from large, well-known retailers located primarily in Canada, the United States and the United Kingdom. Credit risk from accounts receivable encompasses the default risk of retail customers. The Company manages its exposure to credit risk by only working with larger, reputable companies and prior to accepting new customers; the Company assesses the risk of default associated with a particular company. In addition, on an ongoing basis, management monitor the level of accounts receivable attributable to each customer and the length of time taken for amounts to be settled and where necessary, takes appropriate action to follow up on those balances considered overdue.

      Management does not believe that there is significant credit risk arising from any of the Company's customers; however, should one of the Company's main customers is unable to settle amounts due, the impact on the Company could be significant. The maximum exposure to loss arising from accounts receivable is equal to their total carrying amounts. At September 30, 2013, five customers each account for 10% or more of total trade accounts receivable (September 30, 2012: three customers).

      Financial assets past due

      At September 30, 2013, the Company has a provision of $46,491 against trade accounts receivable, the collection of which is considered doubtful. The following table provides information regarding the ageing of financial assets that are past due but which are not impaired. During the year ended September 30, 2013 the Company incurred bad debt expenses of $54,107 (2012: $132,012, 2011: $33,102).

      The following table provides information regarding the ageing of financial assets that are past due but which are not impaired.

      As at September 30, 2013:

              Financial assets that are past due but not impaired    
                              Carrying value
          Neither past due                   on the balance
          nor impaired     31 – 60 days    61 – 90 days      91 days +     sheet  
      Trade accounts receivable $ 2,589,547 $ 439,770   $ 130,187   $ 408,674 $ 3,568,178
      Commodity taxes recoverable   35,868   -     -     -   35,868
      Other    225,608      -       -       -      225,608  
      Total $ 2,851,023   $ 439,770    $ 130,187    $ 408,674   $ 3,829,654  

       

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      The definition of items that are past due is determined by reference to terms agreed with individual customers. Of the 90 days+ balance outstanding at September 30, 2013, 97% has been subsequently collected as at December 6, 2013. None of the amounts outstanding have been challenged by the respective customer(s) and the Company continues to conduct business with them on an ongoing basis. Accordingly, management has no reason to believe that this balance is not fully collectable in the future.

      The Company reviews financial assets past due on an ongoing basis with the objective of identifying potential matters which could delay the collection of funds at an early stage. Once items are identified as being past due, contact is made with the respective company to determine the reason for the delay in payment and to establish an agreement to rectify the breach of contractual terms. At September 30, 2013, the Company had a provision for doubtful accounts of $46,491 which was made against trade accounts receivable in excess of twelve months old or where collection efforts to date have been unsuccessful. All amounts neither past due nor impaired are collectible from large, well-known retailers located in Canada, the United States and the United Kingdom. The Company is not aware of any information suggesting that the collectability of these amounts is in doubt.

      Market risk

      Market risk is the risk to the Company that the fair value or future cash flows of financial instruments will fluctuate due to changes in interest rates and foreign currency exchange rates. Market risk arises as a result of the Company generating revenues and incurring expenses in foreign currencies, holding cash and cash equivalents which earn interest and having operations based in the United Kingdom in the form of its wholly owned subsidiaries.

      Interest rate risk

      The only financial instruments that expose the Company to interest rate risk are its cash and cash equivalents. The Company’s objectives of managing its cash and cash equivalents are to ensure sufficient funds are maintained on hand at all times to meet day-to-day requirements and to place any amounts which are considered in excess of day-to-day requirements on short-term deposit with the Company's banks so that they earn interest. When placing amounts of cash and cash equivalents on short-term deposit, the Company only uses high quality commercial banks and ensures that access to the amounts placed can be obtained on short-notice. As at September 30, 2013 the weighted average interest rate of all cash equivalent investments was approximately nil (2012: nil).

      Currency risk

      The Company generates revenues and incurs expenses and expenditures primarily in Canada, the United States and the United Kingdom and is exposed to risk from changes in foreign currency rates. In addition, the Company holds financial assets and liabilities in foreign currencies that expose the Company to foreign exchange risks. The Company does not utilise any financial instruments or cash management policies to mitigate the risks arising from changes in foreign currency rates.

      At September 30, 2013, through its wholly owned subsidiaries, the Company had cash and cash equivalents of $980,550, accounts receivable of $918,656 and accounts payable of $400,978

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      which were denominated in UK £. In addition, at September 30, 2013, the Company had cash and cash equivalents of $1,444,403, accounts receivable of $2,361,237 and accounts payable of $612,733 which were denominated in US$.

      Sensitivity analysis

      The Company has completed a sensitivity analysis to estimate the impact on net earnings for the year which a change in foreign exchange rates or interest rates during the twelve months ended September 30, 2013 would have had.

      This sensitivity analysis includes the following assumptions:

      • Changes in individual foreign exchange rates do not cause foreign exchange rates in other countries to alter

      • Changes in market interest rates do not cause a change in foreign exchange rates

      The results of the foreign exchange rate sensitivity analysis can be seen in the following table:

          Impact on net profit
         
        $
      Change of +/- 10% in US$ foreign exchange rate +/-206,260
      Change of +/- 10% in UK£ foreign exchange rate +/-179,923

      The above results arise primarily as a result of the Company having US$ denominated trade accounts receivable balances, trade accounts payable balances and bank account balances.

      Limitations of sensitivity analysis

      The above table demonstrates the effect of either a change in foreign exchange rates or interest rates in isolation. In reality, there is a correlation between the two factors.

      Additionally, the financial position of the Company may vary at the time that a change in either of these factors occurs, causing the impact on the Company’s results to differ from that shown above.

      ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

      Not Applicable.

      PART II

      ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

      There have not been any defaults with respect to dividends, arrearages or delinquencies since September 30, 2009.

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      ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

      There have been no material modifications to the rights of our security holders or use of proceeds since September 30, 2009.

      ITEM 15. CONTROLS AND PROCEDURES

      Disclosure Controls And Procedures

      Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

      As required by Rule 13a-15 under the Securities Exchange Act of 1934, we have carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this annual report, being September 30, 2013. This evaluation was carried out by the Company’s Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2013.

      Management’s Annual Report on Internal Control over Financial Reporting

      Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Chief Executive Officer and the Chief Financial Officer and effected by the Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. It includes those policies and procedures that:

      • Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

      • Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are made only in accordance with authorizations of management and the directors of the Company; and

      • Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

      Management has assessed the effectiveness of our internal control over financial reporting as at September 30, 2013 using criteria established in Internal Control – Integrated Framework issued

      70





      by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, management has concluded that the Company maintained effective internal control over financial reporting as at September 30, 2013.

      This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) being signed into law in the United States. Section 989G of the Dodd-Frank Act permanently exempts non-accelerated filers from filing auditor attestation reports over the effectiveness of the Company’s internal controls in accordance with Section 404(b) of the Sarbanes Oxley Act of 2002. For the year ended September 30, 2013, the Company continues to meet the definition of a non-accelerated filer.

      Changes in Internal Control Over Financial Reporting

      There has been no change in our internal control over financial reporting during the Company’s year ending September 30, 2013 that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.

      Limitations of Controls And Procedures

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

      ITEM 16. [RESERVED]

       

      ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

      The members of the audit committee are Rob Chase (Chairman), Peter Fitzgerald, David Jaworski and Josef Vejvoda.

      Our Board of Directors has determined that Rob Chase qualifies as a “financial expert”.

      All members of the audit committee are “independent” (being Rob Chase, David Jaworski, Josef Vejvoda and Peter Fitzgerald) as the term is defined under the rules of the NYSE MKT LLC and all audit committee members are financially literate.

      71





      A member of the audit committee is considered financially literate if he or she has the ability to read and understand a set of financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of the issues that can reasonably be expected to be raised by the Company.

      Relevant Education and Experience

      Mr. Robert Chase is currently Chief Operating Officer (“COO”) of Absolute Software Corporation (“Absolute”) (TSX:ABT), a global technology leader in IT security and management for PC, Mac, iOS and Android devices, servicing over 30,000 customers worldwide through sales and technology partnerships with the world’s leading computer manufacturers. Rob is responsible for the overall corporate strategy, operational alignment and efficiency, and business effectiveness of Absolute. To this role, Rob brings more than 20 years of finance and operational expertise – including 10 years in executive leadership at Absolute. Before becoming COO in July 2010, Mr. Chase served as Absolute’s Chief Financial Officer where he oversaw Absolute’s finance functions and investor market-facing activities. Mr. Chase joined Absolute as Director of Finance in 2000. Prior to joining Absolute, Rob obtained his Chartered Accountant designation while working with Deloitte, and also worked as an executive compensation consultant with Towers Perrin. Mr. Chase holds a Bachelor of Business Administration from Simon Fraser University.

      Mr. David Jaworski is CEO of Meta Media Partners, LLC. Current customers include The Lifebook Company, LLC where Mr. Jaworski currently serves as Chief Operating Officer and NetSteps, LLC where he serves as Vice President of Sales and Marketing. Mr. Jaworski also serves as a Board Member of 2xGlobal, a non-profit focused on developing and mentoring leaders. He developed the Stave Evaluation (http://OnlineTeamEvaluation.com) for 2xGlobal’s for-profit arm, 2xConsulting. Mr. Jaworski is a successful entrepreneur with over 30 years of technology, sales and marketing, and executive management experience. This experience includes developing and delivering profitable, award winning software and Internet technology products. The third employee at Microsoft Canada, Mr. Jaworski was instrumental in launching Microsoft’s Canadian operation. Mr. Jaworski was awarded the first-ever Bill Gates’ Chairman’s Award of Excellence for his work, recognizing him as Microsoft’s #1 employee worldwide that exemplified excellence by Bill Gates and the Microsoft Executive team. He was Microsoft’s National Sales Manager before being promoted to General Manager of U.S. Sales Operations. After leaving Microsoft, Mr. Jaworski served as VP of Sales for Arabesque Software, founder and CEO of Provident Ventures, Inc., Senior VP and General Manager of Gaylord Digital, the Internet division of Gaylord Entertainment and founder and CEO of PassAlong Networks -providing Digital Media and Content Management for over 200 clients including eBay. Mr. Jaworski served as Chief Technology Officer for Intero Alliance, building the Intero Lifestyle Network, a content management system and digital media store platform with extensive integration of global social media. Mr. Jaworski led the Intero delivery of a customized implementation of this technology to Avon Products, Inc., the world’s largest direct sales company, launching it in 62 countries in 37 languages.

      Mr. Josef Vejvoda is the President of Jove Capital Inc., a boutique financial services and investment firm which provides strategic advisory services to a broad range of clients including large institutional investors, numerous boards of directors as well as senior management teams. Mr. Vejvoda has over 20 years of extensive equity capital markets experience in both the public and private sectors. Mr. Vejvoda has held senior management roles at a number of the country’s largest financial institutions including Merrill Lynch Canada, the Ontario Ministry of Economic Development, the Bank of Montreal, National Bank Financial and TD Bank Financial Group. Mr.

      72





      Vejvoda served as the Vice-President of software technology at National Bank Financial as well as VP of technology software/services at TD Securities earlier in his career. As a Managing Director in the investment banking sector, Mr. Vejvoda lead the corporate finance department for a national boutique investment dealer whose parent company managed over $12 billion in assets under administration. Mr. Vejvoda has personally directed or participated in numerous equity financings, initial public offerings and/or merger acquisition transactions, with a collective aggregate valuation easily exceeding a billion dollars. Mr. Vejvoda was an active member of the board of directors of MGI Securities, a full service IIROC registered investment dealer for approximately four years and has also served on numerous non-profit and charity boards. Mr. Vejvoda is a bachelor of computer science graduate from Queen’s University in Kingston, Ontario and has been a registered portfolio manager with the Ontario Securities Commission. Mr. Vejvoda has also completed the Canadian Securities Course, the Portfolio Management Course, the Investment Management Techniques Course, as well as the Partners, Directors and Officers Exam and has earned the Chartered Investment Manager (CIM®) designation from the Canadian Securities Institute.

      Peter Fitzgerald obtained his M.S.C. from the Massachusetts Institute of Technology in 1989; a PMD from the Harvard Business School in 1983; and an FCCA from the Chartered Association of Certified Accountants in 1973. Mr. Fitzgerald joined PNI's Board of Directors in August 2001 and became Chairman of the Board in 2004. Prior to PNI, Mr. Fitzgerald was CEO of Gretag Imaging where he built the company into one of the world's leading manufacturers of imaging equipment and systems before leaving to pursue personal interests. Previous to Gretag, Mr. Fitzgerald was CEO of Qualex, the Kodak photo-processing subsidiary, which he led very successfully for over seven years. While he was CEO of Qualex, Mr. Fitzgerald retained his active role as Vice President within Eastman Kodak where among other titles he carried the role of General Manager, Worldwide Consumer Imaging Services.

      All of the above have had extensive experience reviewing financial statements.

      ITEM 16B. CODE OF ETHICS

      Our policy is to conduct our business in accordance with the highest ethical and legal standards.

      To assist us in achieving this policy, the Board of Directors has adopted a Code of Ethics and Trading Restrictions Policy on December 11, 2006. The Code is designed to deter wrongdoing and to promote:

      (1)

      Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

         

       

      (2)

      Full, fair, accurate, timely and understandable disclosure in reports and documents that we submit to regulatory authorities and communicate to the public;

         

       

      (3)

      Compliance with applicable governmental laws and regulations;

         

       

      (4)

      Prompt internal reporting of violations of the Code to appropriate persons identified in the Code; and

         

       

      (5)

      Accountability for adherence to the Code.

      73





      The Code applies to all of our employees, officers, and directors, including those of our subsidiaries. Depending on the circumstances, it may also apply to agents and other representatives of us.

      The Company undertakes to provide to any person without charge, upon request, a copy of our Code. Such requests can be made to the Company in writing (our principal executive office is located at 590-425 Carrall Street, Vancouver, British Columbia, Canada V6B 6E3) or by telephone (our telephone number is 604-893-8955).

      ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

       

      A. Audit Fees

      The aggregate fees billed by our auditors were CDN $297,000 and CDN$303,750 for the fiscal years ended 2013 and 2012, respectively.

      B. Audit-Related Fees

      The aggregate fees billed by our auditors for audit-related fees were CDN$48,515 and CDN$1,480 for the fiscal years ended 2013 and 2012, respectively.

      C. Tax Fees

      The aggregate fees billed by our auditors for tax fees were CDN$14,700 and CDN$nil for the fiscal years ended 2013 and 2012, respectively. The work performed related to Canadian tax compliance.

      D. All Other Fees

      The aggregate fees billed by our auditors for other services were CDN$nil and CDN$59,500 for the fiscal years ended 2013 and 2012, respectively.

      Pre-Approval of Services by the Independent Auditor

      The Audit Committee is responsible for the pre-approval of audit and permitted non-audit services to be performed by the Company's independent auditor. The Audit Committee will, on an annual basis, consider and, if appropriate, approve the provision of audit and non-audit services by its auditor. Thereafter, the Audit Committee will, as necessary, consider and, if appropriate, approve the provision of additional audit and non-audit services by its auditor which are not encompassed by the Audit Committee's annual pre-approval and are not prohibited by law. The Audit Committee has delegated to the Chair of the Audit Committee the authority to pre-approve, on a case-by-case basis, non-audit services to be performed by the Company’s auditors. The Audit Committee has approved all of the audit and permitted non-audit services performed by the Company’s auditors in the year ended September 30, 2013.

      ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

      Not Applicable

      74





       
      ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

      Not Applicable

      ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT.

      Not Applicable

      ITEM 16G. CORPORATE GOVERNANCE.

      Not Applicable

      ITEM 16H. MINE SAFETY DISCLOSURE

      Not Applicable

      PART III

      ITEM 17. FINANCIAL STATEMENTS

      We are providing financial statements pursuant to Item 18.

      ITEM 18. FINANCIAL STATEMENTS

      Our consolidated financial statements were prepared in accordance with IFRS, as issued by the IASB, and are presented in Canadian dollars.

      The consolidated financial statements are in the following order:

      1.

      Report of Independent Registered Public Accounting Firm;

      2.

      Consolidated Balance Sheets as at September 30, 2013, 2012 and 2011;

      3.

      Consolidated Statement of Operations and Comprehensive (Loss) Income for the years ended September 30, 2013, 2012 and 2011;

      4.

      Consolidated Statements of Changes in Equity for the years ended September 30, 2013, 2012 and 2011;

      6.

      Consolidated Statements of Cash Flows for the years ended September 30, 2013, 2012 and 2011; and

      7.

      Notes to Consolidated Financial Statements.

       

       

      75








      PNI Digital Media Inc.

      Consolidated Financial Statements
      September 30, 2013 and 2012







      76





      MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

      Management is responsible for the integrity and fair presentation of the financial information contained in this annual report. Where appropriate, the financial information, including financial statements, reflects amounts based on the best estimates and judgments of management. The financial statements have been prepared in accordance with accounting principles generally accepted in Canada. Financial information presented elsewhere in the annual report is consistent with that disclosed in the financial statements.

      Management is responsible for establishing and maintaining adequate internal control over financial reporting. Any system of internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The system of controls is also supported by a professional staff of internal auditors who conduct periodic audits of many aspects of our operations and report their findings to management and the Audit Committee.

      Management has a process in place to evaluate internal control over financial reporting based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework.

      The Board of Directors oversees management’s responsibility for financial reporting and internal control systems through an Audit Committee, which is composed entirely of independent directors. The Audit Committee meets periodically with management, our internal auditors and independent auditors to review the scope and results of the annual audit and to review the financial statements and related financial reporting and internal control matters before the financial statements are approved by the Board of Directors and submitted to the shareholders. PricewaterhouseCoopers LLP, an independent registered public accounting firm, appointed by the shareholders, have audited our financial statements in accordance with Canadian generally accepted auditing standards and have expressed their opinion in the auditor’s report.

      /s/ Kyle Hall /s/ Cameron Lawrence
      Kyle Hall Cameron Lawrence
      Chief Executive Officer Chief Financial Officer
      Vancouver, Canada  
       
      December 10, 2013  

       


      77





      To the Shareholders of PNI Digital Media Inc.

      We have audited the accompanying consolidated financial statements of PNI Digital Media Inc. and its subsidiaries, which comprise the consolidated balance sheets as at September 30, 2013 and September 30, 2012 and the consolidated statements of operations and comprehensive (loss) income, changes in equity and cash flows for each of the three years in the year ended September 30, 2013 and the related notes, which comprise a summary of significant accounting policies and other explanatory information.

      Management’s responsibility for the consolidated financial statements
      Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

      Auditor’s responsibility
      Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. Canadian generally accepted auditing standards also require that we comply with ethical requirements.

      An audit involves performing procedures to obtain audit evidence, on a test basis, about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. We were not engaged to perform an audit of the company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting principles and policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

      We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

      Opinion
      In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of PNI Digital Media Inc. and its subsidiaries as at September 30, 2013 and September 30, 2012 and their financial performance and their cash flows for each of the three years in the period September 30, 2013 in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.

      /s/ PricewaterhouseCoopers LLP

      Chartered Accountants
      Vancouver, B.C.
      December 10, 2013


      78




      PNI Digital Media Inc.
      Consolidated Balance Sheets
      As at September 30, 2013 and 2012
      (expressed in Canadian dollars)

       

          September 30, 2013     September 30, 2012  
                   
      Assets            
                   
      Current assets            

      Cash and cash equivalents

      $ 2,425,106   $ 4,611,824  

      Accounts receivable (note 8)

        3,829,654     4,253,541  

      Prepaid expenses and other current assets

        411,728     622,970  

       

                 
          6,666,488     9,488,335  
                   
      Property and equipment (note 9)   4,482,948     4,683,355  
      Deferred income tax asset (note 10)   2,214,519     5,222,603  
      Intangible assets (note 11)   1,254,931     2,124  
      Goodwill (note 12)   -     568,479  
      Other long-term assets   132,346     -  
       
        $ 14,751,232   $ 19,964,896  
      Liabilities                  
                   
      Current liabilities            

      Accounts payable and accrued liabilities (note 13)

      $ 3,037,371   $ 4,390,437  

      Line of credit and overdraft (note 21)

        1,401,070     -  

      Current portion of deferred revenue

        308,990     318,107  

      Current portion of finance lease obligations (note 20 and note 21)

        341,659     -  

      Deferred rent

        22,953     -  

      Contingent consideration (note 6)

        343,279     -  

       

                 
          5,455,322     4,708,544  
                   
      Deferred revenue   273,241     437,140  
      Finance lease obligations (note 20 and note 21)   576,104     -  
      Deferred rent – Long term   275,632     -  
      Deferred income tax liability (note 10)   332,354     -  
          6,912,653     5,145,684  
      Shareholders’ Equity (note 14)            
                   
      Share capital $ 66,881,748   $ 66,817,352  
      Contributed surplus   19,410,066     19,334,098  
          86,291,814     86,151,450  
                   
      Accumulated deficit   (78,802,351 )   (71,135,021 )
      Accumulated other comprehensive income (loss)   349,116     (197,217 )
                   
          (78,453,235 )   (71,332,238 )
                   
          7,838,579     14,819,212  
                   
        $ 14,751,232   $ 19,964,896  

      Subsequent events (note 23)
      Commitments and contingencies (note 20)

      Approved by the Board of Directors


      “Kyle Hall” Director “Peter Fitzgerald” Director

       

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


      79




      PNI Digital Media Inc.
      Consolidated Statements of Operations and Comprehensive (Loss) Income
      Years Ended September 30, 2013, 2012 and 2011
      (expressed in Canadian dollars)

       

          September 30,     September 30,   September 30,  
          2013     2012     2011  
                         
      Revenue (note 16) $ 20,899,204   $ 22,712,805   $ 23,686,351  
      Cost of sales (note 7 and note 19)   10,401,693     10,458,022     9,399,107  
      Gross profit   10,497,511     12,254,783     14,287,244  
                         
      Expenses                  

      Software development

        9,907,590     9,678,638     9,439,423  

      General and administration

        3,591,014     3,768,203     3,928,210  

      Sales and marketing

        1,474,749     1,038,374     988,289  

       

                       
          14,973,353     14,485,215     14,355,922  
                         
      Loss from operations   (4,475,842 )   (2,230,432 )   (68,678 )
                         
      Foreign exchange loss   (483,613 )   (82,647 )   (125,148 )
      Finance income   4,170     4,647     -  
      Finance costs   (18,065 )   -     (5,599 )
      Bargain purchase gain (note 6)   128,537     -     -  
                         
          (368,971 )   (78,000 )   (130,747 )
                         
      Loss before income tax   (4,844,813 )   (2,308,432 )   (199,425 )
                         
      Deferred income tax (expense) recovery (note 10)   (2,822,517 )   (1,814,221 )   1,299,025  
      Income tax (expense) recovery   (2,822,517 )   (1,814,221 )   1,299,025  
                         
      (Loss) profit for the period   (7,667,330 )   (4,122,653 )   1,099,600  
                         
      Other comprehensive gain (loss):                  
                         
      Items that may be subsequently reclassified to the statement of operations                  
                         
      Exchange differences on translation of foreign operations   546,333     (170,956 )   (26,263 )
                       

      Total comprehensive (loss) income for the period

      $ (7,120,997 ) $ (4,293,609 ) $ 1,073,337  
      (Loss) earnings per share (note 14f)                  
      Basic $ (0.22 ) $ (0.12 ) $ 0.03  
      Fully diluted $ (0.22 ) $ (0.12 )   $ 0.03  

      Weighted Average Number of Shares Outstanding - Basic

        34,299,471     34,178,165     33,927,659  

      Weighted Average Number of Shares Outstanding - Diluted

        34,299,471     34,178,165     33,985,271  

       

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


      80




      PNI Digital Media Inc.
      Consolidated Statements of Changes in Equity
      (expressed in Canadian dollars)

       

        Share Capital                                      
                    Share                 Accumulated              
                    capital                 other              
        Number of           purchased                 comprehensive           Total  
        common           for     Contributed     Accumulated     (loss) income      Accumulated deficit     shareholders’  
        shares     Amount      cancellation     surplus     deficit     (AOCI)     and AOCI     equity  
                                               
      Balance October 1, 2010 33,853,782    $ 66,349,735   $ (41,909 ) $ 18,933,619   $ (68,111,967 ) $ -   $ (68,111,967 ) $ 17,129,478  
      Issuance of shares on exercise of options 291,776     498,937           (134,217 )                     364,720  
      Issuance of shares held in escrow 178,500     290,952           (290,952 )                     -  
      Cancellation of shares repurchased (313,100 )   (612,229 )   446,503     165,726                       -  
      Purchase of share capital for cancellation(283,100 shares)             (404,594 )                           (404,594 )
      Stock-based compensation recorded in net profit                   549,142                       549,142  
      Compensation expense in connection with acquisition of WorksMedia Limited                   299,102                       299,102  
      Adjustment relating to the realization of tax benefits associated with share issues costs       (106,823 )                                 (106,823 )
      Profit for the period                         1,099,600           1,099,600        
      Other comprehensive loss                               (26,263 )   (26,263 )      
      Total comprehensive income for the period                                     1,073,337     1,073,337  
                                                     
      Balance September 30, 2011 34,010,958    $ 66,420,572         $ 19,522,420   $ (67,012,367 ) $ (26,263 ) $ (67,038,630 ) $ 18,904,362  
      Issuance of shares on vesting of RSUs and PSUs 68,464     106,119           (106,119 )                     -  
      Issuance of shares held in escrow 178,500     290,952           (290,952 )                     -  
      Stock-based compensation expense                   95,669                       95,669  
      Compensation expense re: acquisition of WorksMedia Limited                   113,080                       113,080  
      Reduction in share capital as a result of realizing the deferred tax expense associated with a portion of deductible share issue costs       (291 )                                 (291 )
      Net loss                         (4,122,654 )         (4,122,654 )      
      Other comprehensive loss                               (170,954 )   (170,954 )      
      Total comprehensive loss for the period                                     (4,293,609 )   (4,293,609 )
                                                     
      Balance September 30, 2012 34,257,922    $ 66,817,352         $ 19,334,098   $ (71,135,021 ) $ (197,217 ) $ (71,332,238 ) $ 14,819,212  
      Issuance of shares on vesting of RSUs and PSUs 41,549     64,396           (64,396 )                     -  
      Stock-based compensation expense                   140,364                       140,364  
      Net Loss                         (7,667,330 )         (7,667,330 )      
      Other comprehensive loss                               546,333     546,333        
      Total comprehensive loss for the period                                     (7,120,997 )   (7,120,997 )
                                                     
      Balance September 30, 2013 34,299,471   $ 66,881,748         $ 19,410,066   $ (78,802,351 ) $ 349,116   $ (78,453,235 ) $ 7,838,579  

       

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


      81




      PNI Digital Media Inc.
      Consolidated Statements of Cash Flows
      (expressed in Canadian dollars)

       

          September 30, 2013     September 30, 2012     September 30, 2011  
                         
      Cash flows from operating activities                  

      Net (loss) profit for the period

      $ (7,667,330 ) $ (4,122,653 ) $ 1,099,600  

      Items not affecting cash

                       

      Amortization of property and equipment

        1,659,913     1,808,725     2,036,953  

      Amortization of intangible assets

        309,156     1,091,024     858,354  

      Stock-based compensation expense

        140,364     208,749     848,244  

      Unrealized foreign exchange loss

        542,234     46,601     71,930  

      Allowance for doubtful accounts

        54,107     132,012     33,102  

      Loss on disposal of property and equipment

        15,801     -     117,306  

      Impairment of intangible asset

        -     540,735     -  

      Deferred rent

        (77,429 )   -     -  

      Deferred income tax expense (recovery)

        2,822,517     1,814,221     (1,299,025 )

      Impairment of goodwill (note 12)

        594,851     77,382     -  

      Bargain purchase gain (note 6)

        (128,537 )   -     -  

       

                       
          (1,734,353 )   1,596,796     3,766,464  

      Net change in non-cash working capital
      items (note 22)

        (1,182,032 )   1,435,556     (1,845,407 )
          (2,916,385 )   3,032,352     1,921,057  
      Cash flows from investing activities                  

      Purchase of property and equipment

        (450,787 )   (1,180,356 )   (2,076,900 )

      Purchase of intangible assets

        (105,438 )   (1,000,713 )   (322,416 )

      Acquisition of Quarterhouse – net of cash received

        (543,907 )   -     -  

      Proceeds on disposal of property and equipment

        1,914     -     2,674  
          (1,098,218 )   (2,181,069 )   (2,396,642 )
      Cash flows from financing activities                  
      Proceeds on exercise of options   -     -     364,720  
      Repurchase of common shares   -     -     (404,594 )
      Proceeds from line of credit and lease facility   1,779,000     -     -  
      Repayment of finance lease obligations   (133,522 )   -     (107,964 )
                         
          1,645,478     -     (147,838 )
                         

      Effect of changes in foreign exchange rates on cash and cash equivalents

        (48,663 )   (175,635 )   (130,756 )
                       

      (Decrease) increase in cash and cash equivalents during the year

        (2,417,788 )   675,648     (754,179 )

       

                               
      Cash and cash equivalents - beginning of year   4,611,824     3,936,176     4,690,355  
                         
      Cash and cash equivalents - end of year (note 22) $ 2,194,036   $ 4,611,824   $ 3,936,176  
                         
      Equipment Acquired Under Finance Leases   1,004,554     -     -  

       

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


      82




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      1. Nature of operations

      PNI Digital Media Inc. is incorporated under the laws of the Province of British Columbia, Canada and is listed on the Toronto Stock Exchange (“TSX”) under the symbol PN and the OTC Bulletin Board under the symbol PNDMF. The address of the Company’s registered office is Suite 590, 425 Carrall Street, Vancouver, B.C. Canada, V6B 6E3.

      PNI Digital Media Inc. and its subsidiaries (together “the Company”) provide retailers transaction processing and order routing services through the operation of the PNI Digital Media Platform. The PNI Digital Media Platform connects consumer-ordered digital content, whether from online, in-store kiosks, desktop software or mobile phones, with retailers that have on-demand manufacturing capabilities for the production of personalized products such as photo prints, gifting products such as photo books and photo calendars, business cards and stationery. The Company’s online platform electronically connects the retailer and its customers through the internet and provides digital image delivery, hosting, transaction processing and storage. In addition, the Company provides the retailer with kiosk software which allows consumers to offload digital images from their digital media and order prints and gifting products within the retailer’s locations. The kiosk software is also connected to the Company’s online platform permitting customers in-store to order gifting products from the kiosk, which are then transmitted from the kiosk to a remote fulfillment facility via the online platform.

      2. Summary of significant accounting policies

       

        a)      

      Basis of presentation

      The principal accounting policies applied in preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all years presented unless otherwise stated.

      These financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and IFRIC interpretations as set out in the Handbook of the Canadian Institute of Chartered Accountants (“CICA Handbook”) and were approved by the Board of Directors for issue on December 10, 2013.

        b)     

      Basis of measurement

      The consolidated financial statements have been prepared under the historical cost convention.

        c)     

      Basis of consolidation

      These consolidated financial statements include the accounts of the Company and each of its wholly-owned subsidiaries. Wholly owned subsidiaries are entities in which the Company has control, directly or indirectly, where control is defined as the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. The Company’s principal operating subsidiaries are QS Quarterhouse Software Inc. (“Quarterhouse”), and PNI Digital Media Europe Ltd.

      All material intercompany balances and transactions are eliminated upon consolidation.


      83




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        d)     

      Business combinations

      The Company accounts for business combinations using the acquisition method of accounting. The cost of an acquisition is measured as the fair value of consideration and the fair value of other assets given, equity instruments issued and liabilities incurred or assumed at the acquisition date. All acquired identifiable assets, liabilities and contingent liabilities are recognized at fair value at the acquisition date. Any excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired is recognized as goodwill. If the cost of an acquisition is less than the fair value of the net assets of the acquired entity, the difference is recognized directly in the statement of operations. Acquisition related costs are expensed as incurred.

        e)     

      Segment reporting

      Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker is responsible for allocating resources and assessing performance of the operating segments and has been identified as the Chief Executive Officer of the Company.

        f)     

      Foreign currency translation

        (i)     

      Function and presentation currency

      Items included in the financial statements of each consolidated entity in the PNI Digital Media Inc. group are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). The functional currency of PNI Digital Media Inc. is the Canadian dollar.

      The financial statements of entities that have a functional currency different from that of PNI Digital Media Inc. (“foreign operations”) are translated into Canadian dollars as follows: assets and liabilities – at the closing rate at the balance sheet date, and income and expenses – at the average rate of the period (as this is considered a reasonable approximation of the actual rates prevailing at the transaction dates). All resulting changes are recognized in other comprehensive (gain) loss.

      Should a foreign operation be sold, the cumulative exchange differences recognized in other comprehensive loss may be reclassified in the consolidated statement of operations.

        (ii)     

      Transactions and balances

      Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of foreign currency transactions and from the translation at exchange rates of monetary assets and liabilities denominated in currencies other than an entities’ functional currency are recognized in the statement of comprehensive income in “realized foreign exchange (loss) gain” and “unrealized foreign exchange (loss) gain” respectively.


      84




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        g)     

      Cash and cash equivalents

      Cash and cash equivalents consist of cash on hand, deposits held with banks, and other short-term highly liquid investments with original maturities of three months or less. In the consolidated balance sheet bank overdrafts are shown in the line of credit and overdrafts within current liabilities. As at September 30, 2013 and 2012 the Company had no investments with original terms to maturity of greater than three months.

        h)     

      Property and equipment

      Property and equipment are recorded at cost less accumulated amortization and accumulated impairment losses (if any). Cost includes expenditures that are directly attributable to the acquisition of the asset. Subsequent costs, if any, are included in the asset’s carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Company and the cost can be measured reliably. Repairs and maintenance costs are charged to the statement of income during the period in which they are incurred.

      The major categories of property and equipment are amortized over their estimated useful lives at the following rates:

      Computer equipment 30% declining balance
      Furniture and office equipment 20% declining balance
      Leasehold improvements Term of the lease
      Equipment held under capital lease Term of the lease

      Residual values, method of amortization and useful lives of the assets are reviewed annually and adjusted if appropriate.

      Gains and losses on disposals of property and equipment are determined by comparing the proceeds with the carrying amount of the asset and are included in the appropriate expense category including cost of sales, software development, general and administration and sales and marketing.

      i)     

      Intangible assets

      (i)     

      Identifiable intangible assets

      Intangible assets acquired in a business combination that meet the specified criteria for recognition, apart from goodwill, are initially recognized and measured at fair value. Intangible assets with finite useful lives, including acquired software, software developed for internal use and customer relationships, are amortized on a straight-line basis over their estimated useful lives as follows:

      Acquired software 3 years
      Customer relationships 3 years
      Internal use software 1-3 years

      Amortization of intangible assets is included within cost of sales. The amortization methods and estimated useful lives of intangible assets are reviewed annually or earlier if events and circumstances change.


      85




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        (ii)     

      Software development costs

      Software development costs includes the costs to customize aspects of the Company's PNI Network software for specific customers as well as the cost of generating the Company's software used in the PNI Network and software sold to customers. For costs incurred to generate software used in the PNI Network or sold to customers, the Company classifies costs into a research phase and a development phase. Costs incurred during the research phase are expensed when incurred as the Company is not able to demonstrate that the software will generate future economic benefits. Costs incurred during the development phase are recognized as intangible assets only if the Company can demonstrate the asset meets the criteria laid out under the relevant standards.

      During the year ended September 30, 2013, no internal development costs were capitalized as these costs did not meet the criteria for capitalization (2012: $508,806, 2011: $186,426), based on lack of certainty over the achieving future economic benefits from these activities.

      During the year ended September 30, 2013, the Company expensed $9,907,590 in software development expenses (2012: $9,678,638, 2011: $9,439,423). These costs principally consist of staff and consulting costs associated with the day to day operations of the Company including customizing aspects of the Company’s PNI Network software for specific customers, generating and maintaining the Company’s software used in the PNI Network and exploring new initiatives.

        (iii)     

      Goodwill

      Goodwill represents the excess of the purchase price of an acquired enterprise over the fair values assigned to the identifiable net assets of the acquired enterprise at the date of acquisition. Goodwill is allocated to each cash-generating unit (“CGU”) or group of CGUs that are expected to benefit from the related business combination. The allocation of goodwill to cash generating units reflects how goodwill is monitored for internal management purposes. A group of CGUs represents the lowest level within the entity at which the goodwill is monitored for internal management purposes, which is not higher than an operating segment. The Company’s CGUs are PNI Canada (its Canadian operations) and PNI Europe (its European operations). Goodwill is not amortized, and is carried at cost less accumulated impairment losses, if any. Management reviews the performance of its cash generating units based on geography, which is also at the operating segment level. Irrespective of any indication of impairment, the recoverable amount of the cash generating unit or group of cash generating units to which goodwill has been allocated is tested annually for impairment or more frequently if there is an indication that the goodwill may be impaired in accordance with “impairment of non-financial assets.” The carrying value of goodwill is compared to the recoverable amounts, which is the higher of the value in use and the fair value less costs to sell. Any impairment is recognized in expense immediately and is not subsequently reversed.

        j)     

      Impairment of non-financial assets

      Property and equipment and intangible assets are tested for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Long-lived assets that are not amortized are subject to an annual impairment test. For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows (CGUs). The recoverable amount is the higher of:

      • An asset’s fair value less costs to sell; and

      • Value in use (being the present value of the expected future cash flows of the relevant asset or CGU).


      86




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      The impairment test methodology is based on a comparison between the higher of fair value less costs to sell and value-in-use of each of the Company's CGUs and the net asset carrying values, including goodwill, of the Company's CGUs. An impairment loss is recognized if the carrying amount of a CGU exceeds its estimated recoverable amount. Value in use is determined as the present value of the future cash flows expected to be derived from an asset or cash generating unit. Estimated future cash flows are calculated using estimated future prices, operating and capital costs.

      An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount.

      The Company evaluates impairment losses, other than goodwill, for potential reversals when events or circumstances warrant such consideration.

      It is possible that some of our tangible or intangible long-lived assets or goodwill could become impaired in the future and that any resulting write-downs could be material.

        k)     

      Current and deferred income taxes

      Income tax comprises current and deferred tax. Income tax is recognized in the statement of operations and comprehensive loss except to the extent that it relates to items recognized directly in other comprehensive income or directly in equity, in which case the income tax is also recognized directly in other comprehensive income (loss) or equity, respectively.

      Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted, at the end of the reporting period, and any adjustment to tax payable in respect of previous years. As at September, 2013, the Company has not incurred any taxes payable (2012: $nil, 2011: $nil).

      Deferred tax is recognized, using the balance sheet liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for operating losses or tax credits. Deferred income tax is determined on a non-discounted basis using tax rates and laws that have been enacted or substantively enacted at the balance sheet date and are expected to apply when the deferred tax asset is realized or liability is settled. Deferred tax assets are recognized to the extent that it is probable that future taxable profit will be available against which the deductible temporary differences can be utilized.

      Deferred income tax assets and liabilities are presented as non-current.

        l)     

      Share capital

      Direct costs associated with the issue of capital stock or warrants are deducted from the related proceeds at the time of the issue.

        m)     

      Revenue

      The Company provides online and in-store digital media solutions to retailers. These solutions are primarily provided through the PNI Digital Media Network services (Network Services). The Company also provides professional services and sells software products to retailers either directly or through license and distribution agreements. The products sold do not have any general rights of


      87




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      return except under arrangements whereby the Company provides the product to the ultimate customer.

      Through Network Services, the Company’s customers obtain access to the PNI Digital Media Platform (Platform) which provides the technology which delivers media transactions between retailers and content providers and their consumers. The Platform provides a transaction and order routing tier which delivers orders placed either through online sites, mobile devices or kiosks to the production facilities of the Company’s customers for production and delivery to end consumers. Through the Platform, customers are able to store, edit, archive, distribute and print photographs and other personalized products. The Company does not produce the content, but may act as an agent for certain retailers for some consumer deliverables. The Network Services provided by the Company may include the software, hosting, storage and archiving facilities, ongoing development up to a specified threshold of hours, initial integration of the software into the customer’s environment, technical support, maintenance services and hardware. Fees for these services are paid through fixed and variable fees. The variable fees are based on different factors and may be based on the number of physical locations connected to the Network, the number of transactions processed through the Platform, the number of images uploaded through the Platform, a percentage of revenue earned by its customers and the amount of storage capacity used in excess of minimums provided in the contract. The Company accounts for the Network Services as a single unit of accounting.

      In some instances, the Company provides services to the ultimate customers who access the PNI Network through a retailer’s website. These services include taking on the responsibility for the fulfillment of print orders, the provision of certain consumer deliverables and other media. The Company pays the retailer a commission for the use of their website and other services provided by the retailer. The Company is responsible for fulfilling the ultimate customers’ orders and fulfills its obligations through the use of third party suppliers who ship the products directly to the customer. Revenue is recognized when the product is shipped, net of estimated returns, as the Company has transferred the significant risks and rewards of ownership to the customer at that time. The Company estimates the provision for returns based on historical experience and adjusts to actual returns when determinable.

      The Company provides professional services in addition to the initial integration services to make changes to the customer’s website and branded environment and to provide email marketing programs to customers.

      Revenue is considered realized or realizable and earned when all of the following criteria are met:

        (i)     

      Persuasive evidence of a sales arrangement exists;

        (ii)     

      Delivery has occurred or services have been rendered;

        (iii)     

      The price is fixed or determinable; and

        (iv)     

      Collectability is reasonably assured.


      88




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      Cash received from customers prior to the related revenue being recognized is recorded as deferred revenue. In addition to this general policy:

      • Fees earned for software licenses relate to the sale of software either directly to retailers or to distributors for resale to retailers for use in-store, allowing end users to edit and order prints and other photo-related items from digital images. Revenue from these arrangements that involve multiple elements are reviewed to determine whether a delivered item(s) has value to the customer on a stand-alone basis and whether there is objective and reliable evidence of the fair value of the undelivered item(s). If these criteria are met, the Company allocates revenue using the relative fair value of each element within the contract that has stand-alone value, such as software products, post contract customer support and maintenance. In instances, where the Company has evidence of the fair value of each element within a multiple deliverable arrangement, revenue is recognized upon the delivery or rendering of service(s) with respect to each section as there is no general right of return. Revenue for perpetual software licenses is recognized upon delivery, as the license holder is not obligated to pay maintenance for the ongoing use of the license. Maintenance fees are recognized on a straight line basis over the term of the maintenance service period. If the fair value of the delivered item is not obtainable, the Company allocates revenue using the residual method in instances where the fair value of the undelivered item is verifiable. The Company does not currently have any multiple deliverable arrangements which require the use of the residual approach.

      • Installation fees are fixed upfront fees related to Network Services which are deferred and recognized on a straight-line basis over the life of the agreement, or where the agreement with the customer is on a month-to-month basis, over the estimated life of the customer relationship period. The customer relationship period is assessed annually, and has been estimated to be 24 to 48 months.

      • Monthly fixed fees per connected location are recognized monthly and are included in membership fees.

      • Fees for storing and archiving digital images for customers in excess of the minimums provided in the agreement are based upon our customers storage capacity needs, and are recognized as the storage is provided and are included in archive fees.

      The Company offers volume and other rebates and discounts to certain customers which are recognized as a reduction of revenue at the date the related revenue is recognized or the date the offer is made for previously recognized revenue. The amount of rebates is based on estimates of the expected rebates to be paid based on historical and expected trends or on the maximum potential rebates that could be earned by a customer if the Company is unable to reasonably estimate the expected rebate. The Company accounts for cash consideration offered to customers, including annual volume discounts, as a reduction in sales revenue. All revenues are reported net of sales and value added taxes.

      Trade accounts receivable balances are shown net of allowances for doubtful accounts.


      89




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        n)     

      Cost of sales

      Cost of sales is comprised of costs associated with providing hosting services to our customers, customer support provided on behalf of our customers, and costs of products sold as it relates to instances where the Company is responsible for fulfillment of certain items sold. Hosting services include costs for renting our data centers, personnel costs associated with maintaining and monitoring the performance of our network, personnel and consulting costs associated with maintaining our customer’s sites and third party software licenses used in maintaining the performance of our network and platform. In addition, cost of sales includes amortization associated with property and equipment used in our data centers, amortization associated with acquired software, customer relationships and internal use software relating to generating revenue.

        o)     

      Share-based payment

      The Company’s share-based awards may take the form of stock options, Performance Share Units (“PSU”), and Restricted Share Units (“RSU”) which are granted to directors and certain employees of the Company as an element of compensation. The cost of the service received as consideration is measured based on an estimate of fair value at the date of the grant. The grant-date fair value is recognized as compensation expense over the related service period with a corresponding increase in contributed surplus. If graded awards are granted, each vesting tranche is accounted for as a separate award. Compensation expense is recognized for awards expected to vest over the applicable vesting period with a corresponding increase in contributed surplus.

      On exercise of stock options, the Company issues common shares from treasury and the consideration received together with the compensation expense previously recorded to contributed surplus is credited to share capital. On vesting of PSUs and RSUs, the Company issues common shares from treasury and the compensation expense previously recorded to contributed surplus is credited to share capital. All awards are equity settled.

      The Company uses the Black-Scholes option pricing model to estimate the fair value of each stock option. The Black-Scholes option pricing model requires the Company to estimate the expected term of the options granted, the volatility of the Company’s common shares, forfeitures, and an expected dividend yield. The Company estimates the expected term of the options granted by considering the Company’s historical experience involving stock option exercise; cancellations and expiries; volatility is estimated with reference to historical volatility data; forfeitures are estimated with reference to historical forfeiture data. The Company does not currently anticipate paying any cash dividends in the foreseeable future and therefore has used an expected dividend yield of zero as detailed in note 15b. The Black-Scholes model also requires the Company to input a risk-free interest rate and the Company uses the Bank of Canada marketable bond rates.

      The fair value of each PSU and RSU awarded is based upon the quoted price of the Company’s stock on the date of grant. All PSU and RSU awards are equity settled. As it relates to PSUs and RSUs, the Company estimates the expected forfeiture rate and no value is attributed to awards that the employee is expected to forfeit as a result of not achieving the service or performance conditions. The expected forfeiture rate is adjusted for actual forfeitures when they occur.

        p)     

      Leases

      Leases entered into are classified as either finance or operating leases. Leases that transfer substantially all of the benefits and risks of ownership of property to the Company are accounted for as finance leases. Property acquired under finance leases is recorded as an asset on the balance


      90




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      sheet with a corresponding increase to the finance lease obligation and depreciated over the term of the lease.

      Leases in which a significant portion of the risk and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to operations on a straight-line basis over the term of the lease. The benefits of lease inducements provided to the Company are recognized on a straight-line basis over the term of the lease agreement.

        q)     

      Financial instruments

      Financial assets and liabilities are recognized when the Company becomes a party to the contractual provisions of the instrument. Financial assets are derecognized when the rights to receive cash flows from the assets have expired or have been transferred and the Company has transferred substantially all risks and rewards of ownership. Financial liabilities are derecognized when the obligation specified in the contract is discharged, cancelled or expires.

      At initial recognition, the Company classifies its financial instruments in the following categories:

        (i)     

      Financial assets and liabilities at fair value through profit or loss: A financial asset or liability is classified in this category if acquired principally for the purpose of selling or repurchasing in the short-term. Derivatives are also included in this category unless they are designated as hedges. The Company’s financial liability at fair value through the profit and loss is contingent consideration. Financial instruments in this category are recognized initially and subsequently at fair value. Transaction costs are expensed in the consolidated statement of operations and comprehensive income (loss).

         

       

        (ii)     

      Loans and receivables: Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. The Company’s loans and receivables comprise accounts receivable, other current assets, and cash and cash equivalents, and are included in current assets due to their short-term nature.

         

       

         

      Loans and receivables are initially recognized at the amount expected to be received less, when material, a discount to reduce the loans and receivables to fair value. Subsequently, loans and receivables are measured at amortized cost using the effective interest method less a provision for impairment. Changes in the amortized cost are recorded in the consolidated statement of operations and comprehensive (loss) income.

      (iii)     

      Financial liabilities at amortized cost: Financial liabilities at amortized cost include trade payables, line of credit and bank overdraft, debt and finance lease obligations. Financial liabilities are initially recognized at the amount required to be paid less, when material, a discount to reduce the payables to fair value. Subsequently, financial liabilities are measured at amortized cost using the effective interest method. Changes in the amortized cost are recorded in the consolidated statement of operations and comprehensive (loss) income.

       

       

       

      Financial liabilities are classified as current liabilities if payment is due within twelve months. Otherwise, they are presented as non-current liabilities.

        r)     

      Provisions

      Provisions are recognized where a legal or constructive obligation has been incurred as a result of past events, it is probable that an outflow of resources embodying economic benefit will be required


      91




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      to settle the obligation, and a reliable estimate of the amount of the obligation can be made. If material, provisions are measured at the present value of the expenditures expected to be required to settle the obligation. The increase in any provision due to passage of time is recognized as accretion expense.

        s)     

      Earnings per share

      Basic earnings per share (“EPS”) is calculated by dividing the net income (loss) for the period attributable to equity owners of PNI Digital Media Inc. by the weighted average number of common shares outstanding during the period.

      Diluted EPS is calculated by adjusting the weighted average number of common shares outstanding for dilutive instruments. Under the treasury stock method, the weighted average number of common shares outstanding for the calculation of diluted net earnings per share assumes that the proceeds to be received on the exercise of dilutive stock options and warrants and the unrecognized portion of the fair value of stock options are applied to repurchase common shares at the average market price for the period. Stock options and warrants are dilutive when the average market price of the common shares during the period exceeds the exercise price of the options and warrants.

      3. Recent accounting pronouncements

      The following new or amended standards were adopted in the year ended September 30, 2013:

        a)     

      IAS 12 – “Income Taxes”. Amendments to IAS 12 clarify how an entity should measure the deferred tax consequences related to accounting recoveries of previously-impaired assets and liabilities underlying deferred tax assets and liabilities. These amendments are effective for annual periods beginning after January 1, 2012.

        b)     

      IAS 1 – “Presentation of Financial Statements” (“IAS 1”). Amendments to IAS 1 require that elements of other comprehensive income that may subsequently be reclassified through profit and loss be differentiated from those items that will not be reclassified.

      The Company adopted the above amendments as of October 1, 2012 . The impact of adoption of the amendments did not have any significant effect on the consolidated financial statements.

      Future accounting pronouncements

      The following new accounting pronouncements have been issued but are not effective and may have an impact on the Company:

        a)     

      IFRS 9, Financial Instruments (“IFRS 9”), which is the result of the first phase of the IASB’s project to replace IAS 39, Financial Instruments: Recognition and Measurement (“IAS 39”). The new standard replaces the current multiple classification and measurement models for financial assets and liabilities with a single model that has only two classification categories: amortized cost and fair value. There is currently no mandatory effective date for IFRS 9..

        b)     

      As of October 1, 2013, the Company will be required to adopt IFRS 10, Consolidated Financial Statements (“IFRS 10”). IFRS 10 replaces the consolidation requirements in SIC-12 Consolidation—Special Purpose Entities (“SIC-12”) and IAS 27, Consolidated and Separate Financial Statements (“IAS 27”). Earlier application of this standard is permitted. IFRS 10 builds on existing principles by identifying the concept of control as the determining factor in whether an entity should be included within the consolidated financial statements of the parent company.


      92




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

       
       

      The standard provides additional guidance to assist in the determination of control. The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

       

      c)     

      As of October 1, 2013, the Company will be required to adopt IFRS 11, Joint Arrangements (“IFRS 11”). The new standard replaces the requirements of IAS 31, Interests in Joint Ventures (“IAS 31”) and SIC-13, Jointly Controlled Entities – Non-Monetary Contributions by Venturers (“SIC-13”) and removes the ability to proportionately consolidate interests in joint ventures, requiring instead use of the equity method to account for such interests. The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

       

      d)     

      As of October 1, 2013, the Company will be required to adopt IFRS 12, Disclosure of Interests in Other Entities (“IFRS 12”). This standard replaces the requirements previously included in IAS

       

       

      27, IAS 31, and IAS 28, Investments in Associates (“IAS 28”), and requires disclosure for all forms of interests in other entities, including subsidiaries, joint arrangements, associates and unconsolidated structured entities. The adoption of this standard is not expected to have a material impact on the Company’s disclosures.

       

      e)     

      As October 1, 2013, the Company will be required to adopt IFRS 13, Fair Value Measurement (“IFRS 13”). This standard establishes a single framework for all fair value measurements where fair value is required or permitted by IFRSs. The adoption of this standard is not expected to have a material impact on the Company’s financial statements.

       

      f)     

      As of October 1, 2013, the Company will be required to adopt the amendments to IFRS 7, Financial Instruments: Disclosures (“IFRS 7”). The amendment requires new disclosures relating to the offset of financial assets and financial liabilities that will enable the users of financial statements better compare financial statements prepared in accordance with IFRS and US Generally Accepted Accounting Principles. The adoption of the amended standard is not expected to have a material impact on the Company’s financial statements.

       

       

      4.     

      Significant accounting judgments and estimates

      The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the reporting date, and the reported amounts of revenues and expenses during the reporting period. The determination of estimates requires the exercise of judgment based on various assumptions and other factors such as historical experience.

      Actual results could differ from those estimates.

      The estimates and underlying assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable in the circumstances. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods, if the revision affects both current and future periods.


      93




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The judgments that management has applied in the application of accounting policies, and the estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are discussed below:

      Estimated impairment of goodwill

      The Company performs an annual impairment tests over goodwill in accordance with the accounting policy stated in note 2. The recoverable amount of the cash generating unit (CGU) have been determined based on the higher of the value in use calculations and the fair vale less costs to sell.

      The Company assessed the carrying values of goodwill, which is allocated to the Company’s European CGU. An impairment charge of $594,851 (2012: $77,382, 2011: $nil) arose in the European CGU, resulting in the carrying amount of the CGU to be written down to its recoverable amount; and write off of the full amount of goodwill.. There was no further write down in CGU as the remaining assets are all liquid and approximate to fair value. The impairment charge was recorded in cost of sales on the consolidated statements of operations and comprehensive (loss) income.

      The recoverable amount was determined using the value in use model.

      The estimates used to determine the value in use are based on the following key assumptions:

      • Cash flows were projected based on past experience, actual operating results and planned results for the near term. Terminal value calculations for the cash generating unit were extrapolated using a constant growth rate of 3%.

      The estimated future cash flows are discounted to their present value using a pre-tax discount rate of 21.7% which reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. Risks specific to the assets of these units have not been included within the calculation of the discount rates used, but have been factored into the cash flow projections. The net present value of the future expected cash flows was compared to the carrying value of the Company’s investment, including goodwill, at year-end and resulted in the impairment of goodwill as noted above.

      Recoverability of deferred income tax assets

      The amount recognised as deferred income tax assets is determined using the undiscounted cash flows aligned with estimates used in the impairment analysis for goodwill. Management considers all factors that could affect the probability that future taxable profits will be available. The factors include profitability of operations, estimate of terminal value, and customer renewal rates. The amount recognised is sensitive to the loss of certain key customers.

      Based on management’s analysis, the Company recorded a write-down of the carrying amount of its deferred income tax assets attributable to its Canadian and European entities by $2,822,517 (2012: $1,814,221 expense, 2011: $1,299,025 recovery). This change is primarily a result of lower projected revenues as the company experiences certain challenges from certain customers in the form of changing fee structures while maintaining the same level if not higher services as well as the change in the kiosk operations. Certain of these contracts were renegotiated in the current year which gave rise to the changes in management’s estimates and the resulting reduction of the deferred tax income asset in both jurisdictions.

      Share-based compensation


      94




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The inputs used in accounting for share-based compensation. See note 14 for a discussion of the key estimates used.

      Fair value of assets and liabilities in business combination

      The inputs used in accounting for fair value of assets and liabilities in business combination. See note 6 for a discussion of the key estimates used.

      5.     

      Seasonality of operations

      Demand for photofinishing products is highly seasonal, with a significant proportion of recurring revenues being generated during the Company’s first fiscal (fourth calendar) quarter, ended December 31. Due to the seasonal nature of the Company’s business, the results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year.

      6.     

      Acquisition of Quarterhouse

      Effective April 11, 2013, the Company completed the acquisition of all of the outstanding shares of privately-held Quarterhouse an Austin, Texas based company that is a leading developer of web-based print on demand software for commercial printers and distributors. The initial focus for this asset will be on business printing. The Company expects that the highly customizable content management systems and automation tools from Quarterhouse will enable the Company to realize operational improvements and to target a wider range of eligible retailers, including strong regional retailers and multi-outlet franchisees. The first new partner on this technology was signed shortly after close of the acquisition.

      The equity purchase has been accounted for as a business combination, with the Company being identified as the acquirer. The results of the acquired Quarterhouse business are included in the Company’s results from operations from the closing date of April 11, 2013. From the date of acquisition, April 11, 2013 (the “Acquisition Date”), to September 30, 2013, the Company recognized revenue from Quarterhouse of $73,850, and a loss of $537,863, which includes $228,116 in amortization associated with the acquired software.

      The aggregate upfront payment of US$500,000 was wholly comprised of cash. All direct costs of the acquisition have been expensed in the Company’s statement of operations in the period in which they are incurred. During the twelve months ended September 30, 2013, the Company recorded $106,000 in acquisition-related expenses within general and administration expense.

      In addition to the purchase price, there is contingent consideration of up to US$500,000 and, which is eligible to be paid to the selling shareholders of Quarterhouse contingent on the achievement of specified sales and development targets over a one year-period, post-acquisition. US$353,775 of the contingent consideration has been included in the purchase price based on the present value of management’s best estimate of the probability that milestone events will be achieved as of the date of acquisition. As of September 30, 2013, certain development milestones have been met resulting in milestones payments of US$50,000 and certain estimates have been revised, resulting in a remaining probability adjusted contingent purchase consideration to US$338,975 based on a discount rate of 15%. At September 30, 2013 management recorded the change in the estimate in relating to the revisions in the probabilities assigned in achieving milestones of approximately $32,062; this was recorded in statement of operations within Bargain Purchase Gain. The potential


      95




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      undiscounted amount of all future payments that the Company could be required to pay under this arrangement is between US$0 and US$450,000. This is a level 3 fair value measurement.
      The allocation of the purchase price disclosed hereunder has been based upon management’s estimates and certain assumptions with respect to the fair value associated with the assets (intangible assets and goodwill) acquired and liabilities (deferred income tax liabilities) assumed.

      The total purchase consideration has been allocated to the fair values of the assets acquired and liabilities assumed based on management’s best estimates and taking into account all available information at the time of the acquisition. The purchase consideration has been allocated to the net assets acquired as follows (“Purchase Price Allocation”):

      In US$      
      Cash $ 13,966  
      Accounts receivable   67,788  
      Property and equipment   4,165  
      Intangible asset (acquired software)   1,435,000  
      Accrued liabilities   (4,296 )
      Deferred income tax liability   (502,250 )
      Fair value of net assets acquired $ 1,014,373  
      Bargain purchase gain   (160,599 )
      Purchase Consideration $ 853,774  

      This intangible asset has been determined to have a useful life of 3 years. The Company valued the software using a depreciated replacement cost methodology. This methodology as it relates to software, estimates the current costs to replicate the software on an “as is” basis, assuming no enhancements or technological improvements. As the value of the assets acquired, particularly the acquired software was in excess of the purchase consideration, the acquisition resulted in a bargain purchase gain of $160,599. In the twelve months ended September 30, 2013, the Company recorded $228,116 of amortization of these acquired intangible assets within cost of sales.

      The following table discloses the revenue and loss of the combined entity for the current reporting period as though the acquisition date for the business combination occurred during the year had been as of October 1, 2012.

                12 Months Ended        
      Description   PNI     Quarterhouse     Pro-forma  
       
      Revenue $ 20,825,353   $ 216,579   $ 21,041,932  
       
      Cost of sales   10,171,726     237,689     10,409,415  
      Software development   9,599,094     341,986     9,941,080  
      General and administration   3,546,821     163,562     3,710,383  
      Sales and marketing   1,458,006     17,265     1,475,271  
      Loss from operations $ (3,950,294 ) $ (543,923 ) $ (4,494,217 )

       


      96




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The Vendor has indemnified the Company from any expense attributable to all taxes (or the non-payment thereof) of Quarterhouse for all taxable periods ended on or before the Acquisition Date and the portion through the end of the Acquisition Date for any taxable period that includes (but does not end on) the Acquisition Date; provided, however, that The Vendor will be liable only to the extent that such taxes exceed the amount, if any, reserved for deferred taxes in the Purchase Price Allocation as of the Acquisition Date. Management has not recorded any asset or liability in relation to these amounts, given the lack of certainty surrounding these amounts.

      7.     

      Cost of sales and operating expenses:

      Within cost of sales and operating expenses, the Company includes charges relating to amortization of plant and equipment, amortization of intangible assets and share-based compensation. These costs are identified below in their relevant statement operations caption.

                  For the year ended September 30, 2013
          Per Amortization Amortizati Loss on Impairment Impairment of Share-   Excluding
          statement of of property on of disposal of of goodwill   based   amortization and
          operations and intangible property and intangible     compensa   share-based
                equipment     assets     equipment      assets           tion     compensation   
      Cost of sales $ 10,401,693     1,318,800     308,406     15,321     -     594,851     6,519   $ 8,157,796   

      Operating expenses

                           

      Software development

        9,907,590 289,103 482 - - -   20,741   9,597,264

      General and administration

         3,591,014 29,883   190  -  -  -    111,865    3,449,076

      Sales and marketing

        1,474,749     22,127     78     480       -     -     1,239     1,450,825   
      Total operating expenses $ 14,973,353     341,113     750     480     -     -     133,845   $ 14,497,165   
        $ 25,375,046     1,659,913     309,156     15,801     -     594,851     140,364   $ 22,654,961   

       

                                  For the year ended September 30, 2012  
          Per statement Amortization Amortizati Loss on Impairment Impairment Share-based     Excluding
          of operations of property on of disposal of of of goodwill compensation     amortization
            and intangible property and intangible         and share-
            equipment assets equipment assets         based
                                                    compensation  
      Cost of sales $ 10,458,022     1,529,978     922,558     -      540,735     77,382     (698 ) $ 7,388,067  
      Operating expenses                      

      Software development

        9,678,638 230,343 168,466 - - - 41,364     9,238,465

      General and administration

        3,768,203 26,873 - - - - 168,636     3,572,694

      Sales and marketing

        1,038,374     21,531     -     -     -     -     (553 )   1,017,396  
      Total operating expenses $ 14,485,215     278,747     168,466     -     -     -     209,447   $ 13,828,555  
        $ 24,943,237       1,808,725       1,091,024       -       540,735       77,382       208,749   $ 21,216,622  

       


      97




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

       
                                  For the year ended September 30, 2011  
          Per statement Amortization Amortizati Loss on Impairment Impairment Share-based   Excluding
          of operations of property on of disposal of intangible goodwill compensation   amortization
            and intangible property and assets       and share-
            equipment assets equipment         based
                                                    compensation  
      Cost of sales $ 9,399,107     1,689,790     858,354     36,294     -     -     43,156   $ 6,771,513  
      Operating expenses                    

      Software development

        9,439,423 294,063 - 69,622 - - 262,225   8,813,513

      General and administration

        3,928,210 30,135 - 6,075 - - 482,129   3,409,871

      Sales and marketing

        988,289     22,966     -     5,315     -     -     60,733      899,275  
      Total operating expenses $ 14,355,922     347,164     -     81,012     -     -     805,087   $ 13,122,659  
        $ 23,755,029     2,036,954     858,354     117,306     -     -     848,243   $ 19,894,172  

       

      8.     

      Accounts receivable

          September 30, 2013     September 30, 2012     September 30, 2011  
       
      Trade accounts receivable $ 3,614,669   $ 4,353,424   $ 4,540,075  
      Allowance for doubtful accounts   (46,491 )   (130,023 )   (145,000 )
          3,568,178     4,223,401     4,395,075  
      Commodity taxes recoverable   35,868     30,140     135,655  
      Other   225,608     -     5,182  
      Total $ 3,829,654   $ 4,253,541   $ 4,535,912  

      Reconciliation of changes in allowance for doubtful accounts:

          September 30, 2013     September 30, 2012     September 30, 2011  
       
      Balance, beginning of period $ 130,023   $ 145,000   $ 176,531  
      Increase in allowance for doubtful accounts   54,107     132,012     33,102  
      Application of existing provision to write-off the amount receivable   (144,988 )   (146,989 )   (63,710 )
      Impact of foreign currency translation   7,349     -     (923 )
      Balance, end of period $ 46,491   $ 130,023   $ 145,000  

      During the year ended September 30, 2013 the Company incurred bad debt expenses of $54,107 (2012: $132,012, 2011: $33,102).


      98




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      As at September 30, 2013

        Financial assets that are past due but not impaired
          Neither past due nor                   Carrying value on
          impaired   31 – 60 days   61 – 90 days      91 days +   the balance sheet   
                             
      Trade accounts receivable $ 2,589,547 $ 439,770   $ 130,187   $ 408,674 $ 3,568,178
      Commodity taxes recoverable   35,868   -     -     -   35,868
      Other   225,608   -     -     -   225,608  
      Total $ 2,851,023 $ 439,770   $ 130,187   $ 408,674 $ 3,829,654   

      As at September 30, 2012

        Financial assets that are past due but not impaired
          Neither past due nor                   Carrying value on
          impaired   31 – 60 days     61 – 90 days     91 days +   the balance sheet  
                             
      Trade accounts receivable $ 2,334,240 $ 328,844   $ 358,600   $ 1,201,717 $ 4,223,401
      Commodity taxes recoverable   30,140   -     -     -   30,140
      Other   -   -     -     -   -  
      Total $ 2,364,380 $ 328,844   $ 358,600   $ 1,201,717 $ 4,253,541   

      As at September 30, 2011

        Financial assets that are past due but not impaired
                              Carrying value
          Neither past due                   on the balance
          nor impaired   31 – 60 days   61 – 90 days     91 days +   sheet   
                             
      Trade accounts receivable $ 3,127,511 $ 36,942   $ 443,565   $ 787,057 $ 4,395,075
      Commodity taxes recoverable   135,655   -     -     -   135,655
      Other   5,182   -     -     -   5,182   
      Total $ 3,268,348 $ 36,942   $ 443,565   $ 787,057 $ 4,535,912   

      At September 30, 2013, four customers each account for 10% or more of total trade accounts receivable (2012: three customers, 2011: five customers).


      99




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

       

      9.     

      Property, plant and equipment

      October 1, 2012 to September 30, 2013

                Furniture and            
          Computer     office     Leasehold      
          equipment     equipment     improvements   Total  
      Cost                      
      As at October 1, 2012 $ 17,159,448   $ 406,577   $ 243,962 $ 17,809,987  

      Additions

        1,233,940     17,637     225,545   1,477,122  

      Disposals / write-offs

        (141,061 )   (3,800 )   -   (144,861 )

      Impairments

        -     -     -   -  

      Currency translation adjustments

        9,809     (22 )   -   9,787  
      As at September 30, 2013 $ 18,262,136   $ 420,392   $ 469,507 $ 19,152,035  
       
      Accumulated Amortization                      
      As at October 1, 2012 $ 12,657,005   $ 303,808   $ 165,819 $ 13,126,632  

      Amortization

        1,583,341     21,661     54,911   1,659,913  

      Disposals / write-offs

        (123,345 )   (3,800 )   -   (127,145 )

      Impairments

        -     -     -   -  

      Currency translation adjustments

        9,700     (13 )   -   9,687  
      As at September 30, 2013 $ 14,126,701   $ 321,656   $ 220,730 $ 14,669,087  
       
      Carrying value – October 1, 2012 $ 4,502,443   $ 102,769   $ 78,143 $ 4,683,355  
      Carrying value – September 30,2013 $ 4,135,435   $ 98,736   $ 248,777 $ 4,482,948  

      October 1, 2011 to September 30, 2012

                Furniture and            
          Computer     office     Leasehold      
          equipment     equipment     improvements   Total  
      Cost                      
      As at October 1, 2011 $ 15,878,073   $ 401,750   $ 181,718 $ 16,461,541  

      Additions

        1,284,842     4,883     62,244   1,351,969  

      Currency translation adjustments

        (3,467 )   (56 )   -   (3,523 )
      As at September 30, 2012 $ 17,159,448   $ 406,577   $ 243,962 $ 17,809,987  
       
      Accumulated Amortization                      
      As at October 1, 2011 $ 10,903,337   $ 278,779   $ 139,275 $ 11,321,391  

      Amortization

        1,757,099     25,082     26,544   1,808,725  

      Currency translation adjustments

        (3,431 )   (53 )   -   (3,484 )
      As at September 30, 2012 $ 12,657,005   $ 303,808   $ 165,819 $ 13,126,632  
       
      Carrying value – October 1, 2011 $ 4,974,736   $ 122,971   $ 42,443 $ 5,140,150  
      Carrying value – September 30, 2012 $ 4,502,443   $ 102,769   $ 78,143 $ 4,683,355  

       


      100




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The carrying value of computer equipment under lease was $853,871 at September 30, 2013 (2012: $nil, 2011: $nil). $150,683 of amortization associated with leased equipment was included in the statement of operations and comprehensive loss (income) in the year ended September 30, 2013 (2012: $nil, 2011: $nil).

      10.     

      Current and deferred income taxes

      For the year ended September 30, 2013 the Company recorded a write-down of $2,822,517 against its deferred income tax assets with the corresponding charge to deferred income tax expense (recovery) (2012: $1,814,221, 2011: ($1,299,025)).

      Non-capital losses were used to offset taxable income where applicable resulting in nil current income tax. The deferred income tax expense in the year primarily arose from a $2,244,440 reversal of previously recognized United Kingdom income tax assets due to uncertainty surrounding their recovery.

      The gross movement of the deferred income tax account is as follows:

          2013     2012     2011  

      Opening balance - October 1

      $ 5,222,603   $ 7,065,857   $ 5,861,504  

      Income tax recovery (expense)

        (2,822,517 )   (1,814,221 )   1,299,025  

      Tax charge relating to components of other comprehensive income

        -     (29,033 )   (94,672 )

      Impact of acquisition of Quarterhouse and other

        (517,921 )   -     -  

      Closing balance - September 30

      $ 1,882,165   $ 5,222,603   $ 7,065,857  

       

      a)     

      Rate changes

      Effective April 1, 2013 the British Columbia tax rate increased from 10% to 11%. The Canadian Federal tax rate decreased during 2012 from 16.5% to 15%.

      During 2012, the United Kingdom government enacted tax reform which included a 1% rate reduction to the main corporate tax rate from 25% to 24% effective April 1, 2012 to March 31, 2013. During 2013, the United Kingdom government enacted further rate reductions to 23% applicable from April 1, 2013, to 21% from April 1, 2014 and to 20% from April 1, 2015.


      101




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

       

      b)     

      Rate reconciliation

      The Company is subject to income taxes in Canada, the United States and the United Kingdom. The income tax expense differs from the amount obtained by applying the applicable statutory income tax rate to the loss before income taxes as follows:

          2013     2012     2011  
      Canadian statutory income tax rate   25.50%   25.38%   27.00%
       
      Income tax recovery based on statutory income tax rate $ (1,235,427 ) $ (585,765 ) $ (53,851 )
      Non-deductible expenses   68,499     72,021     243,052  
      Effect of different foreign statutory rates   (34,172 )   (6,080 )   -  
      Impact of change in tax rates   152,329     263,866     415,662  
      Adjustments in respect of prior year returns   168,247     (11,468 )   (63,394 )
      Share issue costs charged to share capital   -     (397 )   (106,823 )
      De-recognition (recognition) of previously recognized (unrecognized) deferred tax assets   3,703,041     2,082,044     (1,733,671 )
      Income tax expense (recovery) $ 2,822,517   $ 1,814,221   $ (1,299,025 )

      The Company’s loss before tax includes a loss of $3,793,289 (2012: $3,940,457, 2011: $1,672,143) from domestic operations and a loss (income) of $1,051,523 (2012: ($1,632,022), 2011: ($1,472,718)) from foreign operations.

      c)     

      Deferred tax assets and liabilities

      Deferred income tax assets are recognized for tax loss carry-forwards to the extent that the realization of the related tax benefit through future taxable profits is probable. This assumption is based on management’s best estimate of future circumstances and events. If these estimates and assumptions changed in the future, the value of the deferred tax assets could increase or decrease, resulting in an income tax recovery or expense.


      102




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The composition of the Company's deferred income tax assets and liabilities are as follows:

          September 30,     September 30,  
          2013     2012  
      Deferred income tax assets            
       
      Non-capital losses $ 5,406,576   $ 5,163,889  
      Property and equipment   4,318,197     3,795,911  
      Share issue costs   -     396  
      Other   124,806     201,918  
          9,849,579     9,162,114  
      Offset against deferred tax liabilities   (124,641 )   (132,134 )
      Unrecognized deferred tax assets   (7,510,419 )   (3,807,377 )
      Deferred tax assets   2,214,519     5,222,603  
                   
      Deferred income tax liabilities            
       
      Related party interest accrued   -     (102,371 )
      Intangibles   (438,794 )   -  
      Unrealized foreign exchange and other   (18,201 )   (29,763 )
      Offset against deferred tax asset   124,641     132,134  
          (332,354 )   -  
       
      Deferred income tax assets, net   1,882,165     5,222,603  
       
      Deferred income tax assets            
      Deferred tax assets to be recovered within 12 months $ 124,806   $ 197,409  
      Deferred tax assets to be recovered after more than 12 months   2,212,851     5,127,565  
          2,337,657     5,324,974  
      Deferred income tax liabilities            
      Deferred tax liabilities to be recovered within12 months   -     -  
      Deferred tax liabilities to be recovered after more than 12 months    (455,492 )    (102,371 )
           (455,492 )    (102,371 )
      Deferred income tax assets, net $ 1,882,165   $ 5,222,603  

      The Company does not recognize certain tax assets of the Canadian parent, and its UK subsidiaries, PNI Digital Media Ltd. and PNI Digital Media Europe Ltd., that do not meet the more likely than not


      103




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      threshold. Due to this unlikelihood, deductible temporary differences and unused tax losses for which no deferred tax asset have been recognized have been is detailed below:

          September 30,   September
          2013     30, 2012   
      Non-capital losses $ 5,298,633 $ 2,919,449
      Property and equipment    2,211,786       887,928   
      Unrecognized deferred income tax assets, net $ 7,510,419   $ 3,807,377  

       

      d)     

      Non-capital losses

      As at September 30, 2013, the Company had $10,315,048 (2012: $9,046,442) of non-capital losses in Canada available to reduce future taxable income which were not recorded in these financial statements because of the uncertainty of their recovery. These unrecognized income tax losses expire as follows:

             
      2015 $ 731,031
      2026   2,248,406
      2027   3,121,223
      2028   2,616,270
      2033   1,598,118  
        10,315,048  

      As at September 30, 2013, the Company also had £7,859,907 (2012: £7,933,022) of non-capital losses for tax purposes in the United Kingdom that do not have an expiry date and which are available to reduce taxable income in future periods. No deferred income asset has been recognized with regard to these losses.


      104




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

       

      11.     

      Intangible assets

      October 1, 2012 to September 30, 2013

          Acquired   Customer   Internal use    
          software   relationships   software   Total  
      Cost                
      As at October 1, 2012 $ 3,800,421 $ 6,795,803 $ 695,387 $ 11,291,611

      Additions

        1,483,257   -   80,101   1,563,358

      Currency translation adjustments

        174,575   72,176   131   246,882   
      As at September 30, 2013 $ 5,458,253 $ 6,867,979 $ 775,619 $ 13,101,851   
       
      Accumulated Amortization                
      As at October 1, 2012 $ 3,800,421 $ 6,795,803 $ 693,263 $ 11,289,487

      Amortization

        228,115   -   81,041   309,156

      Currency translation adjustments

        176,021   72,176   80   248,277   
      As at September 30, 2013 $ 4,204,557 $ 6,867,979 $ 774,384 $ 11,846,920   
       
      Carrying value – October 1, 2012 $ - $ - $ 2,124 $ 2,124
      Carrying value – September 30, 2013   1,253,696 $ - $ 1,235   1,254,931

      October 1, 2011 to September 30, 2012

          Acquired     Customer     Internal use        
          software     relationships     software     Total  
      Cost                        
      As at October 1, 2011 $ 3,856,324   $ 6,818,688   $ 446,126   $ 11,121,138  

      Additions

        -     -     958,464     958,464  

      Disposals / write-offs

        -     -     (168,466 )   (168,466 )

      Impairments

        -     -     (540,737 )   (540,737 )

      Currency translation adjustments

        (55,903 )   (22,885 )   -     (78,788 )
      As at September 30, 2012 $ 3,800,421   $ 6,795,803   $ 695,387   $ 11,291,611  
       
      Accumulated Amortization                        
      As at October 1, 2011 $ 3,750,048   $ 6,599,419   $ 91,234   $ 10,440,701  

      Amortization

        104,638     215,891     602,029     922,558  

      Currency translation adjustments

        (54,265 )   (19,507 )   -     (73,772 )
      As at September 30, 2012 $ 3,800,421   $ 6,795,803   $ 693,263   $ 11,289,487  
       
      Carrying value – October 1, 2011 $ 106,276   $ 219,269   $ 354,892   $ 680,437  
      Carrying value – September 30, 2012 $ -   $ -   $ 2,124   $ 2,124  

      During the year ended September 30, 2012, the Company wrote-off $168,466 in previously capitalized costs associated with the development of internal use software and included within software development in the Canadian operating segment.


      105




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      During the year ended September 30, 2012 the Company recognized an impairment loss of $540,736. The impairment loss was primarily due to underperforming revenues associated with previously capitalized internal use software used in our social stationery product offerings. This amount was recorded in cost of sales on the consolidated statements of operations and comprehensive income (loss) in the Canadian operating segment, one of the Company’s two CGUs.

      There was nil write off in the current year in relation to these items.

      As at September 30, 2013, intangible assets of $1,235 (2012 : $2,124) were allocated to the Company’s European operating segment, and $1,253,696 (2012: $nil) were allocated to the Company’s Canadian operating segment, which includes Quarterhouse.

      12.     

      Goodwill

          Amount  
      Balance, October 1, 2011 $ 654,222  
      Currency translation adjustments   (8,361 )
      Impairment of goodwill   (77,382 )
      Balance, September 30, 2012 $ 568,479  
      Currency translation adjustments   26,372  
      Impairment of goodwill   (594,851 )
      Balance, September 30, 2013 $ -  

      Based on management’s analysis, the Company recognized an impairment loss of $594,851 in fiscal 2013 (2012: $77,382, 2011: $nil). This amount was recorded in cost of sales on the consolidated statements of operations and comprehensive income (loss) relating to the PNI Europe CGU.

      As at September 30, 2013, goodwill of $nil (2012: $568,479) was allocated to the Company’s European operating segment, while $nil (2012: $nil) was allocated to the Company’s Canadian operating segment.


      106




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      13. Accounts payable and accrued liabilities

       

          September 30, September 30,  
          2013 2012  
                 
          $ $  
        Trade payables 1,610,245 2,134,010  
        Amounts due to customers 654,742 1,283,077  
        Trade accruals 219,495 326,519  
        Accrued payroll and other taxes 71,209 240,896  
        Due to employees and consultants 481,680 405,935  
          $ $  
        Total 3,037,371 4,390,437  

       

      14. Share capital and stock options

       

        a)     

      Authorized

      Unlimited number of common and preferred shares without par value

      As at September 30, 2013, the Company had 34,299,471 common shares issued (September 30, 2012: 34,257,922) and 34,299,471 outstanding (September 30, 2012: 34,257,922). There are no preferred shares issued or outstanding at September 30, 2013 (September 30, 2012: $nil).

        b)     

      Options

      The Company provides stock options to directors and certain employees of the Company pursuant to a stock option plan (the “Plan”). The Plan authorizes a maximum of 10% (3,429,947) of the Company’s issued and outstanding common shares to be reserved for issuance. The term of the options granted under the plan is five years and options are subject to various vesting requirements.


      107




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      The following table summarizes activity under the Company’s stock option plan since September 30, 2011:

          Number of     Average  
          options     exercise  
                price  
        Balance, September 30, 2011 (2,770,201 options exercisable) 1,888,223   $ 2.02  

       

      Granted

      1,350,000     0.47  

       

      Exercised

      -     -  

       

      Expired

      (649,723 )   2.32  

       

      Forfeited

      (356,500 )   1.54  

       

      Cancelled

      -     -  
        Balance, September 30, 2012 (1,032,000 options exercisable) 2,232,000   $ 1.77  

       

      Granted

      1,850,000     0.29  

       

      Exercised

      -     -  

       

      Expired

      (770,881 )   1.79  

       

      Forfeited

      (711,119 )   0.43  

       

      Cancelled

      -     -  
        Balance, September 30, 2013 (663,878 options exercisable) 2,600,000   $ 0.48  

      The following table summarizes information about stock options outstanding and exercisable at September 30, 2013:

            Options outstanding       Options exercisable  
              Weighted              
              average              
              remaining   Weighted       Weighted  
            Number contractual   average   Number   average  
          Exercise price outstanding life (years)   exercise price   exercisable exercise price  
        $ 0.27 1,425,000 3.91 $ 0.27   88,880 $ 0.27  
        $ 0.32 50,000 4.36 $ 0.32   - $ 0.32  
        $ 0.44 200,000 4.07 $ 0.44   - $ 0.44  
        $ 0.46 600,000 3.78 $ 0.46   249,998 $ 0.46  
        $ 1.48 150,000 0.48 $ 1.48   150,000 $ 1.48  
        $ 1.50 25,000 0.85 $ 1.50   25,000 $ 1.50  
        $ 1.55 150,000 2.01 $ 1.55   150,000 $ 1.55  
        $ 0.27 - $ 1.55 2,600,000 2.64 $ 0.27 - $ 1.55   663,878 $ 0.27 - $ 1.55  

      The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model. The following table provides the weighted average grant-date fair value and the weighted average assumptions used in applying the Black-Scholes option pricing model for grants made between September 30, 2012 and September 30, 2013:

        Description   September 30, 2013     September 30, 2012  
                   
        Exercise price $ 0.29   $ 0.47  
        Market price on date of grant   0.29     0.44  
      Expected forfeiture rate   14.49 %   2.7 %

       


      108




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        Expected volatility   62.95% - 72.81 %   59.14% - 61.85 %
        Risk-free interest rate   1.13 %   1.18 %
        Expected life (years)   4.05     4.46  
        Expected dividend yield   0 %   0 %
        Weighted average grant-date fair value ($ per share) $ 0.15   $ 0.21  

      The total fair value of stock options granted during the year ended September 30, 2013 was $278,913 (2012: $280,230, 2011: $383,050).

      During the year ended September 30, 2013, the Company recognized compensation expense of $138,938 (2012: $68,907, 2011: 253,649).

        c)     

      Performance Share Unit Awards

      A Performance Share Unit (“PSU”) is a right granted to an executive level employee to receive one common share of the Company. The PSUs will be earned only if performance goals (non-market conditions) over the performance periods established by or under the direction of the Compensation Committee are met. PSUs vest over three years in equal annual instalments on each anniversary of the date of grant and will be delivered in common stock at the end of each vesting period, based on the recipient’s actual performance compared to the target performance and may equal from zero percent (0%) to one hundred percent (100%) of the target award. The fair value of each PSU awarded is based upon the quoted price of the Company’s stock on the date of grant, as the Company does not expect to pay dividends such an amount has not been included in the fair value of PSUs. The Company recognizes the expense based on an estimate at the end of each reporting period of the degree to which the performance goals are being met, incorporating an expected forfeiture rate of 2.7%, and adjusts the estimate at the conclusion of the performance period. The expense is recognized on a graded-vesting basis over the vesting period.

          Number of PSUs     Weighted average fair  
                value  
        Balance, October 1, 2011 74,000   $ 1.55  
        Granted -     -  
        Forfeited (64,434 )   1.55  
        PSUs issued as common shares upon vesting (4,799 )   1.55  
        Balance, September 30, 2012 4,767     1.55  
        Granted -     -
        Forfeited (1,334 )   1.55  
        PSUs issued as common shares upon vesting (2,383 )   1.55  
        Balance, September 30, 2013 1,050   $ 1.55  

      During the year ended September 30, 2013 the Company issued 2,383 common shares as it related to vested PSUs at a value of $3,694, which represents the fair value at the date of grant, and recorded this amount as an adjustment to contributed surplus and common shares. During the year ended September 30, 2013, the Company recorded an expense recovery on PSUs of $114 (2012: $1,277, 2011: $7,440).


      109




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        d)     

      Restricted Share Unit Awards

      A Restricted Share Unit (“RSU”) is a right granted to a non-executive director or key employee to receive one common share of the Company on a time vested basis. The fair value of the restricted share awards is determined based upon the number of shares granted and the quoted price of the Company’s stock on the date of grant. Restricted shares vest over three years in equal annual instalments on each anniversary of the date of grant and will be delivered in common stock at the end of each vesting period. The expense is recognized on a graded-vesting basis over the vesting period.

          Number of RSUs     Weighted average fair  
                value  
        Balance, October 1, 2011 198,200   $ 1.55  
        Granted -     -  
        Forfeited (51,401 )   1.55  
        RSUs issued as common shares upon vesting (63,665 )   1.55  
        Balance, September 30, 2012 83,134   $ 1.55  
        Granted -     -  
        Forfeited (15,936 )   1.55  
        RSUs issued as common shares upon vesting (39,166 )   1.55  
        Balance, September 30, 2013 28,032   $ 1.55  

      During the year ended September 30, 2013 the Company issued 39,116 common shares as it related to vested RSUs at a value of $60,630 which represents the fair value at the date of grant, and recorded this amount as an adjustment to contributed surplus and common shares.

      During the year ended September 30, 2013, the Company recognized compensation expense of $1,545 (2012: $26,233, 2011: $102,401).

        e)     

      Shares held in escrow

      In connection with the acquisition of WorksMedia Limited, which was completed in March 2009, 750,000 common shares of the Company were issued. 214,500 of these common shares have been included as part of the purchase consideration, while the remaining 535,500 common shares are only being released from escrow upon the continued employment of the Principle Vendors over a three year period.

      On March 10, 2012, the Company released the final installment of 250,000 common shares consisting of 71,500 common shares included as part of the purchase consideration while the remaining 178,500 common shares released related to the continued employment of the Principle Vendors. During the year ended September 30, 2013, the Company recognized compensation expense of $nil (2012: $ 113,080, 2011: $299,102) in connection with the acquisition of WorksMedia Limited.

      110





      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        f)     

      Earnings per share

      The following is a reconciliation of the numerator and the denominators used for the computation of basic and diluted earnings per share amounts:

            September 30, 2013     September 30, 2012     September 30, 2011  
                           
        Net (loss) earnings for the period (numerator) $ (7,667,330 ) $ (4,122,653 ) $ 1,099,600  
                           
        Weighted average number of shares outstanding (denominator)                  
                           
        Basic   34,299,471     34,178,165     33,927,659  
                           
        Effect of dilutive securities:                  
                           
        Stock options   -     -     11,045  
                           
        RSUs   -     -     40,908  
                           
        PSUs   -     -     5,659  
                           
      Total   34,299,471     34,178,165     33,985,271  

       

      15. Segment information

      The Company’s sales by geographical area are as follows:

          Year Ended
        Description September 30, 2013 September 30, 2012  
                   
        Canada $ 4,245,263 $ 4,349,099  
        United States   14,851,631   14,348,137  
        United Kingdom   1,692,570   3,792,752  
        Other   109,740   222,817  
                 
        Total $ 20,899,204 $ 22,712,805  

       

      The Company has two CGUs comprising groups of assets which generate inflows that are largely independent from other assets.

      The Company has two operating segments comprising components of the Group’s operations which have operating results reviewed by the Company’s CODM, and which meet the aggregation criteria for one reportable segment (note 2). The Company’s goodwill prior to the recognition of an impairment loss in the current year was allocated in its entirety to the European operating segment, which is also its PNI Europe CGU. Revenue is attributed to the geographic location of the Company’s customers.


      111




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      As at September 30, 2013 and September 30, 2012, the Company’s assets and liabilities by geographical location are as follows:

                United   United        
            Canada   Kingdom   States     Total  
        September 30, 2013                    
        Assets                    
        Property and equipment $ 4,422,337 $ 3,679 $ 56,932   $ 4,482,948  
        Goodwill and intangible assets $ - $ 1,235 $ 1,253,696   $ 1,254,931  
        Deferred income tax asset $ 2,214,519 $ - $ -   $ 2,214,519  
                             
         Liabilities                    
        Accounts payable and accrued                    
        liabilities $ 2,615,433 $ 400,978 $ 20,960   $ 3,037,371  
        Line of credit and overdraft $ 1 ,401,070 $ - $ -   $ 1,401,070  
        Deferred revenue $ 480,021 $ 99,288 $ 2,922   $ 582,231  
        Finance lease obligations $ 917,763 $ - $ -   $ 917,763  
        Net deferred income tax liability $ - $ - $ 332,354   $ 332,354  
        Contingent consideration $ 343,279 $ - $ -   $ 343,279  
                           
                             
        September 30, 2012                  
        Assets                    
        Property and equipment $ 4,675,595 $ 7,760   -   $ 4,683,355  
        Goodwill and intangible assets $ - $ 570,603   -   $ 570,603  
        Liabilities           -        
        Accounts payable and accrued                    
        liabilities $ 3,294,864 $ 1,095,573   -   $ 4,390,437  
        Deferred revenue $ 614,242 $ 141,005   -   $ 755,247  
                    -        

      Major customer groups that account for 10% or more of the Company’s revenues for the fiscal year are as follows:

          Year Ended
        Description   September 30, 2013 September 30, 2012  
                   
        Customer A $ 5,646,474 $ 5,812,890  
        Customer B   3,691,545   2,928,033  
        Customer C   1,088,275   2,500,214  
        Customer D   8,687,332   9,493,873  
                   
          $ 19,113,626 $ 20,735,010  

       


      112



      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      16. Revenue

       

            Year Ended  
            September 30,   September 30,  
        Description   2013   2012  
                   
        Transaction fees $ 16,305,015 $ 17,730,786  
        Software licenses and installation fees   1,028,882   1,876,901  
        Membership fees   1,661,391   1,780,775  
        Archive fees   1,598,962   1,070,248  
        Professional fees   304,954   254,095  
                 
        Total $ 20,899,204 $ 22,712,805  

       

      17. Related party transactions

      During the year ended September 30, 2013, the Company incurred legal fees of $201,682 (2012: $156,204, 2011: $133,242), for services provided by McMillan LLP, a law firm of which the Corporate Secretary of the Company is a partner. Accounts payable and accrued liabilities at September 30, 2013 included $19,687 (2012: $41,245, 2011: $23,955) related to these services.

      During the year ended September 30, 2013, the Company incurred consulting fees of $60,741 (2012: $59,678, 2011: $60,722), respectively, for services provided by Digital Photoworks, a company of which a Director of the Company controls. The Company does not have any outstanding accounts payable or accrued liabilities as at September 30, 2013 related to this company (2012: $nil, 2011: $5,072).

      During the year ended September 30, 2013, the Company incurred employment expenses of $2,543 (2012: $nil, 2011: $nil) paid to a relative of an Officer of the Company.

      The Company shares its UK premises with another company, Works Unit Ltd., of which a former Officer is a director. During the year ended September 30, 2013, the Company was recharged its proportional share of office running costs totalling $191,575 (2012: $209,850, 2011: $200,592) by this related party. During the year ended September 30, 2013, the Company did not incur expenses relating to the use of the software development services of this company (2012: $105,560, 2011: $58,941). The Company does not have any outstanding accounts payable as at September, 2013 (2012: $nil, 2011: $21,578) related to these services and cost recharges.

      During the year ended September 30, 2013, the Company generated revenue of $6,141 (2012: $7,683, 2011: $5,880) relating to transaction fees, software license and installation fees, and membership fees from a customer, Extrafilm, of which a Director of the Company controls. Accounts receivable as at September 30, 2013 included $299 (2012: $2,581, 2011: $2,102) related to these services.

      All amounts charged were recorded at their exchange amount, which is the amount of consideration established and agreed to by the related parties and having normal trade terms.

      18. Compensation of key management

      Key management includes the Company’s directors, and members of the executive team. Compensation awarded to key management included:


      113




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

            Year Ended  
            September   September   September  
        Description   30, 2013   30, 2012   30, 2011  
                     
        Salaries, director fees and short-term employee benefits $ 1,637,564 $ 1,462,547 $ 1,587,219  
        Share-based payments   125,524   93,723   434,149  
        Compensation expense in connection with acquisition of WorksMedia Limited   -   53,826   142,373  
        Termination benefits   166,667   168,750   87,500  
                       
        Total $ 1,929,755 $ 1,778,846 $ 2,251,241  

       

      19. Expenses by nature

       

          Year Ended  
            September 30,   September 30,     September 30,  
        Description   2013   2012     2011  
        Cost of sales                
        Salary and wages $ 3,258,963 $ 2,854,816   $ 2,445,465  
        Outsourced consultants and third party contractors   102,804   256,615     179,687  
        Direct costs   301,968   557,293     664,486  
        Third party call center   1,604,761   1,470,197     1,302,985  
        Data center fees   1,937,844   1,608,695     1,730,101  
        Amortization of property and equipment   1,318,800   1,529,978     1,689,790  
        Amortization of intangible assets   308,406   922,558     858,354  
        Impairment of intangible assets   -   542,860     -  
        Impairment of goodwill   594,851   77,382     -  
        Share-based payments   6,519   (698 )   43,156  
        Travel   56,172   37,726     15,748  
        Dues, subscriptions & books and licenses   641,027   310,591     266,872  
        Loss on disposal of property and equipment   15,321   -     36,294  
        Rent and other office costs   146,612   95,676     79,548  
        Other expenses   107,645   194,333     86,621  
        Total $ 10,401,693 $ 10,458,022   $ 9,399,107  
                         
        Expenses                
        Salary and wages $ 9,061,917 $ 8,530,388   $ 8,488,837  
        Outsourced consultants and third party contractors   2,289,024   2,370,419     1,849,335  

       

      Amortization of property and equipment and intangible assets

        341,863   278,747     347,164  
        Write-off of intangible assets   -   168,466     -  
        Share-based payments   133,845   209,447     805,088  
        Accounting and Legal fees   1,040,647   653,698     719,010  
        Rent and other office costs   670,390   625,033     683,591  
        Travel, meals & entertainment   671,223   712,789     664,525  
        Dues, subscriptions & books and licenses   170,296   164,551     190,559  
        Loss on disposal of property and equipment   480   -     81,012  
        Board member fees   204,409   248,267     217,000  
        Bad debt expense   54,107   132,012     31,693  
        Investor relations and other public company charges   118,977   188,306     157,840  

       

       

      114




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

        Other expenses   216,175   203,092   120,268  
          $ 14,973,353 $ 14,485,215 $ 14,355,922  
                       
        Total $ 25,375,046 $ 24,943,237 $ 23,755,029  

       

      20. Commitments and Contingencies

       

       a)     

      Commitments

      At September 30, 2013, the Company committed to purchase items of equipment and internal use software totalling $170,995 (2012: $nil).

      The contractual obligations and payments due as at September 30, 2013 are as follows:

                Payments due by period
           
                       
            Total   Less than 1 year   1-3 years   3-5 years  
        Equipment leases $ 966,861   371,131   595,730 $ -  
        Property leases   2,737,744   584,988   1,137,535   1,015,221  
        Other service agreements   3,760,911   1,712,773   2,048,138   -  
          $ 7,465,516   2,668,892   3,781,403 $ 1,015,221  
                           

      Property leases

      Under the Vancouver location property lease, the Company is entitled to receive up to $672,160 in repayable tenant improvement allowances, which bears interest at a rate of 8% per annum. If utilized, the tenant improvement allowance is repayable monthly over the lease term. The Vancouver property lease expires on September 30, 2023, with the option for early termination as of September 30, 2018. The unpaid tenant improvement allowance balance would be due in the event the Company elects to terminate the lease early as September 30, 2018. The lease includes an option to extend for an additional 5 years at the then current market rental rate. In addition, the landlord has included four months of free rent as tenant inducements.

        b)     

      Contingencies

      From time to time the Company may be involved in various litigation matters. In addition, the Company has contractual indemnification obligations as part of certain of our retailer agreements. Any losses that may arise as a result of these binding legal arrangements may be material to the consolidated financial statements.


      115




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      On March 7, 2013, CreateAds LLC filed a complaint for alleged patent infringement against various customers of PNI filed in the U.S. District Court for the District of Delaware. The complaint asserts infringement of U.S. Patent No. 5,535,320, which claim among others things a method of generating a representation of a visual design and applying it to various advertising materials. Subsequent to September 30, 2013, PNI settled the complaint on behalf of all customers for US$105,000, in exchange for the plaintiffs dismissing all claims against the Company and its customers which was included in cost of sales.

      On January 4, 2013, Express Card Systems, LLC filed a complaint for alleged patent infringement against various customers of PNI in the Eastern District of Texas, Tyler Division. The complaint asserts infringement of U.S. Patents Nos., 5,748,484 and 5,552,994. PNI settled the complaint on behalf of all customers for US$122,500, in exchange for the plaintiffs dismissing all claims against the Company and its customers which was included in cost of sales.

      On November 27, 2013, the Company received a letter from Bloom Stationers LLC “Bloom” alleging certain violations of the terms of our Amended and Restated Master Development & Services by and between Bloom and the Company (the “Bloom Agreement”). The complaint asserts that PNI violated the terms of the Bloom Agreement by launching HTML5 based stationery builders in November 2013 with certain retailers and advertising our abilities to provide stationery solutions to new customers. The Company believes the allegations are completely without merit.

        c)     

      Finance lease liabilities

      Lease liabilities are effectively secured as the rights to the leased asset revert to the lessor in the event of default. These leases include purchase option at the end of the lease term at nominal amounts.

            Year Ended  
            September 30,     September 30,  
            2013     2012  
                     
        Gross finance lease liabilities – minimum lease payments $ 966,861   $ -  
        Future finance charges on finance lease liabilities   (49,098 ) $ -  
        Present value of finance lease liabilities $ 917,763   $ -  

       

      21. Line of credit and overdraft

       

      Facility     September 30,     September 30,  
            2013     2012  
      Revolving Demand Facility (a) $ 1,170,000     -  
      Lease Facility (a)   609,000     -  
      Overdraft (b)   231,070     -  
          $ 2,010,070     -  

       


      116




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      (a)         The Company has a Credit Agreement with its bank (the “Bank”) which provides the Company with two separate credit facilities, being a revolving demand facility of up to $1,500,000 (“Revolving Demand Facility”) and a $1,250,000 reducing facility by way of Leases (“Lease Facility”). The two credit facilities and all other obligations of the Company to the Bank are secured by way of a General Security Agreement between the Bank and the Company, constituting a first ranking security interest in all personal property of the Company. The Revolving Demand Facility bears interest at a rate of Bank prime + 1.50% and contains a financial covenant requiring us not to exceed a borrowing limit of 67% of good Canadian and US Accounts receivable less potential prior-ranking claims which include items such as sales and excise taxes, payroll liabilities, and overdue rent, property and business taxes. The Lease Facility will be subject to separate agreements between the Bank and the Company. As at September 30, 2013 $1,170,000 of the Revolving Demand Facility and $609,000 of the Lease Facility had been utilized, resulting in an unutilized amount of $330,000 for the Revolving Demand Facility and an unutilized amount of $641,000 for the Lease Facility. The Lease Facility is included within the Finance Lease Obligations (short term and long term portion).

      (b)         The Company has an overdraft facility with its bank that is payable upon demand at end of the fiscal year end (2012: $nil).

      22. Supplementary cash flow information

       

      Net change in non-cash working capital items              
        September 30,     September 30,     September 30,  
      Description   2013     2012     2011  
                         
      Accounts receivable $ 269,554   $ 133,778   $ 704,723  
      Prepaid expenses and other current assets   78,896     (163,634 )   (13,625 )
      Accounts payable and accrued liabilities   (1,357,426 )   991,373     (2,138,156 )
      Changes in deferred revenue   (173,056 )   474,039     (398,349 )
      Total $ (1,182,032 ) $ 1,435,556   $ (1,845,407 )
      Cash and cash equivalents                  
        September 30,     September 30,     September 30,  
          2013     2012     2011  
                         
      Cash and cash equivalents is made up of:                  
      Cash and cash equivalents $ 2,425,106   $ 4,611,824   $ 3,936,176  
      Overdraft (note 21)   (231,070 )   -     -  
        $ 2,194,036   $ 4,611,824   $ 3,936,176  

       


      117




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      23.  Financial instruments

      The Company is exposed to a number of risks related to changes in foreign currency exchange rates, interest rates, collection of accounts receivable, settlement of liabilities and management of cash and cash equivalents.

      The Company’s financial instruments consist of cash and cash equivalents, accounts receivables, other current assets, accounts payable, line of credit and overdraft, finance lease obligations and contingent consideration.

      Cash and cash equivalents, accounts receivables, other current assets, accounts payable, line of credit and bank overdraft are designated as “loans and receivables” and are measured at amortized cost.

      Contingent consideration is designated as fair value through the profit and loss and measured at fair value.

      The carrying value of accounts receivables, other current assets, accounts payable, line of credit and bank overdraft, and contingent consideration approximate their fair values due to their immediate or short-term maturity.

      The carrying values and fair values of financial assets and liabilities as at September 30, 2013 and September 30, 2012 are as follows:

          Carrying value   Fair value   Carrying value   Fair value  
      September 30   2013   2013   2012   2012  
      Assets                  
      Cash and cash equivalents $ 2,425,106 $ 2,425,106 $ 4,611,824 $ 4,611,824  
      Accounts receivable $ 3,829,654 $ 3,829,654 $ 4,253,541 $ 4,253,541  
      Prepaid expenses and other current assets $ 411,728 $ 411,728 $ 622,970 $ 622,970  
                         
      Liabilities                  
      Accounts payable and accrued liabilities $ 3,037,371 $ 3,037,371 $ 4,390,437 $ 4,390,437  
      Line of credit and overdraft $ 1,401,070 $ 1,401,070 $ - $ -  
      Finance lease obligations $ 917,763 $ 917,763 $ - $ -  
      Contingent consideration $ 343,279 $ 343,279 $ - $ -  

       

      Liquidity risk

      Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with its financial liabilities that are settled by delivery of cash or other financial assets. The Company's approach to managing liquidity risk is to ensure it has sufficient cash available to manage the payment of its financial liabilities. As described in note 21, the Company has a $1,500,000 revolving demand facility and a $1,250,000 reducing facility by way of leases in place to help manage its liquidity position and therefore its liquidity is dependent on the availability of these facilities as well as its overall volume of business activity and ability to manage the collection and payment of its accounts receivable and accounts payable through cash flow management techniques.


      118




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      The following table discloses the undiscounted maturities of the Company’s financial liabilities as at September 30, 2013:

      September 30, 2013   Payments due by period  
          Total   Less than 1   1-3 years   3-5 years  
              year          
      Accounts payable and accrued liabilities $ 3,037,374 $ 3,037,374  $ - $ -  
      Other short-term debt obligations   1,401,067   1,401,067   -   -  
      Equipment leases   966,861   371,131   595,730   -  
      Purchase consideration payable   343,279   343,279   -   -  
        $ 5,748,581 $ 5,152,851 $ 595,730 $ -  
                       
                         
      September 30, 2012   Payments due by period  
          Total   Less than 1   1-3 years   3-5 years  
              year          
      Accounts payable and accrued liabilities $ 4,390,437 $ 4,390,437  $ - $ -  
        $ 4,390,437 $ 4,390,437  $   $ -  

      During the year ended September 30, 2013, the Company generated negative cash flow from operations of $2,916,385. During the same period the Company’s working capital has decreased by $3,568,625 from $4,779,791 to $1,211,166. The Company's liquidity position may, however, fluctuate during the year due to a number of factors which could include unanticipated changes to its volume of business, credit losses and the extent of capital expenditure in the year. The Company's liquidity position may also be adversely impacted by the seasonal nature of its business with the Company's busiest period of activity typically during the first quarter of the fiscal year. The Company has a concentration of business with select key customers which accounts for 91% of total revenues (2012: 91%). Its liquidity position would be adversely impacted if one of these key customer relationships was discontinued (note 15).

      The Company primarily monitors its liquidity position through forecasting expected cash flows based on the timing of expected receipts and payments. Management monitors its cash balances and projections on a weekly and monthly basis. The starting point for its analysis is based upon the contractual maturity date of its liabilities and its expected collection period for its receivables. The Company manages the payment of its financial liabilities based on available cash and matching the settlement of its financial liabilities to realized financial assets. The Company also monitors its debtor collection as described in the credit risk note above. As the Company's revenues are primarily collectible within 30 days of invoicing, which is performed weekly for some customers and monthly for others, the Company aims to be able to collect its accounts receivable more promptly than it settles its third party accounts payable. However, as certain of the Company's operating expenses such as its payroll obligations are contractually due at least monthly, the Company’s working capital position could periodically alter depending on the timing of the maturity of its accounts receivable and accounts payable and accrued liabilities.

      In the current year the Company purchased a number of items of property and equipment using a finance lease. At September 30, 2013, the Company had an outstanding obligation under this lease of $917,763 (2012: $nil).

      The Company’s activities are being funded out of its operating cash flow and cash reserves and its credit facilities. To date the Company has used $1,170,000 (2012: $nil) from the revolving demand facility.


      119




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      Credit risk

      Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and accounts receivable. The Company aims to protect its cash and cash equivalents from undue risk by holding them with various high credit quality financial institutions located in Canada and the United Kingdom. In circumstances in which a bank in which the Company holds a deposit has any significant decline in its credit rating, the Company carefully monitors the extent of any credit risk net of government deposit guarantees and, where appropriate, would take remedial action to minimise the risk of any potential credit loss. Of the amounts held with financial institutions on deposit, $100,000 is covered by the Canada Deposit Insurance Corporation, leaving $2,325,106 at risk should the financial institutions with which the deposits are held cease trading.

      The Company's accounts receivable are all from large, well-known retailers located primarily in Canada, the United States and the United Kingdom. Credit risk from accounts receivable encompasses the default risk of retail customers. The Company manages its exposure to credit risk by only working with larger, reputable companies and prior to accepting new customers; the Company assesses the risk of default associated with a particular company. In addition, on an ongoing basis, management monitor the level of accounts receivable attributable to each customer and the length of time taken for amounts to be settled and where necessary, takes appropriate action to follow up on those balances considered overdue.

      Management does not believe that there is significant credit risk arising from any of the Company's customers; however, should one of the Company's main customers be unable to settle amounts due, the impact on the Company could be significant. The maximum exposure to loss arising from accounts receivable is equal to their total carrying amounts. At September 30, 2013, four customer groups each account for 10% or more of total trade accounts receivable (September 30, 2012 – three customers and September 30, 2011- five customers).

      Financial assets past due

      At September 30, 2013, the Company has a provision of $46,491 against trade accounts receivable, the collection of which is considered doubtful. The following table provides information regarding the ageing of financial assets that are past due but which are not impaired.

      At September 30, 2013

                Financial assets that are past due but not impaired        
                                     
                                  Carrying value  
          Neither past due                       on the balance  
          nor impaired     31 – 60days   61 – 90 days     91 days +     sheet  
      Trade accounts                              
      receivable $ 2,589,547   $ 439,770   $ 130,187   $ 408,674   $ 3,568,178  
      Commodity taxes                              
      recoverable   35,868     -     -     -     35,868  
      Other   225,608     -     -     -     225,608  
      Total $ 2,851,023   $ 439,770   $ 130,187   $ 408,674   $ 3,829,654  

      The definition of items that are past due is determined by reference to terms agreed with individual customers. Of the 91 days+ balance outstanding at September 30, 2013, 97% has been subsequently collected as at December 6, 2013. None of the amounts outstanding have been challenged by the respective customer(s) and the Company continues to conduct business with them on an ongoing basis. Accordingly, management has no reason to believe that this balance is not fully collectable in the future.


      120




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

      The Company reviews financial assets past due on an ongoing basis with the objective of identifying potential matters which could delay the collection of funds at an early stage. Once items are identified as being past due, contact is made with the respective company to determine the reason for the delay in payment and to establish an agreement to rectify the breach of contractual terms. At September 30, 2013, the Company had a provision for doubtful accounts of $46,491 which was made against trade accounts receivable in excess of twelve months old or where collection efforts to date have been unsuccessful. All amounts neither past due nor impaired are collectible from large, well-known retailers located in Canada, the United States and the United Kingdom. The Company is not aware of any information suggesting that the collectability of these amounts is in doubt.

      Market risk

      Market risk is the risk to the Company that the fair value or future cash flows of financial instruments will fluctuate due to changes in interest rates and foreign currency exchange rates. Market risk arises as a result of the Company generating revenues and incurring expenses in foreign currencies, holding cash and cash equivalents which earn interest and having operations based in the United Kingdom in the form of its wholly owned subsidiaries, PNI Digital Media Europe Ltd., and Quarterhouse.

      Interest rate risk

      The only financial instruments that expose the Company to interest rate risk are its cash and cash equivalents. The Company’s objectives of managing its cash and cash equivalents are to ensure sufficient funds are maintained on hand at all times to meet day-to-day requirements and to place any amounts which are considered in excess of day-to-day requirements on short-term deposit with the Company's banks so that they earn interest. When placing amounts of cash and cash equivalents on short-term deposit, the Company only uses high quality commercial banks and ensures that access to the amounts placed can be obtained on short-notice.

      Currency risk

      The Company generates revenues and incurs expenses and expenditures primarily in Canada, the United States and the United Kingdom and is exposed to risk from changes in foreign currency rates. In addition, the Company holds financial assets and liabilities in foreign currencies that expose the Company to foreign exchange risks. The Company does not utilise any financial instruments or cash management policies to mitigate the risks arising from changes in foreign currency rates.

      At September 30, 2013, through its wholly owned subsidiaries, the Company had cash and cash equivalents of $980,550, accounts receivable of $918,656 and accounts payable of $400,978 which were denominated in UK £. In addition, at September 30, 2013, the Company had cash and cash equivalents of $1,444,403, accounts receivable of $2,361,237 and accounts payable of $612,733 which were denominated in US$.

      Sensitivity analysis

      The Company has completed a sensitivity analysis to estimate the impact on net earnings for the year which a change in foreign exchange rates or interest rates during the Year ended September 30, 2013 would have had.

      This sensitivity analysis includes the following assumptions:

      • Changes in individual foreign exchange rates do not cause foreign exchange rates in other countries to alter

      • Changes in market interest rates do not cause a change in foreign exchange rates


      121




      PNI Digital Media Inc.
      Notes to Consolidated Financial Statements
      (expressed in Canadian dollars)

       

      The results of the foreign exchange rate sensitivity analysis can be seen in the following table:

        Impact on net loss  
        $  
      Change of +/- 10% in US$ foreign exchange rate +/-206,260  
      Change of +/- 10% in UK£ foreign exchange rate +/-179,923  

      The above results arise primarily as a result of the Company having US$ denominated trade accounts receivable balances, trade accounts payable balances and bank account balances. Limitations of sensitivity analysis

      The above table demonstrates the effect of either a change in foreign exchange rates or interest rates in isolation. In reality, there is a correlation between the two factors.

      Additionally, the financial position of the Company may vary at the time that a change in either of these factors occurs, causing the impact on the Company’s results to differ from that shown above.

      Capital Management

      The Company considers its share capital, share capital purchased for cancellation, and contributed surplus, as capital, which at September 30, 2013 totalled $86,291,814.

      The Company manages its capital structure in order to ensure sufficient resources are available to meet day to day operating requirements; to allow it to enhance existing product offerings as well as develop new ones and to have the financial ability to expand the size of its operations by taking on new customers. In managing its capital structure, the Company takes into consideration various factors, including the seasonality of the market in which it operates the growth of its business and related infrastructure and the upfront cost of taking on new clients.

      The Company’s Officers and senior management take full responsibility for managing the Company’s capital and do so through quarterly meetings and regular review of financial information. The Company’s Board of Directors are responsible for overseeing this process.

      Methods used by the Company in previous periods to manage its capital include the issuance of new share capital and warrants which has historically been done through private placements primarily with institutional investors as well as utilizing credit facilities such as lines of credit and equipment leases in order to in order to safeguard the Company’s ability to continue as a going concern.

      The Company is not subject to any externally imposed capital requirements.

      23. Subsequent events

      On December 3, 2013, the Company announced that it had entered into an underwriting agreement, for the sale of 6,191,000 common shares at a price (the "Offering Price") of $1.05 per common share (the "Shares") to raise gross proceeds of $6,500,550 under a short form prospectus (the "Offering"). The Company has granted to the underwriters an option (the “Over-Allotment Option”) to purchase up to an additional 928,650 Common Shares (the “Over-Allotment Shares”), representing 15% of the number of Offered Shares sold under the Offering. The offering is expected to close on or about December 20, 2013.


      122












      ITEM 19. EXHIBITS

      The following exhibits are filed as part of this annual report:

      Exhibit  
      Number Description
         
      1.1 Articles, as amended (5)
         
      1.2 Notice of Articles, dated December 2, 2009 (5)
         
      1.3 Notice of Change of Name, dated June 4, 2009 (5)

       

      123





      Exhibit  
      Number Description
         
      4.1 The Services Agreement between Pixology and ASDA Stores Limited is dated 28 September 2005 and continues in full force and effect until terminated by either party giving no less than three calendar month’s notice in writing to the other, such notice to expire at any time on or after the first anniversary of the commencement date.(3)
         
      4.2 The Services Agreement with Sam’s West Inc., dated January 23, 2008.(4)
         
      4.3 The Amended and Restated Services Agreement with Wal-Mart Canada Corp., dated January 31, 2008.(4)
         
      4.4 The Internet Photo Services Agreement with Costco Wholesale Corporation, dated April 29, 2008. (4)
         
      4.5 The lease renewal and modification agreement for our executive offices in Canada with The Old BC Electric Building Corp., dated June 11, 2009.(5)
         
      4.6 The lease agreement for our support offices in Canada with The Old BC Electric Building Corp., dated July 26, 2010. (6)
         
      4.7 The share purchase agreement, dated February 25, 2009, amongst PhotoChannel Networks Inc., as Purchaser and Vendors in relation to the sale and purchase of the whole of the issued share capital of WorksMedia Limited. (5)
         
      4.8 The First Amendment to the Internet Photo Services Agreement with Costco Wholesale Corporation, dated February 16, 2011. (7) (*)
         
      4.9 The share purchase agreement, dated April 8, 2013, amongst PNI Digital Media Inc., as Purchaser, Roger Canann, as Vendor, and QS Quarterhouse Software, Inc. in relation to the sale and purchase of the whole of the issued share capital of QS Quarterhouse Software, Inc. (1) (*)
         
      4.10 The Second Amendment to the Internet Photo Services Agreement with Costco Wholesale Corporation, dated July 16, 2013. (1)
         
      4.11 The Third Amendment to the Internet Photo Services Agreement with Costco Wholesale Corporation, dated September 2, 2013. (1) (*)
         
      8.1 List of Subsidiaries (1)
         
      12.1 Section 302(a) Certification of CEO.(1)
         
      12.2 Section 302(a) Certification of CFO.(1)
         
      13.1 Section 906 Certifications of CEO and CFO.(1)
         
      15.1 Audit Committee Charter. (8)

       

      124





      (1)

      Filed herewith.

      (2)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2006, as filed with the SEC on April 2, 2007.

      (3)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2007, as filed with the SEC on April 4, 2008.

      (4)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2008, as filed with the SEC on January 20, 2009.

      (5)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2009, as filed with the SEC on March 17, 2010.

      (6)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2010, as filed with the SEC on March 29, 2011.

      (7)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2011, as filed with the SEC on March 21, 2012.

      (8)

      Filed as an exhibit to our Annual Report on Form 20-F for our fiscal year ended September 30, 2012, as filed with the SEC on January 7, 2013.

      (*)

      Portions of this exhibit have been omitted pursuant to a request for confidential treatment.

      125





      SIGNATURES

      The registrant certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

          PNI DIGITAL MEDIA INC.
          (Registrant)
              
      Date: December 10, 2013 By: /s/ Kyle Hall
            Kyle Hall
            Chief Executive Officer

       

      126