Pni Digital Media 6-K Notice of No Auditor Review of Interim Financial Statements

Exhibit 99.1

PNI Digital Media Inc.

Unaudited Condensed Consolidated Interim Financial Statements
For the three and six month periods ended March 31, 2014

NOTICE OF NO AUDITOR REVIEW OF INTERIM FINANCIAL STATEMENTS

The accompanying unaudited condensed consolidated interim financial statements of PNI Digital Media Inc. (the “Company”) have been prepared by and are the responsibility of the Company’s management. The Company’s independent auditor has not performed a review of these financial statements in accordance with the standards established by the Canadian Institute of Chartered Accountants for a review of interim financial statements by an entity’s auditor.

PNI Digital Media Inc.

Condensed Consolidated Interim Balance Sheet

Prepared by Management

(expressed in Canadian dollars)

		(Unaudited)
Assets		March 31, 2014			September 30, 2013
Current assets
Cash and cash equivalents	$	7,592,901		$	2,425,106
Accounts receivable		3,692,318			3,829,654
Prepaid expenses and other current assets		1,134,990			411,728
		12,420,209			6,666,488
Property and equipment (note 7)		5,331,583			4,482,948
Deferred income tax asset		2,139,068			2,214,519
Intangible assets		1,104,175			1,254,931
Other long-term assets		108,215			132,346
	$	21,103,250		$	14,751,232
Liabilities
Current liabilities
Accounts payable and accrued liabilities	$	9,119,025		$	3,037,371
Revolving demand facility and overdraft (note 15)		-			1,401,070
Current portion of deferred revenue		283,845			308,990
Current portion of finance obligations (note 14, note 15)		526,133			341,659
Deferred rent		53,873			22,953
Purchase Consideration		27,215			343,279
		10,010,091			5,455,322
Deferred revenue		131,101			273,241
Finance obligations (note 14, note 15)		707,215			576,104
Deferred rent – Long term		770,422			275,632
Deferred income tax liability		281,107			332,354
	$	11,899,936		$	6,912,653
Shareholders’ Equity (note 8)
Share capital	$	73,442,311		$	66,881,748
Contributed surplus		19,687,106			19,410,066
Accumulated deficit		(85,329,892	)		(78,802,351	)
Accumulated other comprehensive loss		1,403,789			349,116
		9,203,314			7,838,579
	$	21,103,250		$	14,751,232

Subsequent events (note 17)

Approved by the Board of Directors

“Kyle Hall” Director “Peter Fitzgerald “ Director

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

PNI Digital Media Inc.

Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income

Unaudited – Prepared by Management

(expressed in Canadian dollars)

		Three Months ended						Six Months ended
		March 31, 2014			March 31, 2013			March 31, 2014		March 31, 2013
Revenue (note 10)	$	5,167,404		$	4,033,516		$	13,317,995		$	10,589,498
Cost of sales		2,453,966			2,310,049			5,531,904			5,233,252
Gross Margin		2,713,438			1,723,467			7,786,091			5,356,246
Expenses
Software development		2,696,477			2,197,413			5,052,534			4,712,587
General and administration		1,034,032			1,009,972			1,980,529			1,983,666
Sales and marketing		363,042			324,492			669,838			658,843
Legal Settlement		5,774,886			-			5,774,886			-
		9,868,437			3,531,877			13,477,787			7,355,096
Income (Loss) from operations		(7,154,999	)		(1,808,410	)		(5,691,696	)		(1,998,850	)
Foreign exchange loss		(191,138	)		389,949			(754,898	)		259,602
Finance income and other costs		(28,353	)		1,058			(38,475	)		2,813
Finance costs		(21,313	)		-			(42,472	)		-
		(240,804	)		391,007			(835,845	)		262,415
Income (Loss) before income tax		(7,395,803	)		(1,417,403	)		(6,527,541	)		(1,736,435	)
Deferred income tax recovery		-			-			-			-
Income tax recovery (expense)		-			-			-			-
Loss for the period		(7,395,803	)		(1,417,403	)		(6,527,541	)		(1,736,435	)
Other comprehensive (loss) gain:
Items subsequently classified to Statement of
Comprehensive loss
Translation of foreign operations		350,748			(544,458	)		1,054,673			(362,195	)
Total comprehensive income (loss) for the period	$	(7,045,055	)	$	(1,961,861	)	$	(5,472,868	)	$	(2,098,630	)
Loss per share
Basic	$	(0.17	)	$	(0.04	)	$	(0.16	)	$	(0.05	)
Fully diluted	$	(0.17	)	$	(0.04	)	$	(0.15	)	$	(0.05	)

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

PNI Digital Media Inc.

Condensed Consolidated Statements of Changes in Equity

Unaudited – Prepared by Management

(expressed in Canadian dollars)

	Share Capital
											Accumulated
	Number of										other			Total
	Common				Contributed			Accumulated			comprehensive			Shareholders’
	Shares	Amount			surplus			deficit			loss			equity
Balance September 30, 2013	34,299,471	$ 66,881,748		$	19,410,066		$	(78,802,351	)	$	349,116		$	7,838,579
Issuance of shares on vesting of RSUs and PSUs	26,682	41,357			(41,357	)								-
Shares issued for cash	7,119,650	7,475,633												7,475,633
Share issuance costs		(956,427	)											(956,427	)
Broker compensation options					251,138									251,138
Stock-based compensation					67,259									67,259
Net loss for the period								(6,527,541	)					(6,527,541	)
Other comprehensive loss											1,054,673			1,054,673
Balance March 31, 2014	41,445,803	$ 73,442,311		$	19,687,106		$	(85,329,892	)	$	1,403,789		$	9,203,314
	Share Capital
											Accumulated
	Number of										other			Total
	Common				Contributed			Accumulated			comprehensive			Shareholders’
	Shares	Amount			surplus			deficit			loss			equity
Balance September 30, 2012	34,257,922	$ 66,817,352		$	19,334,098		$	(71,135,021	)	$	(197,217	)	$	14,819,212
Issuance of shares on vesting of RSUs and PSUs	41,549	64,396			(64,396	)								-
Stock-based compensation					38,038									38,038
Net loss for the period								(1,736,435	)					(1,736,435	)
Other comprehensive gain											(362,195	)		(362,195	)
Balance March 31, 2013	34,299,471	$ 66,881,748 $			19,307,740		$	(72,871,456	)	$	(559,412	)	$	12,758,620

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

PNI Digital Media Inc.

Condensed Consolidated Statement of Cash Flow

Unaudited – Prepared by Management

(expressed in Canadian dollars)

		Three months ended						Six Months Ended
		March 31, 2014		March 31, 2013				March 31, 2014		March 31, 2013
Cash flows from operating activities
Net loss for the period	$	(7,395,803	)	$	(1,417,403	)	$	(6,527,541	)	$	(1,736,435	)
Items not affecting cash
Amortization of property and equipment		395,389			431,641			746,136			813,484
Amortization of intangible assets		154,700			18,704			280,688			36,246
Stock-based compensation expense		32,297			1,587			67,259			38,038
Unrealized foreign exchange loss(gain)		303,914			(368,297	)		865,617			(227,750	)
Loss on disposal of property and equipment		-			-			-			480
Movement in deferred rent and other		(326,509	)		-			(116,460	)		-
		(6,836,012	)		(1,333,768	)		(4,684,301	)		(1,075,937	)
Net change in non-cash working capital Items (note 16)		8,672,963			975,530			5,003,847			(4,918	)
		1,836,951			(358,238	)		319,546			(1,080,855	)
Cash flows from investing activities
Purchase of property and equipment		174,339			(32,751	)		(326,508	)		(229,624	)
Purchase of intangible assets		(32,326	)		(64,607	)		(33,399	)		(96,026	)
Proceeds on disposal of property and equipment		-			-			-			1,914
		142,013			(97,358	)		(359,907	)		(323,736	)
Cash flows from financing activities
Issue of common shares		-			-			7,475,633			-
Cash cost of share issuance		(171,754	)		-			(705,288	)		-
Repayment of line of credit and lease facility		-			-			(1,170,000	)		-
Repayment of finance lease obligations		(158,378	)		-			(232,369	)		-
		(330,132	)		-			5,367,976			-
Effect of changes in foreign exchange rates on cash and cash equivalents		(13,474	)		(49,319	)		71,250			(49,592	)
Increase (Decrease) in cash and cash equivalents during the period		1,635,358			(504,915	)		5,398,865			(1,454,183	)
Cash and cash equivalents - beginning of period (note 16 b)		5,957,543			3,662,556			2,194,036			4,611,824
Cash and cash equivalents - end of period	$	7,592,901		$	3,157,641		$	7,592,901		$	3,157,641
Equipment acquired under finance leases		188,110			-			577,627			-

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

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

1. Nature of operations

PNI Digital Media Inc. is incorporated under the laws of the Province of British Columbia, Canada and is listed on the Toronto Stock Exchange (“TSX”) under the symbol PN and the OTC Bulletin Board under the symbol PNDMF. The address of the Company’s registered office is Suite 100, 425 Carrall Street, Vancouver, B.C. Canada, V6B 6E3.

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

2. Basis of preparation and compliance

These condensed consolidated interim financial statements for the three and six months ended March 31, 2014 have been prepared in accordance with IAS 34,“Interim Financial Reporting”. These condensed consolidated interim financial statements should be read in conjunction with the annual financial statements for the year ended September 30, 2013 which have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”). These condensed consolidated interim financial statements were approved for issue by the Board of Directors on May 14, 2014.

3. Summary of significant accounting policies

The condensed consolidated interim financial statements have been prepared under the historical cost convention except for the contingent consideration that is recorded at fair value through the profit and loss account.

The accounting policies adopted are consistent with those of the previous financial year except taxes on income in the interim periods are accrued using the tax rate that would be applicable to expected total annual income or loss and the adoption of IFRS 10, 11, 12 and 13.

a) IFRS 10, Consolidated Financial Statements, replaces those parts of IAS 27, Consolidated and Separate Financial Statements, that address when and how an investor should prepare consolidated financial statements and replaces SIC-12, Consolidation –

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

Special Purpose Entities, in its entirety. IFRS 10 is effective for annual periods beginning on or after January 1, 2013, with earlier application permitted under certain circumstances. IFRS 10 establishes control as the basis for an investor to consolidate its investees and defines control as an investor’s power over an investee with exposure, or rights, to variable returns from the investee and the ability to affect the investor’s returns through its power over the investee. The application of IFRS 10 has not had a significant impact on our consolidated financial statements.

b) IFRS 11, Joint Arrangements, replaces IAS 31, Interests in Joint Ventures, and SIC-13, Jointly Controlled Entities – Non – Monetary Contributions by Venturers and is effective for annual periods beginning on or after January 1, 2013, with earlier application permitted under certain circumstances. Under IFRS 11, joint arrangements are classified as joint operations or joint ventures based on the rights and obligations of the parties to the joint arrangements. A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement (“joint operators”) have rights to the assets, and obligations for the liabilities, relating to the arrangement. A joint venture is a joint arrangement whereby the parties have joint control of the arrangement (“joint venturers”) have rights to the net assets of the arrangement. IFRS 11 requires that a joint operator recognize its portion of assets, liabilities, revenues and expenses of a joint arrangement, while a joint venturer recognizes its investment in a joint arrangement using the equity method. IFRS 11 will become effective for fiscal years starting on or after January 1, 2013. The application of IFRS 11 has not had a significant impact on our consolidated financial statements.

c) IFRS 12, Disclosure of Involvement with Other Entities, combines and enhances the disclosure requirements for the Company’s subsidiaries, including any joint arrangements, associates and unconsolidated structured entities. The requirements of IFRS 12 include reporting of the nature of risks associated with the Company’s interests in other entities, and the effects of those interests on the Company’s consolidated interim financial statements. IFRS 12 will become effective for fiscal years starting on or after January 1, 2013. The application of IFRS 12 has not had a significant impact on our consolidated financial statements.

d) IFRS 13, Fair Value Measurement, is a comprehensive standard for fair value measurement and disclosure for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. Under existing IFRS, guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measurements and does not always reflect a clear measurement basis or consistent disclosures.

IFRS 13 is effective for annual periods beginning on or after January 1, 2013 with earlier application permitted. The application of IFRS 13 has not had a significant impact on our consolidated financial statements.

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

4. Significant accounting estimate and judgements

The preparation of interim financial statements requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income and expense. Actual results may differ from these estimates.

In preparing these condensed consolidated interim financial statements, the significant judgements made by management in applying the accounting policies and the key sources of estimation uncertainty were the same as those that applied to the consolidated financial statements for the year ended September 30, 2013.

5. Seasonality of operations

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

6. Cost of sales and operating expenses

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

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

			For the three months ended March 31, 2014
		Per statement of		Amortization of	Amortization of	Share-based			Excluding amortization
		operations		property and	intangible assets	compensation			and share-based
				equipment					compensation
Cost of sales	$	2,453,966		325,568	154,490	486		$	1,973,422
Operating expenses
Software development		2,696,477		60,776	150	8,408			2,627,143
General and administration		1,034,032		5,249	60	20,635			1,008,088
Sales and marketing		363,042		3,796	-	2,768			356,478
Legal Settlement		5,774,886							5,774,886
Total operating expenses	$	9,868,437		69,821	210	31,811		$	9,766,595
	$	12,322,403		395,389	154,700	32,297		$	11,740,017
			For the three months ended March 31, 2013
		Per statement of		Amortization of	Amortization of	Share-based			Excluding amortization
		operations		property and	intangible	compensation			and share-based
				equipment	assets				compensation
Cost of sales	$	2,310,049		368,330	18,472	905		$	1,922,342
Operating expenses
Software development		2,197,413		52,380	232	(8,095	)		2,152,896
General and administration		1,009,972		6,547	-	6,595			996,830
Sales and marketing		324,492		4,384	-	2,182			317,926
Total operating expenses	$	3,531,877		63,311	232	682		$	3,467,652
	$	5,841,926		431,641	18,704	1,587		$	5,389,994

			For the six months ended March 31, 2014
		Per statement		Amortization	Amortization	Share-based		Excluding amortization
		of operations		of property	of intangible	compensation		and share-based
				and	assets			compensation
				equipment
Cost of sales	$	5,531,904		618,654	280,282	2,597	$	4,630,371
Operating expenses
Software development		5,052,534		110,402	290	13,356		4,928,486
General and administration		1,980,529		9,669	116	48,202		1,922,542
Sales and marketing		669,838		7,411	-	3,104		659,323
Legal Settlement		5,774,886					$	5,774,886
Total operating expenses	$	13,477,787		127,482	406	64,662	$	13,285,237
	$	19,009,691		746,136	280,688	67,259	$	17,915,608

			For the six months ended March 31, 2013
		Per statement		Amortization of	Amortization	Loss on	Share-based			Excluding
		of operations		property and	of intangible	disposal of	compensation			amortization
				equipment	assets	property and				and share-
						equipment				based
										compensation
Cost of sales	$	5,233,252		688,621	35,778	-	1,997		$	4,506,856
Operating expenses
Software development		4,712,587		104,804	468	-	(2,421	)		4,609,736
General and administration		1,983,666		11,537	-	-	34,277			1,937,852
Sales and marketing		658,843		8,522	-	480	4,185			645,656
Total operating expenses	$	7,355,096		124,863	468	480	36,041		$	7,193,244
	$	12,588,348		813,484	36,246	480	38,038		$	11,700,100

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

7. Property and equipment

October 1, 2013 to March 31, 2014

					Furniture
		Computer			and office			Leasehold
		equipment			equipment			improvements		Total
Cost
As at October 1, 2013	$	18,262,136		$	420,392		$	469,507	$	19,152,035
Additions		891,672			91,510			607,223		1,590,405
Disposals / write-offs		-						-		-
Currency translation adjustments		28,048			824			-		28,872
As at March 31, 2014	$	19,181,856		$	512,726		$	1,076,730	$	20,771,312
Accumulated Amortization
As at October 1, 2013	$	14,126,701		$	321,656		$	220,730	$	14,669,087
Amortization		689,947			13,752			42,437		746,136
Currency translation adjustments		24,499			7			-		24,506
As at March 31, 2014	$	14,841,147		$	335,415		$	263,167	$	15,439,729
Carrying value – October 1, 2013	$	4,135,435		$	98,736		$	248,777	$	4,482,948
Carrying value – March 31, 2014	$	4,340,709		$	177,311		$	813,563	$	5,331,583
October 1, 2012 to September 30, 2013
					Furniture
		Computer			and office			Leasehold
		equipment			equipment			improvements		Total
Cost
As at October 1, 2012	$	17,159,448		$	406,577		$	243,962	$	17,809,987
Additions		1,233,940			17,637			225,545		1,477,122
Disposals / write-offs		(141,061	)		(3,800	)		-		(144,861	)
Currency translation adjustments		9,809			(22	)		-		9,787
As at September 30, 2013	$	18,262,136		$	420,392		$	469,507	$	19,152,035
Accumulated Amortization
As at October 1, 2012	$	12,657,005		$	303,808		$	165,819	$	13,126,632
Amortization		1,583,341			21,661			54,911		1,659,913
Disposals / write-offs		(123,345	)		(3,800	)		-		(127,145	)
Currency translation adjustments		9,700			(13	)		-		9,687
As at September 30, 2013	$	14,126,701		$	321,656		$	220,730	$	14,669,087
Carrying value – October 1, 2012	$	4,502,443		$	102,769		$	78,143	$	4,683,355
Carrying value – September 30, 2013	$	4,135,435		$	98,736		$	248,777	$	4,482,948

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

8. Share capital and stock options

a) Authorized

Unlimited number of common and preferred shares without par value

As at March 31, 2014, the Company had 41,445,803 common shares issued (September 30, 2013: 34,299,471) and 41,445,803 outstanding.

b) Share capital

On December 20, 2013, the Company announced the closing of its public offering of common shares, where the Company issued 7,119,650 common shares priced at $1.05 per common share, for gross proceeds of $7,475,633.

As part of the Offering, the underwriters were granted compensation options (the “Compensation Options”) entitling the underwriters to purchase 427,179 common shares at an exercise price of $1.15, for a period of 24 months from the date of closing. The fair value of each Compensation Option is estimated on the date of grant using the Black-Scholes option pricing model using the follow inputs and included within share issuance costs:

		Compensation
Description		Options
Exercise price	$	1.15
Market price on date of grant		1.16
Expected forfeiture rate		0	%
Expected volatility		95.73	%
Risk-free interest rate		1.07	%
Expected life (years)		1.98
Expected dividend yield		0	%
Grant-date fair value ($ per share)	$	0.59

Total share issuance costs associated with the public offering were $956,427, which included $251,138 relating to the Compensation Options, resulting in net proceeds of $6,519,206.

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

c) Options

The Company provides stock options to directors and certain employees of the Company pursuant to a stock option plan (the “Plan”). The Plan authorizes a maximum of 10% (4,144,580) of the Company’s issued and outstanding common shares to be reserved for issuance. The term of the options granted under the plan is five years and options are subject to various vesting requirements.

The following table summarizes activity under the Company’s stock option plan since September 30, 2013:

	Number of			Average
	options			exercise price
Balance, September 30, 2013 (663,878 options exercisable)	2,600,000		$	0.48
Expired & Forfeited	(117,500	)		0.29
Balance, March 31, 2014 (880,539 options exercisable)	2,482,500		$	0.43

The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model. No stock options were granted between October 1, 2013 and March 31, 2014.

During the three and six months ended March, 2014, the Company recognized compensation expense on options of $32,297 (2013: $7,722) and $67,259 (2013: $42,516).

9. Segment information

The Company provides our retail partners with transaction processing and routing orders for customized digital content and all sales are made in this segment. The Company’s sales by geographical area are as follows:

		Three Months Ended					Six Months Ended
Description		March 31, 2014	March 31, 2013				March 31, 2014		March 31, 2013
Canada	$	1,028,416		$	914,109	$	2,700,118	$	2,275,625
United States		3,781,401			2,787,660		9,694,016		7,241,619
United Kingdom		333,941			288,936		881,875		988,627
Other		23,646			42,811		41,986		83,627
Total	$	5,167,404		$	4,033,516	$	13,317,995	$	10,589,498

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

Revenue is attributed to the geographic location of the Company’s customer.

As at March 31, 2014 and September 30, 2013, the Company’s assets and liabilities by geographical location are as follows:

			Canada		United Kingdom		United States		Total
	March 31, 2014
��	Assets
	Property and equipment	$	5,271,402	$	2,087	$	58,094	$	5,331,583
	Goodwill and intangible assets	$	22,945	$	820	$	1,080,410	$	1,104,175
	Deferred income tax asset	$	2,139,068	$	-	$	-	$	-
	Liabilities
	Accounts payable and accrued liabilities	$	8,695,254	$	397,879	$	25,892	$	9,119,025
	Deferred revenue	$	330,235	$	78,709	$	6,002	$	414,946
	Finance lease obligation	$	1,233,348	$	-	$	-	$	1,233,348
	Deferred income tax liability	$	-	$	-	$	281,107	$	281,107
	Contingent consideration	$	27,215	$	-	$	-	$	27,215
	September 30, 2013
	Assets
	Property and equipment	$	4,422,337	$	3,679	$	56,932	$	4,482,948
	Goodwill and intangible assets	$	-	$	1,235	$	1,253,696	$	1,254,931
	Deferred income tax asset	$	2,214,519	$	-	$	-	$	2,214,519
	Liabilities
	Accounts payable and accrued liabilities	$	2,615,433	$	400,978	$	20,960	$	3,037,371
	Line of credit and overdraft	$	1,401,070	$	-	$	-	$	1,401,070
	Deferred revenue	$	480,021	$	99,288	$	2,922	$	582,231
	Finance lease obligations	$	917,763	$	-	$	-	$	917,763
	Net deferred income tax liability	$	-	$	-	$	332,354	$	332,354
	Contingent consideration	$	343,279	$	-	$	-	$	343,279

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

10. Revenue

		Three Months Ended				Six Months Ended
		March 31,		March 31,		March 31,		March 31,
Description		2014		2013		2014		2013
Transaction fees	$	2,963,215	$	2,991,870	$	9,363,663	$	8,378,774
Software licenses and installation fees		297,213		223,642		520,208		548,657
Membership fees		1,264,466		413,810		2,177,305		830,516
Professional fees		89,022		27,200		246,188		127,291
Archive fees		553,488		376,994		1,010,631		704,260
Total	$	5,167,404	$	4,033,516	$	13,317,995	$	10,589,498

Major customers representing 10% or more of the Company’s sales for the period are as follows:

		Three Months Ended				Six Months Ended
				March 31,				March 31,
Description		March 31, 2014		2013		March 31, 2014		2013
Customer A	$	1,429,480	$	1,112,421	$	3,700,417	$	2,982,215
Customer B		763,644		605,045		2,268,580		1,669,190
Customer C		2,240,947		2,042,328		5,373,044		4,399,075

11. Related Party Transactions

During the three and six months ended March 31, 2014, the Company incurred legal fees of $134,270 (2013: $113,486) and $261,542 (2013: $207,747), respectively, for services provided by McMillan LLP, a law firm of which the Corporate Secretary of the Company is a partner. Accounts payable and accrued liabilities at March 31, 2014 included $130,027 (September 30, 2013: $19,687) related to these services.

During the three and six months ended March 31, 2014, the Company incurred consulting fees of $14,782 (2013: $15,592) and $29,454 (2013: $31,005), respectively, for services provided by Digital Photoworks, a company of which a Director of the Company controls. The Company does not have any outstanding accounts payable or accrued liabilities as at March 31, 2014 related to this company (September 30, 2013: $nil).

During the three and six months ended March 31, 2014, the Company incurred employment expenses of $10,121, (2013: $nil) and $18,701, (2013: $nil), respectively, paid to a relative of an Officer of the Company for services performed in the ordinary course of business.

During the three and six months ended March 31, 2014, the Company generated revenue of $1,065 (2013: $1,541) and $2,442 (2013: $2,917), respectively, relating to transaction fees, software license and installation fees, and membership fees from a customer, Extrafilm, of which a Director of the Company controls. Accounts receivable as at March 31, 2014 included $685 (September 30, 2013: $299) related to these services.

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

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

12. Compensation of key management

Key management includes the Company’s directors, and members of the executive team.

Compensation awarded to key management included:

		Three Months Ended				Six Months Ended
						March 31,		March 31,
Description		March 31, 2014	March 31, 2013			2014		2013
Salaries, director fees and short-term employee benefits	$	400,857	$	372,921	$	838,188	$	837,972
Share-based payments		28,638		4,612		62,038		36,171
Termination benefits		-		-		-		66,667
Total	$	429,495	$	377,533	$	900,226	$	940,810

13. Contingencies

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

See note 17 for a discussion of the Bloom Stationers LLC (“Bloom”) settlement which occurred subsequent to March 31, 2014.

14. Finance lease liabilities

Lease liabilities are effectively secured as the rights to the leased asset revert to the lessor in the event of default. These leases include purchase option at the end of the lease term at nominal amounts. During the six months ended, the Company acquired $577,627 in leased equipment which is included in the gross finance lease liabilities in the table below:

		March 31, 2014			September 30, 2013
Gross finance lease liabilities– minimum lease payments	$	1,292,474		$	966,861
Increase in the period
Repayments
Future finance charges on finance lease liabilities		(59,126	)		(49,098	)
Present value of finance lease liabilities	$	1,233,348		$	917,763

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

15. Line of credit and overdraft

Facility		March 31, 2014		September 30, 2013
Revolving Demand Facility	$	-	$	1,170,000
Lease Facility		777,000		609,000
Overdraft		-		231,070
	$	777,000	$	2 ,010,700

The Company has a Credit Agreement with its bank (the “Bank”) which provides the Company with two separate credit facilities, being a revolving demand facility of up to $1,500,000 (“Revolving Demand Facility”) and a $1,250,000 reducing facility by way of Leases (“Lease Facility”). The two credit facilities and all other obligations of the Company to the Bank are secured by way of a General Security Agreement between the Bank and the Company, constituting a first ranking security interest in all personal property of the Company. The Revolving Demand Facility bears interest at a rate of Bank prime + 1.50% and contains a financial covenant requiring us not to exceed a borrowing limit of 67% of good Canadian and US Accounts receivable less potential prior-ranking claims which include items such as sales and excise taxes, payroll liabilities, and overdue rent, property and business taxes. As at March 31, 2014 none of the Revolving Demand Facility was used (September 30, 2013: $1,170,000), and $777,000 (September 30, 2013: $609,000) of the Lease Facility had been utilized, resulting in an unutilized amount of $1,500,000 for the Revolving Demand Facility and an unutilized amount of $473,000 for the Lease Facility. The Lease Facility is included within the Finance Lease Obligations (short term and long term portion).

16. Supplementary cash flow information

a) Net change in non-cash working capital items

		Three Months Ended						Six Months Ended
								March 31,			March 31,
Description		March 31, 2014			March 31, 2013			2014			2013
					$
Accounts receivable	$	3,359,596			1,896,092		$	237,977		$	970,670
Prepaid expenses and other current assets		(289,429	)		(28,828	)		(694,246	)		74,495
Accounts payable and accrued liabilities		6,099,257			(809,207	)		6,016,531			(1,010,409	)
Changes in deferred revenue		(116,798	)		(82,527	)		(176,752	)		(39,674	)
Milestone bonus payments		(379,663	)		-			(379,663	)		-
Total	$	8,672,963		$	975,530		$	5,003,847		$	(4,918	)

b) Cash and cash equivalents

				September 30,
		March 31, 2014		2013
Cash and Cash equivalents is made up of:
Cash and cash equivalents	$	7,592,901	$	2,425,106

PNI Digital Media Inc.

Notes to Condensed Consolidated Interim Financial Statements

Unaudited – Prepared by Management

(expressed in Canadian dollars)

Overdraft (note 15)		-		(231,070	)
	$	7,592,901	$	2,194,036

17. Subsequent events

a) Bloom Settlement

On May 5, 2014, the Company announced the settlement of a dispute with Bloom in which Bloom alleged certain violations of the terms of an amended and restated master development and services agreement between Bloom and the Company. The dispute was referred to arbitration on January 28, 2014.

Although the Company believes it had a strong defense to the claim, in order to pursue certain strategic initiatives determined to be in the best interests of the Company, the Company determined to settle the claim for US$5.22 million. In settling, the Company received a full and final release from Bloom from the terms of the master development and services agreement, a license to use Bloom intellectual property, and a covenant by Bloom not to sue the Company.

b) Staples Arrangement Agreement

On May 2, 2014, the Company entered into an agreement with Staples, Inc. (“Staples”) pursuant to which Staples has agreed to acquire all of the outstanding shares of PNI for CDN$1.70 per share, representing a total net equity value of approximately CDN$73.9 million.

The transaction will be implemented by way of a statutory plan of arrangement (“Arrangement”) and is subject to customary closing conditions, including approval by PNI shareholders and the approval of the Supreme Court of British Columbia. The special meeting of PNI shareholders to approve the Arrangement is expected to be held on or about July 8, 2014. The Arrangement is expected to close in PNI’s 2014 fiscal fourth quarter.

The definitive agreement for the transaction (the “Arrangement Agreement”) provides for, among other things, a non-solicitation covenant on the part of PNI, subject to customary fiduciary out provisions. The Arrangement Agreement also provides Staples with a right to match potential third party proposals received by PNI. PNI is permitted to terminate the Arrangement Agreement in certain circumstances, including to allow PNI to accept a superior proposal, subject to fulfilling certain conditions. Those conditions include the payment of customary termination fees in certain circumstances.

PNI is expected to operate independently and provide improved service for both its customers and partners by leveraging the strength of Staples, one of the world’s largest internet retailers. PNI expects to continue growing its customer base with Staples’ support while maintaining the necessary resources to consistently meet its customers’ needs.