F20F

20-F 1 f20f.htm F20F 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

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

For the fiscal year ended September 30, 2010

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

For the transition period from _______________ to _______________

£ 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)

Simon Bodymore, 604 893 8955, sbodymore@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
None

Name of each exchange on which registered
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.

33,464,432 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 T

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 T

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 T 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 T

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 £

Other T

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 T

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 T

(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)

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	17
	ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS	33
	ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	51
	ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	61
	ITEM 8. FINANCIAL INFORMATION	63
	ITEM 9. THE OFFER AND LISTING	64
	ITEM 10. ADDITIONAL INFORMATION	66
	ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	71
	ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES	74
PART II		74
	ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES	74
	ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS	74
	ITEM 15. CONTROLS AND PROCEDURES	74
	ITEM 16. [RESERVED]	76
	ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT	76
	ITEM 16B. CODE OF ETHICS	77
	ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES	78
	ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES	78
	ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS	78
PART III		79
	ITEM 17. FINANCIAL STATEMENTS	79
	ITEM 18. FINANCIAL STATEMENTS	79
	ITEM 19. EXHIBITS	79

PART I
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 table summarizes certain selected consolidated financial data for each of the five financial years ended September 30, 2010. The selected financial data set forth below with respect to our consolidated statements of operations for each of the three financial years in the period ended September 30, 2010 and with respect to the consolidated balance sheets as at September 30, 2010 and 2009, are derived from our audited consolidated financial statements included elsewhere in this annual report. With the exceptions of weighted average number of shares and basic diluted net loss per common share data, consolidated statements of operations data for the years ended September 30, 2006 and 2005, and consolidated balance sheet data as at September 30, 2007, 2006 and 2005, have been derived from our consolidated financial statements that have not been included in this annual report.

Readers should read the following selected financial data in conjunction with our consolidated financial statements and the notes thereto appearing in this annual report. The consolidated financial statements were prepared in accordance with accounting principles generally accepted in Canada ("Canadian GAAP"). Readers are referred to Note 23 in the accompanying September 30, 2010 consolidated financial statements for a quantitative and qualitative reconciliation of the measurement differences between Canadian GAAP and generally accepted accounting principles in the United States ("US GAAP"), as it relates to us.

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.

Selected Financial Data:

Under Canadian GAAP	For the years ended September 30th
Item	2010	2009	2008	2007	2006
Revenue	$25,356,570	$24,446,569	$17,049,587	$7,511,328	$4,075,151
Profit (loss) from operations	$1,979,302	($1,902,296)	($8,153,568)	($4,747,488)	($2,628,867)
Net profit (loss) for the year	$6,851,994	($1,769,666)	($8,717,026)	($6,072,236)	($2,632,301)
Comprehensive profit (loss)	$6,341,652	($2,422,327)	($9,063,990)	($6,881,805)	($2,632,301)
Basic net profit (loss) per common share	$0.20	($0.05)	($0.26)	($0.20)	($0.12)

Under Canadian GAAP	For the years ended September 30th
Item	2010	2009	2008	2007	2006
Fully diluted net profit (loss) per common share	$0.20	($0.05)	($0.26)	($0.20)	($0.12)
Total assets	$23,520,358	$21,136,975	$20,623,453	$25,758,619	$4,883,304
Net assets (liabilities)	$17,129,478	$10,192,534	$10,263,657	$17,611,126	$3,434,762
Capital Stock	$66,200,215	$66,017,456	$65,614,347	$65,293,214	$49,115,790
Weighted average number of Common Shares - basic ⁽¹⁾	33,804,338	33,610,843	33,383,866	29,877,739	22,804,712
Weighted average number of Common Shares - diluted ⁽¹⁾	33,908,352	33,610,843	33,383,866	29,877,739	22,804,712
Common shares issued and outstanding ⁽¹⁾	34,210,782	34,243,182	33,464,432	33,315,536	26,048,359
Long term obligations and redeemable preferred stock	Nil	176,056	Nil	Nil	Nil
Cash dividends declared per common share	Nil	Nil	Nil	Nil	Nil

(1) See Item 3.A.

The above selected financial data in accordance with U.S. GAAP is indicated below:

	For the years ended September 30th
Item	2010	2009	2008	2007	2006
Revenue	$25,356,570	$24,446,569	$17,049,587	$7,511,328	$4,075,151
Profit (loss) from operations	$1,939,217	($1,957,373)	($9,240,145)	($4,747,488)	($2,628,867)
Net profit (loss) for the year	$7,693,535	($1,747,135)	($4,045,820)	($5,804,147)	($2,632,301)
Comprehensive profit (loss)	$7,183,193	($2,399,796)	($4,392,784)	($6,613,716)	($2,632,301)
Basic net profit (loss) per common share	$0.23	($0.05)	($0.12)	($0.19)	($0.12)

Fully diluted net profit (loss) per common share	$0.23	($0.05)	($0.12)	($0.19)	($0.12)
Total assets	$30,980,573	$27,648,038	$27,134,516	$32,269,682	$11,394,367
Net assets (liabilities)	$24,589,693	$16,703,597	$16,752,189	$19,428,452	$9,945,825
Capital Stock	$66,199,666	$65,909,296	$65,506,187	$65,185,054	$49,007,630
Weighted average number of Common Shares - basic ⁽¹⁾	33,804,338	33,610,843	33,383,866	29,877,739	22,804,712
Weighted average number of Common Shares - diluted ⁽¹⁾	33,908,352	33,610,843	33,383,866	29,877,739	22,804,712
Common shares issued and outstanding ⁽¹⁾	34,210,782	34,243,182	33,464,432	33,315,536	26,048,359
Long term obligations and redeemable preferred stock	Nil	176,056	Nil	Nil	Nil
Cash dividends declared per common share	Nil	Nil	Nil	Nil	Nil

(1) See Item 3. A.

Currency and Exchange Rates

All dollar amounts set forth in this annual report are in Canadian dollars, unless we indicate otherwise.

The rate of exchange for the U.S. dollar, expressed in Canadian dollars, as of March 14, 2011, was $0.9759, based on the noon buying rate as published by the Bank of Canada:

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

Previous Six Months

	August 2010	September 2010	October 2010	November 2010	December 2010	January 2011
High Rate	1.0642	1.0520	1.0320	1.0264	1.0178	1.0022
Low Rate	1.0158	1.0222	1.0030	1.0013	0.9946	0.9862

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 buying rate as published by the Bank of Canada.

Years ending September 30

	2010	2009	2008	2007	2006
Rate at end of Period	1.0298	1.0722	1.0382	0.9929	1.1142
Average Rate During Period	1.0407	1.1804	1.0090	1.1143	1.1435
High Rate	1.0845	1.3000	1.0819	1.1873	1.1975
Low Rate	0.9961	1.0609	0.9057	0.9914	1.0926

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
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 Costco USA, SAMS Clubs USA and CVS/pharmacy. As a result of this we are now more concentrated in the United States marketplace. The United States marketplace for photofinishing is 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 two 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 China, 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 we currently bill customers in Canadian dollars, U.S. dollars, or United Kingdom pounds. We record the financial results for the operations of our UK subsidiary in United Kingdom pounds 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: Firstly, 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; secondly, 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; and thirdly, 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.

Our operating results are affected by the seasonal nature of our business.

Our business is seasonal, with a significant proportion of our recurring revenues being 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 rapid 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.

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 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;

consumer preferences for digital photography; 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 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 internal controls over our financial reporting were not effective. The deficiencies identified related to management's application of certain complex GAAP requirements. As a result of this, management concluded that our disclosure controls and procedures and internal controls over financial reporting were not effective as of September 30, 2008 and September 30, 2007. 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.

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

While we believe we are seeing increased acceptance of our services and business model, 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 product does not continue to be accepted in the market place, our business could be materially and 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 stationary 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 Company 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 not being recovered.

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 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 assure 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, whether because of failure to market it, we may lose retailers as customers, which would adversely affect our revenue.

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 2010, we earned Cdn$22,025,977 from four (4) customer groups, representing 87% 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 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 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.

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.

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.

We operate in a competitive market place. Our success is dependent upon our ability to maintain our current customers and obtain additional customers. Digital print 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), 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 Kodak Easyshare, 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, Lexmark, 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, we are directly affected by discounts in the price charged to consumers by the retailer under certain agreements 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.

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.

We rely on our ability to attract and retain customers. If we are unable to maintain reliability of our Network and kiosk solutions 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 and kiosk services. 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. 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 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.

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 principal customers, being photofinishing retailers, must install high speed Internet access to be able to provide online one hour in store photofinishing. Our experience has been that the provision of in store printing leads to an increase in the use of our Network. Our customers have not always been able to install high speed Internet access on a timely basis, resulting in a delay in the deployment of our Network and a corresponding delay or loss of revenues. We expect delays in the installation of high speed Internet access to continue in the foreseeable future.

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 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.

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 depends, to a large degree, on our current technology and, in the future, technology that we might 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 resources and the potential loss of intellectual property rights, which could impair our financial and business condition.

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

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.

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. We do not carry key man insurance coverage to mitigate the financial effect of losing the services of any of these key individuals. Our loss of any of these key individuals most likely would have an adverse effect on our business.

In addition, we may require additional capabilities, especially in our representation on the board of directors. We cannot assure that we will be successful in attracting personnel of the appropriate calibre.

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

Our ability to provide our service depends on the uninterrupted operation of our computer and communications systems. Our computer hardware necessary to operate our service is primarily located in two third party hosting facilities one is located in Vancouver, British Columbia and the other 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 we do have redundant systems in multiple locations, however, we do not have all customers hosted in each location and 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.

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.

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 will continue to develop new product lines, such as online printing of business and social stationary, and expand current product lines, during calendar 2011. 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 service turn around times and delays in deploying new customers. These delays could adversely affect our business and results of operations.

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, 2008. We achieved positive cash flows from operations for the years ended September 30, 2009 and 2010 and while we believe we will generate sufficient cash flow to meet our expected cash requirements for fiscal 2011, 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.

Since inception and up to the year ended September 30, 2009 we have operated at a loss and, at September 30, 2010, had an accumulated deficit of Cdn$65,684,820. 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, 2010 we recorded a profit of $6,851,994, the first time in the Company's history that a profit has been recorded on an annual basis. Our profit for the year ended September 30, 2010 consists of profit before tax in the amount of $2,042,130 and a net income tax recovery of $4,809,864 as a result of the Company recording a net deferred tax asset associated with the our expected realization of unused loss carryforwards and other deductible temporary differences. 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, 2010, we had cash and cash equivalents of approximately Cdn$4,690,355 The cash available, along with anticipated positive cash flow from operations are expected to meet our requirements for fiscal 2011. See "Item 5 - Operating and Financial Review and Prospects - B. Liquidity and Capital Resources".

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 is likely to 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.

The Following Risks Relate to Our Acquisition of WorksMedia

We continue to face a number of challenges in integrating and further developing the legacy WorksMedia business. The risks associated with the acquisition of WorksMedia, include:

We made the offer to acquire WorksMedia for strategic reasons, which will only be realized if our operations and those of WorksMedia can be effectively integrated.

The acquisition of all of the outstanding shares of WorksMedia was made with the expectation that its successful completion will result in long-term strategic benefits. These anticipated benefits will depend in part on whether we can integrate the operations of PNI and the legacy WorksMedia business in an efficient and effective manner. As at year end, the integration of operations into the group is completed, however continued additional risks with the acquisition include the maintenance of uniform standards, controls, procedures and policies and the retention of relationships with employees and customers.

If we are unable to continue growing the legacy WorksMedia business in a profitable manner, our business and financial results may be materially and adversely affected.

WorksMedia had a history of profitable operations since inception, and historically its main source of revenue arose from sales of software licences which are non-recurring in nature. Our purchase price of $2,531,410 for the legacy WorksMedia business was based on future revenue and profit projections and included a number of assumptions regarding the ability to meet those projections without a significant increase in costs. On April 1, 2010 the legacy WorksMedia operations were amalgamated with the operations of Pixology Software Limited forming PNI Digital Media Europe Ltd. While the amalgamation was completed as part of the integration of operations into the group; the Company continues to bear the risk that should the projections not be met or require additional costs or management time to achieve, our business and financial results may be materially and adversely affected.

The Following Risks Relate To The Market For Our Common Shares
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.

Our common shares trade in Canada on the TSX Venture Exchange and in the United States on the OTC Bulletin Board. Trading of these shares is presently concentrated in the United States marketplace, 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. We have no agreement with any broker-dealer to act as a market-maker for our common shares. One or more broker-dealers have become market makers in our shares quoted on the OTC Bulletin Board. However, there is no guarantee that this will continue. Any trading is currently limited to the non-NASDAQ over-the-counter market. There can be no assurance that our securities will ever qualify for listing on any other stock market or stock exchange in the US or elsewhere. Accordingly, there can be no assurance that any US market for our securities will continue.

Our common shares may be deemed to be a "penny stock" in the United States. As a result, trading of our shares may be subject to special requirements that could impede our shareholders' ability to resell their shares in the United States.

At present our common shares are deemed to be a "penny stock" as that term is defined in Rule 3a51-1 of the Securities and Exchange Commission. Penny stocks are stocks:

with a price of less than five US dollars per share;

that are not traded on a recognized national exchange;

whose prices are not quoted on the NASDAQ automated quotation system;

of issuers with net tangible assets less than

$2,000,000 if the issuer has been in continuous operation for at least three years; or

$5,000,000 if in continuous operation for less than three years; or

of issuers with average revenues of less than $6,000,000 for the last three years.

Section 15(g) of the Exchange Act, and Rule 15g-2 of the Securities and Exchange Commission, require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor's account. Moreover, Rule 15g-9 of the Securities and Exchange Commission requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer:

to obtain from the investor information concerning his or her financial situation, investment experience and investment objectives;

to determine reasonably, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience so as to be reasonably capable of evaluating the risks of penny stock transactions;

to provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination above; and

to receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor's financial situation, investment experience and investment objectives.

Compliance with these requirements may make it more difficult for holders of our common shares to resell their shares to third parties or to otherwise dispose of them in the United States.

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

On March 14, 2011, our common shares closed at a price of Cdn$1.53 on the TSX-V and US$1.55 on the OTC Bulletin Board. For the period from October 1, 2009 to September 30, 2010, the adjusted high and low trading prices of our common shares on the TSX-V were Cdn$1.95 and Cdn$1.30, respectively, with a total reported trading volume of 7,438,800 shares. For the same period, the adjusted high and low trading prices of our common shares on the OTC Bulletin Board were US$1.87 and US$1.28, respectively, with a total reported trading volume of approximately 9,565,446 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.

Daily trading volume on the TSX-V of our common shares for the period from October 1, 2009 to September 30, 2010 has fluctuated, with a high of 791,500 shares and a low of zero shares, averaging approximately 29,637 shares. Daily trading volume on the OTC Bulletin Board in our common shares for the period from October 1, 2009 to September 30, 2010 has fluctuated with a high of 213,100 and a low of zero, averaging approximately 36,509. 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, including by holders of the notes on conversion or repayment by us in 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 a high level 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.

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-V. 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.

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.

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 offices in, Southampton, England and Secaucus, New Jersey. Substantially all of our business is conducted out of our Vancouver and Southampton offices. Our New Jersey office is a sales office which we acquired upon completion of the acquisition of Pixology plc ("Pixology"). Our Southampton office is a sales and customer support office which we acquired upon completion of the acquisition of WorksMedia Ltd ("WorksMedia"), although has previously operated as an engineering centre. Prior to our acquisition of WorksMedia our UK operations were run out of an office in Guildford, England. After the completion of our acquisition we relocated our Guildford based staff to the newly acquired Southampton office which offered lower day to day operating costs and closed down our Guildford location.

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 stationary 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. Currently, our principal service enables Retailers such as Costco and Sams Clubs to provide photo print and photo gift services through the Internet and at in store kiosks.

Under our general business model we charge Retailers a combination of fixed and variable fees including: initial fees or an annual license fee for the development, maintenance and continued enhancement of the digital print capture portion of their website or kiosk-based software; (ii) monthly fees for their connection to the PNI Digital Media Platform; (iii) transaction fees based on every order placed, or for images uploaded, through the PNI Digital Media Platform; and (iv) fees for the continued storage of the Retailers customers' digital images. There are different variations in the fees charged based upon the contractual relationship with each Retailer and the service provided.

In some instances, we provide services to the ultimate customers who access the PNI Digital Media Platform 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. We pay the retailer a commission for the use of their website and other services provided by the retailer. We are responsible for fulfilling the ultimate customers' orders and fulfill our obligations through the use of third party suppliers who ship the products directly to the customer. Under this type of arrangement, we record the revenue when the product is shipped to the customer, net of estimated returns, as we have transferred the significant risks and rewards of ownership to the customer at that time. We adjust the estimated returns to the actual returns when determinable.

With the acquisition of Pixology in July of 2007, we entered into the provision of a parallel digital print capture service with the delivery of photo kiosk software. Photo kiosks are in store computer interfaces through which consumers upload, edit and order images for pick up in store. This acquisition also resulted in us acquiring Pixology's online photo solution. As we determined that our solution was more robust we have been phasing out this service by replacing it with the PNI Digital Media Platform.

With the acquisition of WorksMedia in 2009, we further provisioned advanced digital print capture services for photo kiosks and websites.

As at September 30, 2010, we have three wholly owned active subsidiaries, PNI Digital Media Ltd (formerly Pixology Limited), PNI Digital Media Europe Ltd (formerly Pixology Software Limited), and Pixology, Inc. PNI Digital Media Ltd., and PNI Digital Media Europe Ltd are located in the United Kingdom and Pixology, Inc. is located in the United States. The consolidated operations of PNI Digital Media Ltd, PNI Digital Media Europe Ltd. and Pixology Inc. are collectively referred to as PNI Europe.

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. On November 2, 2006, we consolidated our outstanding common shares on a one new share for ten old shares basis. On completion of the consolidation, we had approximately 26,060,559 common shares outstanding. Our financial statements for the years since that ended September 30, 2006, have been prepared on a post share consolidation basis. On July 2^nd, 2007, we acquired Pixology PLC, a company with offices based in the UK and a sales office in the United States. On March 11^th2009, we acquired WorksMedia Ltd., a UK-based software company with offices in Southampton. On June 8^th, 2009, we formally changed our name to PNI Digital Media Inc., As of September 30^th, 2010, we had 34,210,782 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, www.photochannel.com. or www.pnidigitalmedia.com.

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 $1,468,825 for the year ended September 30, 2010 compared with $2,182,637 for the year ended September 30, 2009, $4,762,168 in 2008, $1,127,371 in 2007, $777,479 in 2006, and $523,595 in 2005. Prior to 2009 we financed these expenditures primarily by issuing common shares. All expenditures during the year ended September 30, 2009 and 2010 were financed through cash flows generated from operations. 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 March 14, 2011 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.

Acquisition of Pixology plc

On July 2, 2007 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.

Information Concerning Pixology
Overview

Pixology was a provider of software for the digital photography industry and operated a business, parts of which are similar to that of our existing business. Pixology had developed software and networks that enabled equipment manufacturers and retailers of photofinishing services to substitute the analogue film environment with new digital infrastructure.

Pixology had two principal product offerings - in-store kiosk technology and an online digital printing solution which is similar to our PNI Digital 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. Pixology had been providing this service in the retail environment for the past four years. We have taken over this service and currently provide it to a number of retail customers including Tesco in the United Kingdom and Costco in the United States, Canada and Mexico.

Pixology also provided an online digital printing solution similar to the PNI Digital Media Platform called the Pixology Online Photo Center. Upon taking over Pixology we commenced replacing their online customer base with the PNI Digital Media Platform. During fiscal 2008 we were successful in replacing ASDA's online solution and finalised the transfer of Tesco onto the PNI Digital Media Platform during fiscal 2010.

Pixology Since the Acquisition

The Pixology assets, being primarily intellectual property relating to software and systems for in-store kiosks, have been employed where appropriate within our corporate group as a whole, adding peripheral enhancement and kiosk-based elements to our core product. As part of our efforts to consolidate corporate operations across our corporate group as a whole, during 2009 operations for Pixology previously based in Guildford in the UK have been amalgamated into either our Vancouver offices or our office in Southampton.

Prior to the acquisition, Pixology announced that it expected to experience a loss of between L 1.35 and L 1.65 million for the year ending December 31, 2007. We incurred a loss relating to Pixology operations of approximately Cdn$2,231,013 (approximately L 1,054,000) over the three months from the date of the acquisition of Pixology to September 30, 2007. During fiscal 2008, we incurred a loss of $2,514,303 related to Pixology's operations. In fiscal 2009, the losses recorded by Pixology were reduced to $711,683, after charging non-cash amortization of intangible assets of $1,363,129. On April 1, 2010, the operations of Pixology were amalgamated with those of WorksMedia Ltd., our other UK based operating subsidiary. Accordingly, financial information for the year ended September 30, 2010 includes the results of operations of the newly combined entity from that date on. For the year ended September 30, 2010, PNI Europe recorded a profit before tax of $593,366.

Acquisition of WorksMedia Ltd.

On February 25^th, 2009, we entered into a Share Purchase Agreement to acquire 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 shares of PNI Digital Media which are being 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. If certain performance targets are met, the shareholders of WorksMedia receive up to an additional 900,000 common shares over the three year period from the date of acquisition. To date, such performance targets have not been met.

Reasons for the acquisition of WorksMedia:

We determined to acquire WorksMedia for the following reasons:

The addition of the software technology and key personnel that comprised the WorksMedia portfolio and staff are deemed of value to both the present and future operations of the company,

The existing deployment of the WorksMedia software to more than 3000 kiosks opened new geographies and Retailers for the company.

The rich media interface and network of deployments enables us to expand the ability to offer high-margin photo gifts directly from kiosks.

The addition of a more cost-effective location to base our UK operations enabled the company to close our Pixology offices and realize an immediate 30% reduction in UK-based staff, resulting in an annual cost savings of $480,000

WorksMedia has been profitable since inception and could directly contribute to the long term profitability of the company.

WorksMedia Since the Acquisition

Since the acquisition of WorksMedia, we have consolidated our UK operations into WorksMedia's Southampton offices, and reduced our UK based staff from 26 people pre-acquisition to 9 people as of September 30, 2010. WorksMedia's products have been re-branded and are now being distributed under the PNI Digital Media brand and work has been completed to integrate the WorksMedia products into the PNI Platform.

B. Business Overview

We were originally formed to develop and market a suite of "easy to use" multimedia presentation software products for use by consumers wishing to present and display images captured on digital cameras and photo scanners. We marketed these software products under the trade name Slides & Sound Plus^TM. We discontinued development of these products during 1999 in order to focus on the development of our e-processing and network strategy. We ceased actively marketing and supporting these products effective January 31, 2001.

In February 1999, we established our website at www.photochannel.com as an online photo community for both digital camera and conventional film photographers. Our online photo community consisted of an Internet portal through which users could participate in photography focused chat groups, discussion forums, e-mail and have access to articles relating to photography hints, tips and techniques. Users could also upload, store and manipulate digital images online and create photo websites, albums and slide shows.

On October 2, 2000, we introduced an e-processing and photofinishing service as a business-to-consumer strategy, offering film processing, scanning, storage and printing of digital images directly to US consumers via our wholly owned US subsidiary, PhotoChannel, Inc. Our long-term strategy at that time was to develop a membership network of professional photofinishing retailers, and to apply the "mail order" model of our US subsidiary to reach the retailers' customers.

Following the launch of our e-processing and photofinishing service we were able to beta test the technology and the marketing of this concept. Our technology enabled customers to preview and edit their digital/digitized pictures online before ordering any prints from a member of our planned retailer Network. Accordingly, although the targeted end-users of our technology consisted of digital camera users who required a photofinishing solution, we felt that our services would also be attractive conventional film photographers.

In March 2001, we went through a major reorganization, which resulted in a change of management, a complete corporate restructuring and a change in business focus. We determined that we could not offer both solutions, as the e-processing "mail order" model provided by our US subsidiary was, in fact, competing with our Network model. In April of 2001, we ceased to provide the e-processing mail order option. On November 1, 2001, after attempting to settle its outstanding debt, our US operating subsidiary, PhotoChannel, Inc., filed for protection under Chapter 7 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Connecticut.

Subsequent to March 2001, our focus has been one of a digital imaging technology provider for a wide variety of businesses including photofinishing retailers, professional and commercial photo processing labs, image content owners and targeted portal services. We have created and manage a digital network environment (the "Platform" or "PNI Digital Media Platform") whose focus is on delivering digital image orders from capture to fulfillment under the control of our originating Platform member.

On May 10, 2001 the first retail Platform members outfitted with their own branded web sites were activated onto the Platform. These retailers accept the upload of images that originate within digital cameras or have been scanned within the store environment to sites we create and host. Our Platform is a transparent component to the end consumer, existing solely as the technology backbone of the retailer's digital imaging strategy.

With the establishment and launch of our Platform, we distanced ourselves from our past of being an Internet photofinishing "mail order" service and transformed into an Internet infrastructure company that manages a platform environment that today is focused on delivering digital imaging and personalized product creation and ordering through our retail relationships and connectivity to retail locations.

During fiscal 2007 we expanded our product offering to include software that can be installed on in-store kiosks, through our acquisition of Pixology. In fiscal 2009, we acquired WorksMedia to further enhance our software offering for in-stores kiosks. Our in-store kiosk software connects to the Platform to enable users to generate orders for photo prints, photo gifts and other personalized creative products.

Retail Digital Photography Market

Digital photography has grown at a rapid pace in the last several years. Mainstream adoption of digital cameras by consumers replacing older film cameras has been facilitated by improved technology and rapidly falling prices.

Industry analysts estimate that digital camera sales have grown from 4.5 million units in 2000 to a projected 24.8 million units in 2010.¹ By the end of 2010, analysts estimate that 80% of US households will have at least one digital camera.² At the same time, film camera sales have fallen to almost nil by 2010.

In addition to the growth of digital cameras, the digital photography market has grown due to the proliferation of mobile phones that have a built-in digital camera mechanism. These 'camera phones' have increasingly better resolutions, enabling consumers to take images large enough to be produced as a photo print or photo gift.

Camera phone handsets in the North American marketplace totalled some 57 million by the end of 2005 (46% of all handsets) and this market is expected to continue to grow and predicted to reach 900 million units by 2010³. Numbers have grown quickly from an estimated base of 3 million units in 2003 and 16 million in 2004.⁴ Initial handset cameras had limited resolutions of less than 1 Megapixel, and limited capability to otherwise distribute or share the resulting image. However, the latest generation of camera phones have resolutions of up to 8 Megapixels or more. 74% of mobile handsets sold in the 2007 U.S. market are estimated to have built in cameras, with 13% of those having the higher 3.2 Megapixel camera sensors.⁵ Additionally, technology inside the phone unit itself such as Bluetooth wireless technology and improved software systems and navigation from both handset manufacturers and mobile network operators has made it much easier for consumers to transfer, distribute and/or share their camera phone images. Despite these improvements, the vast majority of the billions of camera phone images (estimated at 97%⁶) are today still not yet converted to prints, so a behavioural shift here would be significant.

___________________________
¹ PMA Marketing Research. Photo Industry 2010 Review and Forecast
² Ibid
³ InfoTrends: Mobile Phone Survey 2007
⁴ PMA Marketing Research: Photo Industry 2006 Review and Forecast / iGillott Research
⁵ iSuppli research from Wall Street Journal
⁶ Fuji from WSJ article Feb 08, 2007

DSLR cameras are higher priced, higher resolution, more sophisticated models, and afford consumers better and more professional quality capabilities. They differ from mainstream smaller sleeker point-and-shoot digital cameras with their characteristically lower resolution. DSLR cameras still represent a small (but growing) share of overall unit sales, but account for a disproportionately larger revenue share given their current average sales price of $942,⁷ as compared to a range of $162⁸ - $303⁹ for standard point-and-shoot mainstream digital cameras. DSLRs account for 6% of units shipped but a much more significant 19% of dollar value.¹⁰

The large consumer shift to digital camera technologies over the last few years as described above has brought with it an entirely new set of consumer behaviour and activities relating to the resulting digital photo images, their distribution and enjoyment, and their subsequent transformation into hard copy prints or traditional photos. It has also radically transformed the traditional photofinishing business.

Digital camera and scanner manufacturers fabricate devices for digitizing pictures. Their products capture an image and output it as a digitized picture, which can then be distributed and shared electronically (over the Internet, wireless networks, and otherwise), and printed in different ways. These images can be uploaded to the Internet for storage or transferred to CD, DVD or other forms of removable media and disks. Conventional film images can also be digitized through a scanning mechanism and then be manipulated in much the same way, but the utilization of conventional film cameras by consumers is falling away dramatically as mentioned above, and with it the development of film into prints, and their subsequent need for digitization.

Digitized pictures can be printed either on color inkjet (typically directly at home by the consumer) or dye sublimation photo printers (for instance, by a retailer in a physical commercial setting) Alternatively, they can be processed through an online service, which provides print photographs at a quality consistent with that offered by conventional film processors at retail. Digital pictures may be stored on desktop or laptop computers, camera-enabled mobile phones, CDs, DVDs, other removable media formats, or as negatives at a website of an online digital photography service provider. Consumers may alternatively also physically take the removable media memory card from their digital camera to retailers with digital photo kiosks, where they can then select and format the digital images for subsequent printing in store.

The process is further fuelled by the consumer public's adoption and acceptance of broadband-based internet services, which has enabled a host of alternative services (online and at the retailer) to meet these new photo processing demands. Residential broadband subscriptions in the USA grew 20% in 2006 to exceed 50 million households, and forecast to grow to 60 million households by the end of 2007 (a 55% penetration rate).¹¹ The introduction of camera phones mentioned above has bred a host of different consumer behaviours and activities that include distribution by e-mail, Multimedia Messaging Service (MMS), saving them to the phone screen, transferring them to a PC, sharing them online, printing them, and doing nothing with them. There is a strong correlation between digital camera ownership, broadband usage, and camera phone ownership, with 79% of households with broadband and 63% of camera phone owners having a separate digital camera.¹²

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⁷ NPD Group Inc. from Wall Street Journal
⁸ NPD Group Inc. (Dec. 4, 2006)
⁹ PMA Marketing Research: Photo Industry 2006 Review and Forecast
¹⁰ Camera & Imaging Products Association (CIPA) from http://www.dpreview.com/news/0612/06120101cipashipq3.asp
¹¹ Parks Associates - "Digital Lifestyles: 2007 Outlook"
¹² 2006 PMA Camera/Camcorder, Digital Imaging Survey

The primary target market for our PNI Digital Media Platform services are print origination members such as large multi-outlet retailers, online communities, portals, and print fulfillment members such as photofinishing retailers. The use of digital cameras has increased dramatically (not only in North America, but worldwide), as has the availability of photographic quality digitized print services, both at retail and online.

There is no demographic which digital cameras are exclusive to, especially in light of constantly falling prices the last several years, nor is there a prohibitive degree of technological sophistication required to operate these cameras. The average price paid for a digital camera has fallen from $315 in 2004 to $303 in 2005, and continues to fall.¹³

Photofinishing retailers originally viewed digital camera penetration as threatening their future. Film processing volume has been falling steadily. In the U.S. alone, sales have fallen from 671 million rolls in 2003, to 571 million rolls in 2004, to 480 million in 2005 and an estimated 369 million in 2006 (a total drop of some 45% in that period). Commensurately, processing revenue has fallen in the same period from $5.39 billion in 2003 to an estimated $2.98 billion in 2006, a similar 44.7% drop.¹⁴ As consumers have switched their picture-taking activity from film to digital, one of the greatest challenges has been making them aware of the options for printing their digital pictures. The effect of digital cameras to date and future projections indicate that digital will have an additive effect on the growth of picture taking overall, as the cost to shoot a digital image is nothing compared to a film exposure. In recent years, the photo print market has consolidated greatly into a small group of very large, multi-outlet retailers, who have consumed market share at the expense of independent retailers and other non-direct retailers who could not realize equivalent economies of scale with a transition to digital photo services.

Despite the number of online options for digital printing, we believe that the majority of consumers will not change their habits - they will continue to look to the photofinishing retailer as their destination for convenient, quality driven printing. Photofinishing retailers are making changes to ensure they remain at the center of photofinishing. As picture taking has become increasingly digital, retailers want to ensure they retain the foot traffic in their stores and the relationship with their customers. The first step for them is ensuring they have equipment that can print digital images and can create digital images from film. The central piece of equipment retailers utilize for this is the "digital minilab", with 17,000 of them installed in the US in 2004 (or over 50% of all minilabs), and an estimate of over 25,000 digital minilabs installed by 2008 representing over 76% of all minilabs.¹⁵ The rise of the digital minilab install base has been the defining factor in returning retailers to the forefront of printing pictures. Further, retailers have worked to retain their customer base by introducing online based digital photo processing functionality (with in store pick-up) and placing digital photo kiosks physically in store to serve as wide a customer base as possible.

The amount of digital prints being made at retail (as opposed to at home by consumers directly and online) has been growing. In 2006, it was estimated that 4.5 billion prints (41.3%) of the 10.9 billion printed digital photos in total were made through a photofinishing retailer. Industry analysts estimate that in 2009 there will be 13.9 billion photo prints, of which 9.5 billion photo prints, or 68%, will be printed at a photofinishing retailer.¹⁶Digital camera technologies have enabled consumers to take many more pictures (given the zero cost of shooting in digital, and the immediacy of seeing the result, unlike with film), even if most digital images are never printed. The digital camera has radically changed how pictures are enjoyed, and it is not exclusively through prints anymore, as consumers can now view, share, and otherwise store their images electronically in ways. Consumers have much more control now as to when to decide to want to make prints, and by what method.

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¹³ PMA Marketing Research: Photo Industry 2006 Review and Forecast / NPD Techworld
¹⁴ All figures here from PMA Marketing Research: Photo Industry 2006 Review and Forecast
¹⁵ InfoTrends
¹⁶ PMA Marketing Reseasrch, Photo Industry 2010 Review and Focus

In 2003, 56 Billion digital photo exposures were taken worldwide, with growth to 144 Billion in 2005 and an estimated 312 Billion by 2008.¹⁷ The number of captured digital images in the USA (not including camera phones) has grown from 7.8 Billion in 2003, 12.9 Billion in 2004, 17.1 Billion in 2005, and an estimated 21.7 Billion in 2006. At the same time, the number of digital prints made by all methods has grown from 1.5 Billion (19.2% of total captured) in 2003, 3.1 Billion (24% of total) in 2004, 4.5 Billion (26.3% of total) in 2005, and an estimated 6.4 Billion (29.4% of total) in 2006. Film and digital cameras combined produced 14% fewer prints between 2000 and 2005 including retail, online, and home alternatives. Including prints made at home, the total value of printing was higher at $6.81 Billion in 2005 than the $6.23 Billion in 2000.¹⁸

The growth of printing at retail has recently outpaced home printing, and is expected to continue to do so in the next couple of years, for a variety of reasons. This is reflected in relative home and retail printing volumes. For the first time since the introduction of digital cameras in the US, retail and online entities were the top destinations for digital printing in 2005. By 2008, of the digital photo exposures that get printed worldwide, 56 Billion or 43% were printed by retailers. Translated into photofinishing revenue, it is predicted that digital photofinishing at retail, from both store location drop-off and online orders, will be a $6.2 Billion industry by 2008. In 2000, 89% of all digital image printing was done at home with only 4% at retail, but by 2004, home printing had fallen to 56% with retailers printing 34% of all digital images. By 2010, it is expected retailers will be printing 45% of all digital images.¹⁹

The number of prints ordered online and mailed to consumers' homes peaked at 9 percent of the total prints made in 2005, up from under 7 percent the year before. The market share of pure online printing has faced increasing pressure from the increasing availability of cheap printing options at retail which are taking print orders in store (including at kiosks), and replicating the online entities' offering of online ordering of prints without corresponding shipping charges. Further, retailers are able to significantly improve the consumer experience by allowing in-store print pick-up at a convenient location shortly after order placement online.

The above trends suggest continued growth opportunities for the future, and though more current trends are not yet available, we expect that the trends outlined above will continue into the future.

* Data Sources: PMAI/PMA, InfoTrends, NPD Group Inc., IDC, Gartner Group, iSuppli, Mizuho Securities (Japan), CIPA (Japan), Parks Associates, Wall Street Journal, Fuji, Hewlett Packard (HP)

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¹⁷ Hewlett Packard (HP)
¹⁸ PMA Marketing Research: Photo Industry 2006 Review and Forecast
¹⁹ InfoTrends

Products

The PNI Digital Media Platform

On May 10, 2001 the first retail Plaform 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 have been scanned within the store 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 stationary. 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.

With the establishment and launch of our Platform, we distanced ourselves from our immediate past of being an Internet photofinishing "mail order" service into 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.

In October 2002, we launched our Platform with our first large retail chain, Black Photo Corporation ("Black's"). At the time, Blacks's operated 136 photo retail stores across Canada under the Black's and Astral banners. As part of our Network, we 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. Black's continued as a customer of our online platform until October 2010 when they took that portion of their business in-house as part of a corporate restructure. They continue as a customer of ours however for kiosk and CD-based software products.

Following on from this first deployment of our technology in this manner, we increased our retail photofinishing base to include other large scale retailers as follows:

Customer	Year business won
Black Photo Corporation	2002
Walmart Canada	2004
Costco Canada	2006
CVS/Pharmacy	2006
Walmart Puerto Rico	2007
Walmart Argentina	2007
Loblaws (under a partnership with Fujifilm Canada)	2008
Costco USA	2008
SAM's Club USA	2008
Hallmark UK	2008
Kodak China	2008

Koda Australasia	2008
Marks & Spencer	2009

In May 2008, we partnered with Hallmark PLC in the UK to provide online creation and ordering of greeting cards using the PNI Digital Media Platform. In September 2009, we further extended our business with Hallmark PLC by offering personalized, on-demand greeting card services via the Internet from Marks & Spencer website using the PNI Digital Media Platform. This was the first time we used our Platform for a significant non-photo related service offering.

In addition to the above noted customers, during 2007 we acquired Pixology PLC in the United Kingdom. As a result of this acquisition, the Company acquired ASDA and Tesco as customers in the UK, the two largest grocery chains in the country.

Wal-Mart Canada has connected all of their 340 retail locations, Costco Canada has connected all of their 80 retail locations, CVS/pharmacy in the United States had connected 7,065 of their locations, Sam's Club USA has connected 610 of their locations and Costco US has connected all 398 of their locations enabling all directly connected locations to offer a one hour digital printing solution from online ordering.

The addition of the above noted customers over the years has resulted in the number of transactions being handled over our Platform increasing significantly:

FY2007	FY 2008	FY 2009	FY 2010
3.8 million	7.6 million	14.6 million	17.1 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 also been used to acquire new retailer customers. During the past twelve months, the Company has 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. Small business printing services will 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 an hour from the retailer's store location. Social stationery services will 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. Both of these service offerings are currently in the process of being developed with the cost of development expected to continue through to the end of fiscal 2011. The Company expects to be in a position to launch these new service offerings during the latter part of fiscal 2011.

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 photofinishing market and had developed software and networks that enable equipment manufacturers and retailers of photofinishing services 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 customers 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.

Red-eye correction technology

As part of the acquisition of Pixology, we acquired the IRISS red eye correction software. This software was not considered core to the Company's future plans and upon the expiration of the contracts that were in place at the time of the acquisition, the Company made the decision to dispose of these assets. Accordingly, in March 2009, the Company entered into a licence agreement with a third party granting them an exclusive right to further develop, market and sub-licence the technology with complete ownership passing to them upon reaching certain financial milestones.

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 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 30^th, 2009, we deployed the WorksMedia Software, now branded as the PNI ConnectedKiosk Program, with in-store kiosks in Fred Meyer and King Soopers grocery chains in the USA. On July 9^th, 2009, we announced the addition of a series of resellers of the WorksMedia Software including Retail Imaging Management Group and Photo Gift World Ltd. Additionally, the PNI ConnectedKiosk Program would power the online photo services site PixureThis for Associated Foods Stores in the USA. 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.

Summary of Gross Revenues

During the three years ended September 30, 2010, our revenue was generated as follows:

	Year Ended September 30,
	2010		2009		2008
Canadian based operations	$ 19,536,640	77%	$ 17,344,257	71%	$ 8,425,160	49%
United Kingdom based operations	5,819,930 ___________	23% ____	7,102,312 ___________	29% ____	8,624,427 __________	51% ______
Total Revenue	$ 25,356,570		$ 24,446,569		$ 17,049,587

Competition
Online photo print services

Internet photography service providers offer different services, some associated with photofinishing, personalized photo gifts, stationary 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 through photofinishing or other devices, as well as photo 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.

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

Our online business model of being an open, scalable and secure network provider for the photofinishing industry is currently unique. The most notable names in the online photofinishing business, names such as Kodak's Gallery (formerly known as Ofoto, and now fully reincorporated into Kodak proper) and Shutterfly, do not currently compete for our retail customers. These companies have focused on a pure business to consumer model of online photofinishing. These companies compete with our retailers for end user customers, and directly compete with the established "mail order" retailers such as Mystic Color and District Photo (the world's largest mail order photofinishing operator). It is worth noting that mail order generally declined as a market force over the last decade as the one-hour onsite operations of retailers came to dominate the photofinishing landscape. We believe consumers will continue to show a preference for the in-store printing solutions offered by our retailers.

Our kiosk business model going forward is one of connecting with our Platform to offer a turnkey (online and in-store) digital printing 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 permits 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. We believe that continuing to support the business to consumer model may send a mixed message to the retailer and this may be an advantage to us, as we compete with Snapfish for large US 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 Fuji Film, Lucidiom, HP and Beaufort.

Photofinishing retailers 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, Fuji, Hewlett Packard and DaiNipon also compete with our service in varying manners, but all also work with retailers in terms of providing 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 photofinishing retailer. This allows different retailers and web properties to do business together if they so desire. Up until now, the climate has been fairly one-dimensional with closed, non-integrated networks and software. 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. Photofinishing retailers 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 and architecture of our technologies. The relative importance of each of these factors depends upon the specific customer involved.

C. Organizational structure

We have six (6) wholly owned subsidiaries, PNI Digital Media Ltd (formerly Pixology Limited), PNI Digital Media Europe Ltd (formerly Pixology Software Limited), and Pixology, Inc. are all active and WorksMedia Limited, PhotoChannel Capital Inc. and PhotoChannel Management Inc are inactive. We acquired Pixology Limited, Pixology Software Limited and Pixology, Inc. 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. PhotoChannel Capital Inc. was incorporated on January 25, 2000 to undertake the sale and distribution of units of PhotoChannel.Com Limited Partnership and is the sole shareholder of PhotoChannel Management Inc. PhotoChannel Management Inc. was incorporated on January 25, 2000 and is the general partner of the PhotoChannel.Com Limited Partnership. The PhotoChannel.Com Limited Partnership is inactive and does not carry on any business.

D. Property, plant and equipment

Our executive offices are located at Suites 590 and 450 - 425 Carrall Street, Vancouver, British Columbia, Canada, V6B 6E3. The premises currently comprise approximately 12,266 square feet in an office building and are leased from an unaffiliated party. The company's main lease expired in July 2009 and was extended on identical terms for a further period of five years. The base monthly rent is approximately $13,071.

Our Platform equipment is located at two of TELUS Corporation's co-located hosting facilities, which are located at 73 Laird Drive, East York, Ontario, Canada and 5 - 3777 Kingsway, Burnaby, British Columbia, Canada, V5H 3Z7. The premises are under contract from an unaffiliated party for a period of sixty and thirty-four month periods, respectively. The leases expire on November 16, 2012 and September 16, 2010, respectively. The base monthly rent in Toronto, including prepaid monthly bandwidth usage of 200 Mbps, is approximately $80,286 and in Vancouver, including prepaid monthly bandwidth usage of 100 Mbps, is approximately $19,410.

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 60% 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 $21,000.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

General

In this section, we explain our consolidated financial condition and results of operations for each of the years ended September 30, 2010, 2009 and 2008. As readers read this section, they may find it helpful to refer to our consolidated financial statements at the end 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.

Our consolidated financial statements were prepared in accordance with Canadian GAAP. See Note 23 to the consolidated financial statements for the year ended September 30, 2010 for a discussion of material measurement differences between Canadian and US GAAP, as it relates to us.

Critical Accounting Policies

The preparation of our consolidated financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amount of revenues and expenses during the reporting period. Our estimates are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The result of our ongoing evaluation of these estimates forms the basis for making judgments about the carrying values of assets and liabilities and the reported amount of expenses, which are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions.

Our critical accounting policies are those that affect our consolidated financial statements' materially and involve a significant level of judgment by management. A summary of our significant accounting policies, including the critical accounting policies discussed below, are set forth in Note 2 to our consolidated financial statements.

Intangible assets acquired both individually or with a group of other assets are initially recognized and measured at cost. The cost of a group of intangible assets acquired in a transaction, including those acquired in a business combination that meet the specified criteria for recognition apart from goodwill, is allocated to the individual assets acquired based on their relative fair values. Intangible assets with finite useful lives are amortized over their estimated useful lives. The amortization methods and estimated useful lives of intangible assets are reviewed annually.

Intangible assets with finite useful lives include acquired software and customer relationships and are amortized over their estimated useful lives of three years.

Goodwill is allocated as of the date of the business combination to our reporting units that are expected to benefit from the synergies of the business combination and, in the event of a reorganization of reporting structure, is reassigned to the reporting units affected. The reporting units identified for goodwill impairment testing are the operating segments of the Company due to the manner in which the Company is managed internally and financial information is presented.

Goodwill that arises from the Company's acquisitions is allocated to each of the reporting units that are expected to benefit as a direct result of the transaction. This allocation is made using an acquisition method which involves firstly determining the fair value of the business acquired and then allocating this value to the respective reporting units. The amount of goodwill is then determined by deducting from the consideration allocated to each reporting unit the net assets assigned to each reporting unit.

Goodwill is not amortized and is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Goodwill of the reporting unit is considered to be impaired when the carrying amount of the reporting unit exceeds its fair value.

An impairment loss, if any, would be recognized as a separate line item in the statement of earnings.

The Company carries out an annual impairment test on September 1 of each year. In carrying out the annual impairment test during the year ended September 30, 2010, the estimated fair value of the reporting units was arrived at by using a discounted cash flow model for each reporting unit. This approach involved management developing its best estimate of the expected future cash flows from the business over the remaining expected life of the reporting unit.

At September 1, 2010, the time of the Company's goodwill impairment test, the carrying value of goodwill on the Company's balance sheet was allocated 12% to its Canadian reporting unit and 88% to its UK based reporting unit. In carrying out the goodwill impairment test, it was estimated that the fair value of the Canadian reporting unit was approximately 2 times greater than the value of that unit's net assets, including goodwill. The fair value of the UK based reporting unit was estimated to be approximately 3 times greater than the value of that unit's net assets, including goodwill. In building the estimates of fair value, it was necessary for the Company to estimate future cash flows. In doing so, a number of key assumptions were made, including estimated future growth rates and the ability of the Company to continue operating without the loss of any significant customers during the forecast period.

The Company has a stock option plan, which is described in Note 12 to the financial statements. In November 2001, the Canadian Institute of Chartered Accountants issued Handbook Section 3870, "Stock-Based Compensation and other Stock-Based Payments". Section 3870 sets out a fair value based method for the recognition, measurement and disclosure of certain stock-based compensation and other stock-based payments made in exchange for goods and services. The standard requires the use of the fair value based method for direct awards of stock, stock appreciation rights and awards that call for settlement in cash or other assets. Awards that a company has the ability to settle in stock are recorded as equity, whereas awards that the company is required to or has a practice of settling in cash are recorded as liabilities. This section applies to certain awards outstanding on the date of adoption, being October 1, 2004 for the Company, and relates to all awards granted on or after October 1, 2002. Previously, the company disclosed the pro forma effect of employee stock based compensation expense in the notes to the financial statements.

The Company recorded and recognized a compensation expense of $399,068, $1,846,293 and $1,511,504 for stock options issued to employees for the years ended September 30, 2010, 2009 and 2008, respectively.

The Company uses the liability method of accounting for income taxes. Under the liability method, future 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. Future tax assets and liabilities are measured using substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of substantive enactment. A valuation allowance is recognized to the extent the recoverability of future income tax assets is not considered more likely than not.

Special Note Regarding Forward-Looking Statements

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", this 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.

A. Operating results

The Company has built its business around being a technology producer and integrated provider of services for the photofinishing retailer.

During 2003 and 2004, we deployed our services to photofinishing retailers. With these deployments, increased volumes and changes in the industry, during 2005 we embarked on the architecture, development and deployment of a new network platform, which we launched during 2005. Our new platform now allows us to deliver all orders received to the selected retailers' or wholesalers' digital minilabs within one hour of receipt, as well as enhancing our platform to permit easier, more cost effective launching of new retailer sites. From 2005 to date, we added a number of retailers to our new network platform, including Wal-Mart, Costco and Loblaw in Canada and CVS/pharmacy, Costco and SAMS Club in the United States, and Asda in the United Kingdom.

During 2007, we acquired Pixology and added a kiosk software to our product offering. Pixology is focused exclusively on the photofinishing market and had developed software and networks that enable equipment manufacturers and retailers of photofinishing services 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 included Costco in the United States, Canada and Mexico and Tesco, Boots, Asda and Jessop's in the United Kingdom. Subsequent to our acquisition of Pixology, Boots commenced using a new photo online provider and Jessops decided not to renew our contract for kiosk software which expired in August 2009.

During 2009, we acquired WorksMedia and added further kiosk and desktop software to our product offering. WorksMedia is focused exclusively on the photofinishing market and had developed kiosk and desktop software that allowed consumers to order prints and personalized gift items from digital photographs. WorksMedia's customers are located across a wide geographic area including the United Kingdom, Europe, South Africa and Australia and Include Fuji, 1^st Digital, Foss Fotech, TS Procon, New Teltron, Athentech and Black Photo Corporation. WorksMedia had been in operation for approximately five years prior to our acquisition and we have now taken over responsibility for the contracts they had in place at the date of acquisition.

Years Ended September 30, 2010 and September 30, 2009

Revenue

Revenues for fiscal 2010 were 4% higher than fiscal 2009 reaching $25,356,570. All growth experienced during the year was from increased activity from existing customer accounts. In addition, this growth was achieved despite a 12% decline in the strength of the US dollar and an 11% decline in the strength of the British Pound compared to the Canadian dollar. 79% of the Company's revenue was earned from either the United States or the United Kingdom during the year; therefore a weakening in the value of the US dollar and British Pound relative to the Canadian dollar has a significant impact on financial results. If exchange rates during the current quarter had been at the same levels as they were during fiscal 2009, revenue would have increased year-on-year by 14% to approximately $27.9 million.

Continuing the trend seen throughout the earlier part of fiscal 2010, growth was seen in multiple areas of the business. Transaction fees continue to be the largest element of our revenue base and increased 6% year-on-year to $19,332,006; accounting for 76% of total recorded revenue, compared to 74% in fiscal 2009.

Underlying the increase in recorded transaction fees is a 17% increase in the number of orders placed through the PNI Platform year-on-year which reached 17.1 million for the year and averaged over 46,000 per day.

Software license and installation fees fell by 22% year-on-year to $3,074,895. While a portion of revenue from this source continues to track at consistent levels each month through recurring license fees earned from some of our UK based customers the 11% year-on-year weakening of the UK pound relative to the Canadian dollar has resulted in the amount of license revenue booked in the consolidated financial statements being impacted negatively by approximately $413,000. Other elements of this revenue are non-recurring and are earned either through developing and installing new sites for customers or by making sales of kiosk software licenses. A number of our contracts that provide for recurring revenue in this area expire during fiscal 2010 and therefore sales will become more difficult to predict as they will primarily become one-off in nature.

Membership fees are earned either through monthly fixed fees based on the number of locations customers have connected to the PNI Platform or through annual recurring service and maintenance revenue from customers who have purchased our kiosk software. Revenue from this source has grown strongly over the past twelve months representing an overall increase in the number of customer locations now connected to our network as a result of existing customers expanding their own operations and also as a result of the Company's acquisition of WorksMedia during 2009. Fees earned during fiscal 2010 totaled $1,678,875, representing growth of 24% year-on-year. Revenue earned from this source is largely recurring in nature and remains relatively stable period to period.

Professional fees have shown an overall decrease of 59% or $224,059 during the year compared to fiscal 2009 from $378,118 to $154,059. This is primarily due to a number of one-off projects completed on behalf of a number of our customers during fiscal 2009. Professional fee revenue is non-recurring in nature and dependant on both the demand from our customers and also the availability of internal resources to allocate to this kind of work. While we continue to expect projects to arise and be taken on in future periods this type of revenue stream is not seen as core to our business and may fluctuate considerably from period to period.

Archive fees, which represent charges made to our customers after the volume of data held on their behalf reaches pre-determined limits, increased 76% year-on-year to $1,116,735. This continues the trend seen throughout fiscal 2009 and the earlier part of fiscal 2010. While the past twelve months has seen revenue from this source grow, our customers remain in charge of the business rules offered to their consumers around storage and therefore future revenue growth in this area could be curtailed should any of our customers stop providing their own customers with free storage solutions.

Operating profit and expenses

We recorded a profit from operations for the year ended September 30, 2010 of $1,979,302, representing an improvement of $3,881,598 compared to the same period last year and the first time in the Company's history that a profit has been achieved for the full fiscal year..

A comparison of operating results and non-operating events for the two years ended September 30th are set out in the table below.

Description	2010	2009
Profit (loss) from operations	$ 1,979,302	$ (1,902,296)
Other items	4,872,692	132,630
Net Profit (loss) under Canadian GAAP for the year	$ 6,851,994	$ (1,769,666)
Change in fair value of embedded foreign currency derivative related to warrants	-	22,531
Deferred tax benefit	841,541	-
Net profit (loss) under US GAAP for the year	$ 7,693,535	$ (1,747,135)
Unrealized foreign exchange loss on translation of self-sustaining foreign operations	(510,342)	(652,661)
Comprehensive loss for the year	$ 7,183,193	$ (2,399,796)

Expenses excluding non-cash items

Description	Twelve Months Ended September 30, 2010	Twelve Months Ended September 30, 2009	Change	% Change

Network delivery	$ 5,373,604	$ 6,617,907	$ (1,244,303)	(19)%
Software development	7,984,905	6,855,187	1,129,718	17%
General and administration	3,560,737	3,821,662	(260,925)	(7)%
Sales and marketing	849,011	1,024,378	(175,367)	(17)%
	17,768,257	18,319,134	(550,877)	(3)%

Share-based compensation	690,020	2,016,015	(1,325,995)	(66)%
Amortization	4,918,991	6,013,716	(1,094,725)	(18)%

Total	$ 23,377,268	$ 26,348,865	$ (2,971,597)	(11)%

Total expenses for fiscal 2010 are 11% less than fiscal 2009. Excluding non-cash expenditures of share-based compensation and amortization, controllable cash expenses fell by 3%.

For many years as the Company's platform was being built and many new customers being added, management was confident that the current business model would allow the Company to scale and effectively grow revenue without requiring additional costs of the same magnitude to be incurred. During the current fiscal year the Company has been able to demonstrate this as revenues have increased while controllable cash costs have remained relatively stable. Management believes the technology can be further leveraged in future periods, although a current increase in development headcount to work on a number of specific projects means that the overall cost base of the Company will unlikely show further year on year reductions for the foreseeable future. Should the Company suffer the loss of significant customers or change certain aspects of its current operations requiring additional development expenditures to be incurred, this relationship between revenues and costs may alter.

Network delivery costs decreased $1,244,303, or 19% year-on-year. 66% of this decrease was as a result of lowering the cost of providing the customer support function on behalf of our customers. Part of this reduction was achieved as a result of the successful transfer of a large portion of this work to a third party professional call centre operation which was started during the early part of fiscal 2009 and completed later on in that year. The remainder of the reduction came as a result of improvements made to customer sites during the past twelve months, including the improvement of workflows and the addition of more on-line 'self-serve' help content. Being able to decrease these support costs while maintaining high levels of customer service and simultaneously dealing with a 17% year-on-year volume increase was a major achievement for the Company and the result of a significant effort made during the past year by the various site design teams to improve the quality of our product and service offerings. The remaining decrease in network delivery costs came from slightly reduced direct costs of fulfillment and lab system installations as a result of changes in sales volumes in these areas period-on-period.

Software development expenses have increased $1,129,718 or 17% year-on-year. 83% of the increase was due to the addition of new development staff during the past twelve months who have been recruited to support the continued growth of our customers as well as to work on new initiatives the Company is pursuing, including the development of online business printing services and social stationery products. The remainder of the increase relates to costs of supporting an increased number of development staff. The Company continues to take steps to maintain or where possible, reduce costs and continues to use the services of short-term contractors on an as-needed basis wherever possible to deal with periods of additional workload. Outside of staffing costs, steps continue to be taken to control all other costs in this area, including travel, staff training and general costs of the department. Staffing requirements continue to be monitored on a regular basis with reference to upcoming projects for new and existing customers, ongoing commitments to maintain current service offerings for existing customers and new product development.

General and administration expenses have decreased by 7% to $3,560,737 year-on-year. Year on year increases in investor relation costs, travel and the decision at the beginning of the year to pay quarterly fees to non-executive members of the board for the first time have been offset partially by savings in accounting and legal fees, rent and office running costs. In addition, the fiscal 2009 costs included a one-time charge of approximately $209,000 relating to the expected unrecoverable lease costs of our former Guildford, United Kingdom office location. In addition, approximately $79,000 in accretion expense has been booked during the current year relating to the payments made over a twelve month period to the prior owners of WorksMedia to acquire the business.

Over the past twelve months the Company has worked to reduce overhead costs significantly and undertook some difficult restructuring actions in the UK. These restructuring plans were completed during the earlier part of the year and the Company was able to negotiate a full release from its obligations under the property lease relating to its Guildford, United Kingdom offices. As part of this release, a payment of approximately $96,000 was made to the landlord. These costs had been anticipated during the previous fiscal year and included in the one-off charge of approximately $209,000 resulting in no adverse impact on the current year's results. Changes in the current strategy of the Company or the continued large-scale growth of the business could however result in administrative costs to increase in future periods.

Sales and marketing expenses decreased by 17% to $849,011 year-on-year as a result of cost saving measures implemented across the department with the aim of operating more efficiently. As a result, savings were achieved in travel, communication and employee related costs whilst for most of the year maintaining the same headcount and level of customer interaction that was in place during the latter part of fiscal 2009. In addition, the Company was able to reduce significantly the cost of attending the annual Photo Marketing Association trade show during the current year. This event is the main trade show attended by the Company each year in North America and has historically fallen during either February or March. A small increase was seen in headcount numbers in this area towards the end of the year as the Company strengthened both its sales team and also added further internal marketing resources who will work closely with the Company's retail partners in order to help them improve their strategic marketing plans. As a result of these increases in headcount there will be a corresponding increase in expenditures in this area in future periods.

Share-based compensation costs, representing both the cost of the company's stock options that are issued to employees, directors and consultants of the company and compensation expense associated with shares issued as part of the acquisition of WorksMedia, have decreased year-on-year by 66% to $690,020. This is primarily as a result of the expense associated with the large tranche of stock options that were issued to staff during March 2008 ceasing at the beginning of the fiscal year as all of these options are now fully vested.

Amortization decreased by 18% year-on-year to $4,918,991. The amortization charge for the year is in line with that seen throughout the earlier part of the year and primarily relates to a mixture of both the amortization of intangible assets acquired during the Pixology and WorksMedia acquisitions as well as items of property and equipment. The final amortization associated with the Company's 2007 acquisition of Pixology was expensed during the third quarter of fiscal 2010.

Other income and expenses

During the year ended September 30, 2010, the Company recorded a realized foreign exchange loss of $119,561 and unrealized gains of $304,331. The unrealized gain arose primarily as a result of the translation of inter-company balances between the UK subsidiaries and the Canadian parent, whilst the realized loss arose primarily as a result of unfavorable changes in Canadian dollar exchange rates relative to the US dollar between the time sales invoices were raised and the receipt of funds. Year-on-year, the Canadian dollar strengthened by approximately 12% relative to the United States dollar.

Years Ended September 30, 2009 and September 30, 2008

Revenue

Revenues for the year ended September 30, 2009 show significant growth of 43% year on year reaching $24,446,569.

While during 2009 we saw strong growth has been seen in a number of areas, the most significant element remains the year on year increase in transaction fees which are up 56% or $6,517,910 compared to the prior year. This growth has been achieved through the organic growth of existing customers and as a result of recording revenues for the whole year from a number of customers who were obtained part way through 2008 and who therefore only contributed revenue to part of that year. A total of 14.6 million orders were placed through the PNI platform during fiscal 2009, almost double the number seen in fiscal 2008. The Company has also benefitted from the acquisition of WorksMedia Ltd which was acquired during March 2009 and which contributed revenue, primarily through the sale of software licenses and the earning of membership fees during the latter part of the year.

Transaction fees represented 74% of total revenue for the year ended September 30, 2009 compared to 68% during the comparable period in fiscal 2008 and continue to demonstrate how the Company has moved over the past few years to position itself so that it is able to obtain more exposure to the underlying level of transactions experienced by our retail partners allowing us to grow as they do without incurring additional costs. During the year we assumed one-time marketing related costs of $402,708 in partnership with a customer which under GAAP were recorded as a reduction to transactional fees recorded. The Company believes that this expenditure will result in long-term benefits from increased traffic through its network.

Installation fees remained flat year on year at $3,927,506. A large portion of revenue from this source continues to track at consistent year on year levels through recurring license fees earned from some of our United Kingdom based customers. Other elements of this revenue is non-recurring and is earned either through developing and installing new sites for customers or by making sales of kiosk software licenses. Approximately 90% of this revenue was earned through our UK operations and as a result of this, was earned in Sterling. The value of Sterling relative to the Canadian dollar has on average been 8% less during fiscal 2009 compared to 2008, therefore although our recorded revenue on a consolidated basis is flat year on year, underlying sales in this area have risen by approximately 9%. A number of our contracts that provide for recurring revenue in this area will be expiring during fiscal 2010 and therefore sales will become more difficult to predict as they will primarily become one-off in nature.

Membership fees are earned either through monthly fixed fees based on the number of locations customers have connected to the Company's platform or through annual recurring service and maintenance revenue from customers who have purchased our kiosk software. Revenue from this source has grown strongly over the past twelve months, being 69% greater year on year representing an overall increase in the number of customer locations now connected to our network as a result of existing customers expanding their own operations and also as a result of the Company's acquisition of WorksMedia during the year. WorksMedia has an established base of more than 3,000 kiosks worldwide using its kiosk software and earns recurring service and maintenance revenue from most of these installations.

Professional fees have shown an overall decrease of 19% or $89,878 as they have fallen to $378,118 during the year ended September 30, 2009. This has been primarily as a result of a significant decline of more than $300,000 year on year in the value of e-mail marketing campaigns carried out on behalf of a number of our customers as they moved to carry out these campaigns internally. Despite this reduction, additional one off projects have been taken on during the year allowing the majority to be offset.

Archive fees, which represent charges made to our customers after the volume of data held on their behalf reaches pre-determined limits have increased by 201% during fiscal 2009. While the past twelve months has seen revenue from this source grow, our customers remain in charge of the business rules offered to their consumers around storage and therefore future revenue growth in this area could be curtailed should any of our customers stop providing their own customers with free storage solutions.

Operating Loss and Expenses

We recorded a loss from operations for the year ended September 30, 2009 of $1,879,827, representing an improvement of $7,153,862 compared to the same period last year.

A comparison of operating results and non-operating events for the two years ended September 30th are set out in the table below.

Description	2009	2008
Loss from operations	$ (1,902,296)	$ (9,240,145)
Other items	132,630	523,119
Net loss under Canadian GAAP for the year	$ (1,769,666)	$ (8,717,026)
Change in fair value of embedded foreign currency derivative related to warrants	22,531	4,671,206
Net loss under US GAAP for the year	$ (1,747,135)	$ (4,045,820)
Unrealized foreign exchange loss on translation of self-sustaining foreign operations	(652,661)	(346,964)
Comprehensive loss for the year	$ (2,399,796)	$ (4,392,784)

Expenses excluding non-cash items

Description	Twelve Months Ended 2009	Twelve Months Ended 2008	Change	% Change

Network delivery	$ 6,617,907	$ 7,364,982	$ (747,075)	(10)%
Software development	6,855,187	6,379,553	475,634	7%
General and administration	3,821,662	3,689,489	132,173	4%
Sales and marketing	1,024,378	998,574	25,804	3%
	18,319,134	18,432,598	(113,464)	(1)%

Share-based compensation	2,016,015	1,511,504	504,511	33%
Amortization	6,013,716	5,259,053	754,663	14%

Total	$ 26,348,865	$ 25,203,155	$ 1,145,710	5%

Total expenses for fiscal 2009 are 5% greater than fiscal 2008, although excluding non-cash expenditures of share-based compensation and amortization, controllable cash expenses fell by 1%, continuing the trend seen through the earlier part of the year.

Network delivery costs decreased $747,075, or 10% during the year. Consistent with results for the first three quarters of the year, most of this decrease is due to a reduction in the direct cost of fulfilling products and costs relating to running e-mail marketing campaigns on behalf of a number of our customers. These reductions have been offset by increases in hosting charges as a result of establishing a Canadian datacenter in Toronto during the second quarter of fiscal 2008 as well as increased costs associated with offering customer support functions on behalf of a number of customers during the first half of 2009 which was not being done during the first half of fiscal 2008.

Software development expenses have increased $475,634 or 7% year on year. Approximately one third of this increase is a direct result of the WorksMedia acquisition which took place in March 2009 and the additional development team that was taken on at that time. The remainder of the increase was due to the use of contractors during certain parts of the year as a number of projects were completed on behalf of customers. During the year the Company has taken steps to maintain or where possible, reduce staff numbers and costs and has instead utilized the services of contractors on an as-needed basis to help periods of additional workload. Outside of staffing costs, steps have been taken to reduce all other costs in this area, including travel, staff training costs and general running cots of the department. Staffing requirements continue to be monitored on a regular basis with reference to upcoming projects for new and existing customers, ongoing commitments to maintain current service offerings for existing customers as well as new product development. In addition, steps were taken during the year to reduce the level of development headcount at our United Kingdom operations which should result in significant cost savings in this area in future periods, although one time restructuring costs of approximately $40,000 were incurred as a result of this. While the Company continues to maintain development resources at levels consistent with the prior year, future projects from either existing customers or potential new ones could result in additional resources being taken on. Such projects will only be undertaken should forecasted related revenues justify.

General and administration expenses have increased by 4% or $132,173 during the year. While slight increases year on year have been experienced in salary costs, significant cost reductions have been achieved in many other areas including travel and all office related running costs, including a $140,000 reduction in annual rental costs as a result of renegotiating the UK based office lease part way through fiscal 2008. As a result of the Company's decision to relocate all of its UK based staff to its Southampton location and to shut down its Guildford office, it was necessary however to record a one-time provision of approximately $209,000 relating to the Guildford lease costs that are expected to be unrecoverable over the remaining term of that lease. The Company is actively attempting to sub-let this office space, however due to the current state of the rental property market in Guildford, it is envisaged that this may not be possible for a number of months. Excluding this one-time charge, general and administration costs would have decreased year on year. The Company fully intends to continue scrutinizing administrative costs and will take further steps in future periods to reduce non-essential expenditures. Changes in the current strategy of the Company or the continued large-scale growth of the business could however result in further cost reductions in this area not being achievable or in costs increasing.

Sales and marketing expenses increased by 3% to $1,024,378 during the current year, all of which was as a result of acquiring WorksMedia and incorporating their sales team into the group. Following on from this acquisition, the Company developed a new marketing and business development plan and began cross training staff on the products and services offered by each respective company. This new plan is now in the process of being implemented and is targeting aggressive growth for the Company through not only acquiring new customers but also by helping existing customers grow their own businesses which will in turn will lead to increased revenue for us.

Share-based compensation costs, representing both the cost of the company's stock options that are issued to employees, directors and consultants of the company and compensation expense associated with shares issued as part of the acquisition of WorksMedia, have increased year on year by 33%. This increase is in part due to the large number of stock-options that were provided to plan participants at the end of the second quarter of fiscal 2008; the higher relative fair value that was assigned to those options compared to previous options that had been issued; and also as a result of the shares that were issued during March 2009 in connection with the acquisition of WorksMedia.

Amortization increased by 14% year on year to $6,013,716. The amortization charge for the year to date is in line with that seen towards the end of fiscal 2008 and primarily relates to a mixture of both the amortization of intangible assets acquired from Pixology and also items of property and equipment, but was also increased during the third quarter as a result of the intangible assets acquired as part of the WorksMedia acquisition in March 2009. These new intangible assets which have been allocated a fair value of approximately $2.6 million will be amortized over a three-year period, commencing in March 2009. Subsequent to the acquisition of WorksMedia, the Company recognized certain tax benefits relating to loss carry-forwards available in Pixology in order to offset a potential future income tax liability. This had the effect of reducing intangible assets previously recognized regarding the Pixology acquisition by $301,390. In addition, a further adjustment was made totalling $151,000 which recognized the tax benefit of previously unrecorded loss carry-forwards available to the Company to reduce current year income taxes payable. This adjustment also resulted in a reduction to the carrying value of intangible assets previously recognized. As a result of these two adjustments, the amortization of these assets will be reduced by approximately $92,000 per quarter over their remaining estimated useful life.

Other income and expenses

During the year ended September 30, 2009, the Company recorded realized foreign exchange gains of $115,526 and unrealized gains of $435,467. The unrealized gains arose primarily as a result of the retranslation of inter-company balances between the UK subsidiaries and the Canadian parent, whilst the realized gain arose primarily as a result of favourable changes in Canadian dollar exchange rates relative to the US dollar between the time sales invoices were raised and the receipt of funds. Towards the end of the year the strengthening of the Canadian dollar relative to the US dollar began impacting results negatively as amounts being collected from customers in the United States was lower than the amount originally invoiced.

Years Ended September 30, 2008 and September 30, 2007

Revenue

Revenue for fiscal 2008 is 127% greater than fiscal 2007, due to a combination of the acquisition of Pixology during the fourth quarter of 2007, the addition of large new retailers during the year and the organic growth of PhotoChannel's existing operations over the past twelve months.

Excluding results generated through the acquisition of Pixology, revenues of the PhotoChannel operations increased 58% compared to 2007. This increase was primarily attributable to two factors: organic growth in usage of the Network from customers of our photo-finishing retailers; and the addition of a number of new retail customers during the latter part of the year. We believe that organic growth will continue to grow as the Internet is increasingly adopted by consumers as a means to print images and gifting products. Based upon our past experience, we have traditionally seen an ongoing increase in the use of our service as in-store printing is adopted.

Transaction fees increased 141% compared to 2007 and represented 68% of total revenue for fiscal 2008 compared to 64% in fiscal 2007. This increase in overall transactional revenue has been achieved despite seeing an increase of 189% year on year in installation fees which arose primarily as a result of Pixology charging annual license fees rather than fees based on the level of transactions undertaken. The Company continues to pursue its long-term goal of moving towards a transactional-based revenue model and the results in 2008 demonstrate the success being achieved in this area.

Excluding the results of Pixology for the year, transaction fees represent 78% of the total revenue of the operations that were in existence prior to the acquisition and represent the single largest source of revenue for the Company.

Professional fees were up $68,735 or 17% compared to 2007, as we provided more email marketing assistance to our retailer base. We have seen that email marketing by our retail partners leads to increases in the number of orders placed by their customers and a related increase in transactional fees to us. We expect to continue assisting our customers in the future as requested, in order to drive additional orders through our Network.

Revenue from installation fees increased 189% compared to 2007, primarily as a result of revenue earned through Pixology relating to licence fees charged to customers. These license fees are an annual fee for the use of software and are recognized into revenue over the period to which access to services are provided. Installation fees in PhotoChannel were $192,900 lower in fiscal 2008 compared to fiscal 2007. This is a direct result of the majority of its customers having previously connected their stores to the PhotoChannel Network. In previous years, installation revenues have primarily consisted of lab system installations in our retail partner locations to enable one-hour printing, but also include a nominal monthly charge for licensing fees. Many of our new retail partners are electing to install or have already installed their own lab systems. We expect this trend will continue, leading to reduction of our revenues related directly to lab system installations.

Storage fees of $210,901 were earned during 2008, compared to $60,010 in 2007. This increase was the result of certain customers reaching pre-determined thresholds, after which we charge a monthly storage fee. Our customers remain in charge of the business rules offered to their consumers around storage and therefore future revenue growth in this area could be curtailed should any of our customers stop providing unlimited free storage.

Operating Expenses and Net Loss

We recorded a loss from operations for the year ended September 30, 2008 of $8,276,760, representing an increase of $3,529,272 or 74% compared to the same period last year. The increased loss during 2008 includes an amount of $3,214,908 representing a full year of amortization of intangible assets acquired at the time of the Pixology acquisition, compared to $574,173 recognized during 2007. Excluding this expense, the loss from operations increased by $888,602, or 19% primarily as a result of increased salary and non-cash stock-based compensation expenses as additional staff were recruited to allow the Company to develop sites for its new retail customers. The costs associated with these new staff are incurred well in advance of revenues from the new customer sites.

A comparison of operating results and non-operating events for the two years ended September 30th are set out in the table below.

Description	2008	2007
Loss from operations	$ (8,276,760)	$ (4,747,488)
Other items	(462,053)	(1,324,748)
Net loss under Canadian GAAP for the year	$ (8,717,026)	$ (6,072,236)
Change in fair value of embedded foreign currency derivative related to warrants	4,671,206	268,089
Net loss under US GAAP for the year	$ (4,045,820)	$ (5,804,147)
Unrealized foreign exchange loss on translation of self-sustaining foreign operations	(346,964)	(809,569)
Comprehensive loss for the year	$ (4,392,784)	$ (6,613,716)

Expenses increased by 107% to $25,203,155 compared to 2007. Expenses for 2008 represented a full year of costs associated with Pixology, where fiscal 2007 only included three months, from the date of acquisition to our year end of September 30^th. 39% of costs in fiscal 2008 were incurred by Pixology, with the remaining 61% incurred by PhotoChannel.

There are a number of factors which have resulted in this significant increase in expenditures year-on-year; including the acquisition of Pixology and the related ongoing cost of those operations which are now included in our results, the increase in amortization experienced as a result of the acquisition through the recognition of intangible assets on our balance sheet, along with additional hardware associated with our new data centre and our success during the year in securing a number of new contracts which resulted in an increase in employee costs, prior to the recognition of associated revenues from these contracts.

Pixology often contracts with the gifting fulfillers and takes responsibility for ensuring that orders made through the online photo sites of retailer customers are completed. As a result of this, Pixology recognizes the gross amount of sales made to the end consumer in these instances, together with the associated cost of goods sold. This cost of goods sold is recorded within network delivery costs and amounted to $3,761,946 for fiscal 2008.

PhotoChannel's operations are fulfilled by the retailer resulting in only the transaction fee earned by the Company being recorded in the financial statements as revenue.

Development expenses increased $2,736,180 or 65% year on year. $861,348 or 32% of this increase related to costs incurred by Pixology as a result of fiscal 2008 including a full year of costs compared to fiscal 2007 which included only one quarter post acquisition. The remaining $1,874,832 of increased costs were incurred by operations in Canada, with $1,664,208 due to increased salary and consulting costs incurred as a result of the Company working to develop customized online photo solutions for our new customers, including Sam's Club USA, Costco USA, Loblaws, Kodak Australia and Kodak China as well as continuing to provide ongoing support and development services to our existing client base. The completion of these projects during 2008 will result in the Company earning additional revenue in future periods, relating to the costs that have been incurred up front. As well, additional non-cash stock-based compensation expense of $162,462 was also incurred year on year.

General and administration expenses increased $1,403,723 or 44% year on year. $238,691 of this increase related to costs incurred by Pixology, with the remaining $1,165,032 increase being incurred in Canada. Costs incurred year on year by Pixology are primarily as a result of fiscal 2008 including a full year of costs while fiscal 2007 only included 3 months of costs. Steps have been taken since the acquisition of Pixology to drastically reduce the overheads incurred at our United Kingdom operations with very successful results. The year on year increase in costs in Canada was as a result of a small increase in headcount, an increase of non-cash stock-based compensation expense of $337,000, increased audit and Sarbanes-Oxley compliance costs of $334,000 and small increases in travel expenditures and office related costs.

Network delivery costs increased $4,886,351 or 194% during fiscal 2008, although $3,366,514 or 69% of this increase can be attributed to Pixology. The remaining $1,519,837 of increased costs, which were incurred by PhotoChannel, are primarily as a result of an increase in customer service salaries and temporary contractors of $801,000 as staff numbers were increased to service newly signed customers and the Company's growing customer base; an increase of $30,000 in non-cash stock-based compensation expense; an increase of $770,000 in data storage and hosting costs resulting from the establishment of a second Canadian datacenter in Toronto in January 2008 together with the expansion of the Company's Vancouver datacenter and an increase in the cost of running e-mail marketing campaigns on behalf of a number of our customers of $113,000. These increased costs were offset by a reduction in the lab installation costs which fell in line with the reduction experienced in Canadian installation revenue during the year.

Sales and marketing expenses remained at the same levels year on year at $1,140,000. An increase of $65,000 was incurred by Pixology through the inclusion of United Kingdom specific marketing efforts, while costs in Canada were reduced by $60,000 as a result of decreased salary and consulting costs.

Amortization increased by 330% year on year to $5,259,053. This year on year increase is as a result of the amortization of intangible assets acquired when the Company purchased Pixology, amortization incurred on assets owned by Pixology and an increase seen as a result of the large capital investment undertaken during the second and third quarters of the year establishing a second Canadian datacenter in Toronto.

During the year ended September 30, 2008, the Company recognized a foreign exchange gain of $461,041, primarily as a result of an increase in the value of the United States dollar compared to the Canadian dollar and an increase in the value of the Canadian dollar compared to the British Pound. This gain arose upon the retranslation of United States dollar accounts receivable balances and British Pound denominated loans payable.

During the year ended September 30, 2008, the Company recorded an impairment charge against the carrying value of goodwill related to Pixology. This impairment arose as a result of: planned development synergies not materializing to the extent assumed at the time of the acquisition; cost reductions implemented subsequent to acquisition resulting in the operations reaching a break-even position, but being insufficient to result in the company being able to sustain profitable operations on a recurring basis; and the loss, subsequent to acquisition of a number of retail customers.

B. Liquidity and Capital Resources

Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations as they fall due. 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 does not have any credit facilities in place to help manage its liquidity position and therefore its liquidity is dependent on 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, 2010, the Company generated positive cash flow from operations of $4,489,338 and eliminated its working capital deficit that existed at September 30, 2009. At September 30, 2010, the Company had positive working capital of $5,248,893, compared to negative working capital of $1,129,741 at September 30, 2009. During the same period, the Company's cash position increased from $4,237,284 to $4,690,355 as a result of strong operating results and careful management of working capital. In addition, during the year, the company repaid it short-term loan of just under $1 million and completed making the payments required to the previous owners of WorksMedia under the terms of the share purchase agreement which totalled approximately $938,000.

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 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 its credit risk note. 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, its working capital position could periodically decrease depending on the timing of the maturity of its accounts receivable and accounts payable and accrued liabilities.

In prior years the Company purchased a number of items of property and equipment using a finance lease. At September 30, 2010, the Company has an outstanding obligation under this lease of $107,964, all of which is payable within twelve months. The Company is making these payments out of cash flows generated from operations.

During the year ended September 30, 2010, the Company repaid its loan payable, including interest accrued, of $937,548.

The Company's activities are being funded out of its operating cash flow. As a result of generating positive results during the year ending September 30, 2010 the Company has been able to eliminate its working capital deficit, however if positive results are not continued in future periods there is a risk that the Company would not be able to meet all of its contractual commitments when due.

C. Software development, patents and licenses, etc.

During the fiscal year ended September 30, 2010 we expended $7,985,058 (2009 - $6,855,188; 2008 - $6,379,553) 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 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.

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 quarter ended December 31, 2010, 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. Subsequent to the period end, the Company continues to negotiate the final allocation of the settlement charge with the former customer and expects to conclude its discussions prior to the end of the three month period ended March 31, 2011. Included in these consolidated financial statements is an accrual of US$80,000 representing the Company's best estimate of the amount that it will be required to pay out.

During the three month period ended December 31, 2010, the Company received notice from a customer that a claim had been brought against them from a United States based entity (the "entity"), alleging that certain services offered by the Company's customer infringed on a patent licenced by the entity. A portion of the services that are alleged to be in breach of this patent are provided by the Company. The Company's customer has requested that the Company indemnify them from any damages resulting from this claim. To date, the Company has only been provided with limited information regarding this potential infringement and as a result is still investigating the matter to determine its potential impact. No adjustment has been made in the financial statements as a result of this matter.

D. Trend Information

In recent times, the photo industry has undergone significant changes as a result of improvements in technology. Three major trends have been reshaping the landscape. This first was the emergence of the digital camera as a replacement for film cameras and photo film. The second is the ongoing deployment and consumer acceptance of digital cameras in mobile phones. The third is the deployment by retailers of digital printing equipment to enable them to make digital images from traditional images captured on film and to make prints and creative photo gift products from digital images. As the industry adapts to the technological advancements forcing new ways of business to be conducted, the opportunity exists for the emergence of new players to provide the products and services to make retailers with photofinishing operations successful. A fourth factor outside of the photo industry per se that is also affecting the digital photography landscape has been the increased prevalence of broadband Internet access at home for consumers.

The use of digital cameras is increasing and management believes that the popularity of the digital camera will continue to grow as the cost of such cameras continue to decrease and the availability of photographic quality digital print services increases, at retail, online, and at home. An estimated 55% of US households owned a digital camera by 2005, and this is expected to continue to grow to 81% by 2010.²⁰ The use of digital cameras has increased dramatically (not only in North America, but worldwide) since their introduction in the mid 1990's.There is no demographic which digital cameras are exclusive to, especially in light of constantly falling prices the last several years, nor is there a prohibitive degree of technological sophistication required to operate these cameras. The average price paid for a digital camera has fallen from $315 in 2004 to $303 in 2005, and continues to fall.²¹

Photofinishing retailers originally viewed digital camera penetration as threatening their future. Film processing volume has been falling steadily the last years globally. In the U.S. alone, sales have fallen from 671 million rolls in 2003, to 571 million rolls in 2004, to 480 million in 2005 and an estimated 369 million in 2006 (a total drop of some 45% in that period). Commensurately, processing revenue has fallen in the same period from $5.39 billion in 2003 to an estimated $2.98 billion in 2006, a similar 44.7% drop.²² As consumers have switched their picture-taking activity from film to digital, one of the greatest challenges has been making them aware of the options for printing their digital pictures. The effect of digital cameras to date and future projections indicate that digital will have an additive effect on the growth of picture taking overall, especially as the cost to shoot a digital image is nothing as compared to the cost of developing photo film.

In 2003, 56 Billion digital photo exposures were taken worldwide, with growth to 144 Billion in 2005 and an estimated 312 Billion by 2008.²³ The number of captured digital images in the USA (not including camera phones) has grown from 7.8 Billion in 2003, 12.9 Billion in 2004, 17.1 Billion in 2005, and an estimated 21.7 Billion in 2006. At the same time, the number of digital prints made by all methods has grown from 1.5 Billion (19.2% of total captured) in 2003, 3.1 Billion (24% of total) in 2004, 4.5 Billion (26.3% of total) in 2005, and an estimated 6.4 Billion (29.4% of total) in 2006. Film and digital cameras combined produced 14% fewer prints between 2000 and 2005 including retail, online, and home alternatives. Including prints made at home, the total value of printing was higher at $6.81 Billion in 2005 than the $6.23 Billion in 2000.²⁴

___________________________
²⁰ InfoTrends - 2005 Report
²¹ PMA Marketing Research: Photo Industry 2006 Review and Forecast / NPD Techworld
²² All figures here taken from PMAI / PMA Marketing Research: Photo Industry 2006
²³ Hewlett Packard (HP) as from your previous writing
²⁴ PMA Marketing Research: Photo Industry 2006 Review and Forecast

The growth of printing at retail has recently outpaced home printing, and is expected to continue to do so in the next couple of years, for a variety of reasons. This is reflected in relative home and retail printing volumes, and for the first time since the introduction of digital cameras in the US, retail and online entities were the top destinations for digital printing in 2005. It was forecasted that for 2008, of the digital photo exposures that get printed worldwide, 56 Billion or 43% will be printed by retailers. Translated into photofinishing revenue, it is predicted that digital photofinishing at retail, from both store location drop-off and online orders, will be a $6.2 Billion industry in 2008.

We continue to see a 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, product mix 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.

Data Sources: PMAI / PMA, InfoTrends, Hewlett Packard (HP)

E. Off-Balance Sheet Arrangements

Not Applicable

F. Tabular Disclosure of Contractual Obligations

	Payments due by period
	Total	Less than 1 year	1-3 years	3-5 years	More than 5 years
Property leases	1,009,631	263,382	526,764	219,485	-
Other service agreements	2,383,044	1,188,125	1,194,919	-	-
Capital leases	107,964	107,964	-	-	-
	3,500,639	1,559,471	1,721,683	219,485	-

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Senior Management

The names, residences, ages, positions with us, principal occupations within the last five years and beneficial ownership of our securities of each of our directors and executive officers as at February 28, 2010 are as follows. All Directors serve until the next Annual General Meeting of our Shareholders.

Name and Residence (If a Director, period such position held)	Age	Positions with Company and Principal Occupations During the Last 5 Years	Securities Beneficially Owned, Directly or Indirectly⁽⁴⁾⁽⁵⁾	Percentage of Outstanding Shares⁽⁶⁾
Peter Fitzgerald^{(1)(2) -}Herts, United Kingdom Director (July 31, 2001 - present)	62	March 3, 2005 - September 30, 2008: President & CEO of the Company	1,773,451 Common Shares⁽⁷⁾	5%
Peter Scarth^{(1)(2) -}West Vancouver, BC, Canada Director (Oct 10, 2000 to present)	65	August 1, 2002 - October 4, 2004: President & CEO of the Company March 2001- February 3, 2004: Chairman of the Company. a	835,462 Common Shares⁽⁸⁾	2%
Cory Kent⁽³⁾⁽³⁾Vancouver, BC, Canada Director (March 10, 1999 - Present)	41	February 2003 to Present: Lawyer at McMillan LLP (formerly Lang Michener LLP)	227,778 Common Shares⁽⁹⁾	1%
Thomas Nielsen ^{(1) (2)} Seattle, WA, USA Director (June 23, 2005 - present)	40	November 2009 to present: VP Marketing, Product Management & Business Strategy, Digital Imaging Products, Adobe Systems; October 2004 - November 2009: Director of Engineering, Adobe Systems; and	161,278 Common Shares⁽¹⁰⁾	0.4%
Scott Brownstein^-(2)(3) Florida, USA Director (September 15, 2008 to May 14, 2010)	61	Present - Businessman Brownstein & McCabe Associates; December 2000 to May 2006 - FujiFilm eSystems SVP & CTO		-
Robert Chisholm⁽¹⁾ Vancouver, BC, Canada Director (April 27, 2009 to present)	48	April 2009 - Present: Partner Emprise Capital Corp.; Nov. 2001 - March 2009: Chief Financial Officer of PNI Digital Media Inc.;=	227,778 Common Shares	1%
Lawrence Lerner⁽³⁾Illinois, USA Director (March 10, 2010 to present	46	November 2007 to Present - Businessman UST Global; August 2007 to October 2007 Director Acquity Group; December 2002 to August 2007 Sr. Manager for Cognizant	37,778 Common Shares⁽¹²⁾	0%
Kyle Hall⁽³⁾Vancouver, BC, Canada Director (March 25, 2009 to present)	45	October 1, 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;	290,140 Common Shares⁽¹³⁾	1%

Name and Residence (If a Director, period such position held)	Age	Positions with Company and Principal Occupations During the Last 5 Years	Securities Beneficially Owned, Directly or Indirectly⁽⁴⁾⁽⁵⁾	Percentage of Outstanding Shares⁽⁶⁾
Aaron Rallo Vancouver, BC, Canada Director (March 25, 2009 to present)	38	October 1, 2008 to Present: President & COO; November 2004 - September 30, 2008: Chief Technology Officer of the Company; March 2003 to May 2004: Senior Program Manager of Digital Imaging Devices for Microsoft Corporation;	235,920 Common Shares⁽¹⁴⁾	1%
Simon Bodymore North Vancouver, BC	35	March 2009 - Present: CFO; December 17 to March 2009 - VP of Finance of the Company; January 2008 to December 16 - Director of Finance of the Company; November 2000 to December 2007 - Senior Manager of PricewaterhouseCoopers LLP	82,444 Common Shares⁽¹⁵⁾	0%
Patricia Spice Vancouver, BC, Canada	63	December 1995 - Present: Executive Assistant, PNI Digital Media Inc. October 4, 2004 to present: Corporate Secretary of the Company	62,100 Common Shares	0%
Chris Tivel Vancouver, BC, Canada	40	March 26, 2009 to Present - Chief Technology Officer August 2007 - March 26, 2009: VP Product Development, of the Company	121,474 Common Shares⁽¹⁶⁾	0%
Susan Page New Jersey, USA	40	July 2007 to Present - EVP Sales & Marketing of the Company; June 2005 - July 2007 - Pixology Inc. - VP US Sales;	66,888⁽¹⁷⁾	0.0%
Karl Oertel Surrey, UK	43	July 2007 to Present - VP UK Operations of the Company; August 2006 - July 2007 - Pixology Ltd. VP UK Operations; July 1997 - August 2006 - ITEBA Ltd. - Operations Manager	7,100	0%
Harley Ware Vancouver, BC, Canada	42	November 13, 2009 - Present - EVP In-Store Retail Systems March 11, 2009 - November 13, 2009 - Managing Director Europe	381,166⁽¹⁸⁾	1%

(1) Member of the Audit Committee.

(2) Member of the Compensation Committee.

(3) Member of the Corporate Governance Committee.

(4) Information regarding shares beneficially owned or controlled is as of December 31, 2010 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. 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) On November 2, 2006, we implemented a consolidation of our common shares on a one-new-common-share-for-10-old-common-shares basis. The number of shares disclosed as being beneficially owned or controlled by the named persons are shown on a post-consolidation basis.

(6) Based on 34,007,083 common shares issued and outstanding as of February 28, 2011

(7) Includes 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(8) Includes 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(9) Includes 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(10) Consists of 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(11) Consists of 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(12) Includes 2,778 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(13) Includes 11,110 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(14) Includes 7,334 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(15) Includes 4,444 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(16) Includes 4,444 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(17) Includes 5,388 common shares that may be issued pursuant to stock options exercisable within the next sixty days.

(18) Includes 6,166 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, 2010, 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 $1,966,025. Of such amount, $385,000 was paid or accrued under a described bonus plan.

Our Company may grant, pursuant to the policies of the TSX Venture Exchange, 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, 2010, 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 four most highly compensated executive officers other than the Chief Executive Officer during the fiscal periods indicated.

		Annual Compensation			Long Term Compensation
Name and Principal Position	Fiscal Year	Salary ($)	Bonus ($)	Other Annual Compensation ($)	Common Shares Under- Lying Options Granted (Number)
Kyle Hall ⁽¹⁾ CEO	2010 2009 2008	256,250 235,417 189,583	125,000 10,000 25,000	Nil Nil Nil	- 50,000 75,000
Aaron Rallo President⁽²⁾	2010 2009 2008	225,082 225,299 201,277	112,500 10,000 25,000	Nil Nil Nil	- 50,000 75,000
Simon Bodymore⁽³⁾ CFO	2010 2009 2008	181,250 161,250 85,923	87,500 - -	Nil Nil Nil	- 25,000 50,000
Chris Tivel VP, Product Development ⁽⁴⁾	2010 2009 2008	175,000 172,542 145,500	10,000 17,500 29,100	- - Nil	- - 75,000
Harley Ware, EVP, In-Store Retail Systems ⁽⁵⁾	2010 2009 2008	194,693 98,995 -	50,000 - -	Nil Nil Nil	- - 25,000

(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 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.

(3) On December 17, 2008, Simon Bodymore, formerly Director of Finance for us became VP Finance. On March 26, 2009 Mr. Bodymore became Chief Financial Officer.

(4) On August 16, 2007, Chris Tivel, formerly Senior Architect for us became VP of Product Development. Mr. Tivel was appointed to Chief Technical Officer on March 26, 2009

(5) 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.

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. 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. This committee consists of Robert Chisholm (Chairman), Peter Scarth, Peter Fitzgerald and Thomas Nielsen.

The Compensation Committee consists of three directors. This committee is responsible for recommending salary levels and granting of options for our executive officers. This committee consists of Peter Fitzgerald (Chairman), Peter Scarth, and Thomas Nielsen.

The Corporate Governance Committee consists of three directors. This committee is responsible for corporate governance. This committee consists of , Cory Kent (Chairman), Kyle Hall and Lawrence Lerner.

D. Employees

We currently have one hundred fifteen (115) permanent full-time employees, two (2) permanent part-time employees and eight (8) consultants we retain for regular engagements. None of our staff are unionized.

We currently have the following staffing in our Vancouver office:

Executive Officers	6
Operations	10
Finance/Administration	7, includes 3 executive officers.
Technology and Applications	85, includes 3 executive officers.
Sales, and Business Development	3

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

Executive Officers	1
Operations	2
Finance/Administration	2
Technology and Applications	4, includes 1 executive officer.
Sales, and Business Development	1

We currently have the following staffing in our New Jersey office:

Sales, and Business Development

1, includes 1 executive officer.

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 February 28, 2011. 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 directors and executive officers, they as a group beneficially owned a total of 4,510,757 common shares (including an aggregate of 55,554 common shares that are reserved for issuance pursuant to stock options that are all exercisable within sixty days).

As of February 28, 2011, options to purchase an aggregate of 2,372,999 common shares had been granted and were outstanding, as follows:

Number of Common Shares		Exercise Price Per Common Share	Expiration Date
301,776 669,723 307,500 4,000 200,000 365,000 25,000 500,000		$1.25 $2.32 $3.35 $3.65 $2.00 $1.48 $1.50 $1.55		March 5, 2011 December 11, 2011 March 11, 2013 April 14, 2013 March 10, 2014 March 25, 2014 August 6, 2014 October 4, 2015

In addition, 306,600 Restricted Stock Units had been issued to members of staff, Officers and Directors with an expiry date of October 4, 2013.

As of February 28, 2011, a total of 1,831,000 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:

Name	Grant Date	Exercise Price	Expiration Date	Total Number of Options
Peter Fitzgerald Director, Chairman	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2015	35,000 35,000 50,000 25,000

Name	Grant Date	Exercise Price	Expiration Date	Total Number of Options
Peter Scarth Director	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2010	35,000 100,000 50,000 25,000
Cory Kent Director	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $3.35 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2015	35,000 100,000 50,000 25,000
Thomas Nielsen Director	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2015	35,000 35,000 50,000 25,000
Robert Chisholm Director	March 5, 2006 December 11, 2006 March 11, 2008 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 11, 2013 October 4, 2015	50,000 75,000 50,000 ⁽¹⁾25,000
Lawrence Lerner Director	October 4, 2010	$1.55	October 4, 2015	25,000
Kyle HallDirector & Chief Executive Officer	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2015	50,000 75,000 50,000 100,000
Aaron Rallo Director, President & Chief Operating Officer	March 5, 2006 December 11, 2006 March 25, 2009 October 4, 2010	$1.25 $2.32 $1.48 $1.55	March 5, 2011 December 11, 2011 March 25, 2014 October 4, 2015	3,000 75,000 50,000 66,000
Simon Bodymore Chief Financial Officer	March 25, 2009 October 4, 2010	$1.48 $1.55	March 25, 2014 October 4, 2010	25,000 40,000
Patricia Spice Corporate Secretary	March 5, 2006 December 11, 2006 March 25, 2009	$1.25 $2.32 $1.48	March 5, 2011 December 11, 2011 March 25, 2014	15,000 25,000 15,000
Chris Tivel Chief Technology Officer	March 5, 2006 December 11, 2006 October 4, 2010	$1.25 $2.32 $1.55	March 5, 2011 December 11, 2011 October 4, 2015	13,500 50,000 40,000
Susan Page EVP Sales & Marketing	October 4, 2010	$1.55	October 4, 2015	48,500
Harley Ware, EVP In-Store Retail Systems	March 10, 2009 October 4, 2010	$2.00 $1.55	March 10, 2014 October 4, 2015	100,000 55,000

^{(1) - During the year ended September 30, 2009, the exercise price of 50,000 options previously granted to Robert Chisholm on March 11, 2008 was amended from $3.35 to $1.48

As of February 28, 2011, a total of 74,200 Restricted Share Units ("RSU's") were held by our non-executive directors and executive officers as a group. The following table sets forth particulars of the RSU's held by each of our directors and executive officers:

Name

Grant Date

Grant Price

Expiration Date

Total Number of Restricted Shares Units

Peter Fitzgerald

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Peter Scarth

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Cory Kent

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Thomas Nielsen

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Robert Chisholm

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Lawrence Lerner

Director

Oct. 4, 2010

$1.55

Oct. 4, 2013

10,000

Karl Oertel

VP UK Operations

Oct. 4, 2010

$1.55

Oct. 4, 2013

7,100

Patricia Spice

Corporate Secretary

Oct. 4, 2010

$1.55

Oct. 4, 2013

7,100

As of February 28, 2011, a total of 100,000 Performance Share Units ("PSU's") were held by our executive officers as a group. The following table sets forth particulars of the PSU's held by each of the executive officers:

Name

Grant Date

Grant Price

Expiration Date

Total Number of Performance Share Units

Kyle Hall

Chief Executive Officer

Oct. 4,2010

$1.55

Oct. 4, 2013

21,000

Aaron Rallo

President & Chief Operating Officer

Oct. 4,2010

$1.55

Oct. 4, 2013

20,000

Harley Ware

EVP In-Store Retail Systems

Oct. 4,2010

$1.55

Oct. 4, 2013

20,000

Chris Tivel

Chief Tehnical Officer

Oct. 4,2010

$1.55

Oct. 4, 2013

13,000

Sue Page

EVP Sales & Marketing

Oct. 4,2010

$1.55

Oct. 4, 2013

13.000

Simon Bodymore

Chief Financial Officer

Oct. 4,2010

$1.55

Oct. 4, 2013

13.000

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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 provides 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.
Eligible Optionees
Under the policies of TSX Venture Exchange, to be eligible for the issuance of a stock option under the 2006 Plan, as amended, an Optionee must be, at the time the option is granted, a director, officer or employee of, or a consultant to, our Company or a subsidiary of our Company, or an employee of a company providing management services to our Company or any of our subsidiaries.
Options may be granted only to an individual or to a non-individual that is wholly owned by individuals eligible for an option grant. If the option is granted to a non-individual, it must provide the TSX Venture Exchange with an undertaking that it will not permit any transfer of its securities, nor issue further securities, to any individual or other entity as long as the option remains in effect, without the consent of the TSX Venture Exchange.
Material Terms of the 2006 Plan
The following is a summary of the material terms of the 2006 Plan, as amended:

(a)         all options granted under the 2006 Plan are non-assignable, non-transferable and exercisable for a period of up to 10 years (subject to extension in the event that the expiry of the option occurs during a securities trading black out period);
(b)         for stock options granted to employees or service providers (inclusive of management company employees), our Company must ensure that the proposed Optionee is a bona fide employee or service provider (inclusive of management company employees), as the case may be, of our Company or any subsidiary;

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(c)         if an Optionee ceases to be employed by our Company (other than as a result of termination with cause) or ceases to act as a director or officer of our Company or a subsidiary of the Company, any option held by such Optionee may be exercised within 90 days after the date of such Optionee ceases to be employed or act as an officer or director (30 days if the Optionee is engaged in "Investor Relations Activities: as defined in the policies of the TSX Venture Exchange, and our Company remains listed on the TSX Venture Exchange as a Tier 2 issuer), unless the Board determines to extend the term of the Option for a period of not more than one year;
(d)         the minimum exercise price of an option granted under the 2006 Plan must not be less than the Discounted Market Price (as defined in the policies of the TSXV);
(e)         no Optionee can be granted an option or options to purchase more than 5% of the outstanding listed shares of our Company in any one year period; and
(f)         as indicated above, outstanding stock options granted under the 2004 Plan are now deemed to have been granted under the 2006 Plan and will be subject to the terms and conditions of the 2006 Plan, as amended.
Restricted 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. 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 February 28, 2011, 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, 4,510,757 common shares, representing about 13% of our presently issued and outstanding common shares (including an aggregate of 55,554 common shares that are reserved for issuance pursuant to stock options that are all exercisable within sixty days).

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Pursuant to the policies of the TSX Venture Exchange, 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 31, 2010 no person or corporation owned or had the intent of acquiring 20%or greater of our securities.
Peter Fitzgerald is our Chairman and is a significant shareholder and investor in us. Currently, Mr. Fitzgerald owns 1,770,673 of our common shares or 5% of our outstanding common shares. Mr. Fitzgerald also holds 2,778 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 1,773,451 of our common shares, representing 5% of our then outstanding securities, as of February 28, 2011.
As of February 28, 2011, our shareholders' register listed approximately 71 registered shareholders holding an aggregate of 34,007,083 common shares. A total of 29 of these registered shareholders were shown to be residents of Canada, owning 25,720,973 shares representing 75.6% of our issued and outstanding common shares. A total of 26 of these registered shareholders were shown to be residents of the United States, owning 7,491,530 shares representing 22.03% of our issued and outstanding common shares.
B. Related Party Transactions

During the year ended September 30, 2008, the Company advanced loans to officers of the Company in the amount of $68,000 with interest payable at a rate of 7% per annum. Included in accounts receivable at September 30, 2009 was $19,320, comprising an amount of $17,000 representing a portion of the principal which remains outstanding and $2,320 representing interest accrued on that principal. During the year ended September 30, 2010, the Company received full payment of the principal and accrued interest owing from the loan in the amount of $19,792. Interest income of $472 (2009 - $1,306) was earned on these loan balances during the year ended September 30, 2010.
During the year-ended September 30, 2008, the Company was provided with an unsecured loan from a Director and Officer totalling L 500,000. The loan, which was denominated in Sterling bore interest at a rate equal to the Bank of England base rate, plus 3.75% and fell due for repayment no later than May 31, 2010. In October, 2009 the Company repaid the principal and all accrued interest of this loan, totalling $937,548.

During the year ended September 30, 2010, the Company incurred legal fees of $83,203 (2009 - $130,287) for services provided by a law firm of which a director of the Company is a partner. Accounts payable and accrued liabilities at September 30, 2010 included $4,968 (2008 - $23,217) related to these services.

During the year ended September 30, 2010, the Company incurred consulting fees for services performed by two directors of the Company totalling $6,608 (2009: $122,059). At September 30, 2010, no amounts were due to directors in relation to consulting services performed (2009: $38,288).

During the year ended September 30, 2010, the Company incurred consulting fees of $18,432 (2009: $nil) for services provided by a company of which a Director and Officer of the Company controls. Accounts payable and accrued liabilities at September 30, 2010 included $4,993 (2009: $nil) related to these services.

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During the year ended September 30, 2010, the Company incurred expenses in relation to setting up e-mail marketing campaigns on behalf of a number of our retail customers of $41,740 (2009: $52,398) and website services of $6,920 with a company of which a director of the Company is Chairman and Chief Executive Officer. Accounts payable and accrued liabilities at September 30, 2010 included $7,128 (2009: $18,262) related to these services. The 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.

The Company shares its UK premises with another company of which an Officer is a majority shareholder. During the year ended September 30, 2010, the Company was recharged its proportional share of office running costs totalling $192,395 (2009: $128,819) by this related party. In addition, during the year ended September 30, 2010, the Company used the software development services of this company, incurring costs of $95,398 (2009: $20,660) and carried out professional development work totalling $nil (2009: $18,255) on behalf of this company. At September 30, 2010, accounts payable included $25,118 (2009: $119,076) and accounts receivable $nil (2009: $19,887) due to and from this company respectively.

During the year ended September 30, 2010, the Company utilized the services of an Officers' family member on a contract basis, incurring fees of $28,326 (2009: $22,404). At September 30, 2010, $nil (2009: $3,656) was included in accounts payable related to these fees.
All transactions entered into with Management as disclosed in this section were based on terms and conditions that are similar to those of transactions with disinterested third parties.
C. Interests of Experts and Counsel

Not Applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information

Please see the Consolidated Financial Statements listed in Item 18 hereof and included at the end of this annual report.

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.
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. To date, the Company has only been provided with limited information regarding this potential infringement and as a result is still investigating the matter in order to determine its potential impact. No adjustment has been made in our September 30, 2010 financial statements as a result of this matter.
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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
Our common shares are listed and posted for trading on the TSX Venture Exchange, commonly called the TSX-V, 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 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 for the periods indicated.

Sales Prices (CAN$)

High

Low

Common Shares

Annual Data

2010

1.95

1.30

2009

2.29

1.00

2008

4.50

1.90

2007

5.77

2.31

2006

3.75

0.95

2005

1.90

0.70

Quarterly data

2010

September 30, 2010

1.61

1.30

June 30, 2010

1.82

1.52

March 31, 2010

1.81

1.56

December 31 2009

1.95

1.6

2009

September 30, 2009

2.02

1.40

June 30, 2009

1.82

1.45

March 31, 2009

2.00

1.44

December 31 2008

2.29

1.00

Monthly data

February 2011

1.65

1.40

January 2011

1.60

1.49

December 2010

1.76

1.56

November 2010

1.80

1.53

October 2010

1.62

1.50

September 2010

1.61

1.30

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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

2010

1.87

1.28

2009

2.05

0.89

2008

4.65

1.84

2007

4.88

2.52

2006

3.29

0.63

2005

1.70

0.50

Quarterly Data

2010

September 30 2010

1.57

1.28

June 30 2010

1.83

1.45

March 31 2010

1.70

1.55

December 31, 2009

1.87

1.52

2009

September 30 2009

1.86

1.23

June 30 2009

1.59

1.24

March 31 2009

1.60

1.14

December 31, 2008

2.05

0.89

Monthly data

February 2011

1.66

1.45

January 2011

1.61

1.53

December 2010

1.77

1.60

November 2010

1.75

1.52

October 2010

1.60

1.50

September 2010

1.57

1.28

Our common share register indicates that 26 of our registered shareholders are residents of the United States, owning 7,491,530 shares representing 22.03% 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.
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C. Markets

See Item 9.A(4) above.
D. Selling Shareholders

Not Applicable.
E. Dilution

Not Applicable.
F. Expenses of the Issue

Not Applicable.
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, which agreements are filed as exhibits to this annual report or 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 Toronto Co-Located Hosting Agreement with TELUS Communications Inc., dated November 19, 2007. This agreement is for a 60 month period commencing January 15, 2008.
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2.   The Vancouver Co-Located Hosting Agreement with TELUS Communications Inc., dated November 20, 2007. This agreement is for a 34 month period commencing December 1, 2007.

3.   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.

4.   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.

5.   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.

6.   The Internet Photo Services Agreement with Costco Wholesale Corporation, dated April 29, 2008. This Agreement is for a period of three years, expiring April 29, 2011 (the "Term") and may be extended by Costco for one year periods unless written notice is provided by Costco to at least ninety (90) days prior to the end of the Term or the then current renewal term.

7.   The Master Equipment Lease Agreement with Relational Funding Canada Corp., dated March 10, 2008. This Agreement is for a period of three years.

8.   The lease renewal and modification agreement for our executive offices located at Suites 580 & 590, 425 Carrall Street, Vancouver, British Columbia, Canada, dated June 11, 2009 and covers 6,602 square feet. The amendment comprises an extension to the original lease for the period August 1, 2009 to July 31, 2014. We lease the premises from a third party corporation. The monthly base rent is approximately $6,877.08.

9.   The lease agreement for our support offices located at Suite 100, 425 Carrall Street, Vancouver, British Columbia, Canada dated July 26, 2010. The lease comprises 4,705 square feet in an office building owned by a third party corporation. The lease term is from September 1, 2010 to July 31, 2014. The monthly base rent is approximately $5,195.10

10. 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.
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.
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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 affect 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 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.

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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 or performs independent personal services in Canada through a fixed base in Canada if the shareholder's holding in our stock is effectively connected with such permanent establishment or fixed base. This summary is based upon the provisions of the Canadian Tax 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.
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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. 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.
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.
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%. There are special transitional rules to apply capital losses against capital gains that arose in different periods. The amount by which a shareholder's 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 on taxable capital gains, and may deduct allowable capital losses, realized on a disposition of "taxable Canadian property." Shares of our common stock will constitute taxable Canadian property of a shareholder at a particular time if the shareholder used the shares in carrying on business in Canada, or if at any time in the five years immediately preceding the disposition 25% or more of the issued shares of any class or series in our capital stock belonged to one or more persons in a group comprising the shareholder and persons with whom the shareholder did not deal at arm's length and in certain other circumstances.
The Convention relieves United States residents from liability for Canadian tax on capital gains derived on a disposition of shares unless:

(a)         the value of the shares is derived principally from "real property" in Canada, including the right to explore for or exploit natural resources and rights to amounts computed by reference to production,
(b)         the shareholder was resident in Canada for 120 months during any period of 20 consecutive years preceding the disposition, or was a resident in Canada at any time during the 10 years immediately preceding, and the shares were owned by the shareholder when they ceased to be resident in Canada, or

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(c)         the shares formed part of the business property of a "permanent establishment" that the holder has or had in Canada within the 12 months preceding the disposition.

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

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 which generally have an investment grade rating of a minimum of A- and does not invest any significant deposits in any financial institutions with a rating below that investment grade. 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, $181,365 is covered by either the Financial Services Compensation Scheme in the United Kingdom or the Canada Deposit Insurance Corporation, leaving $4,508,990 at risk should the financial institutions with which the deposits are held cease trading.

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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, 2010, three customers each account for 10% or more of total trade accounts receivable (2009 - four customers).

Financial assets past due

At September 30, 2010, the Company has a provision of $176,531 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, 2010

Financial assets that are past due but not impaired

Neither past

due nor

impaired

31 - 60 days

61 - 90

        days

91 days +

Carrying value

on the balance

sheet

                $

Trade accounts receivable

3,520,349

136,997

982,557

609,371

5,249,274

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, 2010, 65% has been subsequently collected as at March 14, 2011. 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.

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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, 2010, the Company had a provision for doubtful accounts of $176,531 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, 2010 the weighted average interest rate of all cash equivalent investments was nil (2009: 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, 2010, through its wholly owned subsidiaries, the Company had cash and cash equivalents of $2,750,575, accounts receivable of $1,989,819 and accounts payable of $3,367,819 which were denominated in UK L . In addition, at September 30, 2010, the Company had cash and cash equivalents of $1,867,911, accounts receivable of $2,167,447 and accounts payable of $428,653 which were denominated in US$.

Sensitivity analysis

The Company has completed a sensitivity analysis to estimate the impact on net loss for the period which a change in foreign exchange rates or interest rates during the year ended September 30, 2010 would have had.

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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 loss

                       $

Change of +/- 10% in US$ foreign exchange rate

+/- 360,670

Change of +/- 10% in UK L foreign exchange rate

+/- 577,944

The above results arise primarily as a result of the Company having US$ and UK L 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.
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

74

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, 2010. 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, 2010.

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, 2010 using criteria established in Internal Control - Integrated Framework issued 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, 2010.

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, 2010, the Company continues to meet the definition of a non-accelerated filer.

75

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, 2010 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 Robert Chisholm (Chairman), Peter Scarth, Peter Fitzgerald and Thomas Nielsen.
Our Board of Directors has determined that Robert Chisholm and Peter Fitzgerald each qualify as a "financial expert", however, neither is independent according to the standards for audit committee member independence prescribed by the American Stock Exchange.
Two members of the audit committee are independent (being Peter Scarth and Thomas Nielson) and all audit committee members are financially literate.
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.
76

Relevant Education and Experience
Peter Fitzgerald obtained his M.S.C. from the Massachusetts Institute of Technology, MASS., USA in 1989; a PMD from the Harvard Business School in 1983; and an FCCA from the Chartered Association of Certified Accountants in 1973. In his previous employment, Mr. Fitzgerald was CEO of Gretag Imaging and prior to this CEO of Qualex, the Eastman Kodak proto-processing subsidiary.
Peter Scarth obtained his Professional Engineering designation, in Chemical Engineering in 1969 from Queens University. Mr Scarth is a retired businessman, but in his previous employment he was President & CEO of the Company from March 2001 to October 2004 and was Vice President and Business Manager, Consumer Imaging and Vice President of the Motion Picture division within Kodak Canada.
Thomas Neilsen obtained his Bachelor of Computer Science in 1990 from the Tietgenskolen, EDB-skolen, Denmark. Mr. Neilsen is currently the Director of Engineering for Adobe Systems Incorporated Creative Professional Business Unit. Prior to Adobe, Mr. Neilsen led the Windows Printing and Imaging and Windows Digital Document teams at Microsoft.
Robert Chisholm received his Bachelor of Business Administration from Saint Francis Xavier University in Nova Scotia in 1984 and holds a professional accounting designation from the Certified Management Accountants of Canada. Mr. Chisholm was the former Chief Financial Officer ("CFO") of the Company from 2001 to 2009 and currently acts as the CFO for a number of public and private companies.
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.

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.
77

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 $275,000 and CDN$374,000 for the fiscal years ended 2010 and 2009, respectively.

B.        Audit-Related Fees

The aggregate fees billed by our auditors for audit-related fees were CDN$nil and CDN$22,000 for the fiscal years ended 2010 and 2009, respectively and related to review engagements carried out with regards to certain of our quarterly financial statements.
C.        Tax Fees

The aggregate fees billed by our auditors for tax fees were CDN$nil and CDN$9,000 for the fiscal years ended 2008 and 2007, respectively.
D.        All Other Fees

The aggregate fees billed by our auditors for other services were CDN$59,000 and CDN$nil for the fiscal years ended 2010 and 2009, 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, 2010.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not Applicable
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not Applicable
78

ITEM 16F. CHANGE IN REGISTRANT'S CERTIFYING ACCOUNTANT.
Not Applicable
ITEM 16G. CORPORATE GOVERNANCE.
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 are expressed in Canadian dollars and are prepared in accordance with Canadian Generally Accepted Accounting Principles or Canadian GAAP. See Note 16 to the consolidated financial statements for a reconciliation of the measurement differences between Canadian and US GAAP, as they relate to us.
The financial statements and notes thereto as required under Item 18 are attached hereto and are found immediately following the text of this annual report.
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)

4.1

The Services and Software Agreement with CVS Pharmacy, Inc., dated February 1, 2006.* (2)

4.2

The Toronto Co-Located Hosting Agreement with TELUS Communications Inc., dated November 19, 2007. This agreement is for a 60 month period commencing January 15, 2008.*(3)

4.3

The Vancouver Co-Located Hosting Agreement with TELUS Communications Inc., dated November 20, 2007. This agreement is for a 34 month period commencing December 1, 2007.*(3)

79

Exhibit Number

Description

4.4

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)

4.5

The Services Agreement with Sam's West Inc., dated January 23, 2008.*(4)

4.6

The Amended and Restated Services Agreement with Wal-Mart Canada Corp., dated January 31, 2008.*(4)

4.7

The Internet Photo Services Agreement with Costco Wholesale Corporation, dated April 29, 2008.*(4)

4.8

The Master Equipment Lease Agreement with Relational Funding Canada Corp., dated March 10, 2008.*(4)

4.9

The lease renewal and modification agreement for our executive offices in Canada with The Old BC Electric Building Corp., dated June 11, 2009.*(5)

4.10

The lease agreement for our support offices in Canada with The Old BC Electric Building Corp., dated July 26, 2010. (1)

4.11

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. *(5)

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)

_____________________
(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.

80

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.

Date:   March 28, 2011

PNI DIGITAL MEDIA INC.

(Registrant)

By:       "Thomas Kyle Hall"

             Thomas Kyle Hall

             Chief Executive Officer

81

PNI Digital Media Inc.

Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

MANAGEMENT'S 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 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:

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

(b) 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

(c) 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.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management has assessed the effectiveness of our internal control over financial reporting as of September 30, 2010 using criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO" Report").

Based on our assessment and those criteria, management believes that PNI Digital Media Inc. maintained effective internal control over financial reporting as of September 30, 2010.

Kyle Hall

Chief Executive Officer

Vancouver, Canada

December 9, 2010

Simon Bodymore

Chief Financial Officer

PricewaterhouseCoopers LLP

Chartered Accountant

PricewaterhouseCoopers Place

250 Howe Street, Suite 700

Vancouver, British Columbia

Canada V6C 3S7

Telephone +1 604 806 7000

Facsimile +1 604 806 7806

December 9, 2010

To the Shareholders of PNI Digital Media Inc.

We have audited the consolidated balance sheets of PNI Digital Media Inc. as at September 30, 2010 and September 30, 2009 and the consolidated statements of earnings (loss) and comprehensive gain (loss), statements of deficit, shareholders' equity and statements of cash flow for each of the years in the three year period ended September 30, 2010. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these 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 an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at September 30, 2010 and September 30, 2009 and the results of its operations and its cash flows for each of the years in the three year period ended September 30,2010 in accordance with Canadian generally accepted accounting principles.

Signed "PricewaterhouseCoopers LLP"

Chartered Accountants

"PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

PNI Digital Media Inc.

Consolidated Balance Sheets

As at September 30, 2010 and 2009

(expressed in Canadian dollars)

September 30, 2010

September 30, 2009

Assets

Current assets

   Cash and cash equivalents

$ 4,690,355

$ 4,237,284

   Accounts receivable (note 5)

5,302,865

4,855,114

   Prepaid expenses and other current assets

541,026

312,687

   Current portion of future income tax asset (note 11)

1,026,651

             -

11,560,897

9,405,085

Property and equipment (note 6)

5,230,829

6,174,920

Future income tax asset (note 11)

4,953,934

-

Intangible assets (note 7)

1,115,794

3,892,211

Goodwill (note 8)

658,904

1,664,759

$ 23,520,358

$ 21,136,975

Liabilities

Current liabilities

   Accounts payable and accrued liabilities (note 9)

$ 5,471,878

$ 7,785,812

   Purchase consideration payable (note 3)

-

869,803

   Current portion of deferred revenue

613,081

410,088

   Current portion of capital lease obligations (note 15)

107,964

490,072

   Loan payable (note 16)

-

937,548

   Asset retirement obligation (note 10)

-

41,503

   Future income tax liability (note 11)

119,081

             -

6,312,004

10,534,826

Deferred revenue

78,876

195,059

Long-term portion of capital lease obligations (note 15)

-

38,500

Restructuring liability (note 4)

             -

176,056

6,390,880

10,944,441

Shareholders' Equity (note 12)

Share capital

$ 66,200,215

$ 66,017,456

Contributed surplus

18,933,619

18,521,086

85,133,834

84,538,542

Deficit

(65,684,820)

(72,536,814)

Accumulated other comprehensive loss

(2,319,536)

(1,809,194)

(68,004,356)

(74,346,008)

17,129,478

10,192,534

$ 23,520,358

$ 21,136,975

Approved by the Board of Directors

           "Kyle Hall"                   Director

     "Peter Fitzgerald"                    Director

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

PNI Digital Media Inc.

Consolidated Statements of Earnings (Loss) and Comprehensive Gain (Loss)

For the Years Ended September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

2010

2009

2008

Revenue (note 13)

$ 25,356,570

$ 24,446,569

$ 17,049,587

Expenses

   Network delivery

5,376,920

6,672,583

7,409,525

   Software development

8,162,595

7,566,227

6,914,291

   General and administration

4,021,971

4,893,640

4,480,258

   Sales and marketing

896,791

1,202,699

1,140,028

   Amortization of intangible assets

2,550,452

3,243,359

3,214,908

   Amortization of property and equipment

2,368,539

2,770,357

2,044,145

23,377,268

26,348,865

25,203,155

Earnings (loss) from operations before the undernoted

1,979,302

(1,902,296)

(8,153,568)

Realized foreign exchange (loss) gain

(119,561)

115,526

53,818

Unrealized foreign exchange gain

304,331

435,467

407,223

Interest income

642

8,759

134,848

Interest expense - capital lease

(75,850)

(120,696)

(109,383)

Interest expense - other

(1,839)

(99,255)

(13,809)

(Loss) on disposal of property and equipment

(40,085)

(56,171)

(35,698)

(Loss) gain on settlement of asset retirement obligation

(4,810)

-

86,120

Goodwill impairment (note 8)

         -

         -

(1,086,577)

62,828

283,630

(563,458)

Earnings (loss) before income taxes

2,042,130

(1,618,666)

(8,717,026)

Current income tax (expense) (note 11)

(11,892)

-

-

Future income tax (expense) benefit (note 11)

4,821,756

(151,000)

         -

Net earnings (loss)

6,851,994

(1,769,666)

(8,717,026)

Other comprehensive loss:

Unrealized foreign exchange loss on translation of self-

      sustaining foreign operations

(510,342)

(652,661)

(346,964)

Comprehensive gain (loss)

$ 6,341,652

$ (2,422,327)

$ (9,063,990)

Earnings (loss) per share (note 12h)

Basic

$ 0.20

$ (0.05)

$ (0.26)

Fully diluted

$ 0.20

$ (0.05)

$ (0.26)

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

PNI Digital Media Inc.

Consolidated Statements of Deficit

For the Years Ended September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

2010

2009

2008

Balance, beginning of year

$ (72,536,814)

$ (70,767,148)

$ (62,050,122)

Net earnings (loss) for the year

6,851,994

(1,769,666)

(8,717,026)

Balance, end of year

$ (65,684,820)

$ (72,536,814)

$ (70,767,148)

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

PNI Digital Media Inc.

Consolidated Statements of Shareholders' Equity

For the Years Ended September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Share capital

Number of

Common

Shares

Amount

Share capital purchased for

cancellation

Contributed

surplus

Warrants

Deficit

Accumulated other comprehensive

loss

Total

shareholders

equity

Balance September 30,

   2007

33,315,536

$ 65,293,214

-

$ 10,215,777

$ 4,961,826

$ (62,050,122)

$ (809,569)

$ 17,611,126

Issuance of shares on

   exercise of options

148,896

321,133

-

(116,116)

-

-

-

205,017

Stock-based compensation

   recorded in net loss

-

-

1,511,504

-

-

-

1,511,504

Net loss

-

-

-

-

-

(8,717,026)

-

(8,717,026)

Other comprehensive loss

            -

            -

            -

            -

            -

            -

(346,964)

(346,964)

Balance September 30,

   2008

33,464,432

$ 65,614,347

-

$ 11,611,165

$ 4,961,826

$ (70,767,148)

$ (1,156,533)

$ 10,263,657

Issuance of shares on

   exercise of options

28,750

111,045

-

(67,920)

-

-

-

43,125

Stock-based compensation

   recorded in net loss

-

-

-

1,846,293

-

-

-

1,846,293

Compensation expense in

   connection with

   acquisition of

   WorksMedia Limited

   (note 3)

-

-

-

169,722

-

-

-

169,722

Issuance of shares on

   acquisition of

   WorksMedia Limited

   (note 3)

214,500

292,064

-

-

-

-

-

292,064

Net loss

-

-

-

-

-

(1,769,666)

-

(1,769,666)

Expiry of warrants (note 12

   (c))

-

-

-

4,961,826

(4,961,826)

-

-

-

Other comprehensive loss

            -

            -

            -

            -

            -

            -

(652,661)

(652,661)

Balance September 30,

   2009

33,707,682

$ 66,017,456

$         -

$ 18,521,086

$         -

$ (72,536,814)

$ (1,809,194)

$ 10,192,534

Issuance of shares on

   exercise of options

37,600

70,686

-

(14,811)

-

-

-

55,875

Stock-based compensation

   recorded in net earnings

-

-

-

399,068

-

-

-

399,068

Compensation expense in

   connection with

   acquisition of

   WorksMedia Limited

   (note 3)

-

-

-

290,952

-

-

-

290,952

Issuance of shares held in

   escrow (note 12f)

178,500

290,952

-

(290,952)

-

-

-

-

Cancellation of shares

   repurchased

(70,000)

(136,970)

-

28,276

-

-

-

(108,694)

Purchase of share capital

   for cancellation (30,000

   shares)

-

-

(41,909)

-

-

-

-

(41,909)

Net earnings

-

-

-

-

-

6,851,994

-

6,851,994

Other comprehensive loss

            -

            -

            -

            -

            -

            -

(510,342)

(510,342)

Balance September 30,

   2010

33,853,782

$ 66,242,124

$ (41,909)

$ 18,933,619

$            -

$ (65,684,820)

$ (2,319,536)

$ 17,129,478

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

PNI Digital Media Inc.

Consolidated Statements of Cash Flows

For the Years Ended September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

2010

2009

2008

Cash flows from operating activities

   Net earnings (loss) for the year

$ 6,851,994

$ (1,769,666)

$ (8,717,026)

   Items not affecting cash

      Amortization

4,918,991

6,013,716

5,259,053

      Stock-based compensation expense

690,020

2,016,015

1,511,504

      Unrealized foreign exchange (gain) loss

(304,331)

(435,467)

(407,223)

      Allowance for doubtful accounts

33,781

9,945

122,659

      Loss on disposal of property and equipment

40,085

56,171

35,698

      Loss (gain) on settlement of asset retirement

            obligations

4,810

-

(86,120)

      Provision for unrecoverable lease payments

-

185,848

-

      Goodwill impairment

-

-

1,086,577

      Future income tax expense (benefit) (note 11)

(4,821,756)

151,000

-

      Accretion and other items

79,426

29,201

5,186

7,493,020

6,256,763

(1,189,692)

   Net change in non-cash working capital

   items (note 18)

(2,778,275)

(715,432)

654,098

   Payments for unrecoverable lease payments

(180,336)

-

-

   Payments made to settle asset retirement obligations

(45,071)

         -

(36,311)

4,489,338

5,541,331

(571,905)

Cash flows from investing activities

   Purchase of property and equipment

(1,468,825)

(2,182,637)

(4,762,168)

   Proceeds on disposal of property and equipment

-

-

25,652

   Payments made to acquire WorksMedia Limited, net of

      cash acquired

         -

(1,157,501)

         -

(1,468,825)

(3,340,138)

(4,736,516)

Cash flows from financing activities

   Proceeds on exercise of options

55,875

43,125

205,017

   Issuance of common shares (note 3)

-

(7,813)

-

   Repurchase of common shares

(150,603)

-

-

   (Repayment) advance of loan payable

(937,548)

-

943,450

   Repayment of capital lease obligations

(396,186)

(337,375)

(382,517)

   Repayment of loan used to finance the acquisition of

      WorksMedia Limited

(936,343)

         -

         -

(2,364,805)

(302,063)

765,950

Effect of changes in foreign exchange rates on cash and

      cash equivalents

(202,637)

(332,834)

(191,575)

Increase (decrease) in cash and cash equivalents

      during the year

453,071

1,566,296

(4,734,046)

Cash and cash equivalents - beginning of year

4,237,284

2,670,988

7,405,034

Cash and cash equivalents - end of year

$ 4,690,355

$ 4,237,284

$ 2,670,988

Supplementary cash flow information is included in note 18

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

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

1.     Nature of operations

On June 4, 2009, the Company changed its name from PhotoChannel Networks Inc. to PNI Digital Media Inc.

PNI Digital Media Inc. (the "Company") offers the photofinishing retailer and its customers an online and in-store solution for producing prints and gifting products from their digital images. The Company's online platform electronically connects the photofinishing retailer and its customers through the internet and provides digital image delivery, hosting, transaction processing and storage. In addition, the Company provides the photofinishing 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 consolidation

These consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") in Canada, and include the accounts of the Company and each of its wholly-owned subsidiaries, PhotoChannel Capital Inc., PhotoChannel Management Inc., PNI Digital Media Ltd., PNI Digital Media Europe Ltd., Pixology Incorporated and WorksMedia Limited. The results of WorksMedia Limited have been included since the date of acquisition, March 11, 2009.

All material intercompany balances and transactions are eliminated upon consolidation.

b)   Use of estimates

The preparation of consolidated financial statements in conformity with GAAP 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. Significant areas requiring the use of estimates and assumptions include the determination of the fair value of assets and liabilities acquired in a business combination, the determination of the recoverable amounts for property and equipment and intangible assets, impairment of goodwill, the determination of future income taxes and the determination and classification of stock-based transactions. Actual results may differ from those estimates.

c)   Reporting currency and foreign currency translation

These consolidated financial statements are reported in Canadian dollars. Foreign currency denominated revenues and expenses are translated using average rates of exchange during the year. Foreign currency denominated assets and liabilities are translated at the rate of exchange in effect at the balance sheet date.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The Company translates the assets and liabilities of self-sustaining foreign operations to Canadian dollars at the rate of exchange prevailing at the balance sheet dates and revenues and expenses of those operations are translated using the average rates of exchange during the year. Gains and losses resulting from these translation adjustments for self-sustaining foreign operations are recorded in accumulated other comprehensive income, a component of shareholders' equity, until there is a realized reduction in the net investment in the foreign operation.

d)   Cash and cash equivalents

Cash and cash equivalents consist of cash on deposit and highly liquid short-term interest bearing securities with maturities at the date of purchase of three months or less. Investments with an original maturity of more than three months are designated short-term held for trading securities which are measured at fair value with changes in fair value recorded in net loss. As at September 30, 2010 and 2009, the Company had no investments in interest bearing securities with original terms to maturity of greater than three months.

e)   Property and equipment

Property and equipment are recorded at cost less accumulated amortization. Amortization is provided over the estimated useful lives of the assets at the following rates:

Computer equipment

30% declining balance

Software

33-1/3 % - 100% straight-line

Furniture and office equipment

20% declining balance

Leasehold improvements

Life of the lease

Equipment held under capital lease

Life of the lease

The Company assesses the carrying value of long-lived assets for recoverability whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If the total value of the estimated future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss equal to the difference between the asset carrying amount and its fair value is recognized in the period in which the impairment determination is made.

f)   Goodwill

Goodwill represents the excess of the purchase price of an acquired enterprise over the fair values assigned to the assets acquired and liabilities assumed in a business combination. Goodwill is not amortized and is subject to an impairment test at the reporting unit level at least annually or more frequently if events or circumstances suggest that there may be an impairment. If the carrying amount exceeds the fair value of the goodwill, an impairment loss is recognized equal to that excess through the statement of earnings (loss).

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

g)   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 and customer relationships, are amortized on a straight-line basis over their estimated useful lives of three years. The amortization methods and estimated useful lives of intangible assets are reviewed annually.

The Company assesses the carrying value of long-lived assets for recoverability whenever events or changes in circumstances indicate that the carrying value may not be recoverable from future undiscounted cash flows. If the carrying amount exceeds the fair value of the intangible asset, an impairment loss is recognized equal to that excess through the statement of earnings (loss).

h)   Asset retirement obligations

The Company recognizes asset retirement obligations with respect to the restoration of leased office premises at the end of the lease term back to their original condition. The Company estimates fair value by determining the current market cost required to settle the asset retirement obligation, adjusts for inflation through to the expected date of the expenditures and discounts this amount back to the date when the obligation was originally incurred. As the liability is initially recorded on a discounted basis, it is increased each period until the estimated date of settlement. The Company reviews asset retirement obligations on a periodic basis and adjusts the liability as necessary to reflect changes in the estimated amount and timing of future cash flows underlying the initial fair value measurement.

i)   Income taxes

The Company uses the liability method of accounting for income taxes. Under the liability method, future 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. Future tax assets and liabilities are measured using substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of substantive enactment. A valuation allowance is recognized to the extent the recoverability of future income tax assets is not considered more likely than not.

The Company accounts for uncertainty related to income taxes through the recognition of the effect of uncertain tax positions where it is more likely than not based on the technical merits that the position would be sustained. The Company recognizes the amount of the tax benefit that has a greater than 50 percent likelihood of being realized upon settlement. The Company recognizes any change in judgment related to the expected resolution of uncertain tax positions in the year such a change occurs. Accrued interest and penalties related to unrecognized tax benefits are recorded in income tax expense in the current year.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

j)   Share issue costs

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

k)   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 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 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, 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

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 and 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 element 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 or in the absence of fair value of the undelivered item, the entire consideration is deferred and recognized when the overall revenue recognition criteria for the revenue contract as a whole is met. The Company does not currently have any multiple deliverable arrangements which require the use of the residual approach or deferral of the overall consideration.

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 36 months.

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

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

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.

Professional services are recognized when the services are completed and included in professional 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.

l)   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 and maintaining 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 technical feasibility of completing the software so it will be available for use or sale; its intention to complete the software and use or sell it; its ability to use or sell the software; how the software will generate probable future economic benefits; the availability of adequate technical, financial and other resources to complete the development and use and sell the software; and its ability to measure reliably the expenditure attributable to the software during development. If these criteria are not met, the development costs are expensed when incurred for both costs of developing the Company's software used directly in the PNI Network and the software which is sold to customers or customized for customers.

m)   Stock-based compensation

The Company grants stock options 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. 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

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 and an expected dividend yield. The Company estimates the expected term of the options granted by calculating the average term after considering the Company's historical experience involving stock option exercise; cancellations, forfeitures and expiries; volatility is estimated with reference to historical volatility 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 12(e). 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.

n)   Leases

Leases entered into are classified as either capital or operating leases. Leases that transfer substantially all of the benefits and risks of ownership of property to the Company are accounted for as capital leases. Property acquired under capital leases is recorded as an asset on the balance sheet with a corresponding increase to the capital lease obligation and depreciated over the life 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

o)   Financial instruments

Classification of financial instruments

The Company has made the following classifications for its financial instruments:

Cash and cash equivalents are classified as "Held-for-trading" financial assets and are measured at fair value at the end of each period with any change in fair value recognized in the statement of earnings (loss);

Accounts receivable are classified as "Loans and receivables" and are recorded at amortized cost using the effective interest rate method. Subsequent measurement of trade receivables is at amortized cost, less an allowance for doubtful accounts;

Accounts payable and accrued liabilities are classified as "Other financial liabilities" and are measured at amortized cost using the effective interest rate method;

Loan payable, including accrued interest and purchase consideration payable are classified as financial liabilities and are measured at amortized cost using the effective interest rate method;

Transaction costs incurred to acquire financial instruments are recorded through the statement of earnings (loss)

p)   Net earnings (loss) per share

Basic net earnings (loss) per share is computed using the weighted average number of common shares outstanding during the period. The treasury stock method is used for calculation of diluted net earnings per share. 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.

At September 30, 2010, nil warrants (2009 - nil; 2008 - 4,857,147) and 2,775,769 options (2009 - 3,286,780; 2008 - 2,883,869) were outstanding. The options were included in the calculation of diluted earnings per share for the year ending September 30, 2010; whereas the warrants and options were excluded from the calculation of diluted earnings (loss) per share for the years ending September 30, 2009 and September 30, 2008 respectively, as their effects would be anti-dilutive.

q)   Current year accounting changes

Financial Instruments: Disclosures

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Effective October 1, 2009, the Company adopted the amendments included in the CICA Handbook Section 3862 Financial Instruments: Disclosures ("Section 3862"). The amendments require an entity to provide disclosure on financial instruments measured at fair value on its balance sheet using a fair value hierarchy that reflects the extent to which quoted prices or other market or non-market inputs are used in the valuation of those financial instruments. The amendments also expand existing liquidity disclosure requirements and require a maturity analysis for any derivative and non financial liabilities based on expected maturities. The adoption of this amendment did not result in any additional disclosures required in these financial statements.

r)   Recently issued accounting standards

CICA Handbook Sections 1582, Business Combinations; 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests

In January 2008, the CICA issued Handbook Sections 1582, Business Combinations; 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests. These sections replace the former CICA Handbook Section 1581, Business Combinations and CICA 1600, Consolidated Financial Statements and establish a new section for accounting for a non-controlling interest in a subsidiary. These sections also provide the Canadian equivalent to IFRS 3, Business Combinations and IAS 27, Consolidated and Separate Financial Statements.

CICA 1582 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after January 1, 2011. CICA 1601 and CICA 1602 apply to interim and annual consolidated financial statements relating to years beginning on or after January 1, 2011.

Management is currently in the process of determining the impact of these recently issued CICA Handbook Sections on the Company's consolidated financial statements.

EIC 175, Revenue Arrangements with Multiple Developments

In December 2009, the CICA issued Emerging Issue Committee Abstract ("EIC") 175, Revenue Arrangement with multiple Deliverables an amendment to EIC 142, "Revenue Arrangements with Multiple Deliverables". EIC 175 provides guidance on certain aspects of the accounting for arrangements under which the Company will perform multiple revenue-generating activities. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. EIC 175 also includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. EIC 175 is effective prospectively, with retrospective adoption permitted, for revenue arrangements entered into or materially modified in fiscal years beginning on or after January 1, 2011.

Management is currently in the process of determining the impact of this EIC on the Company's consolidated financial statements.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

3.     Acquisitions

WorksMedia Limited

After close of business on March 10, 2009, the Company completed its acquisition of WorksMedia Limited ("WorksMedia"), a private company incorporated in England and Wales and a provider of photo kiosk and desktop photography software.

The acquisition of WorksMedia provided the Company with additional software technology and key personnel in addition to an established customer base across a wide geographic area.

In consideration for the shares of WorksMedia, the Company paid the vendors the Sterling equivalent of $2.1 million based upon the exchange rate published by the Bank of England on February 25, 2009, in 13 equal monthly installments (the "Cash Payment"(s)), with the first installment having been paid on closing and issue 750,000 common shares of the Company. All of these common shares issued as part of the acquisition have been placed in escrow and will be released in three (3) equal installments of 250,000 common shares on March 10, 2010, 2011 and 2012 pursuant to an escrow agreement among the Company, the vendors and the Company's counsel (the "Escrow Agreement"). The shares will be released to the previous shareholders' of WorksMedia in direct proportion to their shareholding in that company immediately prior to the acquisition taking place. However, as part of the share purchase agreement entered into between the Company and the vendors, in order to receive their portion of the share consideration, three of the vendors (the "Principal Vendors"), who collectively controlled 71.40% of WorksMedia prior to acquisition, will be required to remain in the employment of the Company post-acquisition. Should any of these vendors choose to terminate their employment with the Company prior to the release of the shares from escrow, they will immediately forfeit their right to their proportion of the shares and those shares will then be returned to the Company and cancelled.

Of the 750,000 common shares issued as part of the acquisition, 214,500 (28.6%) have been included as part of the purchase consideration while the remaining 535,500 (71.4%) which will only be released from escrow upon the continued employment of the Principal Vendors will be treated as compensation expense of those vendors and will be expensed to the statement of earnings (loss) over the three year period ending March 10, 2012 at an approximate amount of $72,000 per quarter. During the year ended September 30, 2010, $290,952 (2009: $169,722) was recorded as compensation expense.

The 214,500 common shares issued were assigned a fair value of $1.40 per share using the average closing price of the Company's common shares over a five day period both before and after February 25, 2009, the announcement date of the acquisition, and after taking into consideration the Escrow Agreement in place that restricts the issuance over a three year period and the liquidity risks associated with the number of shares issued.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The 535,500 common shares issued which will be released from escrow subject to the continuing employment of the Principal Vendors have been valued using the market value at the date of the grant of $1.63.

Share issuance costs of $7,813 have been recorded against the issuance of the 750,000 common shares.

If the Company fails to make a Cash Payment, the vendors will have the right to the return of the WorksMedia business, and will retain all Cash Payments made and PNI Digital Media shares issued to the vendors in connection with the acquisition. The Cash Payments are secured by a debenture over all of the assets of WorksMedia in favour of the vendors. As additional security for the balance of the cash portion of the consideration, all of the shares of WorksMedia have been placed in escrow with the vendors' solicitor pursuant to a business escrow agreement among the Company, the vendors and the vendor's solicitor (the "Business Escrow Agreement"). The shares of WorksMedia will remain in escrow with the vendor's Solicitor until all of the Cash Payments have been made, at which point the WorksMedia shares will be released from escrow to the Company. The vendors will be entitled to retain all Cash Payments made and shares issued to them before the WorksMedia shares are released to them under the Business Escrow Agreement.

In addition, as further consideration for the acquisition, the share purchase agreement provides for the issuance of up to an additional 900,000 common shares of the Company to the vendors over a period of three years from closing (the "Contingent Consideration"). The amount of Contingent Consideration to be issued is based on specific pre-determined annual performance targets. Any contingent consideration earned by the Principal Vendors in accordance with this share purchase agreement is subject to their continued employment with the Company post acquisition. No common shares were issued upon the passing of the first anniversary of the acquisition of WorksMedia as the pre-determined annual performance target was not met.

Transaction costs of $221,443 were directly incurred with respect to the acquisition and have been included as part of the purchase price.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The purchase price allocation summarizing the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition is as follows:

Purchase consideration

      Paid in cash

161,538

      Loan payable

1,848,552

$ 2,010,090

Purchase consideration - shares issued

299,877

Transaction costs

221,443

2,531,410

Assets acquired and liabilities assumed

Cash and cash equivalents

208,597

Other current assets

451,093

Property and equipment

44,048

Intangible assets - Customer contracts

1,734,000

Intangible assets - acquired software

841,000

Goodwill

638,225

Current liabilities

(651,589)

Future income tax liability

(733,964)

$ 2,531,410

Subsequent to the acquisition, the future income tax liability was offset against the future income tax asset arising from the utilization of losses in Pixology (notes 7 and 8).

Intangible assets acquired are being amortized over a three year period, commencing March 2009.

None of the goodwill arising on the acquisition of WorksMedia is deductible for tax purposes.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

4.     Restructuring

In February 2009, following the announcement of it's acquisition of WorksMedia, the Company announced its intention to undergo a restructuring of its United Kingdom operations and to relocate its Pixology operations from Guildford to the WorksMedia offices in Southampton. In conjunction with this restructuring an immediate reduction in UK based headcount of approximately 30% was made. All remaining UK based employees were offered positions in the Company's Southampton office and operations were relocated from the Guildford office to that location.

A number of costs were incurred relating to the restructuring as follows.

The redundancy, unrecoverable lease costs and other associated costs were recorded as operating costs in the Consolidated Statement of Earnings (loss) during the year ended September 30, 2009 as follows:

2009

Network delivery

$ 12,979

Software development

39,951

General and administration

205,276

$ 258,206

A reconciliation of the opening and closing liability balances relating to the above costs during the year ended September 30, 2010 and September 30, 2009 is as follows:

2010

Opening liability - October 1, 2009

$ 176,056

Accretion expense included in general and administration expenses

1,352

Settlement of liability

(180,336)

Loss on settlement of lease obligation included in general and administration expenses

8,200

Impact of foreign currency translation

(5,272)

Closing liability - September 30, 2010

$              -

2009

Opening liability - October 1, 2008

$                  -

Charged to expenses re. unrecoverable lease costs

185,848

Impact of foreign currency translation

(9,792)

Closing liability - September 30, 2009

$ 176,056

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

During March 2010, the Company entered into a deed of surrender (the "deed) with the landlord of its Guildford property. Under the terms of this deed the Company made a one-off payment of L 57,477 ($96,418) and in return was released from all obligations under the lease that had previously been entered into.

The final settlement of the liability relating to the office move resulted in $8,200 of costs in excess of the original liability being incurred. These costs were recorded in general and administration expenses during the year.

5.     Accounts receivable

As at September

     30, 2010

As at September

     30, 2009

Trade accounts receivable

$ 5,425,805

$ 4,954,122

Allowance for doubtful accounts

(176,531)

(154,945)

5,249,274

4,799,177

Commodity taxes recoverable

53,591

15,832

Other

               -

40,105

Total

$ 5,302,865

$ 4,855,114

Reconciliation of changes in allowance for doubtful accounts:

2010

2009

Balance, beginning of year

$ 154,945

$ 145,000

Increase in allowance for doubtful accounts

33,781

9,945

Write-off of bad debts

(9,945)

-

Impact of foreign currency translation

(2,250)

            -

Balance, end of year

$ 176,531

$ 154,945

6.     Property and equipment

2010



Cost



Accumulated amortization

Net book

value

Computer equipment

$ 14,844,050

$ (9,763,684)

$ 5,080,366

Software

949,844

(949,844)

-

Furniture and office equipment

416,077

(279,531)

136,546

Leasehold improvements

144,986

(131,069)

13,917

$ 16,354,957

$ (11,124,128)

$ 5,230,829

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

2009



Cost



Accumulated amortization

Net book

value

Computer equipment

$ 13,838,160

$ (7,783,378)

$ 6,054,782

Software

814,744

(810,915)

3,829

Furniture and office equipment

364,520

(248,211)

116,309

Leasehold improvements

129,988

(129,988)

            -

$ 15,147,412

$ (8,972,492)

$ 6,174,920

Included within Computer equipment are assets with a net book value of $195,864 (2009 - $624,230) which were acquired using a capital lease.

For the year ended September 30, 2010, amortization of property and equipment was $2,368,539 (2009- $2,770,357; 2008 - $2,044,145), of which $403,945 (2009 - $416,156; 2008 - $212,706) related to assets held under capital leases.

7.     Intangible assets

2010



Acquired software

Customer relationships

Total



Balance, September 30, 2009

$ 1,219,809

$ 2,672,402

$ 3,892,211

Recognition of future income tax asset to offset current year income taxes payable

(89,266)

-

(89,266)

Amortization

(702,152)

(1,848,300)

(2,550,452)

Impact of foreign currency translation

(64,143)

(72,556)

(136,699)

Balance, September 30, 2010

$ 364,248

$ 751,546

$ 1,115,794

An adjustment was made to the carrying value of intangible assets totalling $89,266, representing the application of Pixology loss carry-forwards to eliminate the future income tax liability arising upon the current year income tax expense of Pixology.

2009



Acquired software

Customer relationships

Total



Balance, September 30, 2008

$ 2,107,825

$ 3,056,667

$ 5,164,492

Acquisition of WorksMedia Ltd (note 3)

841,000

1,734,000

2,575,000

Adjustment upon acquisition of WorksMedia

(301,390)

-

(301,390)

Recognition of future income tax asset to offset current year income taxes payable

(151,000)

-

(151,000)

Amortization

(1,149,541)

(2,093,818)

(3,243,359)

Impact of foreign currency translation

(127,085)

(24,447)

(151,532)

Balance, September 30, 2009

$ 1,219,809

$ 2,672,402

$ 3,892,211

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Two adjustments were made to the carrying value of intangible assets totalling $452,390 during the year ended September 30, 2009, representing the application of Pixology loss carry-forwards to eliminate the future income tax liability arising from the acquisition of WorksMedia (note 3) and the current year income tax expense of Pixology.

The acquired software and the customer relationship are being amortized on a straight-line basis over a three year period.

Expected amortization in future years is as follows:

Amount

2011

$ 787,613

2012

328,181

$ 1,115,794

8.     Goodwill

2010

Amount

Balance, September 30, 2009

$ 1,664,759

Recognition of future income tax asset to offset current year income taxes payable

(274,462)

Recognition of future income tax asset

(674,690)

Impact of foreign currency translation

(56,703)

Balance, September 30, 2010

$ 658,904

During the year, two adjustments were made to the carrying value of goodwill totalling $949,152. The first adjustment of $274,462 represents the application of Pixology loss carry-forwards to eliminate the current year income taxes payable of Pixology. The second adjustment of $674,690 represents the application of the future tax asset arising from the amount of Pixology loss carry-forwards the Company considers more likely than not to be utilized.

2009

Amount

Balance, September 30, 2008

$ 1,498,539

Acquisition of WorksMedia Ltd. (note 3)

638,225

Adjustment to previously purchased goodwill upon acquisition of WorksMedia

(432,574)

Impact of foreign currency translation

(39,431)

Balance, September 30, 2009

$ 1,664,759

Upon acquisition of WorksMedia, the goodwill was allocated to the group's reporting units on a relative fair value basis.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

An adjustment of $432,574 was made to the carrying value of goodwill, representing the application of Pixology loss carry-forwards to eliminate the future income tax liability arising from the acquisition of WorksMedia (note 3).

During the year ended September 30, 2008 a review of the carrying value of goodwill was completed and it was determined that the amount allocated to the Company's subsidiary, Pixology was impaired and that $1,086,577 should be written off. This impairment arose as a result of planned development synergies not materializing to the extent assumed at the time of the acquisition; cost reductions implemented subsequent to acquisition resulting in the operations reaching a break-even position, but being insufficient to result in the Company being able to sustain profitable operations on a recurring basis; and the loss, subsequent to acquisition of a number of customers.

9.     Accounts payable and accrued liabilities

As at September

30, 2010

As at September

30, 2009

Trade payables

$ 1,012,246

$ 1,691,363

Amounts due to customers

3,190,355

4,878,169

Trade accruals

314,022

318,860

Accrued payroll and other taxes

417,240

476,269

Due to employees and consultants

538,015

421,151

Total

$ 5,471,878

$ 7,785,812

10.   Asset retirement obligation

The following table summarizes the changes in the balance of asset retirement obligation during the year ended September 30, 2010:

Balance, September 30, 2009

$ 41,503

Payments made for remediation work

(45,071)

Loss on settlement of asset retirement obligation

4,810

Impact of foreign currency translation

(1,242)

Balance, September 30, 2010

$               -

During the year ended September 30, 2008, the Company entered into a lease agreement for new premises. The lease agreement entered into, which had a term of five years, required the Company to restore the leased premises to their original condition at the end of the lease term. At September 30, 2009, the Company had vacated these premises. During March 2010, the Company completed all required work under the terms of its lease prior to entering into a deed of surrender with the landlord of the property. Total remediation costs of $45,071 were incurred during the year ended September 30, 2010.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

11.   Income taxes

a)   Income tax expense (recovery)

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

2010

2009

2008

Canadian statutory income tax rate

28.88%

30.25%

31.91%

Income tax expense (recovery) based on statutory income tax rate

$ 589,767

$ (489,646)

$(2,781,603)

Difference in foreign tax rates

(1,223)

27,097

92,173

Expiration of tax losses

-

-

1,420,273

Non-deductible expenses

291,268

592,330

571,630

Impact of change in tax rates on future tax assets

(17,035)

524,885

205,157

Adjustments in respect of prior year returns

(652,728)

577,399

540,184

Capital gain on expiration of unexercised stock purchase warrants

-

750,476

-

Allocation of acquisition future tax liability to future tax expense

-

151,000

-

Allocation of acquisition future tax liability to intangibles

-

(126,669)

-

Allocation of future tax asset to intangibles

89,266

-

-

Allocation of future tax asset to goodwill

274,462

-

-

Other

6,856

(2,188)

-

Change in valuation allowance

(5,390,497)

(1,853,684)

(47,814)

Income tax expense (recovery)

$ (4,809,864)

$ 151,000

$           -

The Company's earnings (loss) before tax includes $1,903,781 (2009 - $(414,362); 2008 - $(8,136,394)) from domestic operations and $138,349 (2009 - $(1,204,304); 2008 - $(580,632)) from foreign operations.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

b)   Future income tax assets and liabilities

The tax effect of temporary differences that give rise to significant portions of future income tax assets (liabilities) is as follows:

Future income tax assets

2010

2009

2008

Net operating loss carry-forwards

$ 6,944,472

$ 8,344,444

$ 11,881,567

Property and equipment

2,725,577

2,174,502

1,799,245

Share issue costs

107,611

243,506

412,936

Other

71,190

344,369

437,968

9,848,850

11,106,821

14,531,716

Future income tax liabilities

Intangible assets

(335,819)

(1,090,165)

(1,437,026)

Related party interest accrued

(105,216)

(106,964)

(94,079)

Net future tax asset

9,407,815

9,909,692

13,000,611

Valuation allowance

(3,546,311)

(9,909,692)

(13,000,611)

Future income tax assets, net

$ 5,861,504

$           -

$           -

As at September 30, 2010, the Company had $8,812,504 (2009 - $11,183,000) of net operating loss carry-forwards in Canada available to reduce taxable income in future years. These income tax losses expire as follows:

2015

$ 826,605

2026

2,072,638

2027

3,121,223

2028

2,792,038

$ 8,812,504

The Company has $17,235,764 ( L 10,591,633) of future losses for tax purposes in the United Kingdom that do not have an expiry date and which are available to reduce taxable trading income in future periods.

12.   Share capital

a)   Authorized

Unlimited number of common shares without par value

Unlimited number of preferred shares without par value

As at September 30, 2010, the Company had 34,210,782 common shares issued (2009 - 34,243,182) and 33,853,782 outstanding (2009 - 33,707,682). There are no preferred shares issued or outstanding at September 30, 2010, 2009 or 2008.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

b)   Private placements

Year ended September 30, 2007

During the year ended September 30, 2007, the Company issued 4,430,588 units pursuant to a brokered private placement for net proceeds of $16,025,308 and issued 426,559 warrants to agents in consideration for services received. Each unit consisted of one common share and one common share purchase warrant. Each common share purchase warrant entitles the holder to purchase one additional common share of the Company at a price of US$4.00 per share before expiry on March 30, 2009. The net proceeds of $16,025,308 were allocated $11,063,482 to common shares issued and $4,961,826 to the common share purchase warrants (note 12 (c)) on a relative fair value basis. The value allocated to the common share purchase warrants was determined using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of $nil; expected volatility of 72%; risk-free interest rate of 3.95%; and expected life of two years. Effective March 30, 2009 all of these warrants expired, unexercised.

c)   Warrants

The following table summarizes activity related to the Company's issued share purchase warrants during the years ended September 30, 2010, 2009 and 2008:

Number of warrants



Average exercise

price

Balance, September 30, 2007

4,857,147

$ 4.00

Balance, September 30, 2008

4,857,147

$ 4.00

Warrants expired, unexercised

(4,857,147)

4.00

Balance, September 30, 2009 and 2010

           -

$           -

d)   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% (3,385,378) 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. Under the terms of the Plan one-eighteenth of the options granted vest each month with the first eighteenth vesting on the date of grant.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The following table summarizes activity under the Company's stock option plan for the years ended September 30, 2010, 2009 and 2008:

Number of options



Average exercise

price

Balance, September 30, 2007 (1,273,609 options exercisable)

1,602,265

$ 1.81

   Granted

1,465,300

3.35

   Exercised

(148,896)

1.38

   Forfeited

(34,800)

3.11

Balance, September 30, 2008 (1,967,882 options exercisable)

2,883,869

$ 2.60

   Granted

690,000

1.62

   Exercised

(28,750)

1.50

   Forfeited

(258,339)

2.66

Balance, September 30, 2009 (2,815,484 options exercisable)

3,286,780

$ 2.37

   Granted

-

-

   Exercised

(37,600)

1.49

   Expired

(274,500)

1.50

   Forfeited

(198,911)

2.27

Balance, September 30, 2010

2,775,769

$ 2.48

The following table summarizes information about stock options outstanding and exercisable at September 30, 2010:

Options outstanding

Options exercisable

Exercise price

Number

outstanding

Weighted

average

remaining

contractual

life (years)

Weighted

average

exercise

price

Number

exercisable

Weighted

average

exercise

price

$ 1.25

306,776

0.43

$ 1.25

306,776

$ 1.25

$ 1.48

415,000

3.36

$ 1.48

415,000

$ 1.48

$ 1.50

25,000

3.85

$ 1.50

19,432

$ 1.50

$ 2.00

200,000

3.44

$ 2.00

200,000

$ 2.00

$ 2.32

671,993

1.20

$ 2.32

671,993

$ 2.32

$ 3.35

1,153,000

2.45

$ 3.35

1,153,000

$ 3.35

$ 3.65

4,000

2.54

$ 3.65

4,000

$ 3.65

$1.25 - $3.65

2,775,769

2.14

$ 2.48

2,770,201

$ 2.14

The total intrinsic value of options exercised during the year ended September 30, 2010 was $8,267 (2009 - $20,987; 2008 - $356,392). The intrinsic value is calculated as the difference between the market value on the date of exercise and the exercise price of the shares.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Number of shares

Weighted average exercise price

Weighted average remaining contractual life (years)

Aggregate intrinsic value

As at September 30, 2008

  Options outstanding

2,883,869

$ 2.60

3.49

$ 458,160

  Options vested and expected to

  vest

2,883,869

$ 2.60

3.49

$ 458,160

  Options exercisable

1,967,882

$ 2.25

3.04

$ 458,160

As at September 30, 2009

  Options outstanding

3,286,780

$ 2.37

2.97

$ 488,521

  Options vested and expected to

  vest

3,286,780

$ 2.37

2.97

$ 488,521

  Options exercisable

2,815,484

$ 2.48

2.72

$ 488,521

As at September 30, 2010

  Options outstanding

2,775,769

$ 2.48

2.14

$ 167,139

  Options vested and expected to

  vest

2,775,769

$ 2.48

2.14

$ 167,139

  Options exercisable

2,770,201

$ 2.48

2.14

$ 167,139

e) Stock-based compensation

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 the years ended September 30, 2010, 2009 and 2008:

2010

2009

2008

Expected volatility

-

74%

77%

Risk-free interest rate

-

1.91%

3.35%

Expected life (years)

-

4.0

4.0

Expected dividend yield

            -

   0%

   0%

Weighted average grant-date fair value ($ per share)

$            -

$ 0.83

$ 1.98

The total fair value of stock options granted during the year ended September 30, 2010 was $nil (2009 - $602,763; 2008 - $2,896,237).

During the year ended September 30, 2010, the Company recognized compensation expense of $399,068 (2009 - $1,846,293; 2008 - $1,511,504) for stock options issued to employees. The total income tax benefit recognized in the statement of earnings (loss) for stock-based compensation is $Nil for all periods presented.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

f) Shares held in escrow

In connection with the acquisition of WorksMedia Limited (note 3), 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 will only be released from escrow upon the continued employment of the Principal Vendors over a three year period.

On March 10, 2010, the Company released 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. As at September 30, 2010, 357,000 common shares remain in escrow and have been excluded from the number of common shares shown as outstanding and will only be recognized as they are released from escrow.

g) Normal course issuer bid

On April 15, 2010, the Company received approval from the TSX Venture Exchange ("TSX-V") for a Normal Course Issuer Bid (the "Bid") that enables the Company to purchase and cancel up to 340,000, or approximately 1%, of its outstanding common shares between May 1, 2010 and April 30, 2011. During the year ended September 30, 2010, the Company purchased 100,000 shares under the Bid for a total purchase price of $150,603. As at September 30, 2010, 70,000 of these shares have been cancelled.

On cancellation of these 70,000 shares, $28,276, being the difference between the purchase price and the average book value of the common shares was recorded as an adjustment to contributed surplus.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

h)   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, 2010

September

30, 2009

September

30, 2008

Net earnings (loss) for the year (numerator)

$ 6,851,994

$ (1,769,666)

$ (8,717,026)

Weighted average number of shares outstanding (denominator)

Basic

33,804,338

33,610,843

33,383,866

Effect of dilutive securities:

Stock options

104,014

           -

           -

Total

33,908,352

33,610,843

33,383,866

13.   Revenue

Description

2010

2009

2008

Transaction fees

$ 19,332,006

$ 18,153,082

$ 11,635,172

Software licences and installation fees

3,074,895

3,927,506

3,933,413

Membership fees

1,678,875

1,353,688

802,105

Archive fees

1,116,735

634,175

210,901

Professional fees

154,059

378,118

467,996

Total

$ 25,356,570

$ 24,446,569

$ 17,049,587

Product revenue is presented in note 23(a).

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

14.   Segment information

The Company has two operating segments that have similar economic characteristics which are aggregated into a single reportable segment based on the manner in which the Company has organized its operations and provision of financial information to senior management.

The Company's sales by geographical area are as follows:

Description

2010

2009

2008

Canada

$ 5,066,465

$ 4,335,350

$ 4,161,178

United States

14,727,823

13,051,874

4,384,105

United Kingdom

5,202,034

6,632,330

8,441,973

Other

360,248

427,015

62,331

Total

$ 25,356,570

$ 24,446,569

$ 17,049,587

Revenue is attributable to the geographic location of the Company's customer. As at September 30, 2010 and September 30, 2009, the Company's assets by geographical location are as follows:

Canada

United Kingdom

Total

September 30, 2010

Property and equipment

$ 5,216,602

$ 14,227

$ 5,230,829

Goodwill and intangible assets

$ 77,382

$ 1,697,316

$ 1,774,698

September 30, 2009

Property and equipment

$ 6,104,463

$ 70,457

$ 6,174,920

Goodwill and intangible assets

$ 2,336,533

$ 3,220,437

$ 5,556,970

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Major customer groups representing 10% or more of the Company's sales for the year are as follows:

Description

2010

2009

2008

Customer A

$ 6,350,030

$ 5,855,497

$ 4,982,339

Customer B

$ 3,322,722

$ 2,737,662

$ 1,806,567

Customer C

$ 2,489,571

$ 2,894,856

$ 3,621,110

Customer D

$ 9,863,654

$ 9,134,532

$ 2,550,398

15.   Capital lease obligations

During the year ended September 30, 2008, the Company entered into a capital lease to acquire certain items of computer equipment. The amount outstanding under this capital lease at the year end is as follows:

2010

2009

Computer equipment under capital lease, bearing interest at 20.51% per annum

$ 107,964

$ 528,572

Minimum payments

Future minimum lease payments at September 30, 2010 are as follows:

2010

2009

2010

-

490,072

2011

113,500

122,518

113,500

612,590

Less: Amounts representing interest

(5,536)

(84,018)

Present value of lease obligation

107,964

528,572

Less: Current portion

(107,964)

(490,072)

Long-term portion of lease obligation

$             -

$ 38,500

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

16.   Loan payable

At September 30, 2009, the Company had a short-term credit facility of L 1,000,000 ($1,729,300) from a Director of the Company. During the year-ended September 30, 2008, the Company had drawn down L 500,000 against this facility. At September 30, 2009 this amount was outstanding in full. The loan, which is denominated in Sterling bears interest at a rate equal to the Bank of England base rate, plus 3.75% and fell due for repayment no later than May 31, 2010. The effective interest rate of the loan was 5.4% for the year ended September 30, 2009. In October, 2009 the Company repaid the principal and all accrued interest of this loan, totalling $937,548. During the year ended September 30, 2010, interest expense of $940 (2009 - $46,076) was recorded relating to this loan.

17.   Commitments

The Company has entered into agreements to lease premises and services for periods to 2014. The annual rent for premises includes minimum rent plus realty taxes and operating expenses. Minimum payments for each of the remaining five years are as follows:

Property leases



Other

service

agreements

Total



2011

263,382

1,188,125

1,451,507

2012

263,382

1,047,552

1,310,934

2013

263,382

147,367

410,749

2014

219,485

-

219,485

2015

             -

             -

             -

$ 1,009,631

$ 2,383,044

$ 3,392,675

During the year ended September 30, 2010, the Company incurred operating lease expenses of $1,743,887 (2009 - $2,125,576).

At September 30, 2010, the Company was committed to purchasing items of equipment with a cost of $34,802.

During the quarter ended March 31, 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. To date, the Company has only been provided with limited information regarding this potential infringement and as a result is still investigating the matter in order to determine its potential impact. No adjustment has been made in these financial statements as a result of this matter.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

18.   Supplementary cash flow information

Net change in non-cash working capital items

2010

2009

2008

Accounts receivable

$ (610,216)

$ (561,518)

$ (218,707)

Prepaid expenses and other current assets

(237,222)

116,265

71,768

Accounts payable and accrued liabilities

(2,037,906)

163,927

221,924

Changes in deferred expenses

-

52,883

36,922

Changes in deferred revenue

107,069

(486,989)

542,191

$ (2,778,275)

$ (715,432)

$ 654,098

Supplementary information

2010

2009

2008

Interest paid

$ 77,689

$ 152,697

$ 103,989

Interest received

$ 642

$ 7,241

$ 134,848

Taxes paid

$            -

$            -

$            -

Non-cash activities consist of:

Increase in accounts payable related to

   acquisition of equipment

$ 23,883

$            -

$ 123,798

Equipment purchased through capital leases



$            -

$            -

$ 1,248,464

Expiry of unexercised warrants

$            -

$ 4,961,826

$            -

Non-cash portion of common shares issued

   on exercise of options

$ 14,811

$ 67,920

$ 116,116

19.   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 carrying value of cash and cash equivalents, accounts payable and accrued liabilities, purchase consideration payable, and loan payable approximates the fair value due to the immediate or short-term maturity of these financial instruments. The carrying value of receivables approximates the fair value due to their short-term nature and historical collectability. These values represent the estimated amount the Company would receive or pay to terminate agreements taking into consideration current interest rates and the creditworthiness of the counterparties.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

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. The Company does not have any credit facilities in place to help manage its liquidity position and therefore its liquidity is dependent on 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.

The following table discloses the maturities of the Company's financial liabilities as at September 30, 2010:

         Payments due by period

Total

Less than 1 year

1-3 years

3-5 years

Accounts payable and accrued liabilities

5,471,878

5,471,878

-

-

Capital leases

113,500

113,500

-

-

Short-term debt obligations

          -

          -

          -

          -

5,585,378

5,585,378

          -

          -

As the Company has generated positive cash flow from operations for the current year, its working capital has improved by $6,378,634 from a deficit position to a surplus of $5,248,893. The Company's current liabilities have decreased from $10,534,826 to $6,312,004 and the Company's cash position has increased from $4,237,284 to $4,690,355 during the year ended September 30, 2010. 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. 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 $5,248,893 at September 30, 2010 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 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 amount of its working capital deficit could periodically increase depending on the timing of the maturity of its accounts receivable and accounts payable and accrued liabilities.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

In prior years the Company purchased a number of items of property and equipment using a finance lease. At September 30, 2010, the Company has an outstanding obligation under this lease of $107,964, all of which is payable within twelve months. The Company is making these payments out of cash flows generated from operations.

As the Company has not obtained any further financing during the past 12 months, its activities are being funded out of its operating cash flow. As the Company has generated positive cash flow from operations of $4,489,338 during the year it has been able to reduce its working capital deficit into a surplus, however if this trend is not continued, there is a risk that the Company would not be able to meet all of its contractual commitments when due.

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 which generally have an investment grade rating of a minimum of A- and does not invest any significant deposits in any financial institutions with a rating below that investment grade. 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, $181,365 is covered by either the Financial Services Compensation Scheme in the United Kingdom or the Canada Deposit Insurance Corporation, leaving $4,508,990 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, 2010, three customers each account for 10% or more of total trade accounts receivable (2009 - four customers).

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Financial assets past due

At September 30, 2010, the Company has a provision of $176,531 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, 2010

Financial assets that are past due but not impaired

Neither past

due nor

impaired

31 - 60 days

61 - 90

days

91 days +

Carrying value

on the balance

sheet

           $

Trade accounts receivable

3,520,349

136,997

982,557

609,371

5,249,274

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, 2010, 65% has been subsequently collected as at December 8, 2010. 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, 2010, the Company had a provision for doubtful accounts of $176,531 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

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.

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, 2010, through its wholly owned subsidiaries, the Company had cash and cash equivalents of $2,750,575, accounts receivable of $1,989,819 and accounts payable of $3,367,819 which were denominated in UK L . In addition, at September 30, 2010, the Company had cash and cash equivalents of $1,867,911, accounts receivable of $2,167,447 and accounts payable of $428,653 which were denominated in US$.

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, 2010 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

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(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

+/- 360,670

Change of +/- 10% in UK L foreign exchange rate

+/- 577,944

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.

20.   Capital management

The Company considers its share capital, share capital purchased for cancellation, contributed surplus and capital lease obligations, as capital, which at September 30, 2010 totalled $85,241,798.

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 previously 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The Company is not subject to any externally imposed capital requirements.

21.   Related Party Transactions

During the year ended September 30, 2008, the Company advanced loans to officers of the Company in the amount of $68,000 with interest payable at a rate of 7% per annum. Included in accounts receivable at September 30, 2009 was $19,320, comprising an amount of $17,000 representing a portion of the principal which remains outstanding and $2,320 representing interest accrued on that principal. During the year ended September 30, 2010, the Company received full payment of the principal and accrued interest owing from the loan in the amount of $19,792. Interest income of $472 (2009 - $1,306) was earned on these loan balances during the year ended September 30, 2010.

During the year-ended September 30, 2008, the Company was provided with an unsecured loan from a Director and Officer totaling L 500,000. The loan, which was denominated in Sterling bore interest at a rate equal to the Bank of England base rate, plus 3.75% and fell due for repayment no later than May 31, 2010. In October, 2009 the Company repaid the principal and all accrued interest of this loan, totaling $937,548.

During the year ended September 30, 2010, the Company incurred legal fees of $83,203 (2009 - $130,287) for services provided by a law firm of which a director of the Company is a partner. Accounts payable and accrued liabilities at September 30, 2010 included $4,968 (2009 - $23,217) related to these services.

During the year ended September 30, 2010, the Company incurred consulting fees for services performed by two directors of the Company totalling $6,608 (2009: $122,059). At September 30, 2010, no amounts were due to directors in relation to consulting services performed (2009: $38,288).

During the year ended September 30, 2010, the Company incurred consulting fees of $18,432 (2009: $nil) for services provided by a company of which a Director and Officer of the Company controls. Accounts payable and accrued liabilities at September 30, 2010 included $4,993 (2009: $nil) related to these services.

During the year ended September 30, 2010, the Company incurred expenses in relation to setting up e-mail marketing campaigns on behalf of a number of our retail customers of $41,740 (2009: $52,398) and website services of $6,920 with a company of which a director of the Company is Chairman and Chief Executive Officer. Accounts payable and accrued liabilities at September 30, 2010 included $7,128 (2009: $18,262) related to these services. The 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.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The Company shares its UK premises with another company of which an Officer is a majority shareholder. During the year ended September 30, 2010, the Company was recharged its proportional share of office running costs totalling $192,395 (2009: $128,819) by this related party. In addition, during the year ended September 30, 2010, the Company used the software development services of this company, incurring costs of $95,398 (2009: $20,660) and carried out professional development work totalling $nil (2009: $18,255) on behalf of this company. At September 30, 2010, accounts payable included $25,118 (2009: $119,076) and accounts receivable $nil (2009: $19,887) due to and from this company respectively.

During the year ended September 30, 2010, the Company utilized the services of an Officers' family member on a contract basis, incurring fees of $28,326 (2009: $22,404). At September 30, 2010, $nil (2009: $3,656) was included in accounts payable related to these fees.

22.   Pension plan

The Company has a defined contribution pension plan with respect to certain employees in the United Kingdom where the Company's obligation is limited to making regular contributions on behalf of the eligible employees. During the year ended September 30, 2010, the Company made contributions of $31,739 (2009 - $56,529) into this plan.

23.   Reconciliation to accounting principles generally accepted in the United States of America

The financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("Canadian GAAP"), which differ in certain material respects from those principles and practices that the Company would have followed had its financial statements been prepared in accordance with accounting principles and practices generally accepted in the United States ("US GAAP").

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

a)   Statements of earnings (loss) and comprehensive earnings (loss)

Net earnings (loss) from operations, separately identifying revenue earned from the sale of tangible products and the sale of services, together with the respective costs associated with those sales is as follows:

2010

2009

2008

Revenue

Service revenue

$ 22,709,059

$ 21,479,828

$ 11,994,709

Product revenue

2,647,511

2,966,741

5,054,878

25,356,570

24,446,569

17,049,587

Expenses

Network delivery - service revenue

3,988,806

5,055,365

3,647,579

Network delivery - product revenue

1,388,114

1,617,218

3,761,946

Software development

8,162,595

7,566,227

6,914,291

General and administration

4,021,971

4,893,640

4,480,258

Sales and marketing

896,791

1,202,699

1,140,028

Amortization of intangible assets

2,550,452

3,243,359

3,214,908

Amortization of property and equipment

2,368,539

2,770,357

2,044,145

Impairment of property and equipment (f)

40,085

55,077

-

Goodwill impairment (f)

          -

          -

1,086,577

23,417,353

26,403,942

26,289,732

Earnings (loss) from operations

$ 1,939,217

$ (1,957,373)

$ (9,240,145)

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The reconciliation between Canadian GAAP and US GAAP of the net earnings (loss) for the year is as follows:

2010

2009

2008

Net earnings (loss) for the year under

   Canadian GAAP

$ 6,851,994

$ (1,769,666)

$ (8,717,026)

Change in fair value of embedded foreign

   currency derivatives relating to warrants (e)

-

22,531

4,671,206

Deferred tax benefit (i)

841,541

          -

          -

Net earnings (loss) for the year under US

   GAAP

7,693,535

(1,747,135)

(4,045,820)

Other comprehensive loss:

Unrealized foreign exchange loss on

   translation of foreign subsidiaries with

   different functional currencies

(510,342)

(652,661)

(346,964)

Comprehensive gain (loss) under US GAAP

$ 7,183,193

$ (2,399,796)

$ (4,392,784)

Basic earnings (loss) per share under US

   GAAP

$ 0.23

$ (0.05)

$ (0.12)

Fully diluted earnings (loss) per share under

   US GAAP

$ 0.23

$ (0.05)

$ (0.12)

b)   Balance sheets

2010

2009

Canadian GAAP

U.S. GAAP



Canadian GAAP

U.S. GAAP



Assets

   Current assets

$ 11,560,897

$ 11,560,897

$ 9,405,085

$ 9,405,085

   Intangible assets

1,115,794

1,115,794

3,892,211

3,892,211

   Goodwill (note h, i)

658,904

8,119,119

1,664,759

8,175,822

   Deferred tax asset (i)

4,953,934

4,953,934

-

-

   Other long-term assets

5,230,829

5,230,829

6,174,920

6,174,920

   Total assets

$ 23,520,358

$ 30,980,573

$ 21,136,975

$ 27,648,038

Liabilities & Shareholders' Equity

Liabilities

   Current liabilities

$ 6,312,004

$ 6,312,004

$ 10,534,826

$ 10,534,826

   Warrants liability (note e)

-

-

-

-

   Long-term liabilities

78,876

78,876

409,615

409,615

Shareholder's Equity

   Share capital

66,200,215

66,199,666

66,017,456

65,909,296

   Contributed surplus (note e)

18,933,619

16,329,794

18,521,086

15,917,261

   Deficit (note e, h, i)

(65,684,820)

(55,620,231)

(72,536,814)

(63,313,766)

   Accumulated other

   comprehensive loss

(2,319,536)

(2,319,536)

(1,809,194)

(1,809,194)

$ 23,520,358

$ 30,980,573

$ 21,136,975

$ 27,648,038

(c) Subsequent events
The Company has analyzed its operations subsequent to September 30, 2010 and has determined that it does not have any material subsequent events to disclose in these financial statements.

(d) Stock-based compensation

Effective October 1, 2004, the Company adopted ASC 718, Compensation - Stock Compensation (formerly Financial Accounting Standard ("FAS") No. 123, Accounting for Stock-Based Compensation, as subsequently revised by FAS No. 123(R) ("FAS 123(R)"), Share-Based Payment, effective October 1, 2006.) The adoption of this guidance, effective October 1, 2006 under the modified prospective method, had no material impact on the Company's financial position or results of operations. Under US GAAP, the Company recognizes the grant-date fair value of stock-based compensation awards granted to employees and directors over the requisite service period for all awards granted, modified, repurchased or cancelled after October 1, 2004 and the unvested portions of outstanding awards as at October 1, 2004. The Company also adopted CICA Handbook Section 3870, Stock-Based Compensation and Other Stock-Based Payments effective October 1, 2004 for awards granted on or after October 1, 2002.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

As a result of these new accounting standards in Canada and the United States, there are no material GAAP differences related to the Company's stock-based compensation awards during the period ended June 30, 2008 and 2007.

At September 30, 2010, the total compensation cost related to non-vested awards not yet recognized was $4,473 (2009 - $415,027) which will be recognized over the remaining vesting period of 2 months. No amount has been included for forfeitures as the amount is immaterial.

(e) Warrants Liability

Under US GAAP, the Securities Exchange Commission ("SEC") determined that it is not possible to treat as equity, warrants whose exercise price currency denomination is different from the functional currency of the entity. The SEC generally views such instruments as derivative liabilities. Therefore, the Company applied EITF 07-5 "Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock", and allocated the fair value of warrants issued whose exercise price currency denomination is different than the Company's functional currency as a liability, to be carried at fair value, with changes in fair value to be recorded in operations. The change in fair value of these warrants for the year ended September 30, 2010 was $nil (2009 - $22,531) and was recognised through the statement of earnings (loss). Effective March 30, 2009, all warrants outstanding with an exercise price currency denomination different to the Company's functional currency expired, unexercised.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

(f) Classification of impairment charges
Losses recognized with respect to impairments of long-lived assets have been classified as having arisen from non-operating results for Canadian reporting purposes. Under US GAAP, these items are included in the determination of the Company's loss from operations.

(g) Cash flow statements

The Canadian accounting standard for the preparation of cash flow statements is consistent with the guidance provided by International Accounting Standard (IAS) 7, and accordingly, the cash flow statements presented herein have not been reconciled to US GAAP under the accommodation provided by the SEC.

(h) Redemption of Limited Partnership units

During the year ended September 30, 2004, the Company redeemed limited partnership units and recorded the cost as a charge to deficit for Canadian GAAP purposes. Under US GAAP, the Company applied ASC 805, Business Combinations (formerly SFAS No. 141, "Business Combinations"), and allocated the cost of issuing the common shares and share purchase warrants to goodwill, after first considering any allocation to tangible and intangible assets acquired. This resulted in an increase of $6,511,063 in goodwill and shareholders' equity. The Company applies ASC 350, Intangibles - Goodwill and Other, in determining if there is any impairment in value. As at September 30, 2010, no impairment in value has been recorded to date.

(i) Income taxes

The Company follows the liability method with respect to accounting for income taxes. Deferred tax assets and liabilities are determined based on temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred income tax assets and liabilities are measured using enacted tax rates that will be in effect when these differences are expected to reverse. Deferred income tax assets are reduced by a valuation allowance, if based on the weight of available evidence; it is more likely than not that some portion or all of the deferred tax assets will not be realized.

In July 2006, the Financial Accounting Standards Board (the "FASB") issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes, subsequently codified as ASC 740, which clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. ASC 740 prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, ASC 740 provides guidance on the de-recognition, classification, interest and penalties, accounting in interim periods, and disclosure requirements for uncertain tax positions. The Company adopted the provisions of ASC 740 beginning October 1, 2007.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

The Company files income tax returns in the U.S., Canada and the United Kingdom. We are subject to income tax examination by tax authorities in all jurisdictions from our inception to date. Our policy is to recognize interest expense and penalties related to income tax matters as tax expense. At September 30, 2010, we do not have any significant accruals for interest related to unrecognized tax benefits or tax penalties. Based on the Company's evaluation, there are no significant uncertain tax positions requiring recognition or measurement in accordance with ASC 740.

During the year ended September 30, 2010, the Company recorded a deferred tax asset relating to the utilization of Pixology loss carryforwards to offset the current year income taxes payable in the amount of $363,728. The Company also determined that a portion of the previously unrecognized Pixology loss carry forwards should be recognized as the likelihood of realization of the tax asset was estimated to be more likely than not.

Canadian GAAP requires that a future income tax asset acquired in a business combination that was not recognized at the time of acquisition as an identifiable asset but is subsequently recognized by the acquirer should be applied to reduce goodwill and intangibles to zero, with any remaining amount recognized as a reduction to income tax expense.

Accordingly, an amount of $949,152 and $89,266 was credited against Pixology goodwill and intangibles respectively.

US GAAP requires reversals of a valuation allowance related to acquired losses and deductible temporary differences to be recognized as a deferred tax benefit in the Statement of Earnings (Loss) and Comprehensive Gain (Loss).

During the year ended September 30, 2010, the Company determined that it was more likely than not to realize the loss carryforwards and other deductible temporary differences arising in Canada. As a result the Company reversed the valuation allowance relating to these items and recorded a future tax benefit. A portion of the valuation allowance of $107,611 related to share issue costs that are deductible for tax purposes. In accordance with Canadian GAAP, this was recorded as a future tax benefit within the Company's Statement of Earnings (Loss) and Comprehensive Gain (Loss). US GAAP, however, requires the benefit associated with the reversal of a valuation allowance relating to equity items be recorded as an increase to share capital. Accordingly, for US GAAP an amount of $107,611 was recorded as an increase to share capital.

(j) Recent U.S. announcements

Accounting Standards Update 2009-05

Effective October 1, 2009, the Company adopted ASU 2009-05, "Fair Value Measurements and Disclosures". The ASU provides a number of amendments to Subtopic 820-10, "Fair Value Measurements and Disclosures - Overall", regarding the fair value measurements of liabilities. The adoption of this ASU did not have a significant impact on the financial statements of the Company.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Accounting Standards Update 2009-06

Effective October 1, 2009 the Company adopted ASU 2009-06, "Income Taxes". ASU 2009-06 provides additional implementation guidance on accounting for uncertainty in income taxes. The adoption of this ASU has had no significant impact on the financial statements of the Company.

Accounting Standards Update 2009-13

In October 2009, the FASB released ASU 2009-13, "Multiple-deliverable revenue arrangements". ASU 2009-13 is effective for revenue arrangements entered into or materially modified in years beginning on or after June 15, 2010 and provides another alternative for determining the selling price of deliverables and eliminates the residual method of allocating arrangement consideration. The Company is still assessing the potential impact of this amendment on its financial statements.

Accounting Standards Update 2009-14

In October 2009, the FASB released ASU 2009-14, "Revenue arrangements that include software elements". ASU 2009-14 is effective for revenue arrangements entered into or materially modified in years beginning on or after June 15, 2010 and removes non-software components of tangible products and certain software components of tangible products from the scope of existing software revenue guidance resulting in the recognition of revenue similar to that for other tangible products. The Company is still assessing the potential impact of this amendment on its financial statements.

Accounting Standards Update 2010-02

In January 2010, the FASB released ASU 2010-02, "Consolidation (Topic 810): accounting and reporting for decreases in ownership of a subsidiary - a scope clarification". ASU 2010-02 is effective at the beginning of the period ending on or after December 15, 2009 and describes amendments that clarify the types of transactions that should be accounted for as a decrease in ownership of a subsidiary as set forth in consolidations topic of the FASB Accounting Standards Codification (Subtopic 810-10). The Board's objective in making the amendments is to remove the potential conflict between guidance in that Subtopic and asset de-recognition and gain or loss recognition guidance that may exist in other U.S. GAAP. The adoption of this ASU has had no impact on the financial statements of the Company.

Accounting Standards Update 2010-05

In January 2010, the FASB released ASU 2010-05, "Compensation - Stock Compensation (Topic 718): escrowed share arrangements and the presumption of compensation". ASU 2010-05 codifies EITF Topic D-110, escrowed share arrangements and the Presumption of Compensation, and amends paragraphs 505-50-S25-3, 718-10-S25-1, and 718-10-S99-2. The adoption of these amendments had no impact on these financial statements.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Accounting Standards Update 2010-06

In January 2010, the FASB released ASU 2010-06, "Fair Value Measurements and Disclosures (Topic 820): improving disclosures about fair value measurements". The ASU provides a number of amendments to Subtopic 820-10, that require new disclosures and that clarify certain existing disclosures related to fair value measurements. ASU 2010-06 is effective at the beginning of the period ending on or after December 15, 2009. The adoption of this ASU did not have a significant impact on these financial statements.

Accounting Standards Update 2010-08

In February 2010, the FASB released ASU 2010-08, "Technical corrections to various topics". ASU 2010-08 was issued to amend certain US GAAP provisions to eliminate inconsistencies, outdated provisions and provide further clarifications where required. The Board concluded that the guidance in the amendments will not result in pervasive changes to current practice, and while none of the provisions in the amendments in this ASU fundamentally change U.S. GAAP, certain clarifications made to the guidance on embedded derivatives and hedging (Subtopic 815-15) may cause a change in the application of that Subtopic and, thus, special transition provisions are provided for accounting changes related to that Subtopic. The amendments in ASU 2010-08 are effective for the first reporting period beginning after issuance, except for certain amendments made to Topic 815 which are effective for fiscal years beginning after December 15, 2009. The amendments of this ASU have had no impact on the financial statements of the Company.

Accounting Standards Update 2010-09

In February 2010, the FASB released ASU 2010-09, "Subsequent Events (Topic 855): amendments to certain recognition and disclosure requirements. The amendments in ASU 2010-09 are effective upon issuance, and address certain implementation issues including: (i) eliminating the requirement for SEC filers to disclose the date through which it has evaluated subsequent events; (ii) clarifying the period through which conduit bond obligors must evaluate subsequent events; and (iii) refining the scope of the disclosure requirements for reissued financial statements. The Board's objective in making the amendments is to remove potential conflicts between U.S. GAAP and SEC guidance. The adoption of this ASU has had no significant impact on the financial statements of the Company.

Accounting Standards Update 2010-11

In March 2010, the FASB released ASU 2010-11, "Derivatives and Hedging (Topic 815): scope exception related to embedded credit derivatives". The amendments in ASU 2010-11 are effective for each reporting entity at the beginning of its first fiscal quarter beginning after June 15, 2010. ASU 2010-11 provides clarifications and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in paragraphs 815-15-15-8 through 15-9 of Topic 815. The Company does not anticipate the amendments of ASU 2010-11 will significantly impact the financial statements of the Company.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Accounting Standards Update 2010-12

In April 2010, the FASB released ASU 2010-12, "Income Taxes (Topic 740): accounting for certain tax effects of the 2010 health care reform acts". ASU 2010-12 codifies Subtopic 740-10. The amendments have had no impact on the financial statements of the Company.

Accounting Standards Update 2010-13

In April 2010, the FASB released ASU 2010-13, "Compensation - Stock Compensation (Topic 718): effect of denominating the exercise price of a share based payment award in the currency of the market in which the underlying equity security trades - a consensus of the FASB Emerging Issues Task Force." ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition, therefore such an award should not be classified as a liability. The Company does not anticipate the amendments of ASU 2010-13 will have a financial impact on the Company's results.

Accounting Standards Update 2010-20

In July 2010, the FASB released ASU 2010-20, "Receivables (Topic 310)". ASU 2010-20 is effective for interim and annual reporting periods ending on or after December 15, 2010. The objective of ASU 2010-20 is to provide additional information to assist financial statement users in assessing an entity's credit risk exposures and evaluating the adequacy of its allowance for credit losses as it relates to an entity's portfolio of financing receivables. The amendments in ASU 2010-20 affect all entities with financing receivables, excluding short-term trade accounts receivable or receivables at fair value or lower of cost or fair value. The amendments have had no impact on the financial statements of the Company.

Accounting Standards Update 2010-21

In August 2010, the FASB released ASU 2010-21, "Accounting for Technical Amendments to Various SEC Rules and Schedules". ASU 2010-21 amends various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies. The amendments have had no impact on the financial statements of the Company.

PNI Digital Media Inc.

Notes to Consolidated Financial Statements

September 30, 2010, 2009 and 2008

(expressed in Canadian dollars)

Accounting Standards Update 2010-22

In August 2010, the FASB released ASU 2010-22, "Accounting for Various Topics". ASU 2010-22 amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics. The amendments have had no impact on the financial statements of the Company.

Business Combinations

In December 2007, the Financial Accounting Standards Board (FASB) issued new accounting guidance as outlined in ASC 805, Business Combinations regarding business combinations and non-controlling interests in consolidated financial statements. This new guidance retains the fundamental requirements in previous guidance for business combinations requiring that the use of the purchase method be used for all business combinations. The acquirer is required to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. Additionally, business combinations will now require that acquisition costs to be expensed as incurred, the recognition of contingencies, restructuring costs associated with a business combination must generally be expensed and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. This guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which is the year ending September 30, 2010 for the Company. Since adoption of this standard, effective October 1, 2009, the Company has not undertaken any transactions to which these revised rules apply.

Non-controlling Interests in Consolidated Financial Statements

In December 2007, the FASB clarified guidance on non-controlling interests in consolidated financial statements. The clarification requires ownership interests in subsidiaries held by other parties to be classified as equity in the consolidated financial statements and changes in ownership interests in a subsidiary to be accounted for as equity transactions. Deconsolidation of a subsidiary is to be accounted for at fair value. This update is applicable for fiscal years beginning on or after December 15, 2008 on a prospective basis, except for the presentation and disclosure requirements which are to be applied to all periods presented. The Company does not currently have any partially owned subsidiaries and does not expect, based on its current structure, the adoption, effective October 1, 2009 to have any significant impact.

Determination of the Useful Life of Intangible Assets

Effective October 1, 2009 the Company adopted FASB's updated guidance as outlined in ASC 350, Intangibles - Goodwill and Other regarding the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this revised guidance is to improve the consistency between the useful life of a recognized intangible and the period of expected cash flows used to measure the fair value of the asset. The adoption of this revised guidance has not had a significant impact on the financial statements of the Company.

.}

Name	Grant Date	Grant Price	Expiration Date	Total Number of Restricted Shares Units
Peter Fitzgerald Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Peter Scarth Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Cory Kent Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Thomas Nielsen Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Robert Chisholm Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Lawrence Lerner Director	Oct. 4, 2010	$1.55	Oct. 4, 2013	10,000
Karl Oertel VP UK Operations	Oct. 4, 2010	$1.55	Oct. 4, 2013	7,100
Patricia Spice Corporate Secretary	Oct. 4, 2010	$1.55	Oct. 4, 2013	7,100

		Sales Prices (CAN$)
		High	Low
Common Shares
Annual Data	2010	1.95	1.30
	2009	2.29	1.00
	2008	4.50	1.90
	2007	5.77	2.31
	2006	3.75	0.95
	2005	1.90	0.70

Quarterly data	2010
	September 30, 2010	1.61	1.30
	June 30, 2010	1.82	1.52
	March 31, 2010	1.81	1.56
	December 31 2009	1.95	1.6

	2009
	September 30, 2009	2.02	1.40
	June 30, 2009	1.82	1.45
	March 31, 2009	2.00	1.44
	December 31 2008	2.29	1.00

Monthly data	February 2011	1.65	1.40
	January 2011	1.60	1.49
	December 2010	1.76	1.56
	November 2010	1.80	1.53
	October 2010	1.62	1.50
	September 2010	1.61	1.30

		Sales Prices (US$)
		High	Low
Common Shares
Annual Data	2010	1.87	1.28
	2009	2.05	0.89
	2008	4.65	1.84
	2007	4.88	2.52
	2006	3.29	0.63
	2005	1.70	0.50

Quarterly Data	2010
	September 30 2010	1.57	1.28
	June 30 2010	1.83	1.45
	March 31 2010	1.70	1.55
	December 31, 2009	1.87	1.52

	2009
	September 30 2009	1.86	1.23
	June 30 2009	1.59	1.24
	March 31 2009	1.60	1.14
	December 31, 2008	2.05	0.89

Monthly data	February 2011	1.66	1.45
	January 2011	1.61	1.53
	December 2010	1.77	1.60
	November 2010	1.75	1.52
	October 2010	1.60	1.50
	September 2010	1.57	1.28

		Financial assets that are past due but not impaired
	Neither past due nor impaired	31 - 60 days	61 - 90 days	91 days +	Carrying value on the balance sheet $

Trade accounts receivable	3,520,349	136,997	982,557	609,371	5,249,274

	Impact on net loss $

Change of +/- 10% in US$ foreign exchange rate	+/- 360,670
Change of +/- 10% in UK L foreign exchange rate	+/- 577,944

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)
4.1	The Services and Software Agreement with CVS Pharmacy, Inc., dated February 1, 2006.* (2)
4.2	The Toronto Co-Located Hosting Agreement with TELUS Communications Inc., dated November 19, 2007. This agreement is for a 60 month period commencing January 15, 2008.*(3)
4.3	The Vancouver Co-Located Hosting Agreement with TELUS Communications Inc., dated November 20, 2007. This agreement is for a 34 month period commencing December 1, 2007.*(3)

Exhibit Number	Description
4.4	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)
4.5	The Services Agreement with Sam's West Inc., dated January 23, 2008.*(4)
4.6	The Amended and Restated Services Agreement with Wal-Mart Canada Corp., dated January 31, 2008.*(4)
4.7	The Internet Photo Services Agreement with Costco Wholesale Corporation, dated April 29, 2008.*(4)
4.8	The Master Equipment Lease Agreement with Relational Funding Canada Corp., dated March 10, 2008.*(4)
4.9	The lease renewal and modification agreement for our executive offices in Canada with The Old BC Electric Building Corp., dated June 11, 2009.*(5)
4.10	The lease agreement for our support offices in Canada with The Old BC Electric Building Corp., dated July 26, 2010. (1)
4.11	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. *(5)
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)


	PricewaterhouseCoopers LLP Chartered Accountant PricewaterhouseCoopers Place 250 Howe Street, Suite 700 Vancouver, British Columbia Canada V6C 3S7 Telephone +1 604 806 7000 Facsimile +1 604 806 7806
December 9, 2010 To the Shareholders of PNI Digital Media Inc. We have audited the consolidated balance sheets of PNI Digital Media Inc. as at September 30, 2010 and September 30, 2009 and the consolidated statements of earnings (loss) and comprehensive gain (loss), statements of deficit, shareholders' equity and statements of cash flow for each of the years in the three year period ended September 30, 2010. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these 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 an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at September 30, 2010 and September 30, 2009 and the results of its operations and its cash flows for each of the years in the three year period ended September 30,2010 in accordance with Canadian generally accepted accounting principles. Signed "PricewaterhouseCoopers LLP" Chartered Accountants
"PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

	September 30, 2010	September 30, 2009

Assets

Current assets
Cash and cash equivalents	$ 4,690,355	$ 4,237,284
Accounts receivable (note 5)	5,302,865	4,855,114
Prepaid expenses and other current assets	541,026	312,687
Current portion of future income tax asset (note 11)	1,026,651	-

	11,560,897	9,405,085

Property and equipment (note 6)	5,230,829	6,174,920

Future income tax asset (note 11)	4,953,934	-

Intangible assets (note 7)	1,115,794	3,892,211

Goodwill (note 8)	658,904	1,664,759

	$ 23,520,358	$ 21,136,975

Liabilities

Current liabilities
Accounts payable and accrued liabilities (note 9)	$ 5,471,878	$ 7,785,812
Purchase consideration payable (note 3)	-	869,803
Current portion of deferred revenue	613,081	410,088
Current portion of capital lease obligations (note 15)	107,964	490,072
Loan payable (note 16)	-	937,548
Asset retirement obligation (note 10)	-	41,503
Future income tax liability (note 11)	119,081	-

	6,312,004	10,534,826

Deferred revenue	78,876	195,059
Long-term portion of capital lease obligations (note 15)	-	38,500
Restructuring liability (note 4)	-	176,056
	6,390,880	10,944,441

Shareholders' Equity (note 12)

Share capital	$ 66,200,215	$ 66,017,456
Contributed surplus	18,933,619	18,521,086
	85,133,834	84,538,542

Deficit	(65,684,820)	(72,536,814)

Accumulated other comprehensive loss	(2,319,536)	(1,809,194)

	(68,004,356)	(74,346,008)

	17,129,478	10,192,534

	$ 23,520,358	$ 21,136,975


Approved by the Board of Directors

"Kyle Hall" Director	"Peter Fitzgerald" Director

	Share capital

	Number of Common Shares	Amount	Share capital purchased for cancellation	Contributed surplus	Warrants	Deficit	Accumulated other comprehensive loss	Total shareholders equity


Balance September 30, 2007	33,315,536	$ 65,293,214	-	$ 10,215,777	$ 4,961,826	$ (62,050,122)	$ (809,569)		$ 17,611,126
Issuance of shares on exercise of options	148,896	321,133	-	(116,116)	-	-	-		205,017
Stock-based compensation recorded in net loss	-		-	1,511,504	-	-	-		1,511,504
Net loss	-	-	-	-	-	(8,717,026)	-		(8,717,026)
Other comprehensive loss	-	-	-	-	-	-	(346,964)		(346,964)

Balance September 30, 2008	33,464,432	$ 65,614,347	-	$ 11,611,165	$ 4,961,826	$ (70,767,148)	$ (1,156,533)		$ 10,263,657
Issuance of shares on exercise of options	28,750	111,045	-	(67,920)	-	-	-		43,125
Stock-based compensation recorded in net loss	-	-	-	1,846,293	-	-	-		1,846,293
Compensation expense in connection with acquisition of WorksMedia Limited (note 3)	-	-	-	169,722	-	-	-		169,722
Issuance of shares on acquisition of WorksMedia Limited (note 3)	214,500	292,064	-	-	-	-	-		292,064
Net loss	-	-	-	-	-	(1,769,666)	-		(1,769,666)
Expiry of warrants (note 12 (c))	-	-	-	4,961,826	(4,961,826)	-	-		-
Other comprehensive loss	-	-	-	-	-	-	(652,661)		(652,661)

Balance September 30, 2009	33,707,682	$ 66,017,456	$ -	$ 18,521,086	$ -	$ (72,536,814)	$ (1,809,194)		$ 10,192,534
Issuance of shares on exercise of options	37,600	70,686	-	(14,811)	-	-	-		55,875
Stock-based compensation recorded in net earnings	-	-	-	399,068	-	-	-		399,068
Compensation expense in connection with acquisition of WorksMedia Limited (note 3)	-	-	-	290,952	-	-	-		290,952
Issuance of shares held in escrow (note 12f)	178,500	290,952	-	(290,952)	-	-	-		-
Cancellation of shares repurchased	(70,000)	(136,970)	-	28,276	-	-	-		(108,694)
Purchase of share capital for cancellation (30,000 shares)	-	-	(41,909)	-	-	-	-		(41,909)
Net earnings	-	-	-	-	-	6,851,994	-		6,851,994
Other comprehensive loss	-	-	-	-	-	-	(510,342)		(510,342)

Balance September 30, 2010	33,853,782	$ 66,242,124	$ (41,909)	$ 18,933,619	$ -	$ (65,684,820)	$ (2,319,536)		$ 17,129,478

Computer equipment	30% declining balance
Software	33-1/3 % - 100% straight-line
Furniture and office equipment	20% declining balance
Leasehold improvements	Life of the lease
Equipment held under capital lease	Life of the lease

Purchase consideration
Paid in cash	161,538
Loan payable	1,848,552
		$ 2,010,090
Purchase consideration - shares issued		299,877
Transaction costs		221,443
		2,531,410

Assets acquired and liabilities assumed
Cash and cash equivalents		208,597
Other current assets		451,093
Property and equipment		44,048
Intangible assets - Customer contracts		1,734,000
Intangible assets - acquired software		841,000
Goodwill		638,225
Current liabilities		(651,589)
Future income tax liability		(733,964)

		$ 2,531,410

	2009

Network delivery	$ 12,979
Software development	39,951
General and administration	205,276

	$ 258,206

	2010

Opening liability - October 1, 2009	$ 176,056
Accretion expense included in general and administration expenses	1,352
Settlement of liability	(180,336)
Loss on settlement of lease obligation included in general and administration expenses	8,200
Impact of foreign currency translation	(5,272)

Closing liability - September 30, 2010	$ -

	2009

Opening liability - October 1, 2008	$ -
Charged to expenses re. unrecoverable lease costs	185,848
Impact of foreign currency translation	(9,792)

Closing liability - September 30, 2009	$ 176,056

	As at September 30, 2010	As at September 30, 2009

Trade accounts receivable	$ 5,425,805	$ 4,954,122
Allowance for doubtful accounts	(176,531)	(154,945)
	5,249,274	4,799,177

Commodity taxes recoverable	53,591	15,832
Other	-	40,105
Total	$ 5,302,865	$ 4,855,114

	2010	2009

Balance, beginning of year	$ 154,945	$ 145,000
Increase in allowance for doubtful accounts	33,781	9,945
Write-off of bad debts	(9,945)	-
Impact of foreign currency translation	(2,250)	-
Balance, end of year	$ 176,531	$ 154,945

2010	Cost	Accumulated amortization	Net book value

Computer equipment	$ 14,844,050	$ (9,763,684)	$ 5,080,366
Software	949,844	(949,844)	-
Furniture and office equipment	416,077	(279,531)	136,546
Leasehold improvements	144,986	(131,069)	13,917
	$ 16,354,957	$ (11,124,128)	$ 5,230,829

2010	Acquired software	Customer relationships	Total

Balance, September 30, 2009	$ 1,219,809	$ 2,672,402	$ 3,892,211
Recognition of future income tax asset to offset current year income taxes payable	(89,266)	-	(89,266)
Amortization	(702,152)	(1,848,300)	(2,550,452)
Impact of foreign currency translation	(64,143)	(72,556)	(136,699)
Balance, September 30, 2010	$ 364,248	$ 751,546	$ 1,115,794

2009	Amount

Balance, September 30, 2008	$ 1,498,539
Acquisition of WorksMedia Ltd. (note 3)	638,225
Adjustment to previously purchased goodwill upon acquisition of WorksMedia	(432,574)
Impact of foreign currency translation	(39,431)
Balance, September 30, 2009	$ 1,664,759

	As at September 30, 2010	As at September 30, 2009

Trade payables	$ 1,012,246	$ 1,691,363
Amounts due to customers	3,190,355	4,878,169
Trade accruals	314,022	318,860
Accrued payroll and other taxes	417,240	476,269
Due to employees and consultants	538,015	421,151
Total	$ 5,471,878	$ 7,785,812

Balance, September 30, 2009	$ 41,503
Payments made for remediation work	(45,071)
Loss on settlement of asset retirement obligation	4,810
Impact of foreign currency translation	(1,242)
Balance, September 30, 2010	$ -

Future income tax assets

	2010	2009	2008

Net operating loss carry-forwards	$ 6,944,472	$ 8,344,444	$ 11,881,567
Property and equipment	2,725,577	2,174,502	1,799,245
Share issue costs	107,611	243,506	412,936
Other	71,190	344,369	437,968
	9,848,850	11,106,821	14,531,716
Future income tax liabilities

Intangible assets	(335,819)	(1,090,165)	(1,437,026)
Related party interest accrued	(105,216)	(106,964)	(94,079)
Net future tax asset	9,407,815	9,909,692	13,000,611
Valuation allowance	(3,546,311)	(9,909,692)	(13,000,611)
Future income tax assets, net	$ 5,861,504	$ -	$ -


2015	$ 826,605
2026	2,072,638
2027	3,121,223
2028	2,792,038

	$ 8,812,504

	Number of warrants	Average exercise price
Balance, September 30, 2007	4,857,147	$ 4.00

Balance, September 30, 2008	4,857,147	$ 4.00

Warrants expired, unexercised	(4,857,147)	4.00
Balance, September 30, 2009 and 2010	-	$ -

	Number of options	Average exercise price
Balance, September 30, 2007 (1,273,609 options exercisable)	1,602,265	$ 1.81
Granted	1,465,300	3.35
Exercised	(148,896)	1.38
Forfeited	(34,800)	3.11
Balance, September 30, 2008 (1,967,882 options exercisable)	2,883,869	$ 2.60
Granted	690,000	1.62
Exercised	(28,750)	1.50
Forfeited	(258,339)	2.66
Balance, September 30, 2009 (2,815,484 options exercisable)	3,286,780	$ 2.37
Granted	-	-
Exercised	(37,600)	1.49
Expired	(274,500)	1.50
Forfeited	(198,911)	2.27
Balance, September 30, 2010	2,775,769	$ 2.48

	Options outstanding			Options exercisable
Exercise price	Number outstanding	Weighted average remaining contractual life (years)	Weighted average exercise price	Number exercisable	Weighted average exercise price
$ 1.25	306,776	0.43	$ 1.25	306,776	$ 1.25
$ 1.48	415,000	3.36	$ 1.48	415,000	$ 1.48
$ 1.50	25,000	3.85	$ 1.50	19,432	$ 1.50
$ 2.00	200,000	3.44	$ 2.00	200,000	$ 2.00
$ 2.32	671,993	1.20	$ 2.32	671,993	$ 2.32
$ 3.35	1,153,000	2.45	$ 3.35	1,153,000	$ 3.35
$ 3.65	4,000	2.54	$ 3.65	4,000	$ 3.65
$1.25 - $3.65	2,775,769	2.14	$ 2.48	2,770,201	$ 2.14

	Number of shares	Weighted average exercise price	Weighted average remaining contractual life (years)	Aggregate intrinsic value
As at September 30, 2008
Options outstanding	2,883,869	$ 2.60	3.49	$ 458,160
Options vested and expected to vest	2,883,869	$ 2.60	3.49	$ 458,160
Options exercisable	1,967,882	$ 2.25	3.04	$ 458,160
As at September 30, 2009
Options outstanding	3,286,780	$ 2.37	2.97	$ 488,521
Options vested and expected to vest	3,286,780	$ 2.37	2.97	$ 488,521
Options exercisable	2,815,484	$ 2.48	2.72	$ 488,521
As at September 30, 2010
Options outstanding	2,775,769	$ 2.48	2.14	$ 167,139
Options vested and expected to vest	2,775,769	$ 2.48	2.14	$ 167,139
Options exercisable	2,770,201	$ 2.48	2.14	$ 167,139

	September 30, 2010	September 30, 2009	September 30, 2008

Net earnings (loss) for the year (numerator)	$ 6,851,994	$ (1,769,666)	$ (8,717,026)

Weighted average number of shares outstanding (denominator)
Basic	33,804,338	33,610,843	33,383,866
Effect of dilutive securities:

Stock options	104,014	-	-

Total	33,908,352	33,610,843	33,383,866

	Canada	United Kingdom	Total
September 30, 2010
Property and equipment	$ 5,216,602	$ 14,227	$ 5,230,829
Goodwill and intangible assets	$ 77,382	$ 1,697,316	$ 1,774,698

September 30, 2009
Property and equipment	$ 6,104,463	$ 70,457	$ 6,174,920
Goodwill and intangible assets	$ 2,336,533	$ 3,220,437	$ 5,556,970