Pni Digital Media 20-F/A 2005 FY Annual report (foreign) (amended)

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

FORM 20-F/A
Amendment No. 1

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2005

Commission File Number: 0-30148

PHOTOCHANNEL NETWORKS INC.
(Exact name of Registrant as specified in its charter)

BRITISH COLUMBIA, CANADA
(Jurisdiction of incorporation or organization)

506-425 Carrall Street
Vancouver, British Columbia, Canada V6B 6E3
(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:NONE

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 shares of each of the Registrant’s classes of capital stock outstanding as of the close of the period covered by the annual report.

Common Shares                203,514,841 Shares

Indicate by check mark whether the 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 [   ] NO [X]

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 [X] Item 18 [   ]

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

YES [   ] NO [X]

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EXPLANATORY NOTE

This Amendment No. 1 to Form 20-F herby amends the Company’s original Annual Report on Form 20-F for the year ended September 30, 2005, originally filed with the Securities and Exchange Commission on March 30, 2006, as follows:

• The Auditors’ Report is amended to include reference that the audit was conducted in compliance with the standards of the Public Company Accounting Oversight Board.

• The Auditor’s Report is amended to include a currently dated manually signed audit opinion in accordance with Rule 2.02(a) of Regulation S-X.

• The Section 302 Certifications are amended to remove the introductory reference in paragraph 4 and subparagraph 4(b) to the Company’s internal control over financial reporting.

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PART III

Item 17. Financial Statements

Our consolidated financial statements are expressed in Canadian dollars and are prepared in accordance with the standards of the Public Company Accounting Oversight Board.

The financial statements and the notes thereto as required under Item 17 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 on Form 20-F:

ExhibitNumber	Description
1.1	The new articles of the company as filed under theBusiness Corporations Act (British Columbia) (the “BCA”) on June 24, 2005.*
4.1	The rental agreement for our executive offices in Canada with Electric Avenue Properties Inc., dated July 12, 2001.*
4.2	The Hosting Solutions Contract with TELUS Communications Inc., dated September 11, 2001.*
4.3	The Internetworking Services Agreement with TELUS Communications Inc., dated September 11, 2001.*
4.4	The Distribution Agreement, with NBJ Enterprises Ltd., dba Skana Photo-Lab Products, dated February 1, 2002 and amended July 1, 2002.*
4.5	The License Agreement with PhotoChannel Networks Limited Partnership, dated February 12, 2002.*
4.6	The Operating Agreement with PhotoChannel Networks Limited Partnership, dated February 14, 2002.*
4.7	The Support Agreement with PhotoChannel Networks Limited Partnership, dated May 2, 2002.*
4.8	The Management Agreement with PhotoChannel Networks Limited Partnership, dated June 4, 2002.*
4.9	The Amended & Restated Limited Partnership Agreement with 620077 B.C. Ltd., Discovery Capital 2001Technology Limited Partnership, TELUS

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	Corporation, Ex Fund Technologies Corp. and Peter Scarth, dated June 4, 2002.*
4.10	The Option Agreement with Discovery Capital 2001 Technology Limited Partnership, dated June 4, 2002.*
4.11	The Option Agreement with TELUS Corporation, dated June 4, 2002.*
4.12	The Option Agreement with Ex Fund Technologies Corp., dated June 2, 2002.*
4.13	The Option Agreement with Peter Scarth, dated June 4, 2002.*
4.14	The License and Services Agreement with Black Photo Corporation, dated September 13, 2002.*
4.15	The License and Services Agreement with Giant Eagle, Inc., dated December 12, 2002.*
4.16	The Letter Agreement with Photolab.ca, a division of Loblaw Group of Companies, dated February 6, 2003.*
4.17	The Services Agreement with Wal-Mart Canada Corp., dated April 11, 2003.*
4.18	The rental agreement for our executive offices located at Suite 506, 425 Carrall Street, Vancouver, British Columbia, Canada, as amended on May 16, 2003.*
12.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
12.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
13.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

__________________
*Previously filed.

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SIGNATURES

     Pursuant to the requirements of Section 12 of the Securities and Exchange Act of 1934, the Registrant certifies that it meets all of the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.

		PHOTOCHANNEL NETWORKS INC.
		(Registrant)
Date: December 8, 2006.	By:	/s/ Peter David Fitzgerald
		Peter David Fitzgerald
		Chairman

PhotoChannel Networks Inc.

Consolidated Financial Statements

September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

F-1

Auditors’ Report

To the Shareholders of
PhotoChannel Networks Inc.

We have audited the consolidated balance sheets of PhotoChannel Networks Inc. as at September 30, 2005 and 2004 and the consolidated statements of shareholders’ equity (deficiency), loss and deficit and cash flows for each of the years in the three-year period ended September 30, 2005. 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 generally accepted auditing standards in Canada and with standards of the Public Company Accounting Oversight Board (United States of America). 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, 2005 and 2004 and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2005 in accordance with generally accepted accounting principles in Canada.

(signed) PricewaterhouseCoopers LLP

Chartered Accountants

Vancouver, B.C., Canada
March 24, 2006

COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA-U.S. REPORTING DIFFERENCE

In the United States of America, reporting standards for auditors require the addition of an explanatory paragraph following the opinion paragraph when the financial statements are affected by conditions and events that cast substantial doubt on the company’s ability to continue as a going concern, such as those described in note 1 to the financial statements. Our report to the shareholders dated March 24, 2006 is expressed in accordance with reporting standards in Canada, which do not permit a reference to such events and conditions in the auditor’s report when these are adequately disclosed in the financial statements.

(signed) PricewaterhouseCoopers LLP

Chartered Accountants

Vancouver, B.C., Canada
March 24, 2006

F-2

PhotoChannel Networks Inc.

Consolidated Balance Sheets 

As at September 30, 2005

(expressed in Canadian dollars)

	2005 $			2004 $
Assets
Current assets
Cash and cash equivalents		187,318			955,965
Accounts receivable (note 3)		417,766			321,149
Prepaid expenses		133,093			18,239
		738,177			1,295,353
Property, plant and equipment (note 4)		870,075			650,339
		1,608,252			1,945,692
Liabilities
Current liabilities
Accounts payable and accrued liabilities (note 5)		1,138,203			575,844
Deferred revenue		188,040			175,769
		1,326,243			751,613
Shareholders’ Equity
Capital stock (note 6)		43,625,343			41,702,604
Contributed surplus		9,303,378			7,060,029
Loans receivable (note 6)		-			(17,600	)
Warrants (note 6)		698,873			2,188,653
Deficit		(53,345,585	)		(49,739,607	)
		282,009			1,194,079
		1,608,252			1,945,692
Nature of operations and going concern (note 1)
Commitments and contingencies (note 15)
Subsequent event (note 16)

Approved by the Board of Directors
"Peter Fitzgerald"	Director	"Cory Kent"	Director

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

F-3

PhotoChannel Networks Inc.

Consolidated Statements of Shareholders’ Equity (Deficiency)

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

	Capital stock				Other capital accounts
	Number of shares		Amount $		Contributed surplus $		Loans receivable $			Number of warrants			Amount $			Number of Limited Partnership units			Amount $			Deficit $			Total shareholders’ equity (deficiency) $
Balance - September 30, 2002		77,894,968		26,390,849		6,189,605		(227,470	)		37,457,382			3,214,845			1,250			12,410			(37,726,075	)		(2,145,836	)
Issuance of options in exchange for services provided		-		-		97,181		-			-			-			-			-			-			97,181
Issuance of warrants in exchange for services provided		-		-		-		-			4,100,000			198,000			-			-			-			198,000
Expiry of warrants		-		-		690,129		-			(15,883,281	)		(690,129	)		-			-			-			-
Private placement of 5,669,470 units		5,669,470		406,414		-		-			5,669,470			160,533			-			-			-			566,947
Private placement of 25,200,000 units		25,200,000		2,425,414		-		-			500,000			34,364			-			-			-			2,459,778
Shares issued on exercise of warrants		18,549,100		2,604,001		-		-			(18,549,100	)		(749,091	)		-			-			-			1,854,910
Issuance of Limited Partnership units		-		-		-		-			-			-			360			360,000			-			360,000
Employee loan		-		-		-		105,264			-			-			-			-			-			105,264
Loss for the year		-		-		-		-			-			-			-			-			(2,822,394	)		(2,822,394	)
Loss for the year attributable to the Limited Partnership		-		-		-		-			-			-			-			(372,410	)		372,410			-
Balance - September 30, 2003		127,313,538		31,826,678		6,976,915		(122,206	)		13,294,471			2,168,522			1,610			-			(40,176,059	)		673,850
Issuance of shares for cash from exercised options		1,080,333		162,050		-		-			-			-			-			-			-			162,050
Private placement of 9,600,000 units		9,600,000		794,575		-		-			9,600,000			279,176			-			-			-			1,073,751
Shares and warrants issued on redemption of Limited Partnership units		16,100,000		4,242,000		-		-			13,650,000			2,269,063			(1,610	)		-			(6,511,063	)		-
Shares issued on exercise of warrants relating to Limited Partnership		13,150,000		3,500,949		-		-			(13,150,000	)		(2,185,949	)		-			-			-			1,315,000
Expiry of Limited Partnership warrants		-		-		83,114		-			(500,000	)		(83,114	)		-			-			-			-
Shares issued on exercise of warrants		9,103,470		1,176,352		-		-			(9,103,470	)		(259,045	)		-			-			-			917,307
Employee loan		-		-		-		104,606			-			-			-			-						104,606
Loss for the year		-		-		-		-			-			-			-			-			(3,052,485	)		(3,052,485	)
Balance - September 30, 2004		176,347,341		41,702,604		7,060,029		(17,600	)		13,791,001			2,188,653			-			-			(49,739,607	)		1,194,079
Issuance of shares for cash from exercised options		385,000		57,750		-		-			-			-			-			-			-			57,750
Modification of existing warrants (note 6)		-		-		-		-			-			144,000			-			-			(144,000	)		-
Stock-based compensation adjustment (note 2)		-		-		314,011		-			-			-			-			-			(314,011	)		-
Compensation expense for options vested		-		-		124,338		-			-			-			-			-			-			124,338
Private placement of 24,973,500 units		24,937,500		1,589,718		-		-			12,468,750			258,791			-			-			-			1,848,509
Expiry of warrants		-		-		1,805,000		-			(2,100,001	)		(1,805,000	)		-			-			-			-
Shares issued on exercise of warrants		1,845,000		275,271		-		-			(1,845,000	)		(87,571	)		-			-			-			187,700
Employee loan		-		-		-		17,600			-			-			-			-			-			17,600
Loss for the year		-		-		-		-			-			-			-			-			(3,147,967	)		(3,147,967	)
Balance - September 30, 2005		203,514,841		43,625,343		9,303,378		-			22,314,750			698,873			-			-			(53,345,585	)		282,009

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

F-4

PhotoChannel Networks Inc.

Consolidated Statements of Loss and Deficit

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

	2005 $			2004 $			2003 $
Revenue (note 9)		2,116,503			763,140			255,573
Expenses
General and administration (note 10)		1,803,848			1,421,419			1,621,568
Research and development (note 10)		1,606,858			1,279,238			789,189
Network delivery (note 10)		895,702			327,189			111,691
Sales and marketing (note 10)		673,997			642,006			734,792
Amortization		303,859			171,476			280,778
		5,284,264			3,841,328			3,538,018
		(3,167,761	)		(3,078,188	)		(3,282,445	)
Interest and other income		7,088			6,775			263
Foreign exchange gain		12,706			18,928			2,189
Gain on settlement of obligations(note 10)		-			-			457,599
Net loss for the year		(3,147,967	)		(3,052,485	)		(2,822,394	)
Loss attributed to Limited Partnership		-			-			372,410
Net loss for the year attributed to common shareholders		(3,147,967	)		(3,052,485	)		(2,449,984	)
Deficit - Beginning of year		(49,739,607	)		(40,176,059	)		(37,726,075	)
Redemption of Limited Partnership units		-			(6,511,063	)		-
Modification of existing warrants (note 6)		(144,000	)		-			-
Stock-based compensation adjustment (note 2)		(314,011	)		-			-
Deficit - End of year		(53,345,585	)		(49,739,607	)		(40,176,059	)
Basic and fully diluted net loss per share		(0.02	)		(0.02	)		(0.03	)
Weighted average number of common shares		178,682,855			148,741,599			89,448,942

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

F-5

PhotoChannel Networks Inc.

Consolidated Statements of Cash Flows

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

	2005 $			2004 $			2003 $
Cash flows from operating activities
Net loss for the year attributed to common shareholders		(3,147,967	)		(3,052,485	)		(2,449,984	)
Items not affecting cash
Amortization		303,859			171,476			280,778
Stock-based compensation expense		124,338			-			-
Loss attributed to Limited Partnership		-			-			(372,410	)
Loss on sale of property, plant and equipment		-			-			44,209
Issuance of options and warrants for goods and services received		-			-			295,181
		(2,719,770	)		(2,881,009	)		(2,202,226	)
Net change in non-cash working capital items (note 8)		363,159			(648,908	)		(1,641,288	)
		(2,356,611	)		(3,529,917	)		(3,843,514	)
Cash flows from investing activities
Purchase of property, plant and equipment		(523,595	)		(536,241	)		(264,123	)
Sale of short-term deposits		-			-			15,000
Proceeds from sale of property, plant and equipment		-			-			109,562
		(523,595	)		(536,241	)		(139,561	)
Cash flows from financing activities
Issuance of common shares and warrants - net proceeds		1,848,509			1,073,750			3,026,725
Decrease (increase) in cash held in trust		-			345,000			(345,000	)
Issuance of common shares on exercise of warrants and options		245,450			2,394,357			1,854,910
Repayment of loans receivable		17,600			104,606			105,264
Issuance of Limited Partnership units		-			-			360,000
		2,111,559			3,917,713			5,001,899
(Decrease) increase in cash and cash equivalents		(768,647	)		(148,445	)		1,018,824
Cash and cash equivalents - Beginning of year		955,965			1,104,410			85,586
Cash and cash equivalents - End of year		187,318			955,965			1,104,410
Supplementary information
Interest paid		3,811			51,657			113,719
Interest received		4,558			6,520			263
Taxes paid		-			-			-
Non-cash activities consist of:
Redemption of Limited Partnership units		-			6,511,023			-
Expiry of warrants		1,805,000			55,413			690,129
Issuance of common shares on exercise of warrants		87,571			1,716,416			749,091

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

F-6

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

1 Nature of operations and going concern

PhotoChannel Networks Inc. (the company), through the PhotoChannel Network, electronically connects the photo-finishing retailer and its customers through the Internet and provides digital image delivery, hosting, storage and financial reporting for the photo-finishing retailer.

While these consolidated financial statements have been prepared on the going concern basis, which assumes the realization of assets and the settlement of liabilities in the normal course of operations, there are conditions that cast substantial doubt on the validity of this assumption. At September 30, 2005, the company has an accumulated deficit of $53,345,585 (2004 - $49,739,607; 2003 - $40,176,059). During the year ended September 30, 2005, the company used cash of approximately $2,357,000 (2004 - $3,530,000; 2003 - $3,844,000) to fund operations while obtaining approximately $2,112,000 (2004 - $3,918,000; 2003 - $5,002,000) from financing activities. The company has capital requirements in excess of its currently available resources and is dependent upon the proceeds of future financings to further finance the development and implementation of its business objectives. The company’s ability to continue its operations is dependent upon the continued support of its shareholders, obtaining additional financing and generating revenues sufficient to cover its operating costs in an industry characterized by rapid technological change. There is no assurance that the company will be successful in achieving any or all of these objectives in the foreseeable future.

Management is implementing a plan to address these uncertainties and to enable the company to continue as a going concern through the end of fiscal year 2006 and beyond. This plan includes obtaining debt or equity financing in amounts sufficient to sustain operations, expanding the company’s customer base, and increasing revenues from operations. However, there is only a limited operating history with the existing business model, and there is no assurance that the necessary financing can be obtained or on what terms it may be obtained. The accompanying financial statements do not include any adjustments, which may be material, to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty.

2 Significant accounting policies

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 or controlled subsidiaries, PhotoChannel Capital Inc. and PhotoChannel Management Inc.

The consolidated financial statements also included the accounts of PhotoChannel Networks Limited Partnership (the PhotoChannel LP) for all periods that the PhotoChannel LP was in existence up until the redemption of the Limited Partnership units in April 2004 (note 7). The accounts of the PhotoChannel LP had been consolidated in view of the existence of the company’s option to acquire the PhotoChannel LP units from the limited partners and certain common ownership and management of the company and the PhotoChannel LP.

F-7

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

   All material intercompany balances and transactions are eliminated upon consolidation.

Research and development

Research costs are expensed in the period incurred. Where, in the opinion of management, the deferral criteria established under GAAP are satisfied in all material respects, development costs are capitalized and amortized over the estimated life of the related products. Otherwise, development costs are charged as an expense in the period incurred. To date, no development costs have been deferred.

Property, plant and equipment

Property, plant and equipment are recorded at cost less accumulated amortization. Amortization of property, plant and equipment is charged over the estimated useful lives of the assets at the following annual rates:

Computer equipment	30% straight-line
Software	33% - 100% straight-line
Furniture and office equipment	20% straight-line
Leasehold improvements	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 from future undiscounted cash flows. An impairment loss equal to the difference in the asset carrying value and its fair value is recognized in the period in which the determination is made.

Revenue recognition

Revenue is recognized when all of the following criteria have been met: persuasive evidence of an arrangement exists; the services have been provided; the price is fixed or determinable; customer acceptance has been received or implied; and the collection of sales proceeds is reasonably assured. Many of the company’s sales arrangements consist of multiple elements, which may include installation services, monthly membership fees, transactions processed, or archive fees. Under Emerging Issues Committee 142, “Revenue Arrangements with Multiple Deliverables”, the fee from a multiple element sales arrangement is allocated to each of the individual elements based on each element’s relative fair value. The portion of the fee that is allocated to an element is recognized as revenue when all of the criteria for revenue recognition have been met for that element.

Revenue is earned from the provision of the PhotoChannel Network to electronically connect photo-finishing retailers to their customers through the Internet. Revenue received in advance from installation services for the set-up of a customer website is recorded as deferred revenue and is recognized into income over the estimated term of the customer relationship period. Revenue from monthly membership fees from photo-finishing retailers for the connection to the PhotoChannel Network is recognized as the service connection is provided. Revenue from commissions earned on transactions processed by the photo-finishing retailers, utilizing the PhotoChannel Network, is recognized at the time the digital image processing services are provided to the end customer. Revenue from archive fees from online image storage is recognized as the service is provided.

F-8

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

Share issue costs

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

Stock-based compensation plan

The company has a stock option plan, which is described in note 6. In November 2001, the Canadian Institute of Chartered Accountants issued Handbook (CICA HB) 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. As a result, the company applied the recommendations with retroactive application and recorded an adjustment to opening deficit of $314,011. Previously, the company disclosed the pro forma effect of employee stock-based compensation expense in the notes to the financial statements.

When stock options are granted to non-employees, compensation expense is recognized, based on the fair value of the stock options granted. The expense is recorded based on the fair value at the earliest of the date at which the counterparty’s performance is complete, a commitment for performance by the counterparty to earn the stock options is reached, or the stock options are granted, if they are fully vested and non-forfeitable at that date.

Financial instruments

Financial instruments are classified in accordance with the substance of the contractual arrangement. Financial liabilities, which are defined as any contractual obligation to deliver cash or another financial asset to another party, are classified as liabilities. Where a financial instrument contains both a debt and equity component, the instruments are presented at their component fair values at the time they were originally issued.

Net loss per share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the year. The treasury stock method is used for the calculation of diluted net earnings (loss) per share. Under the treasury stock method, the weighted average number of common shares outstanding for the calculation of diluted net loss per share assumes that the proceeds to be received on the exercise of dilutive stock options and warrants 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.

F-9

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

Foreign currency transactions and translation

Monetary assets and liabilities of the company denominated in foreign currencies are translated into Canadian dollars at the exchange rate prevailing at the balance sheet date. Revenue and expenses denominated in foreign currencies are translated at the exchange rate prevailing at the transaction date. Exchange differences are included in the statement of loss as they arise.

Use of estimates and measurement uncertainty

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and other reported amounts in the consolidated financial statements and the related notes. Significant estimates and assumptions are necessary in the determination of the recoverable amounts for property, plant and equipment and in the determination of the value ascribed to the components of stock-based transactions. Actual results may differ from those estimates.

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.

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 balances. Future tax assets and liabilities are measured using 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 enactment. A valuation allowance is recognized to the extent the recoverability of future income tax assets is not considered more likely than not.

Comparative amounts

Comparative amounts have been reclassified, where necessary, to conform with the presentation adopted in the current year.

F-10

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

3 Accounts receivable

	2005 $		2004 $
Trade receivables		394,095		279,009
GST receivable		23,671		42,140
		417,766		321,149

4 Property, plant and equipment

					2005
	Cost $		Accumulated amortization $		Net $
Computer equipment		3,499,995		2,639,305		860,690
Software		250,825		250,825		-
Furniture and office equipment		153,442		152,571		871
Leasehold improvements		71,205		62,691		8,514
		3,975,467		3,105,392		870,075

					2004
	Cost $		Accumulated amortization $		Net $
Computer equipment		3,029,375		2,388,458		640,917
Software		213,649		213,576		73
Furniture and office equipment		152,662		152,451		211
Leasehold improvements		68,206		59,068		9,138
		3,463,892		2,813,553		650,339

Amortization of property, plant and equipment for the year ended September 30, 2005 was $303,859 (2004 - $171,476; 2003 - $280,778).

F-11

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

5 Accounts payable and accrued liabilities

	2005 $		2004 $
Trade payables		578,049		309,738
Trade accruals		141,145		60,000
Accrued payroll taxes		158,717		158,668
Due to employees and consultants		135,292		47,438
Severance payable		125,000		-
		1,138,203		575,844

6 Capital stock, stock options, special warrants, warrants and loans receivable

a) Capital stock

Common shares

Authorized

Unlimited (2004 - 500,000,000; 2003 - 500,000,000) common shares without par value

Issued

203,514,841 (2004 - 176,347,341; 2003 - 127,313,538) common shares without par value

Preferred shares

Authorized

Unlimited (2004 - 10,000,000; 2003 - 10,000,000) preferred shares without par value

Details of the material common stock, stock option and warrant transactions are as follows:

i) At the company’s annual general meeting held on March 24, 2005, the company’s shareholders approved an increase in the authorized share structure to an unlimited number of common shares and an unlimited number of preferred shares.

F-12

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

ii)	Pursuant to a non-brokered private placement during the year ended September 30, 2005, the company issued 24,937,500 units for net proceeds of $1,848,509. Each unit consisted of one common share and one-half of one common share purchase warrant. Each whole common share purchase warrant entitles the holder to purchase one additional common share of the company at a price of $0.12 per share for a period of one year from the date of closing. The net proceeds of $1,848,509 were allocated: $1,589,718 to common shares issued and $258,791 to the common share purchase warrants. 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 80%; risk-free interest rate of 3.03%; and expected life of one year. The common share purchase warrants expire on September 20, 2006. During the year ended September 30, 2005, none of the common share purchase warrants were exercised.
iii)	Pursuant to a non-brokered private placement during the year ended September 30, 2004, the company issued 9,600,000 units for net proceeds of $1,073,751. 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 $0.15 per share for a period of one year from the date of closing. The net proceeds of $1,073,751 were allocated: $794,575 to common shares issued and $279,176 to the common share purchase warrants. 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 100%; risk-free interest rate of 4%; and expected life of one year.
iv)	During the year ended September 30, 2005, the expiry date of common share purchase warrants issued as part of the private placement during the year ended September 30, 2004 was extended by one year to July 7, 2006. This amendment resulted in an additional allocation to the common share purchase warrant in the amount of $144,000, charged directly to the current year’s deficit as a distribution. 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 80%; risk-free interest rate of 3.03%; and expected life of one year. As at September 30, 2005, these common share purchase warrants remained outstanding.

F-13

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

v)	Pursuant to a call option agreement with the limited partners of the PhotoChannel LP, the company exercised its right to acquire all of the Limited Partnership units from the limited partners during the year ended September 30, 2004 (note 7). Under the terms of the call option agreements, the company issued 16,100,000 of its common shares and 13,650,000 common share purchase warrants. Each common share purchase warrant entitled the holder to purchase one additional common share of the company at a price of $0.10 up to June 30, 2004. The 16,100,000 common shares issued to acquire the Limited Partnership units were attributed a value of $4,242,000, which was determined by taking the value of the common shares as quoted on the TSX Venture Exchange on the date of issuance. The 13,650,000 common share purchase warrants were attributed a value of $2,269,063, which was determined using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of $nil; expected volatility of 100%; risk-free interest rate of 4%; expected life of 2.5 months. During the year ended September 30, 2004, 13,150,000 common share purchase warrants were exercised for proceeds of $1,315,000 and the remaining 500,000 common share purchase warrants expired unexercised.
vi)	Pursuant to a non-brokered private placement during the year ended September 30, 2003, the company issued 5,669,470 units for net proceeds of $566,947. Each unit consisted of one common share and one common share purchase warrant. Each common share purchase warrant entitled the holder to purchase one additional common share of the company at a price of $0.10 per share for a period of one year from the date of closing. The net proceeds of $566,947 were allocated: $406,414 to the common shares issued and $160,533 to the common share purchase warrants. 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 100%; risk-free interest rate of 4%; and expected life of one year. During the year ended September 30, 2004, all of the common share purchase warrants were exercised for proceeds of $566,947.
vii)	Pursuant to a non-brokered private placement during the year ended September 30, 2003, the company issued 25,200,000 common shares at $0.10 per share. Net proceeds of $2,425,414 (net of cash issuance costs of $60,222 and share purchase warrants with a value of $34,364 (note 6(c)(i))) were recorded as common shares. The company received $345,000 that had been held in trust at September 30, 2003 related to this private placement. During the year ended September 30, 2005, 80,000 common share purchase warrants were exercised for proceeds of $11,200 (2004 - 174,000 for proceeds of $24,360).

F-14

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

b) Stock options

The company initially adopted a stock option plan (the Plan) in 1997. At the company’s annual general meeting held on March 10, 2004, the number of common shares reserved under the Plan was increased by 4,400,000 common shares. As at September 30, 2005, the company has reserved 18,000,000 common shares (2004 - 18,000,000; 2003 - 13,600,000) under the Plan. The options, which expire five years after the date granted, are subject to various vesting requirements. Under the original terms of the Plan, the majority of options vest one-third on the date of grant and one-third on each of the first and second anniversaries of the date of grant. However, at an extraordinary general meeting of the company’s shareholders held on December 7, 2001, the Plan was amended to include a change in the vesting period, permitting vesting of one-eighteenth of the options granted each month, with the first eighteenth vesting on the date of grant.

The following table summarizes activity under the company’s stock option plan as of September 30, 2003, 2004 and 2005:

Stock options	Number of options			Weighted average exercise price of outstanding options $		Weighted average exercise price of exercisable options $
Outstanding - September 30, 2002 (7,023,490 shares exercisable)		13,339,320			0.15		0.19
Granted		1,050,000			0.16
Expired		(175,000	)		0.31
Forfeited		(1,149,320	)		0.15
Outstanding - September 30, 2003 (11,692,818 shares exercisable)		13,065,000			0.16		0.17
Granted		3,775,000			0.31
Expired		(1,080,333	)		0.15
Outstanding - September 30, 2004 (12,893,001 shares exercisable)		15,759,667			0.20		0.18
Granted		4,700,000			0.15
Expired		(930,396	)		0.38
Forfeited		(1,587,500	)		0.32
Cancelled		(2,200,000	)		0.19
Exercised		(385,000	)		0.15
Outstanding - September 30, 2005 (12,373,438 shares exercisable)		15,356,771			0.16		0.17

F-15

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

The following table summarizes information about stock options outstanding and exercisable at September 30, 2005:

	Options outstanding						Options exercisable
Exercise price $	Number outstanding		Weighted average remaining contractual life (years)		Weighted average exercise price $		Number exercisable		Weighted average exercise price $
0.15		13,319,271		2.4		0.15		10,335,938		0.15
0.17		750,000		3.0		0.17		750,000		0.17
0.31		1,287,500		3.2		0.32		1,287,500		0.31
0.15 - 0.31		15,356,771		2.5		0.16		12,373,438		0.17

During the year ended September 30, 2005, the company recognized a compensation expense of $124,338 for stock options issued to employees (2004 - $314,011; 2003 - $nil).

During the years ended September 30, 2005 and 2004, no stock options were provided to consultants for services rendered. During the year ended September 30, 2003, the company expensed $97,181 in stock-based compensation related to services provided by consultants, who were granted 750,000 stock options.

The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model. Stock-based compensation expense arising from grants of options to employees and non-employees was estimated using the Black-Scholes option pricing model assuming no dividend yield and the following weighted average assumptions for options granted:

	2005			2004			2003
Expected volatility		63	%		100	%		100	%
Risk-free interest rate		3.25	%		4	%		4	%
Expected life (in years)		5			5			5

F-16

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

c) Warrants

i)	During the year ended September 30, 2003, the company retained First Associates Investments Inc. (First Associates) to assist in raising funds for the company. On September 16, 2003 and pursuant to the private placement of 25,200,000 common shares of the company, the TSX Venture Exchange approved the issuance of 500,000 common share purchase warrants, with immediate vesting, for services provided. The common share purchase warrants are exercisable on or before October 7, 2005, at a price of $0.14. The common share purchase warrants were assigned a value of $34,364, which has been included as a share issue cost and recorded in equity. The value was determined using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of $nil; expected volatility of 100%; risk-free interest rate of 4%; and expected life of 1.25 years. During the year ended September 30, 2005, 80,000 common share purchase warrants were exercised for proceeds of $11,200 (2004 - 174,000 for proceeds of $24,360).
ii)	During the year ended September 30, 2002, the company retained TELUS Communications Inc. (TELUS) to provide consulting services to the company, under an agreement dated June 4, 2002. As consideration, the company had agreed to issue TELUS up to 2,100,000 common share purchase warrants, which were provided as earned during and under the terms of the agreement on February 27, 2003 in lieu of fees of $105,000 for services provided to January 4, 2003. The common share purchase warrants were issued with immediate vesting and are exercisable on or before February 27, 2005 at a price of $0.10. These common share purchase warrants were assigned the value of $105,000, which has been included as a general and administrative expense and recorded in equity. During the year ended September 30, 2005, all of these common share purchase warrants expired unexercised.
iii)	During the year ended September 30, 2002, the company retained NBJ Enterprises Ltd., dba Skana Photo-Lab Products (Skana), to act as a distributor for the company’s products in Canada, under an agreement dated February 1, 2002. Amongst other consideration, the company had agreed to issue Skana up to 2,000,000 common share purchase warrants, which were to be provided as earned during and under the terms of the agreement. The common share purchase warrants were issued on January 22, 2003 and are exercisable on or before January 22, 2005, at a price of $0.10. The common share purchase warrants were assigned a value of $93,000, which has been included as a sales and marketing expense and recorded in equity. During the year ended September 30, 2005, the remaining 1,765,000 common share purchase warrants were exercised for proceeds of $176,500 (2004 - 235,000 for proceeds of $23,500).

F-17

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

iv)	During the year ended September 30, 2002, the company retained Discovery Capital Corporation (Discovery) to provide financial advisory services to the company, under an agreement dated February 19, 2002. As consideration, the company issued 4,325,000 common share purchase warrants to Discovery on July 26, 2002, which were exercisable on or before July 26, 2004 at a price of $0.10.
v)	Also during fiscal 2002, the company issued Discovery a finder’s fee of 700,000 common share purchase warrants (Finder’s Warrants), on the private placement of units of the PhotoChannel LP exercisable on or before July 26, 2004, at a price of $0.10. The common share purchase warrants were assigned a value of $125,625, which has been included as an expense and recorded in equity. During the year ended September 30, 2004, the company issued 3,025,000 common shares of the company for proceeds of $302,500 upon exercise of the remaining common share purchase warrants (2003 - 2,000,000 for proceeds of $200,000).
vi)	On May 11, 2000, the company granted a common share purchase warrant, exercisable for a period of five years, to purchase up to 1,000,000 common shares of the company at a price of US$1.75 per share. The common share purchase warrant was assigned a value of $1,700,000, which was recorded in equity. During the year ended September 30, 2005, this share purchase warrant expired unexercised.

d) Loans receivable

During the year ended September 30, 2002, the company made loans totalling $227,470 to employees, which were secured by common shares of the company. As at September 30, 2005, loans totalling $nil (2004 - $17,600) were outstanding and have been recorded as a charge to shareholders’ equity. The loans are non-interest bearing and are repayable on demand.

7 Limited Partnership equity

On February 14, 2002, the PhotoChannel LP was formed under a Limited Partnership Agreement to carry on the sales, marketing and deployment of the PhotoChannel Network in specified market segments. The partnership initially sold 1,250 Limited Partnership units in June 2002, at a price of $1,000 per unit, raising $1,250,000. In December 2002 and September 2003, the partnership sold an additional 115 units and 245 units, respectively, at a price of $1,000 per unit, raising $360,000. The company had granted to the PhotoChannel LP a software license to commercially exploit the PhotoChannel Network in Canada. Pursuant to an operating agreement, the company received payments for services provided to the PhotoChannel LP from the software license agreement and management and operating services agreements (representing software rights, management, personnel and facilities and equipment that the company had agreed to provide to the PhotoChannel LP), which enabled the company to continue its development, deployment and exploitation of its digital imaging network software in other market segments.

F-18

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

A condition of the PhotoChannel LP agreement was that each limited partner enters into an agreement with the company, pursuant to which the company had a call option to acquire all, but not less than all, of the Limited Partnership units from the limited partners, at any time on or before June 30, 2004. Under the call option, each of the Limited Partnership units sold in June and December 2002 would be exchanged for 10,000 units of the company, with each unit comprising one common share and one common share purchase warrant. Each common share purchase warrant entitled the holder to purchase one additional common share of the company, at a price of $0.10 per share, at any time on or before the earlier of two years from the date of issue of the Limited Partnership units and June 30, 2004. Each Limited Partnership unit sold in September 2003 could be exchanged for 10,000 common shares of the company.

Given the existence of the company’s option to acquire the Limited Partnership units from the limited partners, certain common ownership and management of the company and the Limited Partnership, and the company’s effective control over the PhotoChannel LP, the partnership equity was presented as a separate class of equity within shareholders’ equity of the company. The accounts of the partnership were consolidated with those of the company since the inception of the PhotoChannel LP.

The company also entered into a support agreement, pursuant to which the company agreed to provide financing to the Limited Partnership, in connection with operational and capital costs, once substantially all equity generated from the Limited Partnership units was utilized. Losses incurred by the Limited Partnership in 2002 and 2003 were allocated first to the Limited Partnership units to the extent of their equity investment and thereafter to the company.

In April 2004 the company exercised its call options with the limited partners thereby acquiring all of the Limited Partnership units. Under the terms of the call option agreements, the company issued 16,100,000 common shares and 13,650,000 common share purchase warrants. Each common share purchase warrant entitled the holder to purchase one additional common share of the company at a price of $0.10 per share up to June 30, 2004. The company recorded the redemption of the PhotoChannel LP at the fair value of the common shares and common share purchase warrants (note 6), with the offsetting amount recorded as an increase in its deficit.

8 Net change in non-cash working capital items

	2005 $			2004 $			2003 $
Accounts receivable		(96,617	)		(224,399	)		20,935
Prepaid expenses		(114,854	)		1,125			15,603
Accounts payable and accrued liabilities		562,359			(541,403	)		(1,464,214	)
Deferred revenue		12,271			115,769			60,000
Due to related parties		-			-			(273,612	)
		363,159			(648,908	)		(1,641,288	)

F-19

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

9 Revenue

The following is a breakdown of the company’s revenue for the years ended September 30, 2005, 2004 and 2003:

	2005 $		2004 $		2003 $
Transaction commission fees		708,438		361,350		90,054
Installation fees		676,274		187,940		86,914
Membership fees		519,037		96,519		73,120
Archive fees		107,515		57,091		2,944
Other		105,239		60,240		2,541
		2,116,503		763,140		255,573

10 Expense details

	2005 $			2004 $		2003 $
Network delivery
Laboratory system installation		366,852			52,288		9,781
Salaries and customer service		214,633			100,810		20,600
Telecommunication costs		207,210			128,873		71,570
Other		107,007			45,218		9,740
		895,702			327,189		111,691
General and administration
Salaries and consulting		1,011,249			754,439		1,031,291
Office and miscellaneous		258,427			287,797		203,024
Accounting and legal		169,127			123,932		106,498
Stock-based compensation expense		124,338			-		-
Rent		84,499			68,994		92,927
Investor relations		67,500			90,000		29,900
Interest and penalties		66,159			78,157		113,719
Bad debt		29,368			18,100		-
Loss on sale of property, plant and equipment		(6,819	)		-		44,209
		1,803,848			1,421,419		1,621,568
Sales and marketing
Salaries and consulting		566,770			549,797		678,876
Miscellaneous		58,277			42,925		54,342
Printing, advertising and promotion		48,950			49,284		1,574
		673,997			642,006		734,792
Research and development
Salaries and consulting		1,523,716			1,219,808		766,890
Miscellaneous		83,142			59,430		22,299
		1,606,858			1,279,238		789,189

F-20

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

Gain on settlement of obligations

During the year ended September 30, 2003, the company recognized a gain of $457,599 on settlement of obligations as a result of debt settlements with various trade creditors and past employees of the company.

11 Income taxes

The company is subject to Canadian federal and provincial taxes.

The company has non-capital losses for Canadian income tax purposes of approximately $17,349,000, which are available for carry forward to reduce future years’ taxable income. These income tax losses expire as follows:

	$
Year ending September 30
2006		2,065,000
2007		5,391,000
2008		2,630,000
2009		-
2010		2,119,000
2011		2,821,000
2012		2,323,000
		17,349,000

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

	2005 $			2004 $			2003 $
Net operating loss carry-forwards		6,180,000			6,384,000			6,455,911
Property, plant and equipment		2,001,000			1,896,000			1,803,587
Share issue costs		216,000			159,000			72,840
Deferred revenue		67,000			-			-
Unpaid amounts		96,000			-			-
		8,560,000			8,439,000			8,332,338
Valuation allowance		(8,560,000	)		(8,439,000	)		(8,332,338	)
Net future income tax assets		-			-			-

Management believes there is sufficient uncertainty regarding the realization of future income tax assets such that a full valuation allowance is appropriate.

F-21

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

The income tax recovery for the year ended September 30, 2005 differs from the amount obtained by applying the applicable statutory income tax rates to loss before income taxes as follows:

	2005			2004			2003
Combined statutory income tax rate		36	%		36	%		38	%
	$			$			$
Income tax recovery based on combined statutory rate		(1,121,306	)		(1,098,895	)		(930,994	)
Expiration of tax losses		969,092			1,232,140			169,467
Effect of change in tax rates		-			30,525			73,500
Non-deductible expenses and other differences		31,214			(270,432	)		14,193
Change in valuation allowance		121,000			106,662			673,834
		–			–			–

12 Related party transactions

During the year ended September 30, 2005, the company incurred consulting fees to companies controlled by directors and officers of the company of approximately $137,500 (2004 - $179,167; 2003 - $134,658). The fees were recorded in general and administration expense.

As at September 30, 2005, there was $31,250 (2004 - $nil) due for consulting fees owed to such companies.

13 Segmented information

The company’s only reportable segment is the provision of digital image delivery, hosting, storage and financial reporting for photo-finishing retailers.

The company’s sales by geographical area are as follows:

	2005 $		2004 $		2003 $
Canada		1,750,679		567,211		145,559
United States		361,610		187,850		110,014
Other		4,214		8,079		-
		2,116,503		763,140		255,573

F-22

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

Revenue is attributable to the geographic location of the company’s customer. At September 30, 2005 and 2004, all of the company’s property, plant and equipment were located in Canada.

Major customers, representing 10% or more of sales, include:

	2005 $		2004 $
Customer A		1,140,564		177,523
Customer B		255,693		-
Customer C		233,583		-
Customer D		-		108,983
Customer E		-		89,318
Customer F		-		76,063

14 Financial instruments

a)	Fair values
	The fair values of cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities approximate their carrying amounts due to the near-term maturity of these instruments.
b)	Credit risk
	Financial instruments that potentially subject the company to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The company limits its exposure to credit risk by placing its cash and cash equivalents with high credit quality financial institutions and corporations. The company provides its services on credit in the normal course of conducting its business.
c)	Foreign exchange risk
	The company is subject to foreign exchange risk for sales and purchases denominated in foreign currencies. Foreign currency risk arises from the fluctuation of foreign exchange rates and the degree of volatility of these rates relative to the Canadian dollar. The company does not actively manage this risk.

F-23

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

15 Commitments and contingencies

Commitments

The company has entered into agreements to lease premises and services for periods to fiscal 2008. The annual rent for premises includes minimum rent plus realty taxes and operating expenses. Minimum payments for each of the next three years are as follows:

	$
2006		398,796
2007		221,515
2008		4,740
		625,051

Contingencies

The company is 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 will not materially affect the company’s consolidated financial position.

16 Subsequent event

On November 15, 2005, the TSX Venture Exchange accepted for filing documentation with respect to the company’s non-brokered private placement in the amount of $1,700,000 upon issuance of 17,000,000 units. Each such unit comprising one common share of the company and one half of one non-transferable share purchase warrant, each full warrant entitling the purchase of an additional common share of the company for a period of one year, from the date of close, at a price of $0.15. The company closed the private placement on November 15, 2005.

F-24

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

17 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 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 (U.S. GAAP).

The reconciliation of the loss for the year based on Canadian GAAP to U.S. GAAP is as follows:

	2005 $			2004 $			2003 $
Net loss for the year under Canadian GAAP		3,147,967			3,052,485			2,822,394
Compensation cost (recovery) (i)		(8,600	)		(78,428	)		136,416
Minority interest (ii)		-			-			(372,410	)
Net loss and comprehensive loss for the year under U.S. GAAP (iii)		3,139,367			2,974,057			2,586,400
Basic and fully diluted loss per share under U.S. GAAP		0.02			0.02			0.03

The reconciliation of the balance sheet between Canadian GAAP and U.S. GAAP is as follows:

	2005 $		2004 $
Goodwill (iv)
Canadian GAAP		-		-
U.S. GAAP		6,511,063		6,511,063

	Capital Stock $		Contributed Surplus (i) $		Loans receivable $			Warrants $		Deficit (i) and (iv) $			Total, shareholders equity $
Balance - September 30, 2003
Canadian GAAP		31,826,678		6,976,915		(122,206	)		2,168,522		(40,176,059	)		673,850
U.S. GAAP		31,718,518		9,413,344		(122,206	)		2,168,522		(42,504,328	)		673,850
Balance - September 30, 2004
Canadian GAAP		41,702,604		7,060,029		(17,600	)		2,188,653		(49,739,607	)		1,194,079
U.S. GAAP		41,594,444		9,418,030		(17,600	)		2,188,653		(45,478,385	)		7,705,142
Balance - September 30, 2005
Canadian GAAP		43,625,343		9,303,378		-			698,873		(53,345,585	)		282,009
U.S. GAAP		43,517,183		11,652,779		-			698,873		(49,075,763	)		6,793,072

i)	Stock-based compensation
	As more fully described in note 2, the company retroactively adopted the new Canadian GAAP recommendations, which require that a fair value method of accounting be applied to all stock-based compensation awards to both employees and non-employees granted on or after October 1, 2002. The Canadian GAAP recommendations are substantially harmonized with the existing U.S. GAAP rules. Therefore, there is no GAAP difference for stock-based compensation and awards granted in fiscal 2005. The remaining difference relates to options that were modified in fiscal 2002 and remain outstanding and fully vested at year-end.
	In fiscal 2002, 1,889,709 options were modified, of which 215,000 options remain outstanding and fully vested.

F-25

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, requires the company to provide pro forma information regarding net income and earnings per share as if compensation for the company’s stock option plans had been determined in accordance with the fair value based method prescribed in SFAS 123. The company estimates the fair value of each stock option at the grant date or measures compensation for options modified and requiring variable accounting from the date of modification by using the Black-Scholes option pricing model with the following weighted average assumptions used for grants for the fiscal years ended September 30:

	2005			2004			2003
Dividend yield		nil			nil			Nil
Expected volatility (private company)		63	%		100	%		100	%
Risk-free interest rate		3.25	%		4	%		4	%
Expected life (in years)		5			5			5

The weighted average fair value of options granted during 2005 was $0.13 (2004 - $0.22; 2003 - $0.12). The effect of pro forma compensation expense on the company’s loss and loss per share is as follows:

	2005 $		2004 $		2003 $
Loss per U.S. GAAP		3,139,367		2,974,057		2,586,400
Additional compensation expense		19,788		333,799		203,299
Pro forma loss		3,159,155		3,307,856		2,789,699
Pro forma basic and diluted loss per share		0.02		0.02		0.03

ii) Minority interest

Under Canadian GAAP, the company presents the partnership equity within shareholders’ equity and separates the net loss attributed to the Limited Partnership from the net loss attributed to the common shareholders (note 7). Under U.S. GAAP, the company applies Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, (ARB 51) and related interpretations in accounting for the consolidation of the Limited Partnership. Under ARB 51, the partnership equity is presented as minority interest to the extent of the limited partners’ equity investment, net of losses attributed to the limited partners. The loss attributed to the limited partners is shown as minority interest on the statement of loss and deficit.

F-26

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

iii) Comprehensive loss

U.S. GAAP requires disclosure of comprehensive income (loss), which is intended to reflect all changes in equity except those resulting from contributions from owners. There are no material adjustments required to present comprehensive income (loss) for the purposes of these consolidated financial statements.

iv) Redemption of Limited Partnership units

As described in note 7, for Canadian GAAP purposes the redemption of the Limited Partnership units was recorded as a charge to deficit. Under U.S. GAAP, the company applies SFAS No. 141, “Business Combinations”, and has 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. Under U.S. GAAP, goodwill is subject to an annual impairment test. The company applies SFAS No. 144, “Accounting for the Impairment of or Disposal of Long-Lived Assets”, in determining if there is any impairment in value. No impairment in value was recorded in 2005.

v) Cash flow statement

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 U.S. GAAP under the accommodation provided by the Securities and Exchange Commission of the United States (SEC).

vi) Recent U.S. GAAP announcements

Share-based payment

SFAS 123(R) supersedes APB 25 and related implementation guidance, and revises SFAS 123 in a number of areas. Under SFAS 123R, all forms of share-based payment to employees result in compensation cost recognized in financial statements and pro forma disclosure will no longer be permitted with respect to employee stock options. While SFAS 123R states that it is effective for public companies (non-small business issuers) as of the beginning of interim or annual reporting periods that start after June 15, 2005, the SEC has deferred the effective date for public companies to annual, rather than interim, periods that begin after June 15, 2005.

Staff Accounting Bulletin (SAB) 107 expresses views of SEC staff related to SFAS 123(R). In particular, this SAB provides guidance related to transactions with non-employees, transition from non-public to public entity status, valuation methods and assumptions, the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS 123(R) in an interim period, capitalization of compensation cost, accounting for income tax effects, modification of employee share options prior to adoption of SFAS 123(R), and disclosures in Management’s Discussion & Analysis.

F-27

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

SFAS 154 accounting changes and error corrections

SFAS 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

The company has determined that other recently issued Canadian and U.S. accounting pronouncements will have no impact on adoption.

vii) Recent Canadian GAAP announcements

EIC 156 - Vendor consideration

EIC 156 addresses the accounting by a vendor for consideration given to a customer (e.g. rebates, sales incentives) including whether this consideration should be net against revenue or treated as an expense, and how to measure rebate liabilities. This guidance applies to interim and annual financial statements for years beginning on/after January 1, 2006. 

F-28