Pni Digital Media 20F 2005 Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

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 V6B 6E3, Canada

(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 the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes o

No x

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

Item 17 x

Item 18 o

TABLE OF CONTENTS

		Page
PART I

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	12

ITEM 5.	OPERATING AND FINANCIAL REVIEW AND PROSPECTS	21

ITEM 6.	DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	31

ITEM 7.	MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	35

ITEM 8.	FINANCIAL INFORMATION	36

ITEM 9.	THE OFFER AND LISTING	37

ITEM 10.	ADDITIONAL INFORMATION	39

ITEM 11.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	48

ITEM 12.	DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES	48

PART II

ITEM 13.	DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES	49

ITEM 14.	MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS	49

ITEM 15.	INTERNAL CONTROLS	49

ITEM 16.	[RESERVED]	50

PART III

ITEM 17.	FINANCIAL STATEMENTS	52

ITEM 18.	FINANCIAL STATEMENTS	52

ITEM 19.	EXHIBITS	52

Signature Page		53

Certifications

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, 2005. 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, 2005 and with respect to the consolidated balance sheets as at September 30, 2005 and 2004, are derived from our audited consolidated financial statements included elsewhere in this annual report. Consolidated statements of operations data for the years ended September 30, 2002 and 2001, and consolidated balance sheet data as at September 30, 2003, 2002 and 2001, have been derived from our audited 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 17 in the accompanying September 30, 2005 consolidated financial statements for a quantitative 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 30^th
Item	2005			2004			2003			2002			2001
Revenue	$	2,116,503		$	763,140		$	255,573		$	173,801		$	97,112
Loss from operations		($3,167,761	)		($3,078,188	)		($3,282,445	)		($5,334,672	)		($20,259,747	)
Net loss for the year		($3,147,967	)		($3,052,485	)		($2,822,394	)		($1,851,661	)		($19,871,231	)
Loss attributed to Limited Partnership		N/A			N/A		$	372,410		$	1,237,590			N/A
Net loss for the year attributed to common shareholders		($3,147,967	)		($3,052,485	)		($2,449,984	)		($614,071	)		($19,871,231	)
Basic and diluted net loss per common share		($0.02	)		($0.02	)		($0.03	)		($0.01	)		($0.60	)
Redemption of limited partnership units		N/A			($6,511,063	)		N/A			N/A			N/A
Modification of existing warrants		($144,000	)		N/A			N/A			N/A			N/A
Stock-based compensation adjustment		($314,011	)		N/A			N/A			N/A			N/A
Total assets	$	1,608,252		$	1,945,692		$	1,851,097		$	709,237		$	1,488,276
Net assets (liabilities)	$	282,009		$	1,194,079		$	673,850			($2,145,836	)		($5,127,511	)
Capital Stock	$	43,397,853		$	41,702,604		$	31,826,678		$	26,390,849		$	24,168,231
Weighted average number of Common Shares		178,682,855			148,741,599			89,448,942			59,479,315			33,187,579
Long term obligations and redeemable preferred stock		Nil			Nil			Nil			Nil			Nil
Cash dividends declared per common share		Nil			Nil			Nil			Nil			Nil

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

	For the years ended September 30^th
Item	2005			2004			2003			2002			2001
Revenue	$	2,116,503		$	763,140		$	255,573		$	173,801		$	97,112
Loss from operations		($3,167,761	)		($3,078,188	)		($3,282,445	)		($5,334,672	)		($20,259,747	)
Net loss for the year		($3,139,367	)		($2,974,057	)		($2,586,400	)		($615,024	)		($19,692,225	)
Basic and diluted net loss per common share		($0.02	)		($0.02	)		($0.03	)		($0.01	)		($0.60	)
Total assets	$	8,119,315		$	8,456,755		$	1,851,097		$	709,237		$	1,488,276
Net assets (liabilities)	$	6,793,072		$	7,705,142		$	673,850			($2,145,836	)		($5,127,511	)
Capital Stock	$	43,517,183		$	41,594,444		$	31,718,518		$	26,282,689		$	24,060,071
Weighted average number of common shares outstanding		178,682,855			148,741,599			89,448,942			59,479,315			33,187,579
Long term obligations and redeemable preferred stock		Nil			Nil			Nil			Nil			Nil
Cash dividends declared per common share		Nil			Nil			Nil			Nil			Nil

Currency and Exchange Rates

All dollar amounts set forth in this annual report are in Canadian dollars, unless we indicate otherwise. In the following table we set 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 in New York City for cable transfers in Canadian dollars as certified for customs purposes by the Federal Reserve Bank of New York.

Previous Six Months

	September 2005		October 2005		November 2005		December 2005		January 2006		February 2006
High Rate		1.1943		1.1923		1.1975		1.1751		1.1796		1.1611
Low Rate		1.1620		1.1582		1.1542		1.1424		1.1430		1.1375

Years ending September 30

	2005		2004		2003		2002		2001
Rate at end of Period		1.1713		1.2699		1.3536		1.5785		1.5775
Average Rate During Period		1.2235		1.3256		1.4648		1.5730		1.5351
High Rate		1.2755		1.4003		1.5991		1.6195		1.5832
Low Rate		1.1620		1.2672		1.3305		1.5024		1.4895

On September 30, 2005 and March 15, 2006, the noon buying rate in New York City for cable transfers in US dollars as certified for customs purposes by the Federal Reserve Bank of New York was Canadian $1.1713 and $1.1581, respectively, equals US $1.00.

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. 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. Any person who is not in a position to lose the entire amount of any investment should not invest in our securities.

The Following Risks Relate to Our Current and Planned Business Operations

In the past we have relied on the proceeds of financings to fund our operations. If we are unable to generate positive cash flow from operations or continue to raise funds, we may be required to limit or curtail operations.

Since inception we have operated at a loss and, at September 30, 2005, had an accumulated deficit of $53,345,585 and a working capital deficiency of $588,066. Historically, we have funded our operating, administrative and development costs through the sale of equity capital or debt financing. We have had and will continue to have capital requirements in excess of our currently available resources. Currently, we are able to meet our financial commitments as they come due. We are dependent upon the proceeds of future financings to further finance the development and implementation of our business objectives. In the event that our plans and/or assumptions change or prove inaccurate, or we are unable to obtain further financing, or such financing and other capital resources, in addition to projected cash flow, if any, prove to be insufficient to fund operations, our continued viability could be at risk. To the extent that any such financing involves the sale of our equity securities, the interests of our then existing shareholders could be substantially diluted. There is no assurance that we will be successful in achieving any or all of these objectives over the coming year and, accordingly, there exists substantial doubt that we will be able to continue as a going concern.

We are implementing a plan to address these issues and to enable us 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 our customer base, and the realization of sufficient revenues produced by our network. 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 consolidated 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.

As a result of equity financing activities, as of September 30, 2005, we had cash and cash equivalents of approximately $187,318 and as of March 15, 2006, we had cash and cash equivalents of $846,166.

In addition, we currently generate monthly revenues of approximately $180,000, of which $160,000 relates to recurring revenues from the our Network and we have monthly recurring expenditures of approximately $320,000. Accordingly, based on our planned operations during fiscal 2006, we believe that we have sufficient funds for the next three months without need to access the equity markets. We anticipate accessing the equity markets for additional funding depending on actual sales and resulting cash flow during this period. Should our revenue not grow during the next 12 months we would be required to raise a minimum of $1,500,000 to sustain our current level of operations for this period.

We are 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 our customer base, and increasing revenues from operations.

We have yet to generate sufficient revenues to cover our operating expenses. Accordingly, if we are unable to generate positive cash flow from operations or continue to raise funds, we may be required to either limit, curtail, cease or stop operations. In the event that we cease or stop operations, shareholders could lose their entire investment.

Our business is primarily focused on the Canadian marketplace, however, as we enter the United States and should our product set be accepted, we could have significant exposure to foreign exchange rates, which may adversely impact our business model.

We have been focused on the Canadian marketplace. Although we have a limited number of customers in and revenue generated from the United States marketplace, it is now our intent to focus more on the United States marketplace. The United States marketplace for photofinishing is approximately twenty times the size of the Canadian marketplace and should we be successful in the United States market, we would expect a substantial portion of our operations to be based on sales and services rendered to customers in the United States. As a result, our financial performance will be affected by fluctuations in the value of the US dollar to the Canadian dollar. At the present time, we have no plan or policy to utilize forward contracts or currency options to minimize 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 audited financial statements contain a footnote about our ability to continue as a going concern. The auditor’s report on our September 30, 2005 consolidated financial statements contains additional comments that indicate that substantial doubt exists about our ability to continue as a going concern. If we are unable to continue as a going concern, we would be required to restate our consolidated financial statements on a liquidation basis.

Our consolidated financial statements have been prepared on the basis of accounting principles applicable to a going concern. As of September 30, 2005, we had an accumulated deficit of $53,345,585, which, if prepared under US GAAP, would have been an accumulated deficit of $49,095,763. We continue to incur operating losses, including non-cash items of $3,167,761 during fiscal 2005 (2004 - $3,078,188, 2003 - $3,282,445). We currently generate monthly revenues of approximately $180,000, of which $160,000 relates to recurring revenues from the our Network and we have monthly recurring expenditures of approximately $320,000. Our ability to continue as a going concern and the recoverability of the amounts expended on research and development are dependent on our ability to achieve profitable operations. Failure to continue as a going concern would require a restatement of assets and liabilities on a liquidation basis, which would differ materially from the going concern basis on which our consolidated financial statements were prepared.

Under generally accepted auditing standards in the United States of America (“U.S. GAAS”), the auditors’ report on the consolidated financial statements contains an explanatory paragraph when the financial statements are affected by conditions and events that cast substantial doubt on a company’s ability to continue as a going concern, such as those described in Note 1 to the consolidated financial statements.

We are implementing a plan to address these uncertainties and to enable us 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 our 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 consolidated 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.

We believe, but cannot assure, that we will be able to continue to raise equity financing.

Our products are relatively new. If they are not accepted in the marketplace, our business could be materially and adversely affected.

Our Network has only been marketed since May 2001. While we believe we are seeing increased acceptance of our services and business model, there can be no assurance that our services will receive the widespread market acceptance necessary to attain profitable operations. Even if our services 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. We cannot assure that the Network will be accepted in the marketplace to yield material and sustained revenues. If our product is not accepted in the market place, our business could be materially and adversely affected.

Our business is focused on a market niche that has never been fully addressed, and hence our operations are subject to a high level of uncertainty and risk. As the market for our service is new and evolving, it is difficult to predict the size of the market, the future growth rate, if any, or the level of premiums the market will pay for our services. There can be no assurance that the market for our services will emerge to a profitable level or be sustainable. 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 continue to be materially and adversely affected.

Ultimately, our success will depend upon consumer acceptance of the use of the Internet to deliver digital media, including, digital images to our retailers for production. We rely on the retailers to market these services to end users. 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 customers. The failure to attract 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.

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 products 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 market acceptance of our existing solution and our ability to enhance these solutions and introduce new solutions and features to meet changing customer requirements. We cannot assure that we will be successful in identifying, manufacturing 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.

Expected rapid growth in all areas of our Network may place a significant strain on our operational and technical resources. We expect operating expenses and staffing levels to 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 compete with others who provide products comparable to our Network. 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. Many of our potential 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 sure 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.

We rely on our ability to attract and retain customers. If we are unable to maintain reliability of our Network solution we may lose both present and potential customers.

Our ability to attract and retain customers depends on the performance, reliability and availability of our services and network infrastructure. 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 service. 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 Network. 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 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.

We are in the process of inquiring into and applying for patents in Canada and the United States.

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. Although currently we are not engaged in any form of litigation proceedings in respect to the foregoing, in the future, we may receive notice of claims of infringement of other parties' proprietary 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 technology 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 caliber.

We rely on our retail customers to derive revenue the loss of a large customer would likely have an adverse effect on our business.

We have a limited number of retailer customers and the loss of one or more of our larger customers would adversely affect our business.

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. Trading of these shares is presently concentrated in the Canadian marketplace. At present there is a limited trading market in the United States for our common shares and such is unlikely to develop further under the present circumstances. We have no agreement with any broker-dealer to act as a market-maker for our common shares. If one or more broker-dealers become a market maker in our shares, the shares may be quoted on the OTC Bulletin Board. Any trading will be limited to the non-NASDAQ over-the-counter market. We presently do not qualify for trading on either NASDAQ or on any US stock exchange because we do not meet any of those organizations' financial listing requirements. Further, there can be no assurance that our securities will ever qualify for such listing. Accordingly, there can be no assurance that any US market for our securities will develop or, that if developed, it will continue. The absence of such a US market would materially and adversely affect the ability of US shareholders to sell their shares.

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

ITEM 4. INFORMATION ON THE COMPANY

Summary

We develop and market digital imaging technology, which connects the photofinishing retailer to its customer through a wide variety of businesses including professional and commercial photo processing labs, image content owners and targeted portal services. We have created and manage a digital Network environment whose focus is on delivering digital image orders from capture to fulfillment under the control of our originating Network partner.

Our Network is described in greater detail in “Our Services” in Item 4.B Business Overview below.

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 obtained receipts in April 1997 for a Prospectus filed with the British Columbia Securities Commission and the Ontario Securities Commission. Our shares were subsequently listed for trading on the Montreal Exchange on April 21, 1997 under the trading symbol "IMD". We changed our name on July 14, 1999 to PhotoChannel Networks Inc. and concurrently changed our symbol on the Montreal Exchange to “PNI”. In September 2001 the Montreal Exchange (“ME”) merged with the Canadian Venture Exchange (“CDNX”) and effective October 1, 2001 we began trading on the CDNX. Subsequently the CDNX was acquired by the TSX Venture Exchange in 2002 and on April 1, 2002 we were listed for trading on the TSX Venture Exchange.

Our principal executive office is located at 506-425 Carrall Street, Vancouver, British Columbia, Canada V6B 6E3, our telephone number is 604-893-8955 and our website is www.photochannel.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 Since October 1, 1997

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 $523,595 for the year ended September 30, 2005 compared with $536,241 in 2004, $264,123 in 2003, $1,882 in 2002 and $1,186,256 in 2001. We have financed these expenditures primarily by issuing debt and common shares. 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 15, 2006 there were no capital expenditures or divestitures in process outside of the normal course of business.

Public Takeover Offers Since October 1, 2000

There have been no public takeover offers by third parties in respect of our shares or by us in respect of other companies' shares since October 1, 2000.

B. Business Overview

Historically, we have been in the business of developing and marketing digital imaging software products for use by consumers and businesses. We were originally formed to develop and market a suite of “easy to use” multimedia presentation products for use by consumers wishing to present and display images captured on digital cameras and photo scanners. We marketed these 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. During the fiscal year ending September 30, 2000, all of our revenue was generated from the sale of our multimedia presentation products. However, as of January 31, 2001, we no longer actively marketed or supported these products.

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 launched an e-Processing service with the introduction of a photofinishing, e-Processing service as a business - to - consumer strategy providing film processing, scanning, storage and printing of digital images directly to US consumers via our wholly owned US subsidiary, PhotoChannel, Inc. This was to be a joint strategy between our future Network members and the “mail order” model of our US subsidiary. With this launch, we were able to beta test the technology and the marketing of this concept. Our US subsidiary was attempting to target digital camera users who required a photofinishing solution and eventually it was our goal to also provide photofinishing fulfillment through our future Network of professional photofinishing retailers. Regardless of whether our US subsidiary’s customers or our future retailer’s customers were digital camera or conventional film photographers, our Network member’s customers would be able to preview and edit their digital/digitized pictures online before ordering any prints.

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 debt settle with creditors of our US subsidiary, our US operating subsidiary, PhotoChannel, Inc. filed 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 whose focus is on delivering digital image orders from capture to fulfillment under the control of our originating Network member.

On May 10, 2001 the first retail Network members outfitted with their own branded Internet sites were activated onto the Network. 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 Network 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 Network, we distanced ourselves from our immediate past of being an Internet photofinishing “mail order” service into an Internet infrastructure company that manages a Network environment that today is focused on delivering digital imaging from order origination to fulfillment through our retail relationships and connectivity to the retail locations.

The Digital Photography Market

Digital camera and scanner manufacturers fabricate devices for digitizing pictures. Their products capture an image and output it as a digitized picture. Alternatively, conventional film images can be digitized through a scanning mechanism and either uploaded to the Internet for storage or transferred to a floppy disk or CD. Digitized pictures can then be printed on color inkjet or dye sublimination photo printers. Alternatively, they can be processed through an online service, which provides print photographs at a quality consistent with that offered by conventional film processors. Digital pictures may be stored on desktop or laptop computers, on floppy disks or picture CDs or as negatives at a website of an online digital photography service provider.

The primary target market for our Network services are print origination members such as communities, portals and retailers, and print fulfillment members such as photofinishing retailers. The use of digital cameras is increasing and we believe 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 digitized print services increases. In their 2005 report, InfoTrends reported that over 55% of US households own a digital camera already, and that is expected to continue to grow to 81% by 2010. The worldwide install-base of digital cameras has risen quickly since their introduction in the mid 1990’s. There is no demographic which digital cameras are exclusive to, nor is there a prohibitive degree of technological sophistication required to operate these cameras. InfoTrends further predicted in 2004, that 26% of all Internet users would upload a photo in 2004, as compared to 19% in 2003.

On top of the vast number of digital cameras that have entered the market, wireless camera phones within the market have risen dramatically. InfoTrends’ 2005 report, reported that 57 million camera phones are presently in the North America marketplace (46% of all handsets) and that this market is expected to continue to grow reaching 144 million in 2009 (or 86% of all handsets).

Photofinishing retailers originally viewed digital camera penetration as threatening their future. According to PMA’s “Photo Industry 2004 Review and Forecast” film processing volume fell by an estimated 6% in 2003 to 686 million rolls in the United States and processing revenue fell by nearly 8%, to $5.4 billion. This trend continued through 2004 and 2005 with film sales volumes reported by Kodak and others off by over 6% again, compounded annually. As consumers shift 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 imaging today and the future forecasting appears to indicate that digital will have an additive effect on the growth of picture taking.

We believe that 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 becomes 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 piece of equipment retailers are utilizing is known as the “digital minilab”. According to InfoTrends there were over 17,000 digital minilabs installed in the US in 2004 or over 50% of all minilabs. By 2008 InfoTrends has estimated that there will be over 25,000 digital minilabs installed representing over 76% of all minilabs.

According to the Photo Marketing Association, about 1.6 billion or 31 percent of the 5.1 billion printed digital photos were made through a photofinishing retailer in 2004, up from 0.5 billion in 2003. In 2005, this number is expected to reach 3.1 billion or 40 percent of total prints.

The rise of the digital minilab install base has been the defining factor in returning retailers to the forefront of printing pictures. Hewlett Packard (“HP”) reported that in 2003 there were 56 Billion digital photo exposures alone and further predicted this will grow to 144 Billion in 2005 and 312 Billion in 2008. On top of this 2008 metric, HP forecasts that of the digital photo exposures that get printed, 56 Billion or 43% will be printed by retailers. Translated into photofinishing revenue, it is predicted that digital photofinishing at retailers, from both drop off at retail and order on line, will be a $6.2 billion industry by 2008. InfoTrends research support these numbers. According to InfoTrends in 2000, 84% of all digital image printing was done at home with only 2% at retailers. In 2004, Infotrends reported that home printing had fallen to 66% with retailers now printing 19% of all digital images. By 2010, InfoTrends expects retailers to be printing 45% of all digital images.

Although more current trends are not yet available, we expect that the trends outlined above have continued and that these will continue into the future.

Products

The PhotoChannel Network

On May 10, 2001 the first retail Network members outfitted with their own branded Internet sites were activated onto our Network. 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 Network is a transparent component to the consumer, existing solely as the technology backbone of the retailer’s digital imaging strategy.

With the establishment and launch of our Network, we distanced ourselves from our immediate past of being an Internet photofinishing “mail order” service into an Internet infrastructure company that owns retail relationships, the connectivity to the retail locations and manages a Network environment that today is focused on delivering digital imaging from order origination to fulfillment.

In October 2002, we launched our Network with our first large retail chain, Black Photo Corporation (“Black’s”). Black’s is a wholly owned subsidiary of Fuji Film Canada. Black's owns and operates 143 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 at www.blackphotocenter.com, which prints back to a large Canadian wholesaler and is then delivered back to a Black’s location of the customer’s choice for pickup, or is mailed or couriered back to the customer, at the customer’s option. In September 2004 Black’s began to connect their retail locations to allow for prints ordered through our Network to be directly printed in the retail location selected by their customer for pickup. At March 15, 2006, Black’s had connected all of their 143 retail locations enabling these locations to offer a one hour digital printing solution from online ordering.

During fiscal 2003, we increased our retail photofinishing base to include such companies as Wal-Mart Canada, and Giant Eagle, Inc. in the United States. During fiscal 2004, we continued to add new photofinishing retailers, including Konica Minolta Photo Imaging USA, and expanded our offering to provide online image printing and picture messaging services to wireless carriers, with the launch of our first wireless carrier, TELUS Mobility. During fiscal 2005, Wal-Mart Canada began to connect their retail locations to allow for prints order through our Network to be directly printed in the retail location selected by their customer for pickup. At March 15, 2006, Wal-Mart Canada had connected 252 of their 272 retail locations, Black Photo Corp. had connected all of their 143 retail locations, Costco Canada had connected 67 of their 68 retail locations, enabling all of these locations to offer a one hour digital printing solution from online ordering.

Summary of Gross Revenues

During each of the three years ended September 30, 2005, 100% of our revenues were generated from our Network. Revenues for each of the three years were, as follows:

	September 30,
	2005		2004		2003
Total Revenue	$	2,116,503	$	763,140	$	255,573

Competition

Online photo print service

Internet photography service providers offer different services, some associated with photofinishing, others with archiving and sharing, and some provide a comprehensive photo-community service such as we launched. 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 chats 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 through our syndicated websites.

The online photo print service market is a fairly new market. The first generation of online photo print services arose with the 1996 introduction of online photo print services by PictureVision, Inc. under the trade name “PhotoNet”. Shortly thereafter, in August 1997, Eastman Kodak Inc. (“Kodak”) entered the online photo print business with the introduction of the Kodak Picture Network service, which provided conventional film scanning and uploading of digitized pictures to the Internet. In February 1998, Kodak acquired a 51% interest in PictureVision, Inc. Through this acquisition, Kodak then represented almost 100% of the online digital photography service market. Shortly after Kodak acquired a controlling interest in PictureVision, Inc., Sony introduced an online photo print service featuring free uploading of digital images to a Sony image station for online ordering of prints. The other first generation online photo print service provider is Foto Wire Development S.A. of Geneva, Switzerland, which has been providing Internet photo print services designed specifically for digital camera photographers in Europe since 1998. In 1999, Fotowire Development S.A. entered the U.S. market in partnership with two mail order photography developing labs, Mystic Color Lab in Connecticut and Signature Color in Texas. In 2003, Fotowire, ShareAPhoto and Silverlab merged to create Silverwire, which now offers an online solution similar to ours as a means to selling their digital kiosks.

The second generation of online photo print services began in November 1999 with the entry into the market by Ofoto, Shutterfly, PhotoAccess and Snapfish. This generation was a business to consumer model focused on the “mail order” concept of delivering digital/digitized photos through the Internet to a wholesaler with delivery back to the consumer through the postal service or by way of courier.

The provision of online photo print services through a distributed network, as we have contemplated, represents, what we believe to be, the third generation of this type of service.

Network

The market for our solutions and technologies are new, evolving and growing rapidly. Our 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 Ofoto and Shutterfly, are not our direct competitors. These companies have focused on a pure business to consumer model of online photofinishing. These players are competing with the established “mail order” players such as Mystic Color and District Photo (the world's largest mail order photofinishing operator). It's worth noting that mail order has declined as a market force over the last decade as the one-hour onsite operations of retailers have come to dominate the photofinishing landscape. Another notable 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 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.

The photofinishing retailers are our true customers. Organizations such as Kodak, Fuji, Pixology, Pixel Magic and Silverwire 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, print digital 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.

Kodak, through PhotoNet, was developing a similar network, however it was restricted to Kodak affiliates. Some larger retailers have created internal networks, however, such networks are restricted to that retailer’s stores. These companies mentioned above are all in various stages of competitive stance and we believe that we will be able to work with most of them without having to directly compete, as our relationships with the retailer is centered on building the actual physical network in a way that leaves the retailer in complete possession of their customers. We do not get between a retailer and their customers.

One of our strengths is that we offer a complete solution that creates a secure and open network, which is agnostic to the brand of 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. Our business model allows us to create a multi-dimensional digital image network.

Our current customers, when given the alternative of “white branding”, 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. In many cases the big hardware, paper and chemistry companies, such as Kodak and Fuji, are not servicing these accounts properly.

We believe that one of our advantages is that we are a small enough organization to make speedy and informed decisions. This flexibility means the retailer or their customer does not have to go through a bureaucracy to get a decision. 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 two wholly owned subsidiaries, PhotoChannel Capital Inc. and PhotoChannel Management Inc. Both subsidiaries are inactive. 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.

On February 14, 2002, the PhotoChannel Limited Partnership (“PhotoChannel LP”) was formed under a Limited Partnership Agreement to carry on the sales, marketing and deployment of the PhotoChannel Network in Canada. 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. We had granted to the PhotoChannel LP a software license to commercially exploit the PhotoChannel Network in Canada. Pursuant to an operating agreement, we received payments for services provided to the PhotoChannel LP from a software license agreement and management and operating services agreements (representing software rights, management, personnel and facilities and equipment that we had agreed to provide to the PhotoChannel LP), which enabled us to continue our development, deployment and exploitation of our digital imaging network software in other market segments.

A condition of the PhotoChannel LP agreement was that each limited partner enter into an agreement with us, pursuant to which we 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 of our units, with each unit comprising 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 us, 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 of our common shares.

In view of the existence of our option to acquire the Limited Partnership units from the limited partners, certain common ownership and management of us and the PhotoChannel LP and that we control the PhotoChannel LP, the partnership equity was presented as a separate class of our equity within shareholders’ equity. The accounts of the partnership were consolidated with ours since the inception of the PhotoChannel LP.

We also entered into a support agreement, pursuant to which we agreed to provide financing to the PhotoChannel LP, in connection with operational and capital costs, once substantially all equity generated from the Limited Partnership units was utilized. Losses incurred by the PhotoChannel LP in 2002 and 2003 were allocated first to the Limited Partnership units to the extent of their equity investment and thereafter to us. In 2002, we had previously attributed all losses to us. Accordingly, the loss for 2002 was restated for comparative purposes to allocate losses to the Limited Partnership units to the extent of the equity.

This restatement had the effect of reducing the deficit attributable to our common shareholders from $38,963,665 to $37,726,075, the net loss attributed to common shareholders from $1,851,661 to $614,071 and the basic and fully diluted net loss per share from $0.03 to $0.01.

In April, 2004, we exercised our call options with the limited partners thereby acquiring all of the Limited Partnership units. Under the terms of the call option agreements we 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 us at a price of $0.10 per share up to June 30, 2004. We recorded the redemption of the PhotoChannel LP at the fair value of the common shares and common share purchase warrants (See note 6(a)(iv) of our consolidated financial statements for the year ended September 30, 2005). For Canadian GAAP, we recorded the offsetting amount as an increase in our deficit and for US GAAP as goodwill.

D. Property, plant and equipment

Our executive offices are located at 425 - 506 Carrall Street, Vancouver, British Columbia, Canada, V6B 6E3. The premises comprise approximately 4,337 square feet in an office building. The premises are leased from an unaffiliated party for a period of forty-nine months expiring on July 31, 2007. The base monthly rent was approximately $3,995 for the period July 1, 2003 to May 31, 2004 and $6,506 for the period June 1, 2004 to July 31, 2007.

Our Network equipment is located at TELUS Corporation’s co-located hosting facilities, which are located at 5 - 3777 Kingsway, Burnaby, British Columbia, Canada, V5H 3Z7. The premises are under contract from an unaffiliated party for a period of thirty-six months expiring March 14, 2007. The base monthly rent, including prepaid monthly bandwidth usage of 25 Mpbs, is approximately $15,100.

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, 2005, 2004 and 2003. 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 17 to the September 30, 2005 consolidated financial statements 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.

Revenue recognition: During fiscal year 2005, we earned installation, membership, commission and archival revenue from the provision of the PhotoChannel Network to electronically connect photofinishing 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 photofinishing retailers for the connection to the PhotoChannel Network is earned and recognized monthly as the connection is provided. Revenue from commissions earned on transactions processed by the photofinishing retailers, utilizing the PhotoChannel Network, is recognized at the time the digital image processing services are provided to the end customer. Revenue from archival fees earned on digital images, stored on the PhotoChannel Network, is recognized as the service is provided to the end customer.

Bad Debt Allowance: We estimate the amount of uncollectible receivables each period and establish an allowance for uncollectible amounts. The amount of the allowance is based on the age of unpaid amounts, information about the ongoing creditworthiness of the customer(s), and other relevant information. Estimates of uncollectible amounts are revised each period and changes are recorded in the period as they become known.

The Company has a stock option plan, which is described in note 6 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.

As a result of adoption, the Company applied the recommendations with retroactive application and recorded an adjustment to opening deficit of $314,011 and recognized a compensation expense of $124,328 for stock options issued to employees for the year ended September 30, 2005.

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. Readers should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Although we believe that the assumptions that we have used in making forward-looking statements are reasonable, our actual results could and most likely will differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in this annual report:

elsewhere in this Item 5.; and

in the “Risk Factors” subsection of Part I, Item 3 "Key Information.”

Given these uncertainties, we caution readers not to place undue reliance on such forward-looking statements.

A. Operating results

From October 2000 until December 2000 we focused on our subsidiary, PhotoChannel, Inc. Through funding our subsidiary, PhotoChannel, Inc., we were able to assemble a team and develop the infrastructure believed necessary to capture market share in the online, mail order, photofinishing industry.

In January 2001, it became apparent that this business was not sustainable. On March 19, 2001 a new management team took over our operations. The new management team quickly changed focus from being an online photo portal and worked on our restructuring. This restructuring included drastic cuts in staffing and consultants, travel and marketing and focused operations on the deployment of a retailer based network of digital photofinishing.

Our main business focus became being a technology producer and integrated provider of services for the photofinishing retailer. We no longer attempted to compete with the retailer through the online “mail order” concept, but began to support and help the retailer grow and meet the increasing needs of their customers. The new business model focused strictly on a business to business model and ceased all further development of the business to consumer model that our US subsidiary had been developing. Our focus was to complete the “Network”, which would enable the delivery of digital photo image orders under the control of the originating photofinishing retailer.

We installed our first retail member to the Network in May 2001. Our new technology, at this point, was completed and stable. Significant feature additions were added over the next few months and today our technology allows us to build completely customized retailer branded web sites within hours and connect them to our lab server environment in the retail store. The photo retailer now has full administrative control over their customer’s orders and accounts. Our lab server software now connects to any retailer using any one of six of the most popular digital printing and/or scanning devices on the market today. These include such established brands as the Fuji Frontier digital minilab(s), Noritsu digital minilab(s), Agfa D-lab digital minilab and the Konica digital minilab(s). Our technology is open and scalable, providing a vast market within which to sell our products and services.

During the remainder of 2001 and during 2002, we worked on automating all of our processes and procedures in order to reduce future costs. We built an online knowledge database, which significantly reduces the costs of service and support, along with automating sign-up and installation processes connecting retail stores to our Network.

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.

Today, although we have solved many of our past problems, we continue to be beset with the challenge of raising additional capital to rapidly deploy our solution and achieve profitability. We believe that we are well positioned to profit from the large, ever increasing, digital imaging market.

Year Ended September 30, 2005 and September 30, 2004

Revenue

Our strategy is to focus on being 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. Our digital Network is focused on delivering digital image orders from capture to fulfillment under the control of the originating photofinishing retailer. We charge our photofinishing retailers an upfront fee for the development of its website, a monthly fee for their connection to the Network and earn a transaction fee for every order placed through the Network. In addition, we charge the customers of the photofinishing retailers a storage fee for hosting their digital images.

Revenue for the year ended September 30, 2005 was $2,116,503 versus $763,140 for the year ended September 30, 2004. Revenue increased by 177.3% due to a 437.8% increase ($422,518) in membership fees, a 259.8% increase ($488,334) in installation fees and a 96.1% increase ($347,088) in transaction fees as an increased number of retailers and consumers began to adopt our services. The increase in membership fees during fiscal 2005 was directly related to the increase in installation fees, as we connected additional retail locations to our Network offering these locations the ability to offer one hour photofinishing. With this one hour solution we charge our retailers a monthly fee for direct connection to our Network, that is referred to as a membership fee. We defer revenue from installation fees earned for the set-up of a customer website and recognize it as income over the estimated term of the customer relationship period. At September 30, 2005, we had deferred revenue of $188,040 (2004 - $175,769).

During the year ended September 30, 2005, as per note 13 to the consolidated financial statements, we derived $1,629,840 or 77% of our revenues from our three largest customers. Each of whom contributed in excess of 10% of our total revenues for the period.

Operating Expenses and Net Loss

We recorded a loss for the year ended September 30, 2005 of $3,147,967 ($0.02 per share). This represents an increase of $95,482 or 3.1% as compared to the loss attributed to common shareholders of $3,052,485 ($0.02 per share) for the year ended September 30, 2004. The increase in loss during 2005 was primarily the result of increases in Network delivery, general and administrative and research and development costs during fiscal 2005. A comparison of operating results and non-operating events for the two years ended September 30^th are set out in the table below.

Description	2005			2004
Loss from operations		($ 3,167,761	)		($ 3,078,188	)
Other items		19,794			25,703
Net loss for the year attributed to common shareholders		($ 3,147,967	)		($ 3,052,485	)

In fiscal 2005, expenses increased by $1,442,936 to $5,284,264 (2004 - $3,841,328) or 37.6% over 2004 expenses, primarily due to an increase in Network delivery, general and administrative and research and development costs of 173.8%, 26.9% and 25.6%, respectively.

In fiscal 2005, Network delivery costs increased $568,513 to $895,702 (2004 - $327,189), a 173.8% increase over the comparable period of 2004. This increase was primarily due to an increase in the number of lab server installations completed in fiscal 2005, as our customers continue to expand the number of their retail locations that can offer one hour online digital photofinishing. Transactions processed by our Network also increased, resulting in an increase in our usage of bandwidth (i.e. internet related costs), along with an increase in salaries related to customer service staff required. We expect these expenses to continue to increase, as the adoption of our service increases with consumers.

In fiscal 2005, general and administration expenses increased $382,429 to $1,803,848 (2004 - $1,421,419), a 26.9% increase over the comparable period of 2004. The largest contributor to this increase during fiscal 2004 was salaries and consulting, which increased by $346,810 primarily due to a one time charge for severance in the amount of $178,027 to our former Chief Executive Officer. Another large contributor was the adoption of the Canadian Institute of Chartered Accountants’ Handbook Section 3870, “Stock-Based Compensation and other Stock-Based Payments”, which resulted in a compensation expense of $124,328 for stock options issued to employees for the year ended September 30, 2005.

In fiscal 2005, sales and marketing expenses increased $31,991 to $673,997 (2004 - $642,006), a 5.0% increase over the previous fiscal year. This increase was as a result of an increase in salaries and consulting.

In fiscal 2005, research and development costs increased $327,620 to $1,606,858 (2004 -$1,279,238), a 25.6% increase over fiscal 2004. This increase is primarily due to the addition of staffing and consultants required to architect, build and deploy a new infrastructure platform, while continuing to meet the demands of new and existing customers on our old infrastructure platform. The new platform allows our customers the ability to offer one hour online digital photofinishing to their consumers and us the ability to more cost effectively and rapidly deploy new retailer sites.

In fiscal 2005, amortization expense increased $132,383 to $303,859 (2004 - $171,476), a 77.2% increase over fiscal 2004. This increase is primarily the result of the purchase of hardware and software in the amount of $523,595 related to our new infrastructure platform. The purchase of this new equipment provides us with future growth potential and the ability scale much more efficiently, based upon our anticipated growth.

Operating loss for fiscal 2005 increased by 2.9%, due to an increase in operating expenses of 37.6% and was partially offset by an increase in revenue of 177.3% for the period.

Year Ended September 30, 2004 and September 30, 2003

Revenue

Revenue for the year ended September 30, 2004 was $763,140 versus $255,573 for the year ended September 30, 2003. Revenue increased by 198.6% due to a 116.2% increase ($101,026) in installation fees and a 301.2% increase ($271,296) in transaction fees as an increased number of retailers and consumers began to adopt our services. Membership fees during fiscal 2004 increased by 32.0%, as we connected additional retail locations to our Network offering these locations the ability to offer one hour photofinishing. We defer revenue from installation fees earned for the set-up of a customer website and recognize it as income over the estimated term of the customer relationship period. At September 30, 2004, we had deferred revenue of $175,769.

During the year ended September 30, 2004, as per note 13 to the consolidated financial statements, we derived $451,887 or 59% of our revenues from our four largest customers. Each of whom contributed in excess of 10% of our total revenues for the period.

Operating Expenses and Net Loss

We recorded a loss for the year ended September 30, 2004 of $3,052,485 ($0.02 per share). This represents an increase of $602,501 or 24.6% as compared to the loss attributed to common shareholders of $2,449,984 ($0.03 per share) for the year ended September 30, 2003. The significant increase in loss during 2004 was primarily the result of increases in Network delivery and research and development costs during fiscal 2004. The extent of the current period’s increase in loss was partially offset by a reduction in amortization, general and administrative and sales and marketing expenses during fiscal 2004. Also, during fiscal 2003 a portion of the loss, $372,410, was attributable to Limited Partnership units and as well, we recorded a gain on the settlement of obligations during the year of $457,599, both of which resulted in us recording a reduced loss in fiscal 2003. A comparison of operating results and non-operating events for the two years ended September 30 are set out in the table below.

Description	2004			2003
Loss from operations		($ 3,078,188	)		($ 3,282,445	)
Gain on settlement of obligations		-			457,599
Loss attributed to limited partnership		-			372,410
Other items		25,703			2,452
Net loss for the year attributed to common shareholders		($ 3,052,485	)		($ 2,449,984	)

In fiscal 2004, expenses increased by $303,310 to $3,841,328 (2003 - $3,538,018) or 8.6% over 2003 expenses, primarily due to an increase in Network delivery and research and development costs of 192.9% and 62.1%, respectively.

In fiscal 2004, Network delivery costs increased $215,498 to $327,189 (2003 - $111,691), a 192.9% increase over the comparable period of 2003. This increase was primarily due to an increase in the number of transactions processed by our Network and our move to an independent hosting facility at TELUS’ co-location facility in Burnaby, BC. The increase in the number of transactions resulted in an increase in our usage of bandwidth (i.e. internet related costs), along with an increase in salaries related to customer service staff required.

In fiscal 2004, general and administration expenses decreased $200,149 to $1,421,419 (2003 - $1,621,568), a 12.3% decline over the comparable period of 2003. The largest contributor to this reduction during fiscal 2004 was salaries and consulting, which decreased by $276,852 due to senior management’s salaries being reduced in May 2004, in exchange for the ability to earn a future bonus. This decrease was partially offset by an increase in both office and miscellaneous and investor relations expenses.

In fiscal 2004, sales and marketing expenses decreased $92,786 to $642,006 (2003 - $734,792), a 12.6% reduction over the previous fiscal year. This decrease was attributable to costs associated with distributor services provided by NBJ Enterprises Ltd., dba Skana Photo-Lab Products, who were issued common share purchase warrants for services provided in 2003. The common share purchase warrants were attributed a value of $93,000, which was determined using the Black-Scholes option-pricing model.

In fiscal 2004, research and development costs increased $490,049 to $1,279,238 (2003 -$789,189), a 62.1% increase over fiscal 2003. This increase is primarily due to the addition of staffing and consultants required to meet the demands of new customers and maintain our competitive edge in the marketplace by being the first to market with new value added solutions.

In fiscal 2004, amortization expense decreased $109,302 to $171,476 (2003 - $280,778), a 38.9% decrease over fiscal 2003. This reduction is primarily the result of certain of our equipment being fully amortized, along with replacing old expensive equipment with new, less expensive and more cost effective, equipment. The purchase of this new equipment provides us with future growth potential and the ability scale much more efficiently, based upon our anticipated growth.

We recorded a gain on settlement of obligations of $nil during the year ended September 30, 2004, (2003 - $457,599). The gain on settlement in fiscal 2003 was the result of negotiating settlements with our creditors at less than the face value of the original obligations.

Operating loss for fiscal 2004 decreased by 6.2%, which is due to the increase in revenue for the period, partially offset by the increase in operating costs.

Year Ended September 30, 2003 and September 30, 2002

Revenue

Revenue for the year ended September 30, 2003 was $255,573 versus $173,801 for the year ended September 30, 2002. Revenue increased by 47% due to a 51.5% increase ($29,527) in installation fees and a 2,410% increase ($86,466) in transaction fees as an increased number of retailers and consumers began to adopt our services. Membership fees during fiscal 2003 were reduced, as we changed our strategy of providing ADSL (high speed) Internet connections to the photofinishing retailer. Photofinishing retailers now contract directly with the ADSL providers. This also resulted in a significant decrease in our Network delivery costs. We defer revenue from installation fees earned for the set-up of a customer website and recognize it as income over the estimated term of the customer relationship period. At September 30, 2003, we deferred revenue of $60,000.

During the year ended September 30, 2003, as per note 13 to the consolidated financial statements, we derived $132,431 or 52% of our revenues from our four largest customers. Each of whom contributed in excess of 10% of our total revenues for the period

Operating Expenses and Net Loss

Losses incurred by the Limited Partnership in 2002 and 2003 are allocated first to the Limited Partnership units to the extent of their equity investment and thereafter to us. In 2002, we previously attributed all losses to our common shareholders. Accordingly, the loss for 2002 has been restated for comparative purposes to allocate losses to the Limited Partnership units to the extent of its equity. This restatement has had the effect of reducing the deficit attributable to our common shareholders at September 30, 2002 from $38,963,665 to $37,726,075, the net loss attributed to common shareholders from $1,851,661 to $614,071 and the basic and fully diluted net loss per share from $0.03 to $0.01.

We recorded a loss for the year ended September 30, 2003 of $2,449,984 ($0.03 per share). This represents an increase of $1,835,913 or 299% as compared to the restated loss of $614,071 ($0.01 per share) for the year ended September 30, 2002. The significant increase in loss was a result of the change in treatment of the loss attributable to Limited Partnership units (2003 - $372,410 versus 2002 - $1,237,590); the gain on the bankruptcy of our US subsidiary in fiscal 2002 of $2,746,944; and the reduction on gain on the settlement of obligations (2003 - $457,599 versus 2002 - $808,774). The extent of the current period’s increase in loss was partially offset by a large reduction in operating expenses during fiscal 2003. A comparison of operating results and non-operating events for the two years ended September 30 are set out in the table below.

Description	2003			2002
Loss from operations		($ 3,282,445	)		($ 5,334,672	)
Gain on bankruptcy of subsidiary		-			2,746,944
Gain on settlement of obligations		457,599			808,774
Loss attributed to limited partnership		372,410			1,237,590
Other items		2,452			(72,707	)
Net loss for the year attributed to common shareholders		($ 2,449,984	)		($ 614,071	)

In fiscal 2003, expenses decreased by $1,970,455 to $3,538,018 (2002 - $5,508,473) or 35.8% over 2002 expenses, primarily due to a decrease in amortization and general and administrative expenses of 68.5% and 49.2%, respectively.

In fiscal 2003, Network delivery costs decreased $46,119 to $111,691 (2002 - $157,810), a 29.2% decrease over the comparable period of 2002. This decrease was primarily due to a change in our strategy of providing ADSL (high speed) Internet connections to the photofinishing retailer. Photofinishing retailers now contract directly with the ADSL providers.

In fiscal 2003, general and administration expenses decreased $1,569,968 to $1,621,568 (2002 - $3,191,536), a 49.2% decline over the comparable period of 2002. The largest contributors to this reduction during fiscal 2003 were as follows: salaries and consulting decreased by $1,097,854 due to both temporary and permanent layoffs; accounting and legal decreased by $231,071 due to a reduction of legal costs; and office and miscellaneous decreased by $299,284 primarily due to a reduction in travel.

In fiscal 2003, sales and marketing expenses increased $80,536 to $734,792 (2002 - $654,256), a 12.3% increase over the previous fiscal year. This increase was primarily attributable to distributor services provided by NBJ Enterprises Ltd., dba Skana Photo-Lab Products, who were issued common share purchase warrants for services provided. The common share purchase warrants were attributed a value of $93,000, which was determined using the Black-Scholes option-pricing model.

In fiscal 2003, research and development costs increased $174,705 to $789,189 (2002 -$614,484), a 28.4% increase over fiscal 2002. This increase is primarily due to the addition of staffing and consultants required to meet the demands of new customers and maintain our competitive edge in the marketplace by being the first to market with new value added solutions.

In fiscal 2003, amortization expense decreased $609,609 to $280,778 (2002 - $890,387), a 68.5% decrease over fiscal 2002. This reduction is primarily the result of certain of our equipment being fully amortized, along with replacing old expensive equipment with new, less expensive and more cost effective, equipment. The purchase of this new equipment provides us with future growth potential and the ability scale much more efficiently, based upon its anticipated growth.

We recorded a gain on settlement of obligations of $457,599 during the year ended September 30, 2003 (2002 - $808,774). These amounts were the result of negotiating settlements with our creditors at less than the face value of the original obligations.

B. Liquidity and Capital Resources

As at September 30, 2005, we had a working capital deficiency of $588,066 compared to working capital of $543,740 at September 30, 2004 and $388,277 at September 30, 2003. As a growth stage company, we continue to rely upon the sale of equity capital to maintain our operations and will continue to do so until we manage to reach a cash flow positive position.

For the year ended September 30, 2005, we raised a total of $2,111,559 of which $1,848,509 was from the issuance of our common shares and common share purchase warrants, $245,450 was on exercise of common share purchase warrants and options and $17,600 on the repayment of demand loans.

We began generating revenues in July 2001 through our Network solution. In September 2002, we, through our limited partnership signed our first large Canadian national photofinishing retailer. Throughout fiscal 2003, we continued to sign on large Canadian retailers through our limited partnership and signed our first large photofinishing retailer in the United States in December 2003. During fiscal 2004, we exercise our call option with the limited partners of the PhotoChannel LP and reacquired all rights to the contracts previously signed by the PhotoChannel LP with Canadian photofinishing retailers and we continued to contract with new Canadian and US retailers. Currently, our expenses exceed revenues, and there continues to be significant risk that sufficient revenues will not be generated through the Network solution to sustain operations. As a result, we will need to raise funds from private and public equity or debt offerings in order to remain in business.

We currently generate monthly revenues of approximately $180,000, of which $160,000 relates to recurring revenues from the our Network and we have monthly recurring expenditures of approximately $320,000. We believe that cash on hand and recurring revenues will be sufficient to support our operating expenditures for a period of approximately three months, without any revenue growth. We anticipate accessing the equity markets for additional funding depending on actual sales and resulting cash flow during this period. Should our revenue not grow during the next 12 months we would be required to raise a minimum of $1,500,000 to sustain our current level of operations for this period.

C. Research and development, patents and licenses, etc.

During the fiscal year ended September 30, 2005, we expended $1,606,858 on research and development related to our Network. This included architecting, building and commencing deployment of a brand new infrastructure platform, along with maintaining and enhancing our old platform for new and existing customers.

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.

D. Trend Information

The photo industry is undergoing a massive revolution caused by technology. Three major trends are reshaping the landscape. This first is the emergence of the digital camera as an increasingly viable replacement for film. The second is the deployment and consumer acceptance of digital cameras in cellular 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 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.

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 digitized print services increases. In their 2005 report, InfoTrends reported that over 55% of US household own a digital camera already, and that is expected to continue to grow to 81% by 2010. The worldwide install-base of digital cameras has risen quickly since their introduction in the mid 1990’s. There is no demographic in which digital cameras are exclusive to, nor is there a prohibitive degree of technological sophistication required to operate these cameras. InfoTrends further predicted in 2004, that 26% of all Internet users uploaded a photo in 2004, up from 19% in 2003.

Photofinishing retailers originally viewed digital camera penetration as threatening their future. According to PMA’s “Photo Industry 2004 Review and Forecast” film processing volume fell by an estimated 6% in 2003 to 686 million rolls in the United States and processing revenue fell by nearly 8%, to $5.4 billion. This trend continued through 2004 with film sales volumes reported by Kodak and others off by over 6% again. As consumers shift 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 imaging today and the future forecasting indicates that digital will have an additive effect on the growth of picture taking. Photofinishing News estimates that total worldwide photo exposures were 92 billion in 2001 with 81% derived from film and 19% from digital.

According to the Photo Marketing Association, about 1.6 billion or 31 percent of the 5.1 billion printed digital photos were made at retail in 2004, up from 0.5 billion in 2003. In 2005, this number is expected to reach 3.1 billion or 40 percent of total prints.

HP reported that in 2003 there were 56 Billion digital photo exposures alone and further predicted this will grow to 144 Billion in 2005 and 312 Billion in 2008. On top of this 2008 metric, HP forecasts that of the digital photo exposures that get printed, 56 Billion or 43% will be printed by retailers. Translated into photofinishing revenue, it is predicted that digital photofinishing at retailers, from both drop off at retail and order on line, will be a $6.2 billion industry by 2008.

We continue to see a significant organic increase in the usage from our existing customers’ connected to our Network.

E. Off-Balance Sheet Arrangements

Not Applicable

F. Tabular Disclosure of Contractual Obligations

Payments due by period

Contractual Obligations

Total

Less than 1 year

1 - 3 years

3 - 5 years

More than 5 years

Long-Term Debt

Nil

N/A

Capital (Finance) Lease

Nil

N/A

Operating Lease

625,051

398,796

226,255

N/A

Purchase of Equipment

Nil

N/A

Other Long-Term Liabilities

Nil

N/A

Total

625,051

398,796

226,255

N/A

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 March 15, 2006 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⁾
Peter Fitzgerald⁽¹⁾⁽²⁾ Herts, United Kingdom Director (July 31, 2001 - present)	57	March 3, 2005 - Present: President & CEO of the Company February 3, 2003 - Present: Chairman of the Company	14,530,200 Common Shares 1,250,000 Stock Options
Peter Scarth⁽¹⁾⁽²⁾ West Vancouver, BC, Canada Director (Oct 10, 2000 to present)	60	August 1, 2002 - October 4, 2004: President & CEO of the Company March 2001- February 3, 2004: Chairman of the Company; and March 2001 - June 10, 2002: Chief Executive Officer of the Company.	9,517,735 Common Shares 1,200,000 Stock Options
Cory Kent⁽¹⁾⁽³⁾ Vancouver, BC, Canada Director (March 10, 1999 - Present)	36	February 2003 to Present: Lawyer at Lang Michener LLP July 26, 2002 - March 13, 2003 Corporate Secretary of the Company; and 1996 to February 2003: Lawyer at Anfield Sujir Kennedy & Durno	65,000 Common Shares 900,000 Stock Options
Doug Rowan ⁽²⁾⁽³⁾ Kirkland, WA, USA Director (March 24, 2005 - present)	68	July 1997 to Present: President and CEO of Imaging Solutions Corporation.	Nil Common Shares 350,000 Stock Options
Thomas Nielsen ⁽¹⁾⁽³⁾ Seattle, WA, USA Director (June 23, 2005 - present)	35	October 2004 - Present: Director of Engineering, Adobe Systems; and October 1999 - August 2004: Product Unit Manager, Microsoft Corporation.	Nil Common Shares 350,000 Stock Options
Robert Chisholm Vancouver, BC, Canada	44	Nov. 2001 - Present: Chief Financial Officer of the Company; and 1999 - 2001: COO & CFO SCS Solars Computing Systems Inc.	780,000 Common Shares 875,000 Stock Options

Kyle Hall

Vancouver, BC, Canada

March 13, 2003 - October 4, 2004: Corporate Secretary of the Company;

June 5, 2002 to Present: Executive Vice President, Business Development of the Company;

March 9, 2001 - July 5, 2002: Director of the Company;

March 9, 2001 - June 5, 2002: President & C00 of the Company; and

September 15, 2000 - March 9, 2001: Vice-President, Sales & Business Development of the Company’s US subsidiary.

1,931,500

Common Shares

1,225,000

Stock Options

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⁾
Timothy J. Kerbs Palm Beach Gardens, FL, USA	34	March 9, 2001-Present: Executive Vice President, Network Services of the Company; March 29, 2001 - July 5, 2002: Director of the Company; and July 2000 - March 2001: Vice President Operations of the Company’s US subsidiary;	575,500 Common Shares 1,094,264 Stock Options
Aaron Rallo Vancouver, BC, Canada	33	November 2004 - Present: Chief Technology Officer of the Company; March 2003 to May 2004: Senior Program Manager of Digital Imaging Devices for Microsoft Corporation; November 1999 to February 2003: Vice President of Product Development and Operations for Fuji Film E-systems.	20,000 Common Shares 2,000,000 Stock Options
Patricia Spice Vancouver, BC, Canada	58	December 1995 - Present: Executive Assistant, PhotoChannel Networks Inc. December 1, 1995 to July 6, 2002 and October 4, 2004 to present: Corporate Secretary of the Company	97,447 Common Shares 417,500 Stock Options

(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 at the period ended March 15, 2006 and has been furnished by the respective individuals. As such, we assume no responsibility for its accuracy or completeness.

B. Compensation

During the fiscal year ended September 30, 2005, 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 $852,308. Of such amount, $nil was paid or accrued under a described bonus and profit sharing plans.

During the fiscal year ended September 30, 2005, 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				Other Annual	Common Shares Under-
Principal	Fiscal	Salary	Bonus	Compensation	Lying Options Granted
Position	Year	($)	($)	($)	(Number)
Peter Fitzgerald President & CEO	2005	Nil	Nil	Nil	Nil
Peter Scarth ⁽¹⁾ President & CEO	2005 2004 2003	Nil 116,666 142,670	Nil Nil Nil	Nil	Nil
Kyle Hall ⁽²⁾ EVP Business Development	2005 2004 2003	150,000 179,166 142,570	50,000 Nil Nil	Nil	Nil
Timothy Kerbs ⁽³⁾ EVP Operations	2005 2004 2003	153,702 173,298 150,027	46,478 Nil Nil	Nil	Nil
Robert Chisholm CFO	2005 2004 2003	150,000 179,166 135,833	50,000 Nil Nil	Nil	Nil
Aaron Rallo CTO	2005	127,898	Nil	Nil	Nil

⁽¹⁾	On March 16, 2001, Peter Scarth, formerly one of our directors, assumed the role of Chairman of the Board of Directors and Chief Executive Officer. On June 5, 2002, Mr. Scarth assumed the role of President. On February 3, 2004, Mr. Scarth relinquished the role of Chairman, but remains a director. The new chairman of the Board of Directors is Peter Fitzgerald, who has been a director since July 31, 2001. On October 4, 2004, Mr. Scarth resigned as President and Chief Executive Officer and Bart Copeland assumed the role of President and Chief Executive Officer, as well becoming one of our directors. On March 2, 2005, Mr. Copeland resigned from our Board of Directors and was terminated as President and Chief Executive Officer. During the period of Mr. Copeland’s employment with us he earned $72,242, plus Mr. Copeland received a severance payment of $178,027. On March 2, 2005, Mr. Fitzgerald assumed the role of President and Chief Executive Officer.

⁽²⁾	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.

⁽³⁾	On March 29, 2001 Timothy J. Kerbs, formerly VP Operations for our US subsidiary, PhotoChannel, Inc., became our Executive Vice President of Network Services and a director. On June 5, 2002, Mr. Kerbs resigned as a director, but remains our Executive Vice President of Network Services.

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 Peter Scarth (Chairman), Cory Kent, 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 Doug Rowan.

The Corporate Governance Committee consists of three directors. This committee is responsible for corporate governance. This committee consists of Cory Kent (Chairman), Doug Rowan and Thomas Nielsen.

D. Employees

We currently have twenty (20) permanent full-time employees and seven (7) consultants we retain for regular engagements. None of our staff are unionized.

Executive Officers	5
Operations	7, includes 1 executive officer.
Finance/Administration	3, includes 2 executive officers.
Technology and Applications	12, includes 1 executive officer.
Sales, and Business Development	5, includes 1 executive officer.

E. Share Ownership

As of March 15, 2006, each of our current directors and executive officers reported to us the shares he or she owned. The directors and executive officers own a total of 27,517,382 common shares being the number of our common shares designated beside his or her name in Item 6. A.

As of March 15, 2006, options to purchase an aggregate of 14,741,771 common shares had been granted and were outstanding, as follows:

Number of Common Shares

Exercise Price Per Common Share

Expiration Date


3,925,000	$	0.15	July 26, 2006
4,479,271	$	0.15	May 27, 2007
300,000	$	0.15	September 2, 2008
750,000	$	0.17	September 18, 2008
1,587,500	$	0.15	November 24, 2008
1,200,000	$	0.15	August 29, 2010
2,500,000	$	0.15	September 9, 2010

As of March 15, 2006, a total of 9,661,764 common shares were subject to options held by our directors and executive officers as a group, as listed in Item 6. A., as follows:

Number of Common Shares

Exercise Price Per Common Share

Expiration Date


3,675,000	$	0.15	July 26, 2006
1,599,264	$	0.15	May 27, 2007
1,187,500	$	0.15	November 24, 2008
1,200,000	$	0.15	August 29, 2010
2,000,000	$	0.15	September 9, 2010

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. Major Shareholders

To the knowledge of our directors and senior officers, as of March 15, 2006, 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, 27,517,382 common shares, representing about 12.4% of our presently issued and outstanding common shares. As a group, they beneficially own common share options to purchase an aggregate of 9,661,764 common shares.

Discovery Capital Corporation and its affiliated entities (collectively, "Discovery") is a significant shareholder and investor in us. Currently, Discovery owns 12,661,906 of our common shares or 5.7% of our outstanding common shares.

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. In this instance, the disinterested shareholders means our shareholders, other than Discovery. As Discovery has participated in several of our financings in the past and may, in the future invest in our securities, such investments may have the potential to increase Discovery’s ownership interest in us to greater than 20%. Accordingly, at our Annual General Meeting of our shareholders, held on March 10, 2004, we sought and received approval from our disinterested shareholders authorizing the potential increase in the ownership interest of Discovery to greater than 20%.

Peter Fitzgerald is our Chairman and is a significant shareholder and investor in us. Currently, Mr. Fitzgerald owns 14,530,200 of our common shares or 6.6% of our outstanding common shares. Mr. Fitzgerald also holds 1,250,000 common share options 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 15,780,200 of our common shares, representing 7.2% of our then outstanding securities.

Peter Scarth is a director and is a significant shareholder and investor in us. Currently, Mr. Scarth owns 9,517,735 of our common shares or 4.3% of our outstanding common shares. Mr. Scarth also holds 1,200,000 common share options 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. Scarth could own 10,717,735 of our common shares, representing 4.9% of our then outstanding securities.

As of February 28, 2006, our shareholders’ register listed approximately 254 registered shareholders holding an aggregate of 220,514,841 common shares. A total of 189 of these registered shareholders were shown to be residents of Canada, owning 182,392,693 shares representing 82.7% of our issued and outstanding common shares. A total of 49 of these registered shareholders were shown to be residents of the United States, owning 9,895,692 shares representing 4.5% of our issued and outstanding common shares.

B. Related Party Transactions

None of our directors or executive officers, or any associate or affiliate of any such person, has or had any material interest, direct or indirect, in any transaction during the past year or any proposed transaction which has materially affected or will materially affect us, other than as disclosed herein.

For the fiscal year ended September 30, 2005, wages and consulting fees of $837,578 were paid to our directors and officers and consulting fees were paid to companies controlled by directors and officers of us of approximately $106,247. The fees were paid as part of the annual compensation as disclosed in Item 6. B.

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 17 hereof and included at the end of this annual report.

Legal Proceedings.

As of March 15, 2006, 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 are 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 our consolidated financial position.

B. Significant Changes

Since the date of the audited consolidated financial statements, there have been no significant changes other than as detailed 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 “PNI”. 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 each full quarterly period within our two most recent fiscal years:

		Sales Prices (CAN$)
		High		Low
Common Shares
Annual Data	2005	$	0.19	$	0.07
	2004		0.39		0.115
	2003		0.32		0.07
	2002		0.12		0.05
	2001		0.80		0.05

Quarterly data	2005
	December 31, 2005	$	0.14	$	0.095
	September 30, 2005		0.145		0.075
	June 30, 2005		0.115		0.07
	March 31, 2005		0.19		0.10
	2004
	December 31, 2004	$	0.195	$	0.14
	September 30, 2004		0.19		0.115
	June 30, 2004		0.285		0.125
	March 31, 2004		0.34		0.23
	December 31, 2003		0.39		0.24

Monthly Data	February 2006	$	0.165	$	0.115
	January 2006		0.13		0.10
	December 2005		0.12		0.095
	November 2005		0.12		0.095
	October 2005		0.14		0.095
	September 2005		0.14		0.075

Our common shares are also listed on the NASD Over the Counter Bulletin Board (“NASD OTC BB”) in the United States, 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 NASD OTC BB for each full quarterly period within our two most recent fiscal years.

		Sales Prices (US$)
		High		Low
Common Shares
Annual Data	2005	$	0.17	$	0.05
	2004		0.28		0.08
	2003		0.25		0.01
	2002		0.095		0.01
	2001		0.49		0.01

Quarterly data	2005
	December 31, 3005	$	0.127	$	0.08
	September 30, 2005		0.125		0.06
	June 30, 2005		0.10		0.05
	March 31, 2005		0.17		0.08
	2004
	December 31, 2004	$	0.19		0.12
	September 30, 2004		0.15		0.085
	June 30, 2004		0.23		0.08
	March 31, 2004		0.28		0.20
	December 31, 2003		0.28		0.18
Monthly Data	February 2006	$	0.16	$	0.0822
	January 2006		0.12		0.0724
	December 2005		0.10		0.08
	November 2005		0.10		0.08
	October 2005		0.127		0.082
	September 2005		0.125		0.06

Our common share register indicates that 49 persons holding approximately 4.5% of our outstanding common stock are persons with United States addresses. We have no information and express no opinion regarding the identities, addresses or holdings of the beneficial owners of these securities.

B. Plan of Distribution

Not Applicable.

C. Markets

See Item 9A(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. Neither our Notice of Articles nor our Articles contain our purpose or objectives. 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 and transition under the BCA by March 29, 2006. Our directors authorized us to file a transition application with the Registrar of Companies and to comply with the BCA. We filed a Notice of Articles in June 2005. The BCA also permits increased flexibility in the provisions of our Charter Documents governing documents. At our annual general meeting held on March 24, 2005, our shareholders adopted a new set of Articles (the “New Articles”) taking advantage of this increased flexibility. The following is a comparison of the terms of the New Articles to our old Articles (the “Old Articles”) and some important provisions of the BCA.

Pursuant the BCA we are permitted to have an unlimited number of shares as our authorized capital. The alteration of the capital of the Company required approval by a special resolution of the shareholders, being a resolution passed by a majority of not less than three-quarters of the votes cast by the shareholders who, being entitled to do so, voted in person or by proxy at the general meeting of a company.

In addition to the adoption of the New Articles, the shareholders also authorized an increase in our authorized to an unlimited number of common shares without par value and an unlimited number of preferred shares without par value.

The amendments to the Articles principally reflect the provisions of the BCA which modernize British Columbia corporate legislation. The New Articles do not include a number of provisions in the Existing Articles that are now covered by the BCA to avoid the possibility of conflict or the possibility of having to comply both with the statutory provision and a corresponding but different provision in the Articles and include the use ofnew terminology adopted under the BCA. For example, "members" have become "shareholders" and "register of members" has become "central securities register" under the BCA. Most of these terminology and wording changes are not discussed in detail here, as they reflect statutory requirements that we cannot alter or amend or are largely housekeeping matters.

Set out below is a discussion of certain changes under the New Articles. These changes include substantive changes and changes that are simply a result of changes under the BCA.

Borrowing Powers

Under the Old Articles, we were entitled to borrow money, issue bonds, debentures and other debt obligations and mortgage, charge, or give security on the undertaking, or on the whole or any part of our property and assets (both present and future). Under the BCA, we are now also permitted, without restriction (other than general corporate governance principles), to guarantee repayment of money by any other person or the performance of any obligation of any other person. This change reflects the modernization of corporate legislation to effectively respond to increasingly complex financial transactions that companies may enter into in the course of their business. As a result, the New Articles provide that we may guarantee the repayment of money by any other person or the performance of any obligation of any other person. Such guarantees should provide the maximum flexibility in possible future financial transactions, recognizing the duties directors have to ensure that the guarantee must always be in the best interests of the Company.

Share Certificates

Under the Old Articles, a shareholder is entitled to a share certificate representing the number of shares held. Under the BCA, a shareholder is now entitled to a share certificate representing the number of shares held or a written acknowledgement of the shareholder's right to obtain such a share certificate. As a result, the New Articles provide for this additional right. The addition of the ability to issue a written acknowledgement permits flexibility in corporate and securities transmissions.

Indemnity Provisions

Under the BCCA, we could only indemnify directors where we obtained prior court approval, except in certain limited circumstances. Under the BCA, we are now permitted (and, in some circumstances, are required) to indemnify a past or present director or officer without obtaining prior court approval for any legal proceeding relating to the activities of the individual as a director or officer. Under the BCA, we are prohibited from paying an indemnity if:

1. the party did not act honestly and in good faith with a view to the best interests of the Company;

2. the proceeding was not a civil proceeding and the party did not have reasonable grounds for believing that his or her conduct was lawful; and

3. the proceeding is brought against the party by the Company or an associated corporation.

As a result, the New Articles we will indemnify directors, officers and other persons, subject to the limits imposed under the BCA.

Amendment of Articles and Notice of Articles re Share Capital

The New Articles provide that the general authority required to amend all provisions of the Articles and the Notice of Articles relating to the authorized share structure is a resolution of the directors. Prior the adoption of the New Articles, the Old Articles provided that such alterations would continue to require a special resolution of shareholders. If the amendment prejudices or interferes with the rights or special rights attached to any class of issued shares, by the provisions of the BCA, the consent of the holders of that class of shares by a special separate resolution is also required. Under the New Articles, a special separate resolution, will be required to pass such resolutions needing a majority of two-thirds rather than three-quarters of the votes cast.

Shareholders' Meetings

In addition to reflecting the present notice and other provisions of the BCA relating to shareholders' meetings, the New Articles provide that shareholders' meetings may be held at such place as is determined by the directors.

Officers

Under the Old Articles, we were required to have at least a President and Secretary as officers, and separate individuals were required to hold those positions. In addition, the Chairman and President were required to be directors. However, under the BCA, those requirements no longer exist, and as a result, it is proposed that the New Articles remove these requirements leaving us free to continue or discontinue these practices.

Disclosure of Interest of Directors

Under the BCA, the provisions relating to the disclosure of interest by directors have been revised and updated. Under the Old Articles, a director who is any way directly or indirectly interested in a proposed contract or transaction with the Company or who holds any office or possesses any property whereby directly or indirectly a duty might be created which would conflict with his duty or interest as a director shall declare in writing the nature and extent of such interest in such contract or transaction. A director shall not vote in respect of any such contract or transaction if the company in which he is interested and if he should vote his vote shall not be counted but shall be counted in the quorum present at the meeting. Similarly, under the BCA directors are obligated to abstain from voting on matters in which they may be financially interested after fully disclosing such interest. Directors must abstain from voting in such circumstances both under the Old Articles and under the BCA. As the directors are bound by these provisions, the New Articles have deleted reference to the old disclosure of interest provisions contained in the BCCA and refer to the provisions contained in the BCA.

Objects and Purposes

The New Articles, like the Old Articles, do not specify objects or purposes. Under both the BCA and the predecessor BCCA, a British Columbia corporation generally has all the legal powers of a natural person. British Columbia corporations may not undertake certain limited business activities such as operating as a trust company or railroad without alterations to its form of articles and specific government consent.

Directors - Powers and Limitations

The New Articles and the Old Articles do not specify a maximum number of directors (the minimum under British Columbia law for a public company is three). The number of directors is fixed, annually, by shareholders at the annual Shareholders meeting and all directors are elected at that time, there are no staggered directorships. Under both the New and Old Articles the directors are entitled between successive annual general meetings to appoint one or more additional directors but not more than one-third of the number of directors fixed at a shareholders meeting or actually elected at the preceding annual shareholders' meeting. Directors automatically retire at the commencement of each annual meeting but may be re-elected thereat.

Under the BCA, directors are obligated to abstain from voting on matters in which they may be financially interested after disclosing in writing such interest. Directors' compensation is not a matter on which they must abstain. Directors must be of the age of majority (18), and meet eligibility criteria including being mentally competent, not an un-discharged bankrupt, no fraud related convictions in the previous five years and a majority of directors must be ordinarily resident in Canada. There is no mandatory retirement age either under the New or the Old Articles or under the BCA.

Directors' borrowing powers are not generally restricted where the borrowing is in the Company’s best interests, but the directors may not authorize the Company to provide financial assistance for any reason if the Company is insolvent or the providing of the guarantee would render it insolvent. Directors need not own any shares of the Company in order to qualify as directors.

Changes to Rights of Common Shareholders

Under the Old Articles, changes to the Articles require a shareholders' "special resolution" being a resolution passed by not less than 75% of the shares voted in person or by proxy at a duly convened shareholders meeting. Some organic corporate changes including amalgamation with another company, sale of substantially all of our assets, re-domiciling out of the jurisdiction of British Columbia, creation of new classes of shares not only require such 75% approval but generally also give rise to a dissent right which is the right to be paid the fair value of the stockholder's shares in cash if the required special resolution is actually passed and the Company elects to proceed with the matter notwithstanding receipt of dissent notices. A notice of a shareholders meeting at which such an organic change action is intended to be considered must include a prominent notice of the dissent right. Dissent provisions are governed by the BCA and not by the Articles.

Shareholders Meetings

Shareholders meetings are governed by the Articles, but many important shareholder protections are also contained in the Securities Act (British Columbia) and the BCA. The New and Old Articles provide that we will hold an annual shareholders' meeting, will provide at least 21 days' notice and will provide for certain procedural matters and rules of order with respect to conduct of the meeting. The Securities Act (British Columbia) and the BCA superimpose requirements that generally provide that shareholders meetings require not less than a 60 day notice period from initial public notice and that we make a thorough advanced search of intermediary and brokerage registered shareholdings to facilitate communication with beneficial shareholders so that meeting proxy and information materials can be sent via the brokerages to unregistered but beneficial shareholders, The form and content of information circulars and proxies and like matters are governed by the Securities Act. This legislation specifies the disclosure requirements for the proxy materials and various corporate actions, background information on the nominees for election for director, executive compensation paid in the previous year and full details of any unusual matters or related party transactions. We must an annual shareholders meeting open to all shareholders for personal attendance or by proxy at each shareholder's determination. The meeting must be held within 13 months of the previous annual shareholders meeting and we must present audited statements which are no more than 180 days old at such meeting.

Shares Fully Paid

All shares issued must, by applicable law, be issued as fully paid for cash, property or services. They are, therefore, non-assessable and not subject to further calls for payment.

Redemption

We have no redeemable securities authorized or issued. We have no sinking fund or like security redemption fund.

Pre-emptive Rights

There are no pre-emptive rights applicable to our shares which provide a right to any person to participate in offerings of our equity or other securities.

Rights to Profits and Liquidation Rights

All of our common shares participate rateably in any net profit or loss and share rateably any available assets in the event of a winding up or other liquidation. The preferred shares are entitled to a preference over the common shares and participate rateably with respect to other preferred shares in any net profit or loss, and in the available assets in the event of a winding up or liquidation.

No Limitation on Foreign Ownership

There are no limitations our Articles or in the BCA on the right of persons who are not citizens of Canada to hold or vote common shares. (See also "Exchange Controls".)

Dividends

Dividends may be declared by the Board out of available assets and are paid rateably to holders of common shares. No dividend may be paid if we are, or would thereby become, insolvent.

Voting Rights

Each common share is entitled to one vote on matters to which common shares ordinarily vote including the annual election of directors, appointment of auditors and approval of corporate changes. There are no cumulative voting rights applicable to our shares. The preferred shares are not entitled to vote except with respect to matters relating to the rights and restrictions attached to the preferred shares.

Change in Control

We have not implemented any shareholders' rights or other "poison pill" protection against possible take-overs. There are no provisions in its Articles triggered by or affected by a change in outstanding shares which gives rise to a change in control. There are no provisions in our material agreements giving special rights to any person on a change in control.

Insider Share Ownership Reporting

Neither our New nor our Old Articles require disclosure of share ownership. Share ownership of director nominees must be reported annually in proxy materials sent to our shareholders. There are no requirements under British Columbia corporate law to report ownership of our shares but the Securities Act (British Columbia) requires disclosure of trading by insiders (generally officers, directors and holders of 10% of voting shares) within 10 days of the trade. Controlling shareholders (generally those in excess of 20% of outstanding shares) must provide seven days advance notice of share sales.

Securities Act (British Columbia)

This statute applies to us and governs matters typically pertaining to public securities such as continuous quarterly financial reporting, immediate disclosure of material changes, insider trade reporting, take-over protections to ensure fair and equal treatment of all shareholders, exemption and resale rules pertaining to non-prospectus securities issuances as well as civil liability for certain misrepresentations, disciplinary, appeal and discretionary ruling matters. All our shareholders regardless of residence have equal rights under this legislation.

C. Material Contracts

The following summary of our material agreements, which agreements are filed as exhibits to this annual report, 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 rental agreement for our executive offices located at Suite 506, 425 Carrall Street, Vancouver, British Columbia, Canada. The premises comprise approximately 2,663 square feet in an office building. We lease the premises from a third party corporation. The lease is for a period of three years, expiring on July 31, 2004. The base monthly rent is approximately $3,994.50.*
2.	The Hosting Solutions Contract with TELUS Communications Inc., dated September 11, 2001. This agreement is for a 60 month period commencing October 1, 2001.*
3.	The Internetworking Services Agreement with TELUS Communications Inc., dated September 11, 2001. This agreement is for a 60 month period commencing October 1, 2001.*
4.	The Distribution Agreement, with NBJ Enterprises Ltd., dba Skana Photo-Lab Products, dated February 1, 2002 and amended July 1, 2002. This agreement is for a period of 12 months.*
5.	The License Agreement with PhotoChannel Networks Limited Partnership, dated February 14, 2002. This agreement is in perpetuity or until unwound.*
6.	The Operating Agreement with PhotoChannel Networks Limited Partnership, dated February 14, 2002. This agreement is for a period of five years.*
7.	The Support Agreement with PhotoChannel Networks Limited Partnership, dated May 2, 2002. This agreement is in perpetuity or until the License Agreement is unwound.*
8.	The Management Agreement with PhotoChannel Networks Limited Partnership, dated June 4, 2002. This agreement is for a period of approximately five years and seven months, terminating on December 31, 2007.*
9.	The Amended & Restated Limited Partnership Agreement with 620077 B.C. Ltd., Discovery Capital 2001 Technology Limited Partnership, TELUS Corporation, Ex Fund Technologies Corp. and Peter Scarth, dated June 4, 2002.*
10.	The Option Agreement with Discovery Capital 2001 Technology Limited Partnership, dated June 4, 2002. This agreement is for a period of approximately 25 months, expiring on June 30, 2004.*
11.	The Option Agreement with TELUS Corporation, dated June 4, 2002. This agreement is for a period of approximately 25 months, expiring on June 30, 2004.*
12.	The Option Agreement with Ex Fund Technologies Corp., dated June 4, 2002. This agreement is for a period of approximately 25 months, expiring on June 30, 2004.*
13.	The Option Agreement with Peter Scarth, dated June 4, 2002. This agreement is for a period of approximately 25 months, expiring on June 30, 2004.*

14.	The License and Services Agreement with Black Photo Corporation, dated September 13, 2002. This Agreement is for a period of two years, expiring September 12, 2004 (the “Term”) and automatically renews for one year periods unless written notice is provided by one party to the other not less than ninety (90) days prior to the end of the Term or the then current renewal term.*
15.	The License and Services Agreement with Giant Eagle, Inc., dated December 12, 2002. This Agreement is for a period of two years, expiring December 11, 2004 (the “Term”) and automatically renews for one year periods unless written notice is provided by one party to the other not less than ninety (90) days prior to the end of the Term or the then current renewal term.*
16.	The Letter Agreement with Photolab.ca, a division of Loblaw Group of Companies, dated February 6, 2003. This Agreement is for a period of nine months, expiring November 5, 2003.*
17.	The Services Agreement with Wal-Mart Canada Corp., dated April 11, 2003. This Agreement is for a period of two years, expiring April 10, 2005 (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.*
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. The amendment comprises the addition of approximately 1,674 square feet in the office building. We lease the premises from a third party corporation. The amendment has extended the term of the lease by three (3) years to July 31, 2007. The new monthly base rent, effective June 1, 2004, has been increased to approximately $6,505.50.*
19.	The new articles of the company as filed under the Business Corporations Act (British Columbia) (the "BCA") on June 24, 2005.

_____________________

* Previously filed.

D. Exchange Controls

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

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

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 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 on the provisions of the Canadian Tax Act and the regulations thereunder and on an understanding of the administrative practices of Canada Customs & Revenue Agency, and takes into account all specific proposals to amend the Canadian Tax Act or regulations made by the Minister of Finance of Canada as of the date hereof. It has been assumed that there will be no other relevant amendment of any governing law although no assurance can be given in this respect. This discussion is general only and is not a substitute for independent advice from a shareholder’s own Canadian and U.S. tax advisors.

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

Dividends on Common Shares and Other Income

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

The amount of a stock dividend (for tax purposes) would generally be equal to the amount by which our paid up or stated capital had increased by reason of the payment of such dividend. We will furnish additional tax information to shareholders in the event of such a dividend. 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 a pension, retirement or employee benefit fund or plan, if the organization 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 included in income are as follows. For gains net of losses realized before February 28, 2000, as to 75%. For gains net of losses realized after February 27, 2000 and before October 18, 2000, as to 66 2/3%. For gains net of losses realized after October 17, 2000, as to 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 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, and at any time during the 10 years immediately preceding, the disposition and the shares were owned by him when he or she ceased to be resident in Canada, or

(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 506 - 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

Not Applicable because we are a small business issuer as that term is defined in regulation S-B.

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, 2005.

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, 2005.

ITEM 15. CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), we carried out an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2005 being the date of our most recently completed fiscal year. This evaluation was carried out under the supervision and with the participation of our chief executive officer, Mr. Peter David Fitzgerald and our chief financial officer, Mr. John Robert Chisholm. Based upon that evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures are effective to ensure that the information required to be disclosed by us in our reports that we file or submit under the Exchange Act was recorded, processed, summarized and reported within the time periods specified within the time periods specified in the rules and forms of the Securiteis and Exchange Commission.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act 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 our reports filed under the Exchange Act is accumulated and communicated to management, including our chief executive officer and chief financial officer to allow timely decisions regarding required disclosure.

During our most recently completed fiscal year ended September 30, 2005, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

The term “internal control over financial reporting” is defined as a process designed by, or under the supervision of, the registrant's principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant's 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 and includes those policies and procedures that:

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

(2)	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 registrant are being made only in accordance with authorizations of management and directors of the registrant;and

(3)	Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant's assets that could have a material effect on the financial statements.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

The members of the audit committee are Peter Scarth, Peter Fitzgerald, Cory Kent and Thomas Nielsen. Two members of the audit committee are independent (being Cory Kent and Thomas Nielsen) and all audit committee members are financially literate.

A member of the audit committee is independent if the member has no direct or indirect material relationship with the Company. A material relationship means a relationship which could, in the view of the Company’s board of directors, reasonably interfere with the exercise of a member’s independent judgment.

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

Relevant Education and Experience

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.

Cory Kent obtained a LLB from the University of British Columbia in 1995 has practiced securities law for the past 10 years, principally in the areas of corporate finance, mergers, acquisitions, and ongoing corporate compliance.

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

ITEM 16B. CODE OF ETHICS

We have not formally adopted a written code of ethics. We are reviewing the adoption of a formal code of ethics. We have guided our conduct in accordance with the rules and policies of the TSX Venture Exchange, the provisions of the Company Act of British Columbia and our reporting in accordance with the securities legislation applicable to us. Due to our size we have not deemed it necessary to adopt a formal written code of ethics at this time.

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

A. Audit Fees

The aggregate fees billed by our auditors were CDN $67,500 and CDN$65,000 for the fiscal years ended 2005 and 2004, respectively.

B. Audit-Related Fees

The aggregate fees billed by our auditors for audit-related fees were CDN$5,000 and CDN$17,220 for the fiscal years ended 2005 and 2004, respectively.

C. Tax Fees

The aggregate fees billed by our auditors for tax fees were CDN$5,000 and $nil for the fiscal years ended 2005 and 2004, respectively.

D. All Other Fees

Nil

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

PART III

ITEM 17. 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 17 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 17 are attached hereto and are found immediately following the text of this annual report.

ITEM 18. FINANCIAL STATEMENTS

We are providing financial statements pursuant to Item 17.

ITEM 19. EXHIBITS

(a)	The following exhibits are filed as part of this annual report:

Exhibit Number Description

1.	The rental agreement for our executive offices in Canada with Electric Avenue Properties Inc., dated July 12, 2001.*
2.	The Hosting Solutions Contract with TELUS Communications Inc., dated September 11, 2001.*
3.	The Internetworking Services Agreement with TELUS Communications Inc., dated September 11, 2001.*
4.	The Distribution Agreement, with NBJ Enterprises Ltd., dba Skana Photo-Lab Products, dated February 1, 2002 and amended July 1, 2002.*
5.	The License Agreement with PhotoChannel Networks Limited Partnership, dated February 14, 2002.*
6.	The Operating Agreement with PhotoChannel Networks Limited Partnership, dated February 14, 2002.*
7.	The Support Agreement with PhotoChannel Networks Limited Partnership, dated May 2, 2002.*
8.	The Management Agreement with PhotoChannel Networks Limited Partnership, dated June 4, 2002.*
9.	The Amended & Restated Limited Partnership Agreement with 620077 B.C. Ltd., Discovery Capital 2001 Technology Limited Partnership, TELUS Corporation, Ex Fund Technologies Corp. and Peter Scarth, dated June 4, 2002.*
10.	The Option Agreement with Discovery Capital 2001 Technology Limited Partnership, dated June 4, 2002.*
11.	The Option Agreement with TELUS Corporation, dated June 4, 2002.*
12.	The Option Agreement with Ex Fund Technologies Corp., dated June 4, 2002.*
13.	The Option Agreement with Peter Scarth, dated June 4, 2002.*
14.	The License and Services Agreement with Black Photo Corporation, dated September 13, 2002.*
15.	The License and Services Agreement with Giant Eagle, Inc., dated December 12, 2002.*
16.	The Letter Agreement with Photolab.ca, a division of Loblaw Group of Companies, dated February 6, 2003.*
17.	The Services Agreement with Wal-Mart Canada Corp., dated April 11, 2003.*
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.*
19.	The new articles of the company as fuled under the Business Corporations Act (British Columbia) (the "BCA") on June 24, 2005.

_____________________

* Previously filed.

SIGNATURES

Pursuant to the requirements of Section 12 of the Securities 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: March 15, 2006	By:	“Peter David Fitzgerald”
		Peter David Fitzgerald
		Chairman

PhotoChannel Networks Inc.

Consolidated Financial Statements

September 30, 2005, 2004 and 2003

(expressed in Canadian dollars)

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. 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.

Chartered Accountants

Vancouver, B.C., Canada

November 18, 2005

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 November 18, 2005 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.

/s/ PricewaterhouseCoopers LLP

Chartered Accountants

Vancouver, B.C., Canada

March 24, 2006

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.

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.

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.

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.

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.

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.

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.

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.

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).

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

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.

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.

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).

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

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

(expressed in Canadian dollars)

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

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

PhotoChannel Networks Inc.

Notes to Consolidated Financial Statements

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

(expressed in Canadian dollars)

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).

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.

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.

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	)

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

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.

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

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.

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.

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.

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.

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.

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.

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.

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Pni Digital Media Inactive 20-F2005 FY Annual report (foreign)

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