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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION** Washington, D.C. 20549

FORM 10-KSB

(Mark One)

x  ANNUAL
  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended **December 31, 2004**

 ̈  TRANSITION
  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934

For the transition period from ___________ to __________

COMMISSION FILE NUMBER: 000-31909

ALTERNET SYSTEMS, INC.
  (Name of small business issuer in its charter)

|Nevada                                                 | 88-0473897                       
|------------------------------------------------------ | ---------------------------------
|(State or other jurisdiction of incorporation
      or | (IRS Employer Identification No.)
|organization)                                          |                                  

**#610-815 West Hastings Street, Vancouver, BC, V6C
  1B4**
  (Address of Principal Executive Offices)

**604-608-2540**
  (Registrant's Telephone Number)

Securities registered pursuant to Section 12(b) of the Exchange Act: None

**None**
  (Title of class)

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common Stock, $0.00001 Par Value

Check mark whether the issuer (1) has filed all reports required
  to be filed by Section 13 or 15(d) of the 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 x  
  No ̈

Check if there is no disclosure of delinquent filers in response
  to Item 405 of Regulation S-B contained in this form, and no disclosure will
  be contained, to the best of registrant’s knowledge, in definitive proxy
  or information statements incorporated by reference in Part III of this Form
  10-KSB or any amendment to this Form 10-KSB. x

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The issuer had revenues of $57,220 for the fiscal year
  ended December 31, 2004.

Of the 25,779,428 shares of voting stock of the registrant
  issued and outstanding as of March 30, 2005, 16,286,557 shares are held by non-affiliates.
  Because of the absence of an established trading market for the voting stock,
  the registrant is unable to calculate the aggregate market value of the voting
  stock held by non-affiliates as of a specified date within the past 60 days.

Transitional Small Business Disclosure Format (check one) Yes ̈  
  No x

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FORM 10-KSB ANNUAL REPORT
  
  FOR THE YEAR ENDED DECEMBER 31, 2004 
  ALTERNET SYSTEMS, INC.

TABLE OF CONTENTS

|PART I   |                                                                                                                       |   
|-------- | --------------------------------------------------------------------------------------------------------------------- | --
|         |                                                                                                                       |   
|Item     |                                                                                                                       |   
|         |                                                                                                                       |   
|Item 1   | Description of Business                                                                                               | 3 
|         |                                                                                                                       |   
|Item 2   | Description of Property                                                                                               | 7 
|         |                                                                                                                       |   
|Item 3   | Legal Proceedings                                                                                                     | 7 
|         |                                                                                                                       |   
|Item 4   | Submission of Matters to a Vote of Security
      Holders                                                             | 7 
|         |                                                                                                                       |   
|PART II  |                                                                                                                       |   
|         |                                                                                                                       |   
|Item 5   | Market for Common Equity and Related Stockholder
      Matters                                                        | 7 
|         |                                                                                                                       |   
|Item 6   | Management’s Discussion and Analysis
      or Plan of Operation                                                       | 10
|         |                                                                                                                       |   
|Item 7   | Financial Statements                                                                                                  | 14
|         |                                                                                                                       |   
|Item 8   | Changes in and Disagreements With Accountants
      on Accounting and Financial Disclosure                            | 14
|         |                                                                                                                       |   
|Item 8A  | Controls and Procedures                                                                                               | 14
|         |                                                                                                                       |   
|PART III |                                                                                                                       |   
|         |                                                                                                                       |   
|Item 9   | Directors, Executive Officers, Promoters
      and Control Persons; Compliance with Section 16(a) of the Exchange Act | 15
|         |                                                                                                                       |   
|Item 10  | Executive Compensation                                                                                                | 16
|         |                                                                                                                       |   
|Item 11  | Security Ownership of Certain Beneficial
      Owners and Management                                                  | 16
|         |                                                                                                                       |   
|Item 12  | Certain Relationships and Related Transactions                                                                        | 17
|         |                                                                                                                       |   
|Item 13  | Exhibits and Reports on Form 8-K                                                                                      | 17
|         |                                                                                                                       |   
|Item 14  | Principal Accountant Fees and Services                                                                                | 18

PART I

Item 1.           Description
  of Business

Forward Looking Statements

This report contains forward-looking statements. The forward-looking
  statements include all statements that are not statements of historical fact.
  The forward-looking statements are often identifiable by their use of words
  such as “may,” “expect,” “believe,” “anticipate”
  “intend,” “could,” “estimate,” or “continue,”
  or the negative or other variations of these terms or comparable terms. Our
  actual results could differ materially from the anticipated results described
  in the forward-looking statements. Factors that could affect our results include,
  but are not limited to, those discussed in Item 6, “Management’s
  Discussion and Analysis” and include elsewhere in this report.

3

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Company History and Business

Alternet Systems, Inc. (the "Company"), was organized under
  the laws of the State of Nevada on June 26, 2000 under the name North Pacific
  Capital Corp. On June 26, 2000 the Company increased its authorized share capital
  from 20,000 shares with no par value to 100,000,000 shares with a par value
  of $0.00001. On December 20, 2001 the Company received shareholder approval
  to change its name from North Pacific Capital Corp. to its present name "SchoolWeb
  Systems Inc.".

On April 26, 2002, the Company received shareholder approval
  to change its name from SchoolWeb Systems Inc. to Alternet Systems, Inc. and
  in May of 2002 this change of name was completed.

AI Systems Group, Inc., the wholly owned subsidiary of the
  Company, was incorporated in the State of Nevada on October 13, 2000 under the
  name of Alternet Systems, Inc. On January 1, 2001 it entered into a software
  license agreement (the "License Agreement") with Advanced Interactive Inc. and
  its subsidiary, Advanced Interactive (Canada) Inc. (collectively, "AII"). On
  July 3, 2001 the company's name was changed to "SchoolWeb Holdings Inc.". In
  June of 2002, the company's name was changed to "AI Systems Group, Inc.", its
  present name.

On July 2, 2001, the Company entered into an agreement (the
  "Share Exchange Agreement") to purchase all of the 12,343,000 outstanding shares
  of common stock of SchoolWeb Holdings Inc. in exchange for 12,343,000 shares
  of common stock of the Company, in a transaction in which the Company was the
  surviving corporation. The 12,343,000 shares of common stock represented approximately
  86% of the issued and outstanding shares of common stock as of December 31,
  2001.

Under the terms of the Share Exchange Agreement, AII, which
  had licenced software to SchoolWeb under the terms of a software license agreement
  (the "License Agreement") dated January 1, 2001 as amended June 29, 2001 and
  September 10, 2001, acquired a total of 3,000,000 shares of common stock upon
  closing of the Share Exchange Agreement.

As a result of the closing of the Share Exchange Agreement,
  Mr. Michael Dearden and Mr. Griffin Jones, who were concurrently appointed as
  Directors, acquired 17.85% and 17.84% of the issued and outstanding, at the
  time, shares of common stock respectively.

A copy of the Share Exchange Agreement was filed as an exhibit
  to the report on Form 8-K dated September 10, 2001 and is incorporated in its
  entirety herein. A copy of the License Agreement dated January 1, 2001 and amendment
  dated June 29, 2001 and the Settlement Agreement dated September 10, 2001 are
  filed as exhibits to the report on Form 8-K dated September 10, 2001 and are
  incorporated in their entirety herein.

Michael Dearden, Greg Protti, Patrick Fitzsimmons, Brandon
  Douglas, Griffin Jones and Karim Lakhani were appointed to the board of directors
  of the Company when the Company purchased AI Systems Group, Inc.

Alternet Systems, Inc. distributes, markets and sells Internet
  access systems and software, marketed under the names "SchoolWeb Systems" and
  "Community Link".

In the fall of 2001, Hewlett Packard (Canada) expressed an
  interest in acquiring from the Company some or all of its rights under the License
  Agreement. On March 3, 2003 Hewlett Packard (Canada) and

4

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AII entered into an agreement (the “Hewlett Packard
  Agreement”) where Hewlett Packard agreed to market and distribute the
  software which Alternet had licensed from AII under the License Agreement.

Because of the distribution capacity of Hewlett Packard (Canada),
  and the relative lack of distribution and sales capacity of the Company, management
  of the Company believed it to be in the Company’s best interest to consent
  to the Hewlett Packard Agreement. In exchange for Hewlett Packard (Canada)’s
  agreement to market and distribute the Licensed Technology, the Company and
  AII agreed to use Hewlett Packard hardware whenever sales of the Licensed Technology
  were made (provided that Hewlett Packard was able to provide the hardware).

The Company and AII also agreed to give Hewlett Packard Finance
  (a division of Hewlett Packard) the right of first refusal to provide lease
  financing for sales of the Licensed Technology (by the Company or any other
  party). The agreement with Hewlett Packard expired on March 3, 2003 and the
  Company no longer has any agreement, directly or through AII, with Hewlett Packard.

Alternet licensed the SchoolWeb Technology from Advanced Interactive
  Inc. ("AII") under the terms of a license agreement (the "License Agreement")
  which had a term commencing on January 1, 2001. The President and director of
  AII and AIC became a director of the Company under the terms of this License
  Agreement.

The License Agreement granted Alternet and its subsidiary,
  AI Systems Group, Inc., for a term of five (5) years renewable for an additional
  five (5) years, the exclusive right to distribute, market, sell and sub-license
  the Licensed Technology in the US and Canada for educational related purposes
  and granted SchoolWeb Holdings Inc., for a period of five (5) years renewable
  for an additional five (5) years, the non-exclusive worldwide right to distribute,
  market, sell and license the "OfficeServer" portion of the Licensed Technology.
  Under the terms of the License Agreement, SchoolWeb Holdings Inc. was to pay
  to AII the sum of $10,000 per month in year one, $20,000 per month in
  year two and increased payments in subsequent years. AII also was to receive
  a royalty of 40% on net revenue realized from SchoolWeb Holding Inc.'s sales
  of the Licensed Technology which, after the first three years of the License
  Agreement, is subtracted from the amount of the specified monthly payment.

On May 16, 2003, the president of Advanced Interactive Inc.
  Mr. Karim Lakhani, resigned as a director of Alternet Systems Inc.

On October 14, 2003, Alternet Systems terminated its software
  license agreement (the "License Agreement") with AII. The License Agreement
  was terminated for a number of reasons including the failure by AII to grant
  to Alternet North American exclusivity for technologies and software licensed
  under the License Agreement.

On March 13 2004, the Company filed a Writ of Summons and
  Statement of Claim in the Supreme Court of BC, Vancouver, BC. The writ states
  that the defendants, Advanced Interactive Inc., have breached the License Agreement
  as follows and damages are being sought in the amount of $1,804,709. The
  defendants have breached the Agreement as follows: failed to grant exclusivity
  to the Plaintiff as required by the License Agreement; failed to provide technical
  support and/or provide technical support at a reasonable price; and failed to
  provide usable and working software as is required by the License Agreement.
  The likelihood of any gain or loss as a result of the above lawsuit is neither
  determinable nor reasonably estimable at this time and the defendant in the
  lawsuit has counterclaimed for damages (see “Legal Proceedings”).

5

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Since notification of termination of the License Agreement
  was given to AII, Alternet Systems Inc. developed and currently supports its
  own proprietary software. Although the names of its products remain the same,
  the software comprising these products is its own and not licensed software.

The Company's Internet access system and software is presently
  installed in 54 schools and communities in Canada under the names "SchoolWeb"
  and "1nterlink" and “CommunityWeb.

Each basic SchoolWeb "system" or software / hardware package
  is comprised of the SchoolWeb virtual library software, Linux Operating System,
  a network server, redundant file system, software configuration, uninterruptible
  power supply, satellite or cable port, SchoolWeb user license, 24 hour technical
  support , on-site installation(provided by resellers and distributors), training
  , system maintenance and 5X9 on-site warranty.

Because SchoolWeb is a new software technology, acceptance
  of the SchoolWeb software (the Company believes) must be preceded by a test
  period of placing the SchoolWeb software and servers in schools for as long
  as a year to build comfort with the system and generate (after the test period
  has been completed) orders and revenue. The Company has found, in dealing with
  potential clients, that a new software system or company has to prove itself
  before a sale can be made. Testing is the easiest way of accomplishing this
  (SchoolWeb software does not, at this time, have the established reputation
  of software, like Microsoft Word or Outlook Express which most potential customers
  are aware of and know will meet their needs).

For example, the SchoolWeb system and software were installed
  on a test basis in Burnaby School District in Vancouver, Canada for almost two
  years prior to Burnaby School District placing an order for installation in
  52 schools. This installation was completed in February of 2003.

The Company markets SchoolWeb into the US school district
  market and internationally. Company personnel have also been attending trade
  shows in North America and making presentations to school districts in the United
  States.

SchoolWeb has been granted trademark rights in the Canada
  for the trademark "SchoolWeb". The initial application was filed in Canada on
  March 30, 2001 and it was granted in March of 2003. The trademark is also registered
  on the supplemental register in the United States, as the United States trademark
  was applied for based on the Canadian trademark application. Once a company
  has used a supplemental register mark in the United States for five years, the
  company's mark is placed on the full register. In the meantime, its rights in
  the United States are protected.

The Company anticipates that it will begin the process of
  registering the "HealthWeb" and "CommunityWeb" names. There can be no guarantee
  that all, or any, of these names will be successfully registered in the United
  States or Canada.

Additional Products

SchoolWeb InMotion Web Conferencing

The Company also offers a web conferencing product that is
  sold to schools for the purpose of video conferencing for principals and teachers,
  as well as distance learning to remote or at home students. The Company sources
  software and services from several suppliers and resells it under the SchoolWeb
  InMotion name. The Company acts as a reseller of any such software, not as a
  proprietor and developer.

6

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To this end, the Company has installed a co-located server
  in Vancouver, British Columbia which will act to service web-based video conferencing
  clients and currently offers this product to school districts in North America
  and internationally. No attempt has yet been made to trademark or otherwise
  protect the InMotion name.

Item 2.           Description
  of Property

The Company does not own any real property as of March 30,
  2005.

The Company rents approximately 1700 sq. ft. of office space
  at Suite #610 – 815 West Hastings Street, British Columbia, Canada V6C
  1B4. The rent is on a month to month basis and is $2,140.

Item 3.           Legal
  Proceedings

Other than as described below, management is not aware of
  any legal proceedings (either presently engaged in or contemplated) by any government
  authority or other party involving the Company, its properties or its products.

On March 13, 2004, the Company filed a Writ of Summons and
  Statement of Claim (No. S041464) in the Supreme Court of British Columbia in
  the Vancouver, British Columbia Court Registry. The writ states that the defendants,
  Advanced Interactive, Inc. (“AII”) have breached the License Agreement
  between the Company and AI as follows and damages are sought in the amount of
  $1,804,709. The Company alleges that AII breached the agreement by failing
  to grant exclusivity to the Company as required by the License Agreement, failed
  to provide technical support, failed to provide technical support at a reasonable
  price, failed to provide usable software and failed to provide working software.
  The defendant in this action has made a counterclaim of Cdn $1,379,150 plus
  interest and costs. This amount represents license payments that would be owed
  if the License Agreement were in effect plus interest and costs. The counterclaim
  also includes unspecified additional damages.

On March 14, 2005 the Company was named as a defendant in
  a Writ of Summons and Statement of Claim in the Supreme Court of British Columbia,
  Vancouver Registry in which the Native Trade and Investment Association requests
  an order to pay the Plaintiff Cdn $53,500 and 100,000 common shares for
  trade shows attended by the Company. Alternet Systems Inc. disputes this claim
  and is defending this action.

No directors, officers, or affiliate of the Company is (i)
  a party adverse to the Company in any legal proceedings, or (ii) has an adverse
  interest to the Company in any legal proceedings.

Item 4.           Submission
  of Matters To A Vote of Security Holders

No matters were submitted to a vote of security holders during
  the fourth quarter of the fiscal year ended December 31, 2004.

PART II

Item 5.           Market
  for Common Equity and Related Stockholder Matters

Market for Common Stock

The Company’s securities trade on the NASD’s OTCBB
  under the symbol “ASYI”.

7

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The following table summarizes the high and low bid prices
  for our common stock for the periods indicated as reported by the OTC Bulletin
  Board:

|2004           | HIGH  | LOW  
|-------------- | ----- | -----
|               |       |      
|First Quarter  | $0.37 | $0.13
|Second Quarter | $0.16 | $0.08
|Third Quarter  | $0.17 | $0.06
|Fourth Quarter | $0.34 | $0.15

Holders of Common Stock

On December 31, 2004, there were approximately 131 holders
  of record of our common stock and there were 25,779,428 shares outstanding.
  There are no indirect holdings of registered shares to outside institutions
  or stock brokerage firms, and we estimate that there are no additional beneficial
  shareholders beyond the 131 registered shareholders at December 31, 2004.

Dividends

We have not declared or paid a cash dividend to stockholders
  since our incorporation. The Board of Directors presently intends to retain
  any earnings to finance company operations and does not expect to authorize
  cash dividends in the foreseeable future. Any payment of cash dividends in the
  future will depend upon our earnings, capital requirements and other factors.

Recent Sales of Unregistered Securities

Sales in 2004:

On May 17, 2004 the Company issued a total of 2,628,499 shares
  to 46 persons resident in the United States and a total of 1,413,000 shares
  to 16 persons resident in Canada. All of the shares were sold at a price of
  $0.15 per shares for total proceeds of $606,225.

On October 25, 2004, the Company issued a total of 621,900
  shares at a price of $0.15 to 5 persons resident in Canada for total proceeds
  of $93,285.

Sales in 2003:

On March 14, 2003 the Company issued a total of 165,944 units
  to a total of 15 persons resident in Canada at a price of $0.35 per unit
  for total proceeds of $58,080. Each unit was comprised of one common share
  and one share purchase warrant exercisable for a period of 2 years at $0.50
  per warrant.

The 165,944 units were sold under the exemption from registration
  made available by Regulation S.

Where the offerings described in “Sales in 2003”
  and “Sales in 2004” above were made to Canadian residents they were
  undertaken under Regulation S and they were made under Rule 903 (Category 3,
  equity securities) and:

|– | the sale was made in an offshore
        transaction;                             
|- | ----------------------------------------------------------------------------------
|  |                                                                                   
|– | no directed selling efforts
        were made in the United States by the Company;

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|– | the purchaser certified
        that it is not a US person and is not acquiring the securities for the
        account or benefit of any US person;                                                                                     
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                         
|– | the purchaser agreed to
        resell such securities only in accordance with the provisions of the Securities
        Act of 1933 or regulations applicable to their securities;                                                      
|  |                                                                                                                                                                                                                                         
|– | the securities contained
        a legend to the effect that transfer was prohibited unless the securities
        were first registered under the Securities Act of 1933 or resale was made
        pursuant to an exemption therefrom.

No commission or professional fees were paid in connection
  with the Company's sales of unregistered securities under Regulation S.

Where the sales were made to residents of the United States,
  each person to whom the sale was made was asked by the Company to confirm in
  writing that they were accredited investors, as that term is defined in the
  rules and regulations of the Securities Exchange Commission.

Neither we nor any person acting on our behalf offered or
  sold the foregoing securities by means of any form of general solicitation or
  general advertising. All purchasers represented in writing that they acquired
  the securities for their own accounts. A resale legend has been provided for
  the stock certificates stating that the securities have not been registered
  under the Securities Act of 1933 and cannot be resold or otherwise transferred
  without registration or an exemption (such as that provided by Regulation S
  or Rule 144).

ISSUANCE OF NON- RESTRICTED STOCK

The Company has issued the following non-restricted stock:

Sales in 2004:

On January 6, 2004, the Company issued a total of 1,785,000
  shares at a price of $0.26 per share pursuant to the Company’s S8
  Registration Statement filed on March 1, 2003. These shares were issued to 10
  persons resident in Canada under the terms of management agreements by which
  they provided various services, including management consulting, software programming
  and software manual development.

On June 10, 2004, the Company issued a total of 1,500,000
  shares at a price of $0.11 per share pursuant to the Company’s S8
  Registration Statement filed on March 1, 2003. These shares were issued to 3
  persons resident in Canada under the terms of management agreements by which
  they provided various services to the Company including product marketing consulting
  and other services.

On August 30, 2004, the Company issued 431,000 shares at a
  price of $0.23 pursuant to the Company’s S8 Registration Statement
  filed on March 1, 2003. Of these shares, 406,000 shares were issued to 6 persons
  resident in Canada and 25,000 shares were issued to 1 person resident in the
  United States under the terms of management agreements by which they provided
  various services including product marketing, financial consulting and software
  development services.

Sales in 2003:

The Company issued a total of 640,000 shares of non-restricted
  common stock in the year ending December 31, 2003.

9

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On May 29, 2003, a total of 100,000 shares were issued to
  a Canadian resident under the terms of a management agreement at a price of
  $0.33 per share. The shares were registered pursuant to the Company’s
  S8 Registration Statement filed on March 1, 2003.

On June 10, 2003, a total of 540,000 shares were issued to
  four Canadian residents under the terms of management agreements by which they
  provide various services, including software programming, management consulting
  and software manual development, at a price of $0.31 per share. The shares
  were registered pursuant to the Company’s S8 Registration Statement filed
  on March 1, 2003.

INCENTIVE STOCK OPTION PLAN

The Company adopted an incentive stock option plan on May
  31, 2004. The Option Plan calls for the issuance of up to 3,000,000 incentive
  stock options to directors, officers, employees and consultants. To date, no
  incentive stock options have been issued. The Option Plan is managed by the
  Company’s Board of Directors and options, when granted under the terms
  of the Option Plan, can be granted for a term of up to five (5) years at an
  option exercise price determined at the discretion of the Board of Directors
  considering the prevailing market prices for the Company’s shares.

RETAINER STOCK PLAN

The Company adopted a retainer stock plan on March 1, 2003.
  The Retainer Plan calls for the issuance of up to 5,000,000 shares of common
  stock to directors, officers, employees and consultants to compensate them for
  services rendered to the Company in lieu of cash compensation.

To date, a total of 4,851,000 shares of common stock have
  been issued under the terms of the Retainer Plan for various management and
  technical (software related) services (see “Issuance of Non-Restricted
  Stock” above).

Item 6.           Management’s
  Discussion and Analysis or Plan of Operation

The following discussion should be read in conjunction with
  the Company’s consolidated financial statements and the notes thereto.
  The discussion of results, causes and trends should not be construed to imply
  any conclusion that such results or trends will necessarily continue in the
  future.

Critical Accounting Policies

We believe that the estimates, assumptions and judgments involved
  in the accounting policies described below have the greatest potential impact
  on our financial statements, so we consider these to be our critical accounting
  policies. Because of the uncertainty inherent in these matters, actual results
  could differ from the estimates we used in applying the critical accounting
  policies. Within the context of these critical accounting policies, we are not
  currently aware of any reasonably likely event that would result in materially
  different amounts being reported.

Results of Operation:

(For the year ended December 31, 2004 compared to the year
  ended December 31, 2003).

With the closing of the SchoolWeb Agreement in September of
  2001, the Company’s results, on a consolidated basis, reflected its own
  results consolidated with its subsidiary, AI Systems Group Inc.

10

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(formerly known as SchoolWeb Holdings Inc). For the remainder
  of this part, the term “Company” refers to both the Company and
  its wholly owned subsidiary, AI Systems Group Inc.

Net Sales

For the year ending December 31, 2004, the Company had sales
  of $ 57,220. During the corresponding year ended December 31, 2003, the
  Company had sales of $81,354. The 30% decrease in sales is attributable
  to the fact that the Company has been undergoing a re-organization of its sales
  and marketing staff over the past six months. The objective of the re-organization
  of the sales and marketing functions was to reduce overhead by utilizing independent
  sales agents to market SchoolWeb and CommunityWeb. The Company’s ComunityWeb
  Sales Manager and a former director of the Company, Mr. Greg Protti resigned
  on August 1 2004.

The Company continues to market SchoolWeb and CommunityWeb
  in North America and internationally.

Net Loss

For the year ending December 31, 2004, the Company had a net
  loss of $628,064 or $(0.03) per share, which was a reduction of 70%
  when compared to the net loss for the corresponding year to December 31, 2003
  of $1,706,867 or $(0.10) per share. The decreased loss was due primarily
  to: a decrease in marketing expenses, management and consulting fees, and no
  license fees incurred to our former software developer, Advanced Interactive
  Inc.

Gross Profit

Gross Profit was $ 20,591 compared to $ 66,830 for
  the year ended December 31, 2003. This represents a 70% decrease when compared
  to last year and is primarily due to the decline in sales.

Selling, General and Administrative Expenses

For the year ended December 31, 2004, the Company incurred
  office and general expenses of $46,307. Marketing expenses of $90,898
  were 84% lower than the year ending 2003; management and consulting fees of
  $348,217 were a 30% reduction from the year ending December 31 2003; no
  fees were payable under the License Agreement and $46,307 was incurred in
  professional fees. Training and documentation fees were $38,673 a 74% reduction
  over the year ending December 31 2003.

For the corresponding year to December 31, 2003, the Company
  had office and general expenses of $38,597; marketing expenses of $
  548,212 management and consulting fees of $494,906, fees payable under the
  License Agreement of $336,000 and professional fees of $40,995. Training
  and documentation fees were $107,145 in 2003. Accounts payable were $537,719
  at December 31 2004 of which $386,162 are license fees owing to Advanced
  Interactive Inc., which are currently in dispute. This compares to accounts
  payable of $596,605 at December 31 2003 of which $386,162 are disputed
  license fees owing.

The decrease in marketing expenses, and management and consulting
  expense this year, compared to the corresponding year to December 31, 2003,
  is a result of decreased activity in the last six months of 2004 in marketing
  the SchoolWeb and CommunityWeb when compared to 2003. The Company underwent
  a corporate downsizing during the last six months of 2004, choosing to contract
  out its software development, in order to reduce overhead.

11

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During the year, a total of $208,730 was expensed by the
  Company in connection with management and sales and marketing agreements entered
  into by the Company during the year ended December 31, 2003 and 2004. This amount
  includes the fair value of share consideration where shares were issued as compensation
  for services rendered. This compares to $494,906 expensed in 2003, a decrease
  when compared to the year ending December 31 2004. This is a result of all management
  contracts being terminated during the last six months of 2004. Readers should
  consult Note 6 to the financial statements for an explanation of this expense.

Advanced Interactive Inc. Software License Agreement

No license fees were incurred to Advanced Interactive during
  the year ending December 31, 2004, compared to $336,000 in license fees
  payable in 2003. This was due to the Company canceling the license agreement
  with Advanced Interactive during the year ending December 31 2003. Although
  the parties have commenced legal proceedings against each other, the Company
  continues to negotiate a settlement of all debts and liabilities between the
  two Companies, although no assurance can be given at this time that these negotiations
  will result in a settlement.

Interest and other expenses

The Company had no material interest expenses.

Liquidity and Capital Resources

As at December 31, 2004, the Company had $30 cash in the
  bank. This compares to $113,161 cash in the bank and prepaid expenses of
  $8,633 as at December 31, 2003. The Company had a working capital deficiency
  of $566,255 as at December 31, 2004 compared to $528,754 as at December
  31, 2003. The Company is currently pursuing financing to fund ongoing operations
  and to pay current debts. The Company’s ability to continue as a going
  concern will be negatively affected if it is unsuccessful.

Solflex Energy Development Corp.

On October 15 2004 the Company entered into a Letter of Intent
  (the “Solflex Agreement”) with Solflex Energy Development Corp.
  (“Solflex”).

Under the terms of the Solflex Agreement, the Company would
  acquire a 25% equity interest in Solflex and an exclusive license for North
  and South America to Solflex’s proprietary solar panel technology. The
  terms of the agreement call for payment to Solfex of $170,000 within 14
  days of signing the License Agreement and $320,000 by November 15 2004.

To date, the Company has not advanced any funds to Solflex
  for this acquisition and has not entered into a license agreement for Solflex’s
  technology. In addition, the Company has not received any documentation from
  Solflex regarding this acquisition. No assurance can be given that the Company
  will complete this acquisition, and as such, no assurance that the Company will
  be entering into the solar energy industry can be given at this time.

12

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PLAN OF OPERATION

Over the next 12 months the Company will be concentrating
  on marketing its SchoolWeb products to US and Canadian school districts, and
  internationally. The Company markets its products internationally through approved
  independent sales agents.

Sales and marketing is also accomplished through the Company’s
  existing sales staff, who contact school districts through direct mail, personal
  sales, trade shows and industry associations.

Although the Company believes that demand will exist for its
  products, there can be no assurance that any sales will be made in the future.

The Company is also marketing the InMotion web conferencing
  product. Marketing of InMotion is accomplished through the Company’s existing
  sales staff, who offer the web conferencing product in conjunction with SchoolWeb
  in all direct mail, personal sales calls, trade shows and industry associations.
  No development costs are anticipated with InMotion web conferencing as the Company
  will be outsourcing the software development and service through outside providers
  and is essentially, acting as a reseller.

The Company is expected to remain dependent upon debt or equity
  financing unless revenues from operations grow significantly.

FUNDS REQUIRED FOR OPERATIONS

The Company anticipates the following for monthly cash expenses
  in the next 12 months (excluding the cost of any share issuances which may be
  made pursuant to management agreements between the Company and senior management):

|Consulting Fees              | $ | 9,000  | 
|---------------------------- | - | ------ | 
|                             |   |        | 
|Product Development Expense: | $ | 1,000  | 
|                             |   |        | 
|Office Rent                  | $ | 2,200  | 
|                             |   |        | 
|Telephones                   | $ | 1,000  | 
|                             |   |        | 
|Travel                       | $ | 1,000  | 
|                             |   |        | 
|Marketing Expenses           | $ | 1,000  | 
|                             |   |        | 
|Professional Fees            | $ | 1,500  | 
|                             |   |        | 
|Accounting fees              | $ | 1,000  | 
|                             |   |        | 
|Total Monthly Expenses:      | $ | 16,700 | 

The Company is dependent for the continuance of its operations
  on further debt or equity financings. Failure to obtain such financings could
  result in the Company being unable to continue its operations.

There can be no certainty that such financings would be obtained
  on favorable terms, if at all, and any equity financings could dilute the interests
  of existing shareholders.

Inflation

Management does not believe that inflation had a material
  adverse affect on the financial statements for the periods presented.

13

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Qualitative and Quantitative Disclosure Regarding Risk

The Company is exposed to a number of risks, including the
  following:

|– | The Company may be unable to market and
        sell its software products;                                                                                                                                                                             
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|– | The Company has a history of operating
        its software business at a significant loss;                                                                                                                                                             
|– | The Company requires additional equity
        financing to continue operations and may be unable to obtain this financing
        given its past sales performance;                                                                                    
|– | If further equity financing is obtained,
        it will dilute the value of existing shareholders’ stock;                                                                                                                                              
|– | The Company has no working capital with
        which to continue operations;                                                                                                                                                                           
|– | The software industry is extremely competitive
        and the Company faces competition from more established software distributors
        and producers with greater financial resources and established sales and
        distribution capabilities;
|– | The Company has a significant number
        of shares outstanding which may be eligible for resale under Rule 144
        and which, if sold, could depress the market price of the Company’s
        shares;                                          
|– | The profit margins in the software industry
        have been steadily eroding such that, even if it is able to make sales
        for its software products, the Company may be unable to do so at a profitable
        margin.                        

Item 7.           Financial
  Statements

The audited Consolidated Financial Statements are included
  in this Form 10-KSB beginning on page F-1 following the signature page.

Item 8.           Changes
  in and Disagreements With Accountants on Accounting andFinancial
  Disclosure

During the Company’s two most recent fiscal years and
  to the date of change in certifying accountant, there were no disagreements
  with the Company’s accountants on any matter of accounting principle or
  practices, financial statement disclosure or auditing scope or procedure. In
  addition, there were no reportable events as described in Item 304(a)(1)(iv)(B)1
  through 3 of Regulation S-B that occurred within the Company’s two most
  recent fiscal years and the subsequent interim periods.

Item 8A. Controls
  and Procedures

The Company maintains a system of disclosure controls and
  procedures that are designed for the purposes of ensuring that information required
  to be disclosed in the Company's Securities Exchange Act of 1934 reports is
  recorded, processed, summarized and reported within the time periods specified
  in the SEC's rules and forms, and that such information is accumulated and communicated
  to the Company's management, including the Chief Executive Officer, as appropriate
  to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, the Company
  carried out an evaluation, under the supervision and with the participation
  of the Company's management, including the Chief Executive Officer, of the effectiveness
  of the design and operation of the Company's disclosure controls and procedures
  pursuant to Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c). Based
  upon that evaluation, the Chief Executive Officer concluded that the Company's
  disclosure controls and procedures are effective in connection with the filing
  of this annual report on Form 10-KSB for the fiscal year ended December 31,
  2004.

14

---

There have been no significant changes in the Company's internal
  controls over financial reporting during the fiscal year ended December 31,
  2004 that have materially affected or are reasonably likely to materially affect,
  our internal controls over financial reporting.

PART III

Item 9.           Directors,
  Executive Officers, Promoters and Control Persons; Compliance with Section 16(a)
  of the Exchange Act

The following discussion contains disclosure concerning the
  directors, officers and control persons of the Company. There are no persons
  which have acted as a promoter, controlling person, or significant employee
  of the Company other than as disclosed below.

|Name                | Position                               | Term of Office*1*2 
|------------------- | -------------------------------------- | -------------------
|Michael Dearden     | President and Director                 | Expires at next AGM
|Griffin Jones       | Secretary, Treasurer, CEO and Director | Expires at next AGM
|Patrick Fitzsimmons | Director                               | Expires at next AGM

|1. | Directors, whether appointed at a meeting of stockholders
        or by the remaining directors, are appointed until the next annual meeting
        of stockholders. The Company anticipates holding its next AGM during June
        of 2005.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | The President, Secretary, CEO and Treasurer do not
        have a set term of office. They serve at the pleasure of the Directors
        and can be removed at any time by the Directors.                                                     

Michael Dearden, President and Director

Michael Dearden, age 50. Mr. Dearden has over 25 years experience
  in sales and marketing, and for the past 17 years has focused specifically on
  corporate marketing and venture capital financing. Prior to joining Alternet
  in 2000, Mr. Dearden was, for five years, a director of Rolland Virtual Business
  Systems Limited (formerly Americ Resources Corp.), where he helped to facilitate
  the merger of Rolland Virtual Business Systems Limited and Americ Resources
  Corp. and helped to facilitate a concurrent financing of $1,800,000. Rolland
  Virtual Business Systems Limited is a Montreal, Canada, based E-commerce software
  developer with approximately 35 employees.

Griffin Jones, Secretary, Treasurer, CEO and Director

Griffin Jones, age 50. Mr. Jones has been self-employed for
  approximately 17 years as a management consultant. Mr. Jones brings to the Company
  experience in financial management, and experience in providing management to
  companies in a number of industry areas including high technology, industrial
  products and mining. Mr. Jones has worked in marketing management, finance and
  corporate relations.

Patrick Fitzsimmons, Director

Pat Fitzsimmons, age 51. Mr. Fitzsimmons brings to the Company
  sales and management experience, gained from a 24-year career in the high-technology
  marketplace. Mr. Fitzsimmons has represented firms such as NCR, Timeplex, Rogers
  Cable, and Newbridge Networks, offering a wide range of

15

---

technology solutions. His most recent position was Manager,
  Major Accounts, AT&T Canada, Vancouver B.C., Canada.

Item 10.         Executive
  Compensation

Summary Compensation Table

|Name and   principal   position 
      (a)     | Year (b)                                                   | Annual Compensation                              | Long-term compensation                                   
|---------------------------------------------- | ---------------------------------------------------------- | ------------------------------------------------ | ---------------------------------------------------------
|Salary   ($)  (c)                              | Bonus   ($)  (d)                                           | Other   Annual   Compen-
      sation   ($)  (e) | Awards                                                   
|Restricted   Stock   Award(s)  
      ($)  (f) | Securities   Underlying   options/ 
       SARs   (#)  (g) | LTIP   payouts   ($)  (h)                        | All   other  
      Compen-
      sation  
      ($)  (i)
|Michael  
       Dearden,   President          | 2004   2003   2002                                         | 46,100   74,186   18,515                         | 0 0 0                                                    
|Griffin Jones,  
       Treasurer and   CEO    | 2004   2003   2002                                         | 46,100   77,998   35,164                         | 0 0 0                                                    

Item 11.  Security
  Ownership of Certain Beneficial Owners and Management

The following table sets forth information regarding the beneficial
  ownership of shares of the Company’s common stock as of December 31, 2004
  (25,779,428 issued and outstanding) by (i) all stockholders known to the Company
  to be beneficial owners of more than 5% of the outstanding common stock; and
  (ii) all directors and executive officers of the Company, and as a group (each
  person has sole voting power and sole dispositive power as to all of the shares
  shown as beneficially owned by them):

|Name and Address                                                                                                                                                               | Position                       | Amount of Stock
      Beneficially Owned                                                                              | Percentage of Class
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------ | --------------------------------------------------------------------------------------------------------------------- | -------------------
|Michael Dearden and  Mikden Investments
      Inc. (formerly  
      Streamline  Investments, Inc.) (2)  
      711 South Carson St.  
      Carson City, Nevada  
      89701 | Director, President            | 2,696,300 common shares of which 313,330
      are held personally and 2,383,000 are held by Mikden Investments       | 10.5%              
|Griffin Jones and Nahatlatch Capital Corp. (3) 
      
      711 South Carson St.  
      Carson City, Nevada  
      89701                                                    | Director, Secretary, Treasurer | 2,473,000 common shares of which 260,000
      are held personally and 2,213,000 are held in Nahatlatch Capital Corp. | 9.6%               

16

---

|Patrick Fitzsimmons  1406-151 E. Keith Rd.
       N. Vancouver, BC  V7L 4M3                  | Director, VP Sales | 1,095,000 | 4.3% 
|-------------------------------------------------------------------------------------------- | ------------------ | --------- | -----
|Advanced Interactive Inc.  718 – 1350
      East Flamingo Road  Las Vegas, NV  89119         |                    | 1,728,571 | 6.7% 
|Advanced Interactive Canada Inc.  2101 –
      1177 W.  Hastings St.  Vancouver, BC  V6E 2K3 |                    | 1,500,000 | 5.8% 
|Directors, Officers and 5% stockholders in total
      (6 Persons)                           |                    | 9,492,871 | 36.8%

|1. | The 12.5% of the Company’s shares of common
        stock held by Advanced Interactive are the subject of legal proceedings
        (see “Legal Proceedings”)      
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | Mikden Investments Inc. (formerly Streamline Investments,
        Inc.) is a company wholly owned by the Company’s President and Director,
        Michael Dearden.
|3. | Nahatlatch Capital Corp. is a company wholly owned
        by the Company’s Treasurer, Secretary and Director, Griffin Jones.                                      

Item 12.         Certain
  Relationships and Related Transactions

Except as concerns compensation to directors and officers,
  during the past two years, there have not been any transactions that have occurred
  between the Company and its officers, directors, and five percent or greater
  shareholders. Executive compensation and related party compensation are disclosed
  in the notes to the Company’s financial statements included herein and
  in “Executive Compensation” above.

Certain of the officers and directors of the Company are engaged
  in other businesses, either individually or through partnerships and corporations
  in which they have an interest, hold an office, or serve on a board of directors.
  As a result, certain conflicts of interest may arise between the Company and
  its officers and directors. The Company will attempt to resolve such conflicts
  of interest in favor of the Company. The officers and directors of the Company
  are accountable to it and its shareholders as fiduciaries, which require that
  such officers and directors exercise good faith and integrity in handling the
  company’s affairs. A shareholder may be able to institute legal action
  on behalf of the Company or on behalf of itself and other similarly situated
  shareholders to recover damages or for other relief in cases of the resolution
  of conflicts is in any manner prejudicial to the Company.

Item 13.         Exhibits
  and Reports on Form 8-K

The exhibits to be filed with this Form 10-KSB are listed
  below in the Exhibit Index.

17

---

During the reporting period and subsequent to it but prior
  to the date of this Report, the Registrant filed two reports on Form 8-K on
  April 4, 2004 and November 27, 2004 on the SEC’s EDGAR system available
  at www.sec.gov.

Item 14.         Principal
  Accountant Fees and Services

As of the date of this Annual Report, the Company has not
  appointed members to an audit committee and, therefore, the respective role
  of an audit committee has been conducted by the board of directors of the Company.
  When established, the audit committee’s primary function will be to provide
  advice with respect to the Company’s financial matters and to assist the
  board of Directors in fulfilling its oversight responsibilities regarding finance,
  accounting, tax and legal compliance. The audit committee’s primary duties
  and responsibilities will be to: (i) serve as an independent and objective party
  to monitor the Company’s financial reporting process and internal control
  system; (ii) review and appraise the audit efforts of the Company’s independent
  accountant’s; (iii) evaluate the Company’s quarterly financial performance
  as well as its compliance with laws and regulations; (iv) oversee management’s
  establishment and enforcement of financial policies and business practices;
  and (v) provide an open avenue of communication among the independent accountants,
  management and the board of directors.

The board of directors has considered whether the regulatory
  provision of non-audit services is compatible with maintaining the principal
  independent accountant’s independence.

Audit and Audit Related Fees

During the fiscal years ended December 31, 2004 and December
  31, 2003, the Company incurred approximately $15,300 and $14,100 respectively
  in fees to its principal independent accountants for professional services rendered
  in connection with the audits of the Company’s financial statements. Included
  in these amounts are billing for other accounting services consisting solely
  of review of the Company’s quarterly reports filed on Form 10-QSB for
  the periods ended March 31, 2004, June 30, 2004, and September 30, 2004.

Financial Information Systems Design and Implementation
  Fees

During fiscal year ended December 31, 2004, the Company did
  not incur any fees for professional services rendered by its principal independent
  accountant for certain information technology services which may include, but
  is not limited to, operating or supervising or managing the Company’s
  information or local area network or designing or implementing a hardware or
  software system that aggregate source data underlying the financial statements.

All Other Fees

During fiscal year ended December 31, 2004, the Company did
  not incur any other fees for professional services rendered by its principal
  independent accountant for all other non-audit services which may include, but
  is not limited to, tax-related services, actuarial services or valuation services.

18

---

EXHIBIT INDEX

|Number |  | Exhibit Description                                                                                                                                           
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|       |  |                                                                                                                                                               
|3.1    |  | Articles of Incorporation (incorporated
      by reference to Exhibit 3.1 of the Registration Statement on Form 10SB filed
      on EDGAR on November 6, 2000)
|       |  |                                                                                                                                                               
|3.2    |  | Certificate of amendment to
      Aricles of Incorporation (incorporated by reference to Exhibit 3.2 on the
      report on Form 8-K filed on May 23, 2002    
|       |  |                                                                                                                                                               
|14.1   |  | Code
      of Business Conduct                                                                                                                                
|       |  |                                                                                                                                                               
|31.1   |  | Section
      302 Certification of Chief Executive Officer                                                                                                    
|       |  |                                                                                                                                                               
|31.2   |  | Section
      302 Certification of Chief Financial Officer                                                                                                    
|       |  |                                                                                                                                                               
|32.1   |  | Section
      906 Certification of Chief Executive Officer                                                                                                    
|       |  |                                                                                                                                                               
|32.2   |  | Section
      906 Certification of Chief Financial Officer                                                                                                    

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the
  Securities Exchange Act of 1934, the Registrant has duly caused this report
  to be signed on its behalf by the undersigned, thereunto duly authorized.

|                      | ALTERNET SYSTEMS, INC.
|--------------------- | ----------------------
|                      |                       
|                      |                       
|Dated: March 30, 2005 | By:                   
|                      |                       

In accordance with the Exchange Act, this report has been
  signed by the following persons on behalf of the Registrant and in the capacities
  and on the dates indicated.

|Dated: March 30, 2005 | By: | /s/ Griffin Jones                  
|--------------------- | --- | -----------------------------------
|                      |     | Griffin Jones, Director, Secretary,
|                      |     | Treasurer                          
|                      |     |                                    
|                      |     |                                    
|Dated: March 30, 2005 | By: | /s/ Patrick Fitzsimmons            
|                      |     | Patrick Fitzsimmons, Director      

19

---

ALTERNET INTERNATIONAL CORPORATION 
  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                               |                                                                  | PAGE       
|-------------------------------------------------------------- | ---------------------------------------------------------------- | -----------
|                                                               |                                                                  |            
|Index to Consolidated Financial
      Statements               | F-1                                                             
|                                                               |                                                                 
|Reports of Independent
      Registered Public Accounting Firm | F-2 – F-3                                                       
|                                                               |                                                                 
|Consolidated Financial Statements                              |                                                                 
|                                                               |                                                                  |            
|                                                               | Balance sheet                                                    | F-4        
|                                                               |                                                                  |            
|                                                               | Statements of operations and comprehensive
      loss            | F-5        
|                                                               |                                                                  |            
|                                                               | Statements of changes in stockholders’
      equity (deficiency) | F-7– F-9   
|                                                               |                                                                  |            
|                                                               | Statements of cash flows                                         | F-6        
|                                                               |                                                                  |            
|                                                               | Notes to financial statements                                    | F-10 – F-16

---

ALTERNET SYSTEMS INC.

(A Development Stage Company)

CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2004







CONSOLIDATED BALANCE SHEETS

CONSOLIDATED STATEMENTS OF OPERATIONS

CONSOLIDATED STATEMENTS OF CASH FLOWS

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Alternet Systems Inc. 
  (A Development Stage Company)

We have audited the accompanying consolidated balance sheets
  of Alternet Systems Inc. (A Development Stage Company) as of December 31, 2004
  and 2003 and the related consolidated statements of operations, stockholders’
  equity and cash flows for the years then ended. 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 the Standards of
  the Public Company Accounting Oversight Board (United States). Those standards
  require that we plan and perform the audit to obtain reasonable assurance 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. We believe that our audit provides
  a reasonable basis for our opinion.

In our opinion, these consolidated financial statements present
  fairly, in all material respects, the financial position of the Company, as
  of December 31, 2004 and 2003, and the results of its operations and its cash
  flows and the changes in stockholders’ equity for the years then ended,
  in conformity with generally accepted accounting principles used in the United
  States of America.

The accompanying consolidated financial statements have been
  prepared assuming that the Company will continue as a going concern. As discussed
  in Note 1 to the financial statements, to date the Company has not generated
  any significant revenues from operations and requires additional funds to meet
  its obligations and fund the costs of its operations. These factors raise substantial
  doubt about the Company’s ability to continue as a going concern. Management’s
  plans in this regard are described in Note 1. The financial statements do not
  include any adjustments that might result from the outcome of this uncertainty.

“Dale Matheson Carr-Hilton LaBonte”

CHARTERED ACCOUNTANTS

Vancouver, Canada 
  February 28, 2005




---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATED BALANCE SHEETSAs at December 31, 2004 and 2003
|---------------------------------------------------------------------------------------------------------------------
|                                                                                                                     

|                                                                      |   | 2004       |   |   | 2003       |  
|--------------------------------------------------------------------- | - | ---------- | - | - | ---------- | -
|                                                                      |   |            |   |   |            |  
|ASSETS                                                                |   |            |   |   |            |  
|Current Assets                                                        |   |            |   |   |            |  
|Cash                                                                  | $ | 30         |   | $ | 113,161    |  
|Prepaid expenses                                                      |   | 3,981      |   |   | 8,633      |  
|                                                                      |   |            |   |   |            |  
|Total Current Assets                                                  |   | 4,011      |   |   | 121,794    |  
|                                                                      |   |            |   |   |            |  
|Equipment -net of depreciation                                        |   | 13,340     |   |   | 5,121      |  
|                                                                      |   |            |   |   |            |  
|                                                                      |   |            |   |   |            |  
|TOTAL ASSETS                                                          | $ | 17,351     |   | $ | 126,915    |  
|                                                                      |   |            |   |   |            |  
|LIABILITIES                                                           |   |            |   |   |            |  
|Current Liabilities                                                   |   |            |   |   |            |  
|Accounts payable and
      accrued liabilities (Notes 3 and 5)        | $ | 537,719    |   | $ | 596,605    |  
|Deferred license revenue                                              |   | 10,394     |   |   | 19,874     |  
|Due to related parties
      (Note 5)                                 |   | 22,153     |   |   | 34,069     |  
|                                                                      |   |            |   |   |            |  
|TOTAL LIABILITIES                                                     |   | 570,266    |   |   | 650,548    |  
|                                                                      |   |            |   |   |            |  
|Commitments and contingencies (Notes 1, 3 and 6)                      |   |            |   |   |            |  
|                                                                      |   |            |   |   |            |  
|STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)                             |   |            |   |   |            |  
|                                                                      |   |            |   |   |            |  
|Capital Stock (Notes
      3 and 4)                                   |   |            |   |   |            |  
|Common stock, $0.00001 par value, 100,000,000
      shares authorized |   |            |   |   |            |  
|25,779,428 (2003 – 17,400,029) issued and outstanding                 |   | 259        |   |   | 175        |  
|Additional paid-in
      capital                                      |   | 2,469,320  |   |   | 1,044,293  |  
|Private placement
      subscriptions                                 |   | 50,250     |   |   | 365,921    |  
|Obligation to issue
      shares                                      |   | 37,150     |   |   | 553,720    |  
|Accumulated other
      comprehensive loss                            |   | (557       | ) |   | (6,469     | )
|Deficit accumulated
      during development stage                    |   | (3,109,337 | ) |   | (2,481,273 | )
|                                                                      |   |            |   |   |            |  
|TOTAL STOCKHOLDERS' EQUITY (CAPITAL DEFICENCY)                        |   | (552,915   | ) |   | (523,633   | )
|                                                                      |   |            |   |   |            |  
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                            | $ | 17,351     |   | $ | 126,915    |  

See accompanying notes to the consolidated financial statements

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATED STATEMENT OF OPERATIONSFor the year ended December 31, 2004
|----------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                  

|                                           |   |            |   |   |            |   |   | October 13, |  
|------------------------------------------ | - | ---------- | - | - | ---------- | - | - | ----------- | -
|                                           |   |            |   |   |            |   |   | 2000        |  
|                                           |   | Year ended |   |   | Year ended |   |   | (inception) |  
|                                           |   | December   |   |   | December   |   |   | to December |  
|                                           |   | 31, 2004   |   |   | 31, 2003   |   |   | 31, 2004    |  
|                                           |   |            |   |   |            |   |   |             |  
|REVENUE                                    |   |            |   |   |            |   |   |             |  
|License fees, hardware and software sales  | $ | 57,220     |   | $ | 81,354     |   | $ | 207,342     |  
|                                           |   |            |   |   |            |   |   |             |  
|COST OF SALES                              |   |            |   |   |            |   |   |             |  
|Purchases                                  |   | 16,393     |   |   | -          |   |   | 16,393      |  
|Royalties                                  |   | 15,443     |   |   | 11,093     |   |   | 26,536      |  
|Installation costs and other               |   | 4,793      |   |   | 3,431      |   |   | 58,127      |  
|                                           |   | 36,629     |   |   | 14,524     |   |   | 101,056     |  
|                                           |   |            |   |   |            |   |   |             |  
|GROSS PROFIT                               |   | 20,591     |   |   | 66,830     |   |   | 106,286     |  
|                                           |   |            |   |   |            |   |   |             |  
|OPERATING EXPENSES                         |   |            |   |   |            |   |   |             |  
|Advertising and promotion                  |   | 8,030      |   |   | 100,574    |   |   | 110,753     |  
|Bad debts                                  |   | -          |   |   | 15,344     |   |   | 15,344      |  
|Commissions                                |   | -          |   |   | 13,061     |   |   | 13,439      |  
|Depreciation and amortization              |   | 3,142      |   |   | 19,028     |   |   | 35,852      |  
|License fees                               |   | -          |   |   | 336,000    |   |   | 696,000     |  
|Management and consulting fees             |   | 348,217    |   |   | 494,906    |   |   | 934,946     |  
|Marketing (Notes 5 and 6)                  |   | 90,898     |   |   | 548,212    |   |   | 764,902     |  
|Office and general                         |   | 53,295     |   |   | 38,597     |   |   | 169,324     |  
|Professional fees                          |   | 46,307     |   |   | 40,995     |   |   | 168,432     |  
|Rent                                       |   | 30,714     |   |   | 31,062     |   |   | 80,554      |  
|Telephone and utilities                    |   | 9,516      |   |   | 13,463     |   |   | 25,408      |  
|Training and documentation                 |   | 38,673     |   |   | 107,145    |   |   | 153,154     |  
|Travel                                     |   | 19,863     |   |   | 15,310     |   |   | 47,515      |  
|                                           |   | 648,655    |   |   | 1,773,697  |   |   | 3,215,623   |  
|NET LOSS FOR THE YEAR                      | $ | (628,064   | ) | $ | (1,706,867 | ) | $ | (3,109,337  | )
|                                           |   |            |   |   |            |   |   |             |  
|BASIC NET LOSS PER SHARE                   | $ | (0.03      | ) | $ | (0.10      | ) |   |             |  
|                                           |   |            |   |   |            |   |   |             |  
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING |   | 22,791,071 |   |   | 16,718,677 |   |   |             |  

See accompanying notes to the consolidated financial statements

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATED STATEMENT OF CASH FLOWSFor the year ended December 31, 2004
|----------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                  

|                                                                                                                                                                 |   |            |   |   |            |   |   | October 13, |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ---------- | - | - | ---------- | - | - | ----------- | -
|                                                                                                                                                                 |   |            |   |   |            |   |   | 2000        |  
|                                                                                                                                                                 |   | Year ended |   |   | Year ended |   |   | (inception) |  
|                                                                                                                                                                 |   | December   |   |   | December   |   |   | to December |  
|                                                                                                                                                                 |   | 31, 2004   |   |   | 31, 2003   |   |   | 31, 2004    |  
|OPERATING ACTIVITIES                                                                                                                                             |   |            |   |   |            |   |   |             |  
|Net Loss For the Year                                                                                                                                            | $ | (628,064   | ) | $ | (1,706,867 | ) | $ | (3,109,337  | )
|Add: Items Not Affecting
      Cash                                                                                                                              |   |            |   |   |            |   |   |             |  
|Depreciation                                                                                                                                                     |   | 3,142      |   |   | 19,028     |   |   | 35,852      |  
|Gain on disposal of assets                                                                                                                                       |   | -          |   |   | -          |   |   | (215        | )
|Non-cash services                                                                                                                                                |   | 209,030    |   |   | 880,279    |   |   | 1,089,309   |  
|Changes In Non-Cash
      Working Capital:                                                                                                                       |   |            |   |   |            |   |   |             |  
|Changes in accounts
      receivable                                                                                                                             |   | -          |   |   | 17,125     |   |   | -           |  
|Changes in prepaids                                                                                                                                              |   | 4,652      |   |   | (4,875     | ) |   | (3,981      | )
|Amortization of deferred
      license revenue                                                                                                                   |   | (9,480     | ) |   | 14,864     |   |   | 10,394      |  
|Accounts payable and
      accrued charges                                                                                                                       |   | (58,886    | ) |   | 464,378    |   |   | 613,579     |  
|Net cash flows used in operations                                                                                                                                |   | (479,606   | ) |   | (316,068   | ) |   | (1,364,399  | )
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|INVESTING ACTIVITIES                                                                                                                                             |   |            |   |   |            |   |   |             |  
|Net acquisition of
      equipment                                                                                                                               |   | (11,361    | ) |   | (5,410     | ) |   | (18,977     | )
|Cash acquired on reverse
      acquisition of SchoolWeb                                                                                                          |   | -          |   |   | -          |   |   | 74          |  
|Net cash flows used in investing activities                                                                                                                      |   | (11,361    | ) |   | (5,410     | ) |   | (18,903     | )
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|FINANCING ACTIVITIES                                                                                                                                             |   |            |   |   |            |   |   |             |  
|Advances (to) from
      related parties                                                                                                                         |   | (11,916    | ) |   | 21,287     |   |   | 18,315      |  
|Net proceeds on subscriptions and sale of common stock                                                                                                           |   | 383,840    |   |   | 420,351    |   |   | 1,365,571   |  
|Net cash flows from financing activities                                                                                                                         |   | 371,924    |   |   | 441,638    |   |   | 1,383,886   |  
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                                                                          |   | 5,912      |   |   | (7,202     | ) |   | (557        | )
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|NET CHANGE IN CASH DURING THE YEAR                                                                                                                               |   | (113,131   | ) |   | 112,958    |   |   | 27          |  
|CASH, BEGINNING OF YEAR                                                                                                                                          |   | 113,161    |   |   | 203        |   |   | 3           |  
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|CASH, END OF YEAR                                                                                                                                                | $ | 30         |   | $ | 113,161    |   | $ | 30          |  
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|OTHER SIGNIFICANT NON-CASH TRANSACTIONS                                                                                                                          |   |            |   |   |            |   |   |             |  
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|During 2004 the Company issued 3,716,000 shares
      for services valued at $725,600 of which 2,019,000 valued at $527,720
      was owed at December 31, 2003. |  
|                                                                                                                                                                 |   |            |   |   |            |   |   |             |  
|SUPPLEMENTARY DISCLOSURE:                                                                                                                                        |   |            |   |   |            |   |   |             |  
|Interest paid                                                                                                                                                    | $ | -          |   | $ | -          |   | $ | -           |  
|Income taxes paid                                                                                                                                                | $ | -          |   | $ | -          |   | $ | -           |  

See accompanying notes to the consolidated financial statements

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERS’EQUITYFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2004
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                 

|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   | Deficit     |   |   | Other   |   |   |          |  
|------------------------------------------------------------------------ | ----------- | - | - | ------- | - | - | ---------- | - | - | ------------- |  | - | ------------- |  | - | ----------- | - | - | ------- | - | - | -------- | -
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   | accumulated |   |   | compre- |   |   |          |  
|                                                                         |             |   |   |         |   |   | Additional |   |   |               |  |   | Private       |  |   | during      |   |   | hensive |   |   |          |  
|                                                                         | Number of   |   |   |         |   |   | paid-in    |   |   | Obligation to |  |   | placement     |  |   | development |   |   | income  |   |   |          |  
|                                                                         | shares      |   |   | Amount  |   |   | capital    |   |   | issue shares  |  |   | subscriptions |  |   | stage       |   |   | (loss)  |   |   | Total    |  
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|Issuance of common stock for cash at $.001 per share –                   |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|October 16, 2000                                                         | 3,000       |   | $ | 3       |   | $ | -          |   | $ | -             |  | $ | -             |  | $ | -           |   | $ | -       |   | $ | 3        |  
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|Balance, December 31, 2000                                               | 3,000       |   |   | 3       |   |   | -          |   |   | -             |  |   | -             |  |   | -           |   |   | -       |   |   | 3        |  
|Issuance of common stock for cash at $.007 per share –                   |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|May 24, 2001                                                             | 5,500,000   |   |   | 5,500   |   |   | 33,000     |   |   | -             |  |   |               |  |   | -           |   |   |         |   |   | 38,500   |  
|Issuance of common stock for cash at $.01 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|June 4, 2001                                                             | 4,010,000   |   |   | 4,010   |   |   | 36,090     |   |   | -             |  |   |               |  |   | -           |   |   |         |   |   | 40,100   |  
|Issuance of common stock for cash at $.15 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|June 8, 2001                                                             | 330,000     |   |   | 330     |   |   | 49,170     |   |   | -             |  |   |               |  |   | -           |   |   |         |   |   | 49,500   |  
|Issuance of common stock for license agreement at                        |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|$.01 per share – June 29,
      2001                                     | 2,500,000   |   |   | 2,500   |   |   | 22,500     |   |   | -             |  |   |               |  |   | -           |   |   |         |   |   | 25,000   |  
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|Schoolweb Holdings Inc. balance before reverse acquisition               | 12,343,000  |   |   | 12,343  |   |   | 140,760    |   |   | -             |  |   | -             |  |   | -           |   |   |         |   |   | 153,103  |  
|Schoolweb Systems Inc. balance before reverse acquisition
      (Note 5) | 1,350,000   |   |   | 14      |   |   | 19         |   |   | -             |  |   | -             |  |   | (7,937      | ) |   | -       |   |   | (7,904   | )
|Issued to effect reverse acquisition                                     | 12,343,000  |   |   | 123     |   |   | (123       | ) |   | -             |  |   | -             |  |   | -           |   |   | -       |   |   | -        |  
|Reverse acquisition recapitalization adjustment                          | (12,343,000 | ) |   | (12,343 | ) |   | 4,406      |   |   | -             |  |   | -             |  |   | 7,937       |   |   | -       |   |   | -        |  
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|Schoolweb Systems Inc. balance after reverse acquisition                 | 13,693,000  |   |   | 137     |   |   | 145,062    |   |   | -             |  |   | -             |  |   | -           |   |   | -       |   |   | 145,199  |  
|Issuance of common stock for license agreement at $.01                   |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|per share – September
      10, 2001 (Note 3)                            | 500,000     |   |   | 5       |   |   | 4,995      |   |   | -             |  |   |               |  |   | -           |   |   | -       |   |   | 5,000    |  
|Issuance of common stock for cash at $.10 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|September 11, 2001                                                       | 100,000     |   |   | 1       |   |   | 9,999      |   |   | -             |  |   |               |  |   | -           |   |   | -       |   |   | 10,000   |  
|Issuance of common stock for cash at $.10 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|November 5, 2001                                                         | 50,000      |   |   | 1       |   |   | 4,999      |   |   | -             |  |   |               |  |   | -           |   |   | -       |   |   | 5,000    |  
|Issuance of common stock for cash at $.15 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|November 8, 2001                                                         | 15,000      |   |   | -       |   |   | 2,250      |   |   | -             |  |   |               |  |   | -           |   |   | -       |   |   | 2,250    |  
|Issuance of common stock for cash at $.20 per share –                    |             |   |   |         |   |   |            |   |   |               |  |   | -             |  |   |             |   |   |         |   |   |          |  
|November 24, 2001                                                        | 375,000     |   |   | 3       |   |   | 74,997     |   |   | -             |  |   |               |  |   | -           |   |   | -       |   |   | 75,000   |  
|Foreign exchange translation adjustment                                  | -           |   |   | -       |   |   | -          |   |   | -             |  |   | -             |  |   | -           |   |   | (1,950  | ) |   | (1,950   | )
|Net loss for the year ended December 31, 2001                            | -           |   |   | -       |   |   | -          |   |   | -             |  |   | -             |  |   | (263,249    | ) |   | -       |   |   | (263,249 | )
|                                                                         |             |   |   |         |   |   |            |   |   |               |  |   |               |  |   |             |   |   |         |   |   |          |  
|Balance, December 31, 2001                                               | 14,733,000  |   | $ | 147     |   | $ | 242,302    |   | $ | -             |  | $ | -             |  | $ | (263,249    | ) | $ | (1,950  | ) | $ | (22,750  | )

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERS’EQUITYFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2004
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                 

|                                                                           |            |  |   |        |  |   |            |  |   |               |  |   |               |   |   | Deficit     |   |   | Other   |   |   |            |  
|-------------------------------------------------------------------------- | ---------- |  | - | ------ |  | - | ---------- |  | - | ------------- |  | - | ------------- | - | - | ----------- | - | - | ------- | - | - | ---------- | -
|                                                                           |            |  |   |        |  |   |            |  |   |               |  |   |               |   |   | accumulated |   |   | compre- |   |   |            |  
|                                                                           |            |  |   |        |  |   | Additional |  |   |               |  |   | Private       |   |   | during      |   |   | hensive |   |   |            |  
|                                                                           | Number of  |  |   |        |  |   | paid-in    |  |   | Obligation to |  |   | placement     |   |   | development |   |   | income  |   |   |            |  
|                                                                           | shares     |  |   | Amount |  |   | capital    |  |   | issue shares  |  |   | subscriptions |   |   | stage       |   |   | (loss)  |   |   | Total      |  
|Balance, December 31, 2001                                                 | 14,733,000 |  | $ | 147    |  | $ | 242,302    |  |   |               |  |   |               |   | $ | (263,249    | ) | $ | (1,950  | ) | $ | (22,750    | )
|                                                                           |            |  |   |        |  |   |            |  | $ | -             |  | $ | -             |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.20 per share –
      March 1, 2002  | 510,000    |  |   | 5      |  |   | 101,995    |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 102,000    |  
|                                                                           |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.35 per share                        | 100,000    |  |   | 1      |  |   | 34,999     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 35,000     |  
|– March 15, 2002                                                           |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.35 per share
      – April 30, 2002 | 140,000    |  |   | 1      |  |   | 48,999     |  |   | -             |  |   | -             |   |   | -           |   |   | -       |   |   | 49,000     |  
|Issuance of common stock for cash at $.35 per share –June
      27, 2002   | 97,371     |  |   | 1      |  |   | 34,079     |  |   | -             |  |   | -             |   |   | -           |   |   | -       |   |   | 34,080     |  
|Issuance of common stock for cash at $.35 per share –
      July 8, 2002   | 49,143     |  |   | 1      |  |   | 17,199     |  |   | -             |  |   | -             |   |   | -           |   |   | -       |   |   | 17,200     |  
|Issuance of common stock for debt at $.35 per share                        | 228,571    |  |   | 2      |  |   | 79,998     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 80,000     |  
|- September 11, 2002                                                       |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.35 per share                        | 193,000    |  |   | 2      |  |   | 67,548     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 67,550     |  
|–October 9, 2002                                                           |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.35 per share                        | 93,000     |  |   | 1      |  |   | 32,549     |  |   |               |  |   | (5,250        | ) |   | -           |   |   | -       |   |   | 27,300     |  
|– December 16, 2002                                                        |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Private placement subscriptions received                                   | -          |  |   | -      |  |   | -          |  |   | -             |  |   | 8,900         |   |   | -           |   |   |         |   |   | 8,900      |  
|Foreign exchange translation adjustment                                    | -          |  |   | -      |  |   | -          |  |   | -             |  |   | -             |   |   | -           |   |   | 2,683   |   |   | 2,683      |  
|Net loss for the year ended December 31, 2002                              | -          |  |   | -      |  |   | -          |  |   | -             |  |   | -             |   |   | (511,157    | ) |   | -       |   |   | (511,157   | )
|                                                                           |            |  |   |        |  |   |            |  |   |               |  |   |               |   |   |             |   |   |         |   |   |            |  
|Balance, December 31, 2002                                                 | 16,144,085 |  |   | 161    |  |   | 659,668    |  |   | -             |  |   | 3,650         |   |   | (774,406    | ) |   | 733     |   |   | (110,194   | )
|                                                                           |            |  |   |        |  |   |            |  |   |               |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for cash at $.35 per share                        | 165,944    |  |   | 2      |  |   | 58,078     |  |   |               |  |   | (3,650        | ) |   | -           |   |   | -       |   |   | 54,430     |  
|– March 20, 2003                                                           |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.24 per share                    | 100,000    |  |   | 1      |  |   | 23,999     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 24,000     |  
|– May 29, 2003                                                             |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.34 per share                    | 300,000    |  |   | 3      |  |   | 101,156    |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 101,159    |  
|– June 10, 2003                                                            |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.35 per share                    | 180,000    |  |   | 2      |  |   | 62,998     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 63,000     |  
|– June 10, 2003                                                            |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.20 per share                    | 60,000     |  |   | 1      |  |   | 12,399     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 12,400     |  
|– June 10, 2003                                                            |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.35 per share                    | 100,000    |  |   | 1      |  |   | 34,999     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 35,000     |  
|– October 27, 2003                                                         |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Issuance of common stock for services at $.26 per share                    | 350,000    |  |   | 4      |  |   | 90,996     |  |   |               |  |   | -             |   |   | -           |   |   | -       |   |   | 91,000     |  
|– October 27, 2003                                                         |            |  |   |        |  |   |            |  |   | -             |  |   |               |   |   |             |   |   |         |   |   |            |  
|Private placement subscriptions received                                   |            |  |   |        |  |   |            |  |   |               |  |   | 365,921       |   |   | -           |   |   |         |   |   | 365,921    |  
|Obligation to issue shares for services rendered                           | -          |  |   | -      |  |   | -          |  |   | 553,720       |  |   | -             |   |   | -           |   |   | -       |   |   | 553,720    |  
|Foreign exchange translation adjustment                                    | -          |  |   | -      |  |   | -          |  |   | -             |  |   | -             |   |   |             |   |   | (7,202  | ) |   | (7,202     | )
|Net loss for the year ended December 31, 2003                              | -          |  |   | -      |  |   | -          |  |   | -             |  |   | -             |   |   | (1,706,867  | ) |   | -       |   |   | (1,706,867 | )
|Balance, December 31, 2003                                                 | 17,400,029 |  | $ | 175    |  | $ | 1,044,293  |  | 4 | 553,720       |  | $ | 365,921       |   | $ | (2,481,273  | ) | $ | (6,469  | ) | $ | (523,633   | )

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERS’EQUITYFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2004
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                 

|                                                                         |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   | Deficit     |   |   | Other   |   |   |          |  
|------------------------------------------------------------------------ | ---------- |  | - | ------ |  | - | ---------- |  | - | ------------- | - | - | ------------- | - | - | ----------- | - | - | ------- | - | - | -------- | -
|                                                                         |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   | accumulated |   |   | compre- |   |   |          |  
|                                                                         |            |  |   |        |  |   | Additional |  |   |               |   |   | Private       |   |   | during      |   |   | hensive |   |   |          |  
|                                                                         | Number of  |  |   |        |  |   | paid-in    |  |   | Obligation to |   |   | placement     |   |   | development |   |   | income  |   |   |          |  
|                                                                         | shares     |  |   | Amount |  |   | capital    |  |   | issue shares  |   |   | subscriptions |   |   | stage       |   |   | (loss)  |   |   | Total    |  
|                                                                         |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   |             |   |   |         |   |   |          |  
|Balance, December 31, 2003                                               | 17,400,029 |  | $ | 175    |  | $ | 1,044,293  |  | $ | 553,720       |   | $ | 365,921       |   | $ | (2,481,273  | ) | $ | (6,469  | ) | $ | (523,633 | )
|                                                                         |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   |             |   |   |         |   |   |          |  
|Private placement subscriptions received                                 | -          |  |   | -      |  |   | -          |  |   | -             |   |   | 360,054       |   |   | -           |   |   | -       |   |   | 360,054  |  
|Issuance of common stock for services at $0.26 per share                 | 1,785,000  |  |   | 18     |  |   | 466,302    |  |   | (466,320      | ) |   | -             |   |   | -           |   |   | -       |   |   | -        |  
|– January 6, 2004                                                        |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   |             |   |   |         |   |   |          |  
|Issuance of common stock for cash at $.15 per share
      – May 17, 2004 | 4,041,499  |  |   | 40     |  |   | 606,185    |  |   | -             |   |   | (606,225      | ) |   | -           |   |   | -       |   |   | -        |  
|Issuance of common stock for services at $.11 per share                  | 1,500,000  |  |   | 15     |  |   | 164,985    |  |   |               |   |   | -             |   |   | -           |   |   | -       |   |   | 165,000  |  
|– June 10, 2004                                                          |            |  |   |        |  |   |            |  |   | -             |   |   |               |   |   |             |   |   |         |   |   |          |  
|Issuance of common stock for services at $0.23 per share                 | 407,000    |  |   | 4      |  |   | 91,876     |  |   | (61,400       | ) |   | -             |   |   | -           |   |   | -       |   |   | 30,480   |  
|– August 30, 2004                                                        |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   |             |   |   |         |   |   |          |  
|Issuance of common stock for services at $.10 per share                  | 24,000     |  |   | 1      |  |   | 2,400      |  |   |               |   |   | -             |   |   | -           |   |   | -       |   |   | 2,401    |  
|– August 30, 2004                                                        |            |  |   |        |  |   |            |  |   | -             |   |   |               |   |   |             |   |   |         |   |   |          |  
|Issuance of common stock for cash at $.15 per share                      | 621,900    |  |   | 6      |  |   | 93,279     |  |   |               |   |   | (69,500       | ) |   | -           |   |   | -       |   |   | 23,785   |  
|– October 25, 2004                                                       |            |  |   |        |  |   |            |  |   | -             |   |   |               |   |   |             |   |   |         |   |   |          |  
|Obligation to issue shares for services rendered                         | -          |  |   | -      |  |   | -          |  |   | 11,150        |   |   | -             |   |   | -           |   |   | -       |   |   | 11,150   |  
|Foreign exchange translation adjustment                                  | -          |  |   | -      |  |   | -          |  |   | -             |   |   | -             |   |   | -           |   |   | 5,912   |   |   | 5,912    |  
|Net loss for the year ended December 31, 2004                            | -          |  |   | -      |  |   | -          |  |   | -             |   |   | -             |   |   | (628,064    | ) |   | -       |   |   | (628,064 | )
|                                                                         |            |  |   |        |  |   |            |  |   |               |   |   |               |   |   |             |   |   |         |   |   |          |  
|Balance, December 31, 2004                                               | 25,779,428 |  | $ | 259    |  | $ | 2,469,320  |  | $ | 37,150        |   | $ | 50,250        |   | $ | (3,109,337  | ) | $ | (557    | ) | $ | (552,915 | )

---

|ALTERNET
        SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|---------------------------------------------------------------------------------------------------------------------
|                                                                                                                     

NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Alternet Systems Inc. (“Alternet” or the “Company”)
  designs, markets and sells proprietary software and hardware systems known as
  “SchoolWeb” and “CommunityWeb”. The Company’s
  products provide high speed Internet access to schools and rural communities,
  in North America and internationally (refer to Note 3).

The Company was incorporated on June 26, 2000 in the State
  of Nevada as North Pacific Capital Corp. and was organized for the purpose of
  creating a corporate vehicle to locate and acquire an operating business. On
  December 19, 2001 the Company changed its name to Schoolweb Systems Inc. and
  on May 14, 2002 the Company changed its name to Alternet Systems Inc. (“Alternet”
  or the “Company”). On November 6, 2000, the Company filed a Form
  10SB registration statement with the United States Securities and Exchange Commission
  (“SEC”) and as a result is subject to the regulations governing
  reporting issuers in the United States. On March 14, 2003 the Company was listed
  for quotation on the Over the Counter Bulletin Board.

By agreement dated July 2, 2001 and completed September 10,
  2001, Alternet issued 12,343,000 shares of restricted common stock to the shareholders
  of Schoolweb Holdings Inc. (“SW Holdings”), a development stage
  company incorporated October 13, 2000 in the State of Nevada, in exchange for
  all of the issued and outstanding shares of SW Holdings. On June 26, 2002 SW
  Holdings changed its name to AI Systems Group, Inc. (“AI Systems”).

The acquisition resulted in the former shareholders of SW
  Holdings acquiring 90.1% of the then outstanding shares of the Company and has
  been accounted for as a reverse merger with SW Holdings being treated as the
  accounting parent and Alternet, the legal parent, being treated as the accounting
  subsidiary. Accordingly, the consolidated results of operations of the Company
  include those of SW Holdings for all periods shown and those of the Alternet
  since the date of the reverse acquisition. The results of operations of SW Holdings
  are from its inception, October 13, 2000 and include the results of its wholly-owned
  subsidiary, AI Systems Group (Canada) Ltd. (formerly SchoolWeb Systems (Canada)
  Ltd.), a company incorporated April 17, 2001 in the Province of British Columbia.

These consolidated financial statements have been prepared
  on the basis of a going concern, which contemplates the realization of assets
  and satisfaction of liabilities in the normal course of business. At December
  31, 2004 the Company had a working capital deficiency of $566,255 (2003
  - $528,754) and an accumulated deficit of $3,109,337. The Company has
  incurred losses since inception and further losses are anticipated in the development
  of its products raising substantial doubt as to the Company’s ability
  to continue as a going concern. The Company’s continued operations are
  dependent on the successful implementation of its business plan, its ability
  to obtain additional financing as needed, continued support from creditors,
  settling its outstanding debts and ultimately attaining profitable operations.
  It is management's intention to continue to pursue market acceptance for its
  proprietary software and hardware systems technology, to settle its outstanding
  debts and to identify funding sources until such time that there is sufficient
  operating cash flow to fund operating requirements. Funding for continuing operations
  will be pursued on a private placement basis with qualified investors in applicable
  US states and Canada.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These consolidated financial statements have been prepared
  in accordance with accounting principles generally accepted in the United States
  of America.

Principles of Consolidation 
  The consolidated financial statements include the accounts of the Company and
  its wholly-owned subsidiaries, AI Systems Group, Inc. and AI Systems Group (Canada)
  Ltd. All intercompany transactions and account balances have been eliminated.

Use of Estimates and Assumptions 
  Preparation of the Company’s financial statements in conformity with generally
  accepted accounting principles requires management to make estimates and assumptions
  that affect certain reported amounts and disclosures. Accordingly, actual results
  could differ from those estimates.

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  (continued)

License Rights 
  The Company amortizes the cost of acquiring license rights on a straight-line
  basis over the term of the license. The Company evaluates the carrying amount
  of its unamortized license rights against the undiscounted future anticipated
  cash flows associated with them. If the evaluation indicates that the future
  undiscounted cash flows are not sufficient to recover the carrying value, an
  impairment provision is recorded to adjust the carrying value of the license
  rights to their fair value. During 2003 management determined that based on
  evaluation there was no reliable basis for estimating new cash flows from the
  license and the Company wrote off the carrying balance of the AII license.

Equipment 
  Equipment is recorded at cost and depreciated on a declining balance basis at
  a rate of 30% per annum.

Impairment of long lived assets 
  Management monitors the recoverability of long-lived assets based on estimates
  using factors such as current market value, future asset utilization, and future
  undiscounted cash flows expected to result from its investment or use of the
  related assets. The Company’s policy is to record any impairment loss
  in the period when it is determined that the carrying amount of the asset may
  not be recoverable. Any impairment loss is calculated as the excess of the carrying
  value over estimated realizable value.

Revenue recognition 
  The Company licenses its SchoolWeb system on a prepaid basis for terms ranging
  from one to three years. The Company recognizes license revenues on a straight-line
  basis over the license term upon completion of the required hardware and software
  installations and upon acceptance by the purchasers, subject to collection being
  reasonably assured. License fees paid in advance are recorded as deferred license
  revenue.

The Company has generated revenues from hardware sales in
  connection with the testing of the SchoolWeb system. Hardware sales are recognized
  upon completion and acceptance of installation by the purchasers and collection
  is reasonably assured.

Foreign Currency Translation 
  These financial statements are presented in United States dollars. In accordance
  with Statement of Financial Accounting Standards (“SFAS”) No. 52,
  “Foreign Currency Translation”, foreign denominated monetary assets
  and liabilities are translated into their United States dollar equivalents using
  foreign exchange rates which prevailed at the balance sheet date. Revenue and
  expenses are translated at average rates of exchange during the year. Related
  translation adjustments are reported as a separate component of stockholders’
  equity, whereas gains or losses resulting from foreign currency transactions
  are included in results of operations.

Fair Value of Financial Instruments 
  In accordance with the requirements of SFAS No. 107, the Company has determined
  the estimated fair value of financial instruments using available market information
  and appropriate valuation methodologies. The fair value of financial instruments
  classified as current assets or liabilities approximate carrying value due to
  the short-term maturity of the instruments.

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  (continued)

Stock-Based Compensation 
  In December 2002, the Financial Accounting Standards Board issued Financial
  Accounting Standard (“FASB”) No. 148, “Accounting for Stock-Based
  Compensation – Transition and Disclosure” (“SFAS No. 148”),
  an amendment of Financial Accounting Standard No. 123 “Accounting for
  Stock-Based Compensation” (“SFAS No. 123”). The purpose of
  SFAS No. 148 is to: (1) provide alternative methods of transition for an entity
  that voluntarily changes to the fair value based method of accounting for stock-
  based employee compensation, (2) amend the disclosure provisions to require
  prominent disclosure about the effects on reported net income of an entity’s
  accounting policy decisions with respect to stock-based employee compensation,
  and (3) to require disclosure of those effects in interim financial information.
  The disclosure provisions of SFAS No. 148 were effective for the Company commencing
  for the year ended December 31, 2004. As no options were granted in 2002, 2003
  or 2004, no pro-forma disclosures are required.

The Company has elected to continue to account for stock options
  granted to employees and officers using the intrinsic value based method in
  accordance with the provisions of Accounting Principles Board Opinion No. 25,
  “Accounting for Stock Issued to Employees”, (“APB No. 25”)
  and comply with the disclosure provisions of SFAS No. 123 as amended by SFAS
  No. 148 as described above. Under APB No. 25, compensation expense is recognized
  based on the difference, if any, on the date of grant between the estimated
  fair value of the Company’s stock and the amount an employee must pay
  to acquire the stock. Compensation expense is recognized immediately for past
  services and pro-rata for future services over the option-vesting period. In
  addition, with respect to stock options granted to employees, the Company provides
  pro-forma information as required by SFAS No. 123 showing the results of applying
  the fair value method using the Black-Scholes option pricing model. In accordance
  with SFAS No. 123, the Company also applies the fair value method using the
  Black-Scholes option-pricing model in accounting for options granted to consultants.

The Company accounts for equity instruments issued in exchange
  for the receipt of goods or services from other than employees in accordance
  with SFAS No. 123 and the conclusions reached by the Emerging Issues Task Force
  (“EITF”) in Issue No. 96-18. Costs are measured at the estimated
  fair market value of the consideration received or the estimated fair value
  of the equity instruments issued, whichever is more reliably measurable. The
  value of equity instruments issued for consideration other than employee services
  is determined on the earliest of a performance commitment or completion of performance
  by the provider of goods or services as defined by EITF 96-18.

The Company has also adopted the provisions of the Financial
  Accounting Standards Board Interpretation No.44, Accounting for Certain Transactions
  Involving Stock Compensation – An Interpretation of APB Opinion No. 25
  (“FIN 44”), which provides guidance as to certain applications of
  APB 25. FIN 44 is generally effective July 1, 2000 with the exception of certain
  events occurring after December 15, 1998.

The Company accounts for direct awards of share for services
  at the fair value of the shares awarded. The Company records the obligation
  to issue the shares at such time as performance of the service is complete.

Income taxes
  The Company follows the liability method of accounting for income taxes. Under
  this method, deferred tax assets and liabilities are recognized for the future
  tax consequences attributable to differences between the financial statement
  carrying amounts of existing assets and liabilities and their respective tax
  balances. Deferred tax assets and liabilities are measured using enacted or
  substantially enacted tax rates expected to apply to the taxable income in the
  years in which those differences are expected to be recovered or settled. The
  effect on deferred tax assets and liabilities of a change in tax rates is recognized
  in income in the period that includes the date of enactment or substantive enactment.
  As at December 31, 2004 the Company had net operating loss carryforwards; however,
  due to the uncertainty of realization the Company has provided a full valuation
  allowance for the deferred tax assets resulting from these loss carryforwards.

Loss per share 
  Basic earnings (loss) per share includes no dilution and is computed by dividing
  income available to common stockholders by the weighted average number of common
  shares outstanding for the period. Dilutive loss per share reflects the potential
  dilution of securities that could share in the earnings of the Company. Diluted
  loss per share has not been presented as the effects of warrants exercised have
  been excluded as they are anti-dilutive.

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent Accounting Pronouncements
  In December 2004, the FASB issued SFAS No. 153, Exchanges of Non-monetary
  Assets, an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions
  (“SFAS 153”). SFAS 153 requires that exchanges of non-monetary assets
  are to be measured based on fair value and eliminates the exception for exchanges
  of non-monetary, similar productive assets, and adds an exemption for non-monetary
  exchanges that do not have commercial substance. SFAS 153 will be effective
  for fiscal periods beginning after June 15, 2005. Management does not believe
  that the adoption of this standard will have a material impact on the Company’s
  financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 123R, “Share
  Based Payment”. SFAS 123R is a revision of SFAS No. 123 “Accounting
  for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting
  for Stock Issued to Employees” and its related implementation guidance.
  SFAS 123R establishes standards for the accounting for transactions in which
  an entity exchanges its equity instruments for goods or services. It also addresses
  transactions in which an entity incurs liabilities in exchange for goods or
  services that are based on the fair value of the entity’s equity instruments
  or that may be settled by the issuance of those equity instruments. SFAS 123R
  focuses primarily on accounting for transactions in which an entity obtains
  employee services in share-based payment transactions. SFAS 123R does not change
  the accounting guidance for share-based payment transactions with parties other
  than employees provided in SFAS 123 as originally issued and EITF Issue No.
  96-18, “Accounting for Equity Instruments That Are Issued to Other Than
  Employees for Acquiring, or in Conjunction with Selling, Goods or Services”.
  SFAS 123R does not address the accounting for employee share ownership plans,
  which are subject to AICPA Statement of Position 93-6, “Employers’
  Accounting for Employee Stock Ownership Plans”. SFAS 123R requires a public
  entity to measure the cost of employee services received in exchange for an
  award of equity instruments based on the grant-date fair value of the award
  (with limited exceptions). That cost will be recognized over the period during
  which an employee is required to provide service in exchange for the award –
  the requisite service period (usually the vesting period). SFAS 123R requires
  that the compensation cost relating to share-based payment transactions be recognized
  in financial statements. That cost will be measured based on the fair value
  of the equity or liability instruments issued. The scope of SFAS 123R includes
  a wide range of share-based compensation arrangements including share options,
  restricted share plans, performance-based awards, share appreciation rights,
  and employee share purchase plans. Public entities (other than those filing
  as small business issuers) will be required to apply SFAS 123R as of the first
  interim or annual reporting period that begins after June 15, 2005. Public entities
  that file as small business issuers will be required to apply SFAS 123R in the
  first interim or annual reporting period that begins after December 15, 2005.
  For nonpublic entities, SFAS 123R must be applied as of the beginning of the
  first annual reporting period beginning after December 15, 2005. Management
  is currently evaluating the impact, which the adoption of this standard will
  have on the Company’s results of operations or financial position.

NOTE 3 - LICENSE RIGHTS

By agreement dated January 1, 2001, SW Holdings entered into
  an agreement with Advanced Interactive Inc. (“AII”) and Advanced
  Interactive (Canada) Inc. (“AIC”) whereby SW Holdings acquired exclusive
  and non-exclusive rights and licenses to commercialise, distribute and market
  AII and AIC technology, products and services in the United States and Canada
  for a period of five years renewable for a further five years at SW Holdings’
  option. SW Holdings issued 2,500,000 shares on June 29, 2001 valued at $.01
  per share or $25,000 to acquire the license. SW Holdings must pay royalties
  equal to 40% of net revenue received plus a fixed amount of $10,000 per
  month in the first year, $20,000 per month in year two, and increasing by
  $8,000 per month in each of the subsequent years to a maximum of $84,000
  per month in year ten. After year three, the fixed monthly payment is reduced
  by the amount of royalties otherwise payable.

Effective September 10, 2001 SW Holdings, AII and AIC amended
  the original agreement such that AII and AIC received an additional 500,000
  shares valued at $5,000 which the Company issued on September 10, 2001.
  Also effective September 10, 2001 the President and director of AII and AIC
  became a director of the Company until May 16, 2003 when this director resigned.
  On June 26 2002, SW Holdings changed its name to AI Systems Group Inc. (“AI
  Systems”).

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 3 - LICENSE RIGHTS (continued)

On October 14, 2003, AI Systems terminated its software license
  agreement (the "License Agreement") with AII. The License Agreement was terminated
  for a number of reasons including the failure by AII to grant to AI Systems
  North American exclusivity for technologies and software licensed under the
  License Agreement.

AI Systems has advised AII that it does not intend to pay
  the $386,162 in unpaid monthly license fees and other costs accrued under
  the License Agreement. AI Systems has also advised AII that it intends to cancel
  the 3,000,000 common shares issued to AII under the terms of the License Agreement.

AII has advised AI Systems, in writing, that it considers
  the agreement now to be a non-exclusive license that is still in effect and
  that unpaid monthly license fees and related costs are still due to AII. The
  software licensed under the License Agreement is no longer used in any products
  sold by the Company.

The terms of the License Agreement state that if either party
  has a dispute with the other party the dispute should be submitted to arbitration
  for settlement. If this were to occur, or if other proceedings including court
  proceedings were to be commenced, such arbitration or other proceedings could
  involve claims for monetary or other damages, recovery of the unpaid monthly
  license payments, royalty payments or other claims and would likely be significant
  and material to the business of the Company and to its liquidity and capital
  resources. The Company has developed its own proprietary software and continues
  to market SchoolWeb and CommunityWeb in North America and internationally.

On March 13 2004, the Company filed a Writ of Summons and
  Statement of Claim in the Supreme Court of BC, Vancouver, BC. against AII The
  writ alleges that the defendants have breached the License Agreement and damages
  are being sought in the amount of $1,804,709. The Company alleges that the
  defendants have breached the Agreement as follows: failed to grant exclusivity
  to the Plaintiff as required by the License Agreement; failed to provide technical
  support and/or provide technical support at a reasonable price; and failed to
  provide usable and working software as is required by the License Agreement.
  The Company has received a counterclaim in the lawsuit in the amount of $1,379,150,
  representing the amount of license fees that would be payable if the License
  Agreement was still in effect plus interest of 2% and costs and unspecified
  damages. The likelihood of any gain or loss resulting from the above lawsuit
  is not determinable at this time. The Company is currently in negotiations to
  achieve a settlement of all debt and liabilities with the Defendant in this
  action, although no outcome can be predicted at this time.

NOTE 4 – CAPITAL STOCK

To December 31, 2004, the Company has not granted any stock
  options although shareholders approved a stock option plan (the "Option Plan")
  for 3,000,000 incentive stock options at its annual meeting of shareholders
  held on May 31, 2004. Options under the Option Plan, when granted, can be for
  a term of up to five (5) years at an exercise price to be determined by the
  Directors.

During the year ended December 31, 2004 the Company issued
  3,716,000 shares for services valued at $725,600 of which $527,720 related
  to services provided during fiscal 2003. Also, during the year ended December
  31, 2004 the Company completed a private placement of 4,663,399 shares at a
  price of $0.15 per share for total proceeds of $699,510.

The Company is also obligated to issue 45,000 common shares
  with a fair market value of $11,150 for final settlement with two consultants
  under marketing contacts (Note 6). The Company is also obligated to issue 100,000
  common shares in settlement of debt of $26,000 outstanding from 2003.

Effective March 1, 2003 the Company adopted a Retainer Stock
  Plan for employees, directors and consultants (the “Plan”) for the
  purpose of providing the Company with the means to compensate employees, directors
  and consultants for their efforts in furthering the future success of the Company.
  The Plan allows for direct awards of common stock as a reward or incentive to
  employees or as consideration to directors or consultants for their services.
  A total of 5,000,000 shares may be awarded under this Plan. The Plan will terminate
  February 29, 2008. The Company filed a Registration Statement on Form S-8 to
  cover the Plan. To date 4,851,000 shares valued at $1,063,310 relating to
  services provided in 2003 and 2004 have been awarded, of which 45,000 shares
  for final settlement valued at $11,150 have not yet been issued.

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 4 – CAPITAL STOCK (continued)

The Company has received $50,250 towards a planned private
  placement at $0.10 per share.

A summary of the Company’s warrants at December 31,
  2004 and the changes for the period is as follows:

|                           |             |  | Weighted |  | Weighted   | 
|-------------------------- | ----------- |  | -------- |  | ---------- | 
|                           |             |  | Average  |  | Average    | 
|                           | Warrants    |  | Exercise |  | Remaining  | 
|                           | Outstanding |  | Price    |  | Life       | 
|                           |             |  |          |  |            | 
|Balance, December 31, 2002 | 1,557,514   |  | $0.50    |  | 0.31 years | 
|Issued                     | 165,944     |  | $0.50    |  | 1.20 years | 
|Exercised                  | -           |  | -        |  |            | 
|Cancelled                  | -           |  | -        |  |            | 
|Expired                    | 375,000     |  | -        |  |            | 
|                           |             |  |          |  |            | 
|Balance, December 31, 2003 | 1,348,458   |  | $0.50    |  | 0.52 years | 
|Granted                    | -           |  | -        |  |            | 
|Exercised                  | -           |  | -        |  |            | 
|Cancelled                  | -           |  | -        |  |            | 
|Expired                    | 1,182,514   |  | -        |  |            | 
|                           |             |  |          |  |            | 
|Balance December 31, 2004  | 165,944     |  | $0.50    |  | 0.20 years | 

The warrants subsequently expired without exercise.

NOTE 5 – RELATED PARTY TRANSACTIONS

At December 31, 2004 a total of $22,153 (2003 - $34,069)
  is owing to directors and shareholders. Amounts due to related parties are non-interest
  bearing and have no specific terms of repayment.

During the year ended December 31, 2004, the following amounts
  were incurred to directors of the Company or its subsidiary, a company with
  a director in common and a company controlled by a shareholder of the Company.

| |              |   | Year ended December 31, | 
| | ------------ | - | ----------------------- | 
| |              |   | 2004                    | 
| |              |   |                         | 
| | Consulting   | $ | 92,200                  | 
| | License fees |   | -                       | 
| | Marketing    |   | 69,440                  | 
| | Royalties    |   | -                       | 
| |              | $ | 161,640                 | 

Of the amounts incurred above, the license fees were incurred
  to AII and AIC. AII and AIC became related to the Company effective September
  10, 2001 when the President and director of AII and AIC became a director of
  the Company until May 16, 2003 when this director resigned. Included in accounts
  payable at December 31, 2004 and 2003 are license fees totalling $386,162
  owing to AII which are currently under dispute (refer to Note 3).

---

|ALTERNET SYSTEMS INC.(A Development Stage Company)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004
|-------------------------------------------------------------------------------------------------------------

NOTE 6 – COMMITMENTS

Effective February 1, 2003, March 1, 2003 and December 1,
  2003, the Company entered into twenty-four month consulting, management and
  marketing agreements which require payment in cash and shares of the Company’s
  common stock on a monthly basis. These contracts could be terminated with seven
  days notice at any time and with no further cost to the Company. The Company
  also signed three other marketing agreements covering shorter time periods which
  require payment in shares of the Company’s common stock on a monthly basis.
  All of these contracts have been terminated during 2004 and no future commitments
  remain.

During 2004 the Company expensed $208,730 representing
  cash of $125,000 and 382,000 shares valued at $83,730 in connection
  with these agreements.

During 2004 the Company negotiated settlements with three
  marketing consultants. As part of these settlements the Company has reversed
  certain obligations to issue shares and accounts payable, resulting in a recovery
  of previously accrued marketing expenses of $83,925.

NOTE 7 – INCOME TAXES

The Company and its subsidiaries have tax losses which may
  be available to reduce future year’s taxable income, that result in deferred
  tax assets. Management believes that the realization of the benefits from these
  deferred tax assets appears uncertain due to the Company’s limited operating
  history and losses to date. Accordingly a full, deferred tax asset valuation
  allowance has been provided and no deferred tax asset benefit has been recorded.

NOTE 8 – PROPOSED AGREEMENT

The Company has entered into a Letter of Intent (the “Solflex
  Agreement”) with Solflex Energy Development Corp. (“Solflex”)
  dated effective October 15, 2004. Solflex has developed a method of manufacturing
  solar photovoltaic (PV) panels using screen printing onto a flexible acetate
  substrate. The Solflex Agreement calls for the Company to acquire a 25% equity
  interest in Solflex and an exclusive License of its technology for North and
  South America in exchange for total consideration of $500,000. The Company
  also agreed to pay as a license royalty $1.20 per watt sold from Solflex
  products.

To maintain its rights under the Solflex Agreement, the Company
  must sell a minimum of $1,000,000 in solar panels within 2 years of commencement
  of commercial production of the Solflex solar panels. If this minimum sales
  target is achieved, the Company will be granted an additional 5 year license
  which will subsequently be renewable at Solflex’s discretion.

Solflex is a company which is in the development stage of
  operations. It does not have any significant revenues to date and has been primarily
  engaged in developing its proprietary technology. There can be no assurance
  that the Company will be able to market and sell Solflex’s products, that
  the market will accept Solflex’s products, or that Solflex will be able
  to successfully produce them.

The Company has not advanced any funds to Solflex for this
  acquisition and has not entered into a License Agreement. The Company is still
  conducting the necessary due diligence before making a decision to proceed with
  this acquisition.

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