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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2006

[   ]  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 [   ]

---

Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K (Section 229.405 of this Chapter) is
not contained herein, and will not 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-K or any amendment to this Form 10-K.
[   ]

Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act) Yes [   ] No [X]

Of the 47,556,428 shares of voting stock of the registrant
issued and outstanding as of March 13, 2007, 41,282,428 shares are held by
non-affiliates.

The aggregate market value of the voting stock held by
non-affiliates of the registrant as of December 31, 2006 was approximately
$2,889,770 based upon the closing price per share of the registrant's common
shares of $0.07 on that date.

The issuer had revenues of $3,604 for the fiscal year ended
December 31, 2006.

Transitional Small Business Disclosure Format (check one)
Yes [   ] No [X]

Indicate by check mark whether the registrant is a shell company
  (as defined in Rule 12b-2 of the Exchange 
  Act). Yes [   ] No [X]

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FORM 10-KSB ANNUAL REPORT 
  FOR THE YEAR ENDED DECEMBER 31, 2006 
  ALTERNET SYSTEMS, INC.

TABLE OF CONTENTS

|PART I   |                                                                                                                       |   
|-------- | --------------------------------------------------------------------------------------------------------------------- | --
|         |                                                                                                                       |   
|Item 1   | Description of Business                                                                                               | 3 
|         |                                                                                                                       |   
|Item 2   | Description of Property                                                                                               | 5 
|         |                                                                                                                       |   
|Item 3   | Legal Proceedings                                                                                                     | 5 
|         |                                                                                                                       |   
|Item 4   | Submission of Matters to a Vote of Security Holders                                                                   | 6 
|         |                                                                                                                       |   
|PART II  |                                                                                                                       |   
|         |                                                                                                                       |   
|Item 5   | Market for Common Equity and Related Stockholder Matters                                                              | 6 
|         |                                                                                                                       |   
|Item 6   | Managements Discussion and Analysis or Plan of Operation                                                             | 12
|         |                                                                                                                       |   
|Item 7   | Financial Statements                                                                                                  | 16
|         |                                                                                                                       |   
|Item 8   | Changes in and Disagreements With Accountants on Accounting
      and Financial Disclosure                            | 16
|         |                                                                                                                       |   
|Item 8A  | Controls and Procedures                                                                                               | 16
|         |                                                                                                                       |   
|PART III |                                                                                                                       |   
|         |                                                                                                                       |   
|Item 9   | Directors, Executive Officers, Promoters and Control Persons;
      Compliance with Section 16(a) of the Exchange Act | 17
|         |                                                                                                                       |   
|Item 10  | Executive Compensation                                                                                                | 18
|         |                                                                                                                       |   
|Item 11  | Security Ownership of Certain Beneficial Owners and Management                                                        | 19
|         |                                                                                                                       |   
|Item 12  | Certain Relationships and Related Transactions                                                                        | 19
|         |                                                                                                                       |   
|Item 13  | Exhibits and Reports on Form 8-K                                                                                      | 20
|         |                                                                                                                       |   
|Item 14  | Principal Accountant Fees and Services                                                                                | 20

2

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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.

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.

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

3

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The Company markets SchoolWeb into the US and Canadian 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.

TekVoice Inc. Merger Proposal

On March 21, 2007Alternet Systems Inc. announced
  it had executed a letter of intent (LOI) agreement to commence with due diligence
  for a proposed merger with TekVoice Communications, Inc. of Miami, Florida.
  TekVoice is a telecommunications services company with operations in North and
  South America. TekVoice revenues were $3 million in 2006, and the company is
  forecasting significant growth in 2007. The specific terms for the proposed
  merger are subject to further negotiations between the parties.

The combined entity will be called Alternet Systems Inc. and
its primary business will be to acquire and develop wireless broadband networks
in under-served countries in Latin America and the Caribbean, delivering voice,
data and content services to customers in these regions. Alternet will offer a
portfolio of next-generation wireless broadband and telecom solutions for
government, business, schools, hospitals and community residents.

Management believes that the combination of Alternet with
TekVoice is the ideal strategy to achieve our goal of offering a complete
wireless telecommunications solution for this growing market.

The combination of Alternets proprietary software systems,
with the TekVoice VoIP based telecommunications offerings, supplied over a
cost-effective network platform, will significantly improve the way rural
telecom services, education and medical information technology are delivered in
rural areas of Latin America.

About TekVoice Communications Inc.

4

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TekVoice Communications, Inc. is a Voice over IP
telecommunications company that since 2002, offers convergent voice and data
services over IP networks. With sales of over $3 million in 2006, it has
capitalized on its in-depth knowledge of the Hispanic and Latin American market,
the quality of its telecommunications network and the dramatic cost savings that
the network delivers to its customers. As a pioneer in the VoIP industry,
TekVoice has been at the leading edge in the design and deployment of new
products and services for the corporate and residential markets. TekVoice
Communications, Inc. is a U.S. corporation with offices in Miami, Dallas,
Caracas, Venezuela and Lima, Peru.

Terms of the merger are to be negotiated after due diligence by
both parties is completed.

Item
2.           Description of
Property

The Company does not own any real property as of March 13,
2007.

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 $2,500.

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 stated that the defendants,
Advanced Interactive, Inc. (AII) had breached the License Agreement between
the Company and AI as follows and damages are sought in the amount of
$1,804,709. The Company alleged 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 made a counterclaim of Cdn $1,379,150 plus interest
and costs. This amount represented license payments that would be owed if the
License Agreement were in effect plus interest and costs. The counterclaim also
included unspecified additional damages.

This lawsuit was settled during the fourth quarter of 2005 and
a Consent Dismissal Order was entered in the Supreme Court of British Columbia
on November 1 2005. The settlement called for the cancellation of all claims and
debts between the two parties. Alternet has recorded a net gain on settlement of
the License Agreement on its Consolidated Statement of Operations for the year
ending December 31, 2005 of $398,552.

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 requested
  an order to pay the Plaintiff Cdn $53,500 and 100,000 common shares for trade
  shows attended by the Company. On February 6 2007 The Supreme Court of British
  Columbia ordered the Company to pay NITA $53,500 plus interest of $4,126 and
  costs of $5,673 and 100,000 common shares. As a result of the settlement, the
  Company recorded a net gain of $8,443 in 2006.

5

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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, 2006.

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.

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:

2006
    HIGH
    LOWFirst Quarter
    $0.185
    $0.07Second Quarter
    $0.24
    $0.13Third Quarter
    $0.19
    $0.14Fourth Quarter
    $0.19
    $0.07


Holders of Common Stock

On December 31, 2006, there were approximately 96 holders of
record of our common stock and there were 47,556,428 shares outstanding. There
are 205 indirect holders of common shares in outside institutions or stock
brokerage firms, and we estimate that there are no additional beneficial
shareholders beyond the 96 registered shareholders and 205 non-registered
shareholders at December 31, 2006.

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 2006

6

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On February 20 2006 the Company issued a total of 5,765,000
shares at a price of $0.05 per share. Of this amount, 1,523,000 shares were sold
to 1 person resident in the United States and a total of 4,242,000 shares to 4
persons resident in Canada. All of the shares were sold at a price of $0.05 per
shares for total proceeds of $288,250.

On June 1 2006 the Company issued a total of 4,690,000 shares
at a price of $0.05 per share, to 4 persons resident in Canada for total
proceeds of $234,500.

Sales in 2005

There were no sales of unregistered securities in 2005.

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 and Sales in 2006 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;                                                                                                                                                  
|  |                                                                                                                                                                                                                                   
| | 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.

7

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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 under Regulation D 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:

Issuance in 2006

On January 11, 2006, the Company issued a total of 990,000 shares at a price of $0.09 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 1 person resident in Canada under the
terms of a management agreement by which they provided product marketing and financial consulting services to the Company.

On May 15 2006 the Company issued 80,000 shares at a price of $0.15 per share pursuant to the Company S8 Registration Statement filed on May 5 2006. These shares were issued under a debt settlement for accounting and administrative services.

On August 4 2006 the Company issued a total of 3,000,000 shares to three directors at a price of $0.16 pursuant to the Companys S8 Registration Statement filed on May 5 2006. These shares were issued under management consulting agreements
by which the three directors provide marketing consulting services to the Company over a twelve month period.

On August 30 2006 the Company issued a total of 200,000 shares at a price of $0.15 per share pursuant to the Companys S8 Registration Statement filed on May 5 2006. These shares were issued to one person resident in Canada under a
management consulting agreement by which they provided product marketing consulting services.

On October 25 2006 the Company issued 57,000 shares at a price
  of $0.13 per share under a debt settlement agreement for accounting and
  administrative services, pursuant to the Companys S8 Registration Statement
  filed on May 5 2006.

8

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On October 30 2006 the Company issued 2,000,000 shares at a price of $0.10 per share pursuant to a management contract for product marketing services over a twelve month period under the Companys S8 Registration Statement filed on May 5
2006. These shares were issued to one person resident in Canada.

On November 15 2006 the company issued 200,000 shares for cash at a price of $0.10 per share pursuant to the exercise of stock options. These shares were registered under the Companys S8 Registration Statement filed on May 5 2006.

On November 15 2006 the Company issued 100,000 shares at a price of $0.10 per share under a debt settlement agreement for administrative services, pursuant to the Companys S8 Registration Statement filed on May 5 2006

On December 22 2006 the Company issued 500,000 shares at a price of $0.07 per share pursuant to the companys S8 Registration Statement filed on May 5 2006. These shares were issued to one person resident in Canada under a management
contract for product marketing consulting services over a twelve month period.

Issuances in 2005:

On January 5, 2005 the Company issued 70,000 shares to one person for settlement of debt for legal services at a price of $0.20 per share. These shares were issued pursuant to the Companys S8 Registration Statement filed on March 1 2003.

On May 2 2005 the Company issued a total of 1,000,000 shares at a price of $0.095 per share to one person pursuant to the Companys S8 Registration Statement filed on January 21, 2005. These shares were issued to 1 person resident in Canada
under the terms of management agreements by which they provided various services including product marketing consulting services.

On May 4 2005 the Company issued 400,000 shares at a price of $0.08 per share to two Companies resident in Canada for settlement of debt for accounting and administrative services pursuant to the Companys S8 Registration filed on January
21 2005.

On June 15, 2005, the Company issued a total of 1,000,000 shares at a price of $0.135 per share pursuant to the Companys S8 Registration Statement filed on January 21, 2005. These shares were issued to 2 persons resident in Canada under
the terms of management agreements by which they provided various services to the Company including product marketing consulting and administrative services.

On July 15, 2005, the Company issued a total of 360,000 shares at an average price of $0.15 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 2 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 16, 2005, the Company issued a total of 200,000
  shares at a price of $0.135 per share pursuant to the Companys S8
  Registration Statement filed on January 21 2005. These shares were issued to
  1 person resident in Germany under the terms of a management agreement by which
  they provided product marketing consulting services to the Company.

9

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On September 23, 2005, the Company issued a total of 300,000 shares at a price of $0.15 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 1 person resident in Germany under
the terms of management agreements by which they provided product marketing consulting services to the Company.

On October 7, 2005, the Company issued a total of 165,000 shares at a price of $0.16 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 2 persons resident in Canada under the
terms of debt settlement agreements by which they provided accounting and administrative consulting services to the Company.

On October 10, 2005, the Company issued a total of 200,000 shares at prices of $0.18 and $0.16 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 2 persons resident in
Canada under the terms of management agreements by which they provided product marketing consulting services to the Company.

On October 20 2005, the Company issued a total of 60,000 shares at a price of $0.22 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 1 person resident in Canada under the
terms of a management agreement by which they provided product marketing consulting services to the Company.

On December 4, the Company issued a total of 440,000 shares at prices of $0.15 and $0.162 per share pursuant to the Companys S8 Registration Statement filed on January 21 2005. These shares were issued to 1 person resident in Canada
and 1 person resident in Germany under the terms of management agreements by which they provided product marketing consulting and administrative services to the Company.

Issuances 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.

10

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Issuances in 2003:

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

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.

RETAINER STOCK PLAN - 2004

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 - 2005

The Company adopted a retainer stock plan on January 21, 2005. 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 4,750,000 shares of common stock have
  been issued under the terms of the Retainer Plan for various management and
  product marketing related services (see Issuance of Non-Restricted Stock
  above).

RETAINER STOCK PLAN - 2006

The Company adopted a retainer stock plan on May 3, 2006. The Retainer Plan calls for the issuance of up to 6,000,000 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 5,500,000 shares have issued under this plan.

RETAINER STOCK PLAN - 2007

The Company adopted a retainer stock plan on February 15 2007.
  The Retainer Plan calls for the issuance of up to 10,000,000 shares of common
  stock to directors, officers, employees and consultants to compensate them for
  services rendered to the Company in lieu of cash compensation. The 2007 Plan
  will terminate on February 15, 2012. The Company filed a Registration Statement
  on Form S8 to register the underlying shares included in the 2007 Plan.

11

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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

In Note 2 to the audited financial statements for the years
ended December 31, 2006 and 2005, included in this Form 10-KSB, the Company
discusses those accounting policies that are considered to be significant in
determining the results of operations and its financial position. The Company
believes that the accounting principles utilized by it conform to accounting
principles generally accepted in the United States of America.

The preparation of financial statements requires Company management
  to make significant estimates and judgments that affect the reported amounts
  of assets, liabilities, revenues and expenses. By their nature, these judgments
  are subject to an inherent degree of uncertainty. On an on-going basis, the
  Company evaluates estimates. The Company bases its estimates on historical experience
  and other facts and circumstances that are believed to be reasonable, and the
  results form the basis for making judgments about the carrying value of assets
  and liabilities. The actual results may differ from these estimates under different
  assumptions or conditions.

Results of Operations :

For the year ended December 31, 2006 compared to the year ended
December 31, 2005

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. 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, 2006, the Company had sales of
$3,604. During the corresponding year ended December 31, 2005, the Company had
sales of $15,027. The decrease in sales is attributable to the fact that the
Company re-organized its sales and marketing plan and has been implementing the
new plan over the past year. The objective of the Companys marketing plan was
to establish a pilot wireless broadband network in a developing country in Latin
America, Africa or Eastern Europe. Due to a variety of factors, the Company was
unable to establish the pilot network it required to demonstrate the Companys
SchoolWeb, HealthWeb and CommunityWeb system software. The Company continues to
market SchoolWeb, HealthWeb and CommunityWeb in North America and
internationally.

Net Loss

For the year ending December 31, 2006, the Company had a net
  loss of $1,000,692 or ($0.03) per share, which was an increase of 380% when
  compared to the net loss for the corresponding year to December 31, 2005 of
  $263,564 or $(0.01) per share. The increased loss was due primarily to a gain
  on settlement of our License Agreement in the year ended December 31 2005 of
  $398,552; and an increase in management, consulting and marketing fees of approximately
  $340,000. The net loss from operations for the year ended

12

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December 31 2005, before the settlement gain, was $662,116, compared to the net loss from operations of $1,000,692 for the year ended December 31 2006, which was an increase of 34% from the previous year.

Gross Profit

Gross Profit was $3,604 in the year ended December 31 2006, compared to $8,478 for the year ended December 31, 2005. This represents a 60% decrease when compared to last year and is primarily due to the decline in sales of SchoolWeb,
HealthWeb and CommunityWeb.

Selling, General and Administrative Expenses

For the year ended December 31 2006 the Company incurred office and general expenses of $30,585, which was virtually unchanged from the $28,987 incurred in the previous year ending December 31 2005. Marketing expenses of $436,175 were
65% higher than the marketing expenses of $258,316 for the year ending December 31 2005.

Management and consulting fees of $431,398 represents a 62% increase from the management and consulting fees of $268,731 incurred in the year ending December 31 2005. Professional fees of $53,394 were incurred in the period ending
December 31 2006, which was a 24% reduction from the professional fees of $69,702 incurred in the previous year ending December 31 2005. The increase in marketing expenses is a result of increased activity in 2006 in marketing SchoolWeb,
HealthWeb and CommunityWeb systems and the increase in management consulting expense this year, is a result of increased staffing levels compared to the corresponding year ending December 31, 2005.

Accounts payable were $215,884 at December 31 2006, which was an 18% increase when compared to accounts payable of $177,163 at December 31 2005.

Interest and other expenses

The Company had no material interest expenses.

13

---

Liquidity and Capital Resources

As at December 31, 2006, the Company had $2,527 cash in the
bank and prepaid expenses of $1,727. The Company had a working capital
deficiency of $221,880 as at December 31 2006. 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.

PLAN OF OPERATION

Over the next 12 months the Company will be concentrating on
marketing its SchoolWeb, HealthWeb and CommunityWeb in North America and
internationally.

Sales and marketing is also accomplished through the Companys
existing sales staff, who contact potential clients 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.

FUND 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
    $
    12,000Product Development Expense:
    $
    1,000Office Rent
    $
    2,500Telephones
    $
    1,000Travel
    $
    2,000Marketing Expenses
    $
    4,000Professional Fees
    $
    1,500 14


---

Accounting fees
    $
    1,000Total Monthly Expenses:
    $
    25,000


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.

15

---

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 and Financial 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**

We maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the U.S. Securities and Exchange Commission rules and forms, and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.

Disclosure controls and procedures are controls and other procedures
  that are designed to ensure that information required to be disclosed in our
  reports filed or submitted under the Exchange Act is recorded, processed, summarized
  and reported, within the time periods specified in the Securities and Exchange
  Commission's rules and forms. Disclosure controls and procedures include, without
  limitation, controls and

16

---

procedures designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required disclosure. As
of December 31, 2006, we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14.
Based upon the foregoing, our Chief Executive Officer /Chief Financial Officer
concluded that our disclosure controls and procedures are effective in the
timely alerting of management to material information relating to us which is
required to be included in our periodic SEC filings.

There were no changes in our internal controls or in other
factors that could materially affect these controls subsequent to the date of
their evaluation and since the last period reported, including any significant
deficiencies or material weaknesses of internal controls that would require
corrective action.

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*2Patrick Fitzsimmons
    President, CEO and Director
    Expires at next AGMGriffin Jones
    Secretary, Treasurer, CFO and Director
    Expires at next AGMMichael Dearden
    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 May
      of 2007.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.                                                  

Patrick Fitzsimmons, President and Director

Pat Fitzsimmons, age 53. Mr. Fitzsimmons has extensive sales
and management experience gained from a 27-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 technology solutions.
His most recent position was Manager, Major Accounts, AT&T Canada, Vancouver
B.C., Canada.

Griffin Jones, Secretary, Treasurer, CFO and Director

Griffin Jones, age 52. Mr. Jones has been self-employed for approximately
  20 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.

17

---

Michael Dearden, Director

Michael Dearden, age 52. Mr. Dearden has over 27 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.

Item
10.           Executive
Compensation

Summary Compensation Table

Name and 
        principal 
        position (a)
      Year (b)
      Annual Compensation
      Long-term compensationSalary 
        ($) (c)
      Bonus 
        ($) (d)
      Other 
        Annual 
        Compen- 
        sation 
        ($) (e)
      Awards
      PayoutsRestricted 
        Stock 
        Award(s) 
        ($) (f)
      Securities 
        Underlying 
        options/ 
        SARs 
        (#) (g)
      LTIP 
        payouts 
        ($) (h)
      All 
        other 
        Compen- 
        sation 
        ($) (i)Patrick 
        Fitzsimmons, 
        President
      2006
      44,051
      0
      0
      75,000
      1,000,000
      0
      0Griffin Jones, 
        Treasurer and 
        CFO
      2006 
        2005 
        2004 
        2003 
        2002
      67,554 
        9,249 
        46,100 
        77,998 
        35,164
      0 
        0 
        0 
        0 
        0
      0 
        0 
        0 
        0 
        0
      0 
        0 
        0 
        0 
        0
      0 
        0 
        0 
        0 
        0
      0 
        0 
        0 
        0 
        0
      0 
        0 
        0 
        0 
        0Michael 
        Dearden, 
        Director
      2006 
        2005
      26,495 
        0
      0 
        0
      0 
        0
      0 
        0
      0 
        0
      0 
        0
      0 
        0Paul 
        Brandenberg, 
        Director
      2006
      33,165
      0
      0
      75,000
      1,000,000
      0
      0John Puente, 
        Director
      2006
      0
      0
      0
      75,000
      1,000,000
      0
      0 18


---

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,
2005 (29,974,428 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 ClassPatrick Fitzsimmons
          1406-151 E. Keith Rd. 
          N. Vancouver, BC 
          V7L 4M3
      President, Director,
      1,345,000
      3.7%Griffin Jones and Nahatlatch 
        Capital Corp. (3) 
        711 South Carson St. 
        Carson City, Nevada 
        89701
      Director, Secretary/ 
        Treasurer
      2,173,000 common shares of 
        which 260,000 are held 
        personally and 1,913,000 are 
        held in Nahatlatch Capital 
        Corp.
      7.2%Michael Dearden and Mikden 
        Investments Inc. (formerly 
        Streamline Investments, 
        Inc.) (2) 
        711 South Carson St. 
        Carson City, Nevada 
        89701
      Director,
      2,756,000 common shares of 
        which 373,000 are held 
        personally and 2,383,000 are 
        held by Mikden Investments
      8.9%Directors, Officers and 5% 
        stockholders in total
      
      5,924,000
      20%


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

19

---

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.

During the reporting period and subsequent to it but prior to
the date of this Report, the Registrant filed three reports on Form 8-K on
January 13 2006, June 19 2006, and August 30 2006 and one report on Form 8K
subsequent to the year ended December 31 2006 on January 13 2007 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 Fees

During the years ended December 31, 2006 and December 31, 2005,
the Company will incur approximately $26,000 and has incurred $21,300,
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, June 30, and September 30.

Audit-related Fees

During the years ended December 31, 2006 and 2005, the Company
  did not incur any audit-related fees for professional services rendered by its
  principal independent accountant.

20

---

Tax Fees

During the years ended December 31, 2006 and 2005, the Company
did not incur any fees for tax compliance, advisory or planning services
rendered by its principal independent accountant.

During fiscal year ended December 31, 2006, 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 the years ended December 31, 2006 and 2005, 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.

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                                                                                                                                  
|           |  |                                                                                                                                                                   
|23.1       |  | Consent
        of Auditor, Dale Matheson Carr-Hilton LaBonte LLP                                                                                                 
|           |  |                                                                                                                                                                   
|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                                                                                                      

21

---

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, 2007 | 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, 2007 | By: | /s/ Griffin Jones                          
|--------------------- | --- | -------------------------------------------
|                      |     | Griffin Jones, Director,
      Secretary,  
|                      |     | Treasurer                                  
|                      |     |                                            
|                      |     |                                            
|Dated: March 30, 2007 | By: | /s/ Patrick Fitzsimmons                    
|                      |     | Patrick Fitzsimmons, President and Director

22

---

ALTERNET SYSTEMS, INC.INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS

|                                                               |                                                 | PAGE
|-------------------------------------------------------------- | ----------------------------------------------- | ----
|                                                               |                                                 |     
|Index to Consolidated Financial Statements                     | F-1                                            
|                                                               |                                                 |     
|Reports of Independent Registered Public Accounting
      Firm | F-2                                            
|                                                               |                                                 |     
|Consolidated Financial Statements                              |                                                
|                                                               |                                                 |     
|                                                               | Consolidated Balance sheets                     | F-3 
|                                                               |                                                 |     
|                                                               | Consolidated Statements of Operations           | F-4 
|                                                               |                                                 |     
|                                                               | Consolidated Statement of Stockholders Deficit | F-5 
|                                                               |                                                 |     
|                                                               | Consolidated Statement of Cash Flows            | F-10
|                                                               |                                                 |     
|                                                               | Notes to Consolidated Financial Statements      | F-11

F-i

---









ALTERNET SYSTEMS INC.

(A Development Stage Company)

CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2006











|REPORT OF INDEPENDENT
      REGISTERED PUBLIC ACCOUNTING FIRM
|-------------------------------------------------------------
|                                                             
|CONSOLIDATED BALANCE
      SHEETS                            
|                                                             
|CONSOLIDATED STATEMENTS
      OF OPERATIONS                  
|                                                             
|CONSOLDIATED STATEMENT
      OF STOCKHOLDERS DEFICIT        
|                                                             
|CONSOLIDATED STATEMENTS
      OF CASH FLOWS                  
|                                                             
|NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS             

F-1

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Alternet Systems
  Inc.

We have audited the accompanying consolidated balance sheets
  of Alternet Systems Inc. (a development stage company) as of December 31, 2006
  and 2005 and the consolidated statements of operations, stockholders deficit
  and cash flows for the years then ended and the period from October 13, 2000
  (inception) to December 31, 2006. 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 an audit to obtain reasonable assurance whether the
  financial statements are free of material misstatement. The Company is not required
  to have, nor were we engaged to perform, an audit of its internal control over
  financial reporting. Our audits included consideration of internal control over
  financial reporting as a basis for designing audit procedures that are appropriate
  in the circumstances, but not for the purpose of expressing an opinion on the
  effectiveness of the Companys internal control over financial reporting.
  Accordingly, we express no such opinion. An audit also 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 audits provide 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, 2006 and 2005 and the results of its operations and its cash flows
  for the years ended December 31, 2006 and 2005 and the period from October 13,
  2000 (inception) to December 31, 2006 in conformity with accounting principles
  generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming
  that the Company will continue as a going concern. As discussed in Note 1 to
  the financial statements, the Company has not generated revenues since inception,
  has incurred losses in developing its business, and further losses are anticipated.
  The Company requires additional funds to meet its obligations and to 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.

“DMCL”

DALE MATHESON CARR-HILTON LABONTE LLP 
  CHARTERED ACCOUNTANTS

Vancouver, Canada 
  March 20, 2007



F-2

---

|ALTERNET SYSTEMS INC.        
|-----------------------------
|                             
|(A Development Stage Company)
|                             
|CONSOLIDATED BALANCE SHEETS  
|                             

|                                                                      |   | December, 31 |  
|--------------------------------------------------------------------- | - | ------------ | -
|                                                                      |   | 2006         |  
|ASSETS                                                                |   |              |  
|Current Assets                                                        |   |              |  
|Cash                                                                  | $ | 2,527        |  
|Prepaid expenses                                                      |   | 1,727        |  
|                                                                      |   |              |  
|Total Current Assets                                                  |   | 4,254        |  
|                                                                      |   |              |  
|EQUIPMENT(Note 3)                                                     |   | 10,625       |  
|                                                                      |   |              |  
|TOTAL ASSETS                                                          | $ | 14,879       |  
|                                                                      |   |              |  
|LIABILITIES                                                           |   |              |  
|Current Liabilities                                                   |   |              |  
|Accounts payable and accrued liabilities                              | $ | 215,884      |  
|Deferred license revenue                                              |   | -            |  
|Due to related parties (Note 6)                                       |   | 10,250       |  
|                                                                      |   |              |  
|TOTAL LIABILITIES                                                     |   | 226,134      |  
|                                                                      |   |              |  
|CONTINGENCIES (Notes 1 and 9)                                         |   |              |  
|                                                                      |   |              |  
|STOCKHOLDERS' DEFICIT                                                 |   |              |  
|Capital Stock (Note 5)                                                |   |              |  
|Common stock, $0.00001 par
      value, 100,000,000 shares authorized |   |              |  
|47,556,428
      (2005  29,947,428) issued and outstanding           |   | 477          |  
|Additional paid-in capital                                            |   | 4,513,639    |  
|Private placement subscriptions                                       |   | 175,122      |  
|Obligation to issue shares (Note 9)                                   |   | -            |  
|Accumulated other comprehensive
      income                          |   | 2,072        |  
|Deferred compensation (Note 7)                                        |   | (528,972     | )
|Deficit accumulated during
      the development stage                |   | (4,373,593   | )
|                                                                      |   |              |  
|TOTAL STOCKHOLDERS' DEFICIT                                           |   | (211,255     | )
|                                                                      |   |              |  
|TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT                           | $ | 14,879       |  

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

F-3

---

|ALTERNET SYSTEMS INC.                
|-------------------------------------
|                                     
|(A Development Stage Company)        
|                                     
|CONSOLIDATED STATEMENTS OF OPERATIONS
|                                     

|                                             |   |            |   |   |            |   |   | Results of       |  
|-------------------------------------------- | - | ---------- | - | - | ---------- | - | - | ---------------- | -
|                                             |   |            |   |   |            |   |   | Operations from  |  
|                                             |   |            |   |   |            |   |   | October 13,      |  
|                                             |   | Year ended |   |   | Year ended |   |   | 2000 (inception) |  
|                                             |   | December   |   |   | December   |   |   | to December      |  
|                                             |   | 31, 2006   |   |   | 31, 2005   |   |   | 31, 2006         |  
|REVENUE                                      |   |            |   |   |            |   |   |                  |  
|License fees and hardware sales              | $ | 3,604      |   | $ | 15,027     |   | $ | 225,973          |  
|                                             |   |            |   |   |            |   |   |                  |  
|COST OF SALES                                |   |            |   |   |            |   |   |                  |  
|Purchases                                    |   | -          |   |   | -          |   |   | 16,393           |  
|Royalties                                    |   | -          |   |   | 2,697      |   |   | 29,233           |  
|Installation
      costs and other           |   | -          |   |   | -          |   |   | 58,127           |  
|                                             |   | -          |   |   | 2,697      |   |   | 103,753          |  
|                                             |   |            |   |   |            |   |   |                  |  
|GROSS PROFIT                                 |   | 3,604      |   |   | 12,330     |   |   | 122,220          |  
|                                             |   |            |   |   |            |   |   |                  |  
|OPERATING EXPENSES                           |   |            |   |   |            |   |   |                  |  
|Advertising
      and promotion              |   | -          |   |   | -          |   |   | 110,753          |  
|Bad debt                                     |   | -          |   |   | -          |   |   | 15,344           |  
|Commissions                                  |   | -          |   |   | -          |   |   | 13,439           |  
|Depreciation                                 |   | 3,932      |   |   | 4,369      |   |   | 44,153           |  
|License
      fees                           |   | -          |   |   | -          |   |   | 696,000          |  
|Management and consulting (Note 6)           |   | 431,398    |   |   | 268,731    |   |   | 1,635,075        |  
|Marketing                                    |   | 436,175    |   |   | 258,316    |   |   | 1,459,393        |  
|Office and general                           |   | 30,585     |   |   | 28,987     |   |   | 228,896          |  
|Professional
      fees                      |   | 53,394     |   |   | 69,702     |   |   | 291,528          |  
|Rent                                         |   | 36,003     |   |   | 32,874     |   |   | 149,431          |  
|Telephone
      and utilities                |   | 7,693      |   |   | 8,617      |   |   | 41,718           |  
|Training and documentation                   |   | -          |   |   | -          |   |   | 153,154          |  
|Travel                                       |   | 13,559     |   |   | 2,850      |   |   | 63,924           |  
|                                             |   | 1,012,739  |   |   | 674,446    |   |   | 4,902,808        |  
|                                             |   |            |   |   |            |   |   |                  |  
|LOSS FROM OPERATIONS                         |   | (1,009,135 | ) |   | (662,116   | ) |   | (4,780,588       | )
|                                             |   |            |   |   |            |   |   |                  |  
|Gain
      on license settlement (Note 4)    |   | -          |   |   | 398,552    |   |   | 398,552          |  
|Gain on settlement
      of lawsuit (Note 9) |   | 8,443      |   |   | -          |   |   | 8,443            |  
|                                             |   |            |   |   |            |   |   |                  |  
|NET LOSS                                     | $ | (1,000,692 | ) | $ | (263,564   | ) | $ | (4,373,593       | )
|                                             |   |            |   |   |            |   |   |                  |  
|BASIC AND DILUTED NET LOSS PER SHARE         | $ | (0.03      | ) | $ | (0.01      | ) |   |                  |  
|                                             |   |            |   |   |            |   |   |                  |  
|WEIGHTED AVERAGE COMMON SHARES               |   |            |   |   |            |   |   |                  |  
|OUTSTANDING  BASIC AND DILUTED              |   | 40,439,198 |   |   | 27,757,894 |   |   |                  |  

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

F-4

---

ALTERNETSYSTEMSINC.
  (ADevelopmentStageCompany)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERSDEFICITFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2006

Deficit
      
      
      
      
      
      Otheraccumulated
      
      
      
      
      
      compre-Additional
      
      
      Obligation to
      
      
      Private
      
      
      during
      
      
      Deferred
      
      
      hensiveNumber of
      
      
      
      
      
      paid-in
      
      
      issue shares
      
      
      placement
      
      
      development
      
      
      compensa-
      
      
      incomeshares
      
      
      Amount
      
      
      capital
      
      
      
      
      
      subscriptions
      
      
      stage
      
      
      tion
      
      
      (loss)
      
      
      TotalIssuance of common stock for cash at $.001 per share October 16, 2000
      3,000
      
      $
      3
      
      $
      -
      
      $
      -
      
      $
      -
      
      $
      -
      
      $
      -
      
      $
      -
      
      $
      3Balance, December 31, 2000
      3,000
      
      
      3
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      3Issuance of common stock for cash at $.007 per share May 24, 2001
      5,500,000
      
      
      5,500
      
      
      33,000
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      38,500Issuance of common stock for cash at $.01 per share June 4, 2001
      4,010,000
      
      
      4,010
      
      
      36,090
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      40,100Issuance of common stock for cash at $.15 per share June 8, 2001
      330,000
      
      
      330
      
      
      49,170
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      49,500Issuance of common stock for license agreement at$.01 per share  June 29, 2001 (Note 4)
      2,500,000
      
      
      2,500
      
      
      22,500
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      25,000Schoolweb Holdings Inc. balance before reverse
        acquisition
      12,343,000
      
      
      12,343
      
      
      140,760
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      153,103Schoolweb 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
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      145,199Issuance of common stock for license agreement at $.01per share  September 10, 2001
      500,000
      
      
      5
      
      
      4,995
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      5,000Issuance of common stock for cash at $.10 per share September 11, 2001
      100,000
      
      
      1
      
      
      9,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      10,000Issuance of common stock for cash at $.10 per share November 5, 2001
      50,000
      
      
      1
      
      
      4,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      5,000Issuance of common stock for cash at $.15 per share November 8, 2001
      15,000
      
      
      -
      
      
      2,250
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      2,250Issuance of common stock for cash at $.20 per share November 24, 2001
      375,000
      
      
      3
      
      
      74,997
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      75,000Foreign 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
      )


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

F-5

---

ALTERNETSYSTEMSINC. 
  (ADevelopmentStageCompany)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERSDEFICITFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2006

Deficit
      
      
      
      
      
      Otheraccumulated
      
      
      
      
      
      compre-Additional
      
      
      
      
      
      Private
      
      
      during
      
      
      Deferred
      
      
      hensiveNumber of
      
      
      
      
      
      paid-in
      
      
      Obligation to
      
      
      placement
      
      
      development
      
      
      compensat-
      
      
      incomeshares
      
      
      Amount
      
      
      capital
      
      
      issue
        shares
      
      
      subscriptions
      
      
      stage
      
      
      ion
      
      
      (loss)
      
      
      TotalBalance, 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
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      102,000Issuance of common stock for cash at $.35
        per share  March15, 2002
      100,000
      
      
      1
      
      
      34,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      35,000Issuance of common stock for cash at $.35
        per share  April 30,2002
      140,000
      
      
      1
      
      
      48,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      49,000Issuance of common stock for cash at $.35
        per share June 27,2002
      97,371
      
      
      1
      
      
      34,079
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      34,080Issuance of common stock for cash at $.35
        per share  July 8,2002
      49,143
      
      
      1
      
      
      17,199
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      17,200Issuance of common stock for debt at $.35
        per share -September 11, 2002
      228,571
      
      
      2
      
      
      79,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      80,000Issuance of common stock for cash at $.35
        per share October9, 2002
      193,000
      
      
      2
      
      
      67,548
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      67,550Issuance of common stock for cash at $.35
        per share December 16, 2002
      93,000
      
      
      1
      
      
      32,549
      
      
      -
      
      
      (5,250
      )
      
      -
      
      
      -
      
      
      -
      
      
      27,300Private placement subscriptions received
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      8,900
      
      
      -
      
      
      -
      
      
      
      
      
      8,900Foreign exchange translation adjustment
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      2,683
      
      
      2,683Net 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  March20, 2003
      165,944
      
      
      2
      
      
      58,078
      
      
      -
      
      
      (3,650
      )
      
      -
      
      
      -
      
      
      -
      
      
      54,430Issuance of common stock for services at
        $.24 per share  May29, 2003
      100,000
      
      
      1
      
      
      23,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      24,000Issuance of common stock for services at
        $.34 per share  June10, 2003
      300,000
      
      
      3
      
      
      101,156
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      101,159Issuance of common stock for services at
        $.35 per share  June10, 2003
      180,000
      
      
      2
      
      
      62,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      63,000Issuance of common stock for services at
        $.20 per share  June10, 2003
      60,000
      
      
      1
      
      
      12,399
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      12,400Issuance of common stock for services at
        $.35 per share October 27, 2003
      100,000
      
      
      1
      
      
      34,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      35,000Issuance of common stock for services at
        $.26 per share October
        27, 2003
      350,000
      
      
      4
      
      
      90,996
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      91,000Subtotal
      17,400,029
      
      $
      175
      
      $
      1,044,293
      
      $
      -
      
      $
      -
      
      $
      (774,406
      )
      $
      -
      
      $
      733
      
      $
      270,795


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

F-6

---

ALTERNETSYSTEMSINC. 
  (ADevelopmentStageCompany)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERSDEFICITFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2006

Deficit
      
      
      
      
      
      Otheraccumulated
      
      
      
      
      
      compre-Additional
      
      
      
      
      
      Private
      
      
      during
      
      
      Deferred
      
      
      hensiveNumber of
      
      
      
      
      
      paid-in
      
      
      Obligation to
      
      
      placement
      
      
      development
      
      
      compensat-
      
      
      incomeshares
      
      
      Amount
      
      
      capital
      
      
      issue shares
      
      
      subscriptions
      
      
      stage
      
      
      ion
      
      
      (loss)
      
      
      TotalBalance forward
      17,400,029
      
      $
      175
      
      $
      1,044,293
      
      $
      -
      
      $
      -
      
      $
      (774,406
      )
      $
      -
      
      $
      733
      
      $
      270,795Private placement subscriptions received
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      365,921
      
      
      --
      
      
      -
      
      
      -
      
      
      365,921Obligation to issue shares for services
        rendered
      -
      
      
      -
      
      
      -
      
      
      553,720
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      553,720Foreign 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
      
      
      553,720
      
      
      365,921
      
      
      (2,481,273
      )
      
      -
      
      
      (6,469
      )
      
      (523,633
      )Private placement subscriptions received
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      360,054
      
      
      -
      
      
      -
      
      
      
      
      
      360,054Issuance of common stock for services 
        January 6, 2004
      1,785,000
      
      
      18
      
      
      466,302
      
      
      (466,320
      )
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -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
         June10, 2004
      1,500,000
      
      
      15
      
      
      164,985
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      165,000Issuance of common stock for services  August 30,
        2004
      407,000
      
      
      4
      
      
      91,876
      
      
      (61,400
      )
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for services at
        $.10 per share August 30, 2004
      24,000
      
      
      1
      
      
      2,400
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      2,401Issuance of common stock for cash at $.15
        per share  October25, 2004
      621,900
      
      
      6
      
      
      93,279
      
      
      -
      
      
      (69,500
      )
      
      -
      
      
      -
      
      
      -
      
      
      23,785Obligation to issue shares for services
        rendered
      -
      
      
      -
      
      
      -
      
      
      11,150
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      41,630Foreign exchange translation adjustment
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      5,912
      
      
      5,912Net 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
      )Issuance of common stock for services at
        $.20 per share January 5, 2005
      70,000
      
      
      1
      
      
      13,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      14,000Issuance of common stock for services at
        $0.10 per share  May2, 2005
      1,000,000
      
      
      10
      
      
      94,990
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      95,000Issuance of common stock for debt settlement
        at $0.08 per share May 4, 2005
      200,000
      
      
      2
      
      
      15,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      16,000Issuance of common stock for debt settlement
        at $0.08 per share May 4, 2005
      200,000
      
      
      2
      
      
      16,156
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      16,158Issuance of common stock for services at
        $0.14 per share  June15, 2005
      500,000
      
      
      5
      
      
      67,495
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      67,500Issuance of common stock for services at
        $0.14 per share  June15, 2005
      500,000
      
      
      5
      
      
      67,495
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      67,500Issuance of common stock for services at
        $0.15 per share  July15, 2005
      250,000
      
      
      2
      
      
      38,498
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      38,500Issuance of common stock for services at
        $0.15 per share  July15, 2005
      110,000
      
      
      1
      
      
      15,949
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      15,950Subtotal
      28,609,428
      
      $
      287
      
      $
      2,799,900
      
      $
      37,150
      
      $
      50,250
      
      $
      (3,109,337
      )
      $
      -
      
      $
      (557
      )
      $
      (222,307
      )


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

F-7

---

ALTERNETSYSTEMSINC. 
  (ADevelopmentStageCompany)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERSDEFICITFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2006

Deficit
      
      
      
      
      
      Otheraccumulated
      
      
      
      
      
      compre-Additional
      
      
      Obligation
      
      
      Private
      
      
      during
      
      
      Deferred
      
      
      hensiveNumber of
      
      
      
      
      
      paid-in
      
      
      to issue
      
      
      placement
      
      
      development
      
      
      compensat-
      
      
      incomeshares
      
      
      Amount
      
      
      capital
      
      
      shares
      
      
      subscriptions
      
      
      stage
      
      
      ion
      
      
      (loss)
      
      
      TotalBalance forward
      28,609,428
      
      $
      287
      
      $
      2,799,900
      
      $
      37,150
      
      $
      50,250
      
      $
      (3,109,337
      )
      $
      -
      
      $
      (557
      )
      $
      (222,307
      )Issuance of common stock for services at $0.14 per share
        August 16, 2005
      200,000
      
      
      2
      
      
      26,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      27,000Issuance of common stock for services at $0.15 per share
        September 23, 2005
      300,000
      
      
      3
      
      
      44,997
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      45,000Issuance of common stock for debt settlement
        at $0.15 per share October 7, 2005
      65,000
      
      
      1
      
      
      9,749
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      9,750Issuance of common stock for debt settlement
        at $0.16 per share October 7, 2005
      100,000
      
      
      1
      
      
      15,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      16,000Issuance of common stock for services at
        $0.16 per share October 10, 2005
      50,000
      
      
      1
      
      
      7,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      8,000Issuance of common stock for services at
        $0.18 per share October 10, 2005
      150,000
      
      
      1
      
      
      26,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      26,999Issuance of common stock for services at
        $0.22 per share October 20, 2005
      60,000
      
      
      1
      
      
      13,199
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      13,200Issuance of common stock for services at
        $0.16 per share December 4, 2005
      240,000
      
      
      2
      
      
      38,798
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      38,800Issuance of common stock for services at
        $0.15 per share December 4, 2005
      200,000
      
      
      2
      
      
      29,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      30,000Obligation to issue shares for services rendered
      -
      
      
      -
      
      
      -
      
      
      (11,150
      )
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      (11,150
      )Private placement subscriptions received
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      111,558
      
      
      -
      
      
      -
      
      
      -
      
      
      111,558Foreign exchange translation adjustment
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      2,696
      
      
      2,696Net loss for the
        year
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      (263,564
      )
      
      -
      
      
      -
      
      
      (263,564
      )Balance, December 31, 2005
      29,974,428
      
      
      301
      
      
      3,014,635
      
      
      26,000
      
      
      161,808
      
      
      (3,372,901
      )
      
      -
      
      
      2,139
      
      
      (168,018
      )Issuance of common stock for services at $0.09 per share
        January 11, 2006
      990,000
      
      
      10
      
      
      89,090
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      89,100Issuance of common stock for cash at $0.05 per share February 20, 2006
      1,285,000
      
      
      13
      
      
      64,237
      
      
      -
      
      
      (64,250
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share February 20, 2006
      1,554,000
      
      
      15
      
      
      77,685
      
      
      -
      
      
      (77,700
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share February 20, 2006
      500,000
      
      
      5
      
      
      24,995
      
      
      -
      
      
      (25,000
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share February 20, 2006
      645,000
      
      
      6
      
      
      32,244
      
      
      -
      
      
      (32,250
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share February 20, 2006
      1,523,000
      
      
      15
      
      
      76,135
      
      
      -
      
      
      (76,150
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Subtotal
      36,471,428
      
      $
      365
      
      $
      3,379,021
      
      $
      26,000
      
      $
      (113,542
      )
      $
      (3,372,901
      )
      $
      -
      
      $
      2,139
      
      $
      (789,187
      )


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

F-8

---

ALTERNETSYSTEMSINC. 
  (ADevelopmentStageCompany)CONSOLIDATEDSTATEMENTOFSTOCKHOLDERSDEFICITFOR THEPERIODFROMOCTOBER13, 2000(INCEPTION)TODECEMBER31, 2006

Deficit
      
      
      
      
      
      Otheraccumulated
      
      
      
      
      
      compre-Additional
      
      
      
      
      
      Private
      
      
      during
      
      
      Deferred
      
      
      hensiveNumber of
      
      
      
      
      
      paid-in
      
      
      Obligation to
      
      
      placement
      
      
      development
      
      
      compensat-
      
      
      incomeshares
      
      
      Amount
      
      
      capital
      
      
      issue shares
      
      
      subscriptions
      
      
      stage
      
      
      ion
      
      
      (loss)
      
      
      TotalBalance forward
      36,471,428
      
      $
      365
      
      $
      3,379,021
      
      $
      26,000
      
      $
      (113,542
      )
      $
      (3,372,901
      )
      $
      -
      
      $
      2,139
      
      $
      (789,187
      )Issuance of common stock for cash at $0.05 per share February 20, 2006
      258,000
      
      
      3
      
      
      12,897
      
      
      -
      
      
      (12,900
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for debt settlement at $0.175 pershare  May 15,
        2006
      80,000
      
      
      1
      
      
      13,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      14,000Issuance of common stock for cash at $0.05 per share 
        June 1,2006
      1,500,000
      
      
      15
      
      
      74,985
      
      
      -
      
      
      (75,000
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share 
        June 1,2006
      300,000
      
      
      3
      
      
      14,997
      
      
      -
      
      
      (15,000
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share 
        June 1,2006
      1,460,000
      
      
      15
      
      
      72,985
      
      
      -
      
      
      (73,000
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for cash at $0.05 per share 
        June 1,2006
      1,430,000
      
      
      14
      
      
      71,486
      
      
      -
      
      
      (71,500
      )
      
      -
      
      
      -
      
      
      -
      
      
      -Issuance of common stock for services at $0.18 per share
        August 4, 2006
      1,000,000
      
      
      10
      
      
      179,990
      
      
      -
      
      
      -
      
      
      -
      
      
      (105,000
      )
      
      -
      
      
      75,000Issuance of common stock for services at $0.18 per share
        August 4, 2006
      1,000,000
      
      
      10
      
      
      179,990
      
      
      -
      
      
      -
      
      
      -
      
      
      (105,000
      )
      
      -
      
      
      75,000Issuance of common stock for services at $0.18 per share
        August 4, 2006
      1,000,000
      
      
      10
      
      
      179,990
      
      
      -
      
      
      -
      
      
      -
      
      
      (105,000
      )
      
      -
      
      
      75,000Issuance of common stock for services at $0.17 per share
        August 30, 2006
      200,000
      
      
      2
      
      
      33,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      34,000Stock-based compensation (Note 5)
      -
      
      
      -
      
      
      11,920
      
      
      
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      11,920Issuance of common stock for debt settlement
        at $0.13 per share October 25, 2006
      57,000
      
      
      1
      
      
      7,409
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      7,410Issuance of common stock for debt settlement
        at $0.10 per share October 25, 2006
      100,000
      
      
      1
      
      
      9,999
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      10,000Exercise of stock options at $0.10 per share
         October 25, 2006
      200,000
      
      
      2
      
      
      19,998
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      20,000Issuance of common stock for services at $0.10 per share
        October 30, 2006
      2,000,000
      
      
      20
      
      
      199,980
      
      
      -
      
      
      -
      
      
      -
      
      
      (165,479
      )
      
      -
      
      
      34,521Issuance of common stock for services at $0.10 per share
        December 22, 2006
      500,000
      
      
      5
      
      
      49,995
      
      
      -
      
      
      -
      
      
      -
      
      
      (48,493
      )
      
      -
      
      
      1,507Private placement subscriptions received
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      536,064
      
      
      -
      
      
      -
      
      
      -
      
      
      536,064Foreign exchange translation adjustment
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      (67
      )
      
      (67
      )Settlement of lawsuit (Note 9)
      
      
      
      
      
      
      -
      
      
      (26,000
      )
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      (26,000
      )Net loss for the year
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      -
      
      
      (1,000,692
      )
      
      -
      
      
      -
      
      
      (1,000,692
      )Balance, December 31, 2006
      47,556,428
      
      $
      477
      
      $
      4,513,639
      
      $
      -
      
      $
      175,122
      
      $
      (4,373,593
      )
      $
      (528,972
      )
      $
      2,072
      
      $
      (211,255
      )


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

F-9

---

|ALTERNET SYSTEMS INC.                
|-------------------------------------
|                                     
|(A Development Stage Company)        
|                                     
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     

|                                                                    |   |            |   |   |            |   |   | October 13,          |  
|------------------------------------------------------------------- | - | ---------- | - | - | ---------- | - | - | -------------------- | -
|                                                                    |   | Year ended |   |   | Year ended |   |   | **2000 (inception)** |  
|                                                                    |   | December   |   |   | December   |   |   | to December          |  
|                                                                    |   | 31, 2006   |   |   | 31, 2005   |   |   | 31, 2006             |  
|OPERATING ACTIVITIES                                                |   |            |   |   |            |   |   |                      |  
|Net loss                                                            | $ | (1,000,692 | ) | $ | (263,564   | ) | $ | (4,373,593           | )
|Adjustments to reconcile net loss to net cash used in operating     |   |            |   |   |            |   |   |                      |  
|activities:                                                         |   |            |   |   |            |   |   |                      |  
|Depreciation                                                        |   | 3,932      |   |   | 4,369      |   |   | 44,153               |  
|Gain on disposal
      of assets                                    |   | -          |   |   | -          |   |   | (215                 | )
|Gain on settlement of debt                                          |   | -          |   |   | (398,552   | ) |   | (398,552             | )
|Issuance
      of shares for services rendered (Note 7)             |   | 384,128    |   |   | 487,450    |   |   | 1,457,417            |  
|Obligation to issue shares
      for services rendered              |   | -          |   |   | (11,150    | ) |   | 492,320              |  
|Stock-based
      compensation                                      |   | 11,920     |   |   | -          |   |   | 11,920               |  
|Gain on settlement of lawsuit                                       |   | (8,443     | ) |   | -          |   |   | (8,443               | )
|Changes in operating assets and liabilities:                        |   |            |   |   |            |   |   |                      |  
|Prepaid expenses                                                    |   | 2,254      |   |   | -          |   |   | (1,727               | )
|Deferred
      license revenue                                      |   | (2,140     | ) |   | (8,254     | ) |   | -                    |  
|Accounts payable and accrued
      liabilities                      |   | 52,574     |   |   | 95,904     |   |   | 762,056              |  
|Net cash used in operating activities                               |   | (556,467   | ) |   | (93,797    | ) |   | (2,014,664           | )
|                                                                    |   |            |   |   |            |   |   |                      |  
|INVESTING ACTIVITIES                                                |   |            |   |   |            |   |   |                      |  
|Acquisition of equipment                                            |   | (1,959     | ) |   | (3,628     | ) |   | (24,564              | )
|Cash acquired
      on reverse acquisition of SchoolWeb             |   | -          |   |   | -          |   |   | 74                   |  
|Net cash used in investing activities                               |   | (1,959     | ) |   | (3,628     | ) |   | (24,490              | )
|                                                                    |   |            |   |   |            |   |   |                      |  
|FINANCING ACTIVITIES                                                |   |            |   |   |            |   |   |                      |  
|Advances
      (to) from related parties                            |   | 4,951      |   |   | (16,854    | ) |   | 6,412                |  
|Net proceeds on sale of common
      stock and subscriptions        |   | 556,064    |   |   | 111,558    |   |   | 2,033,194            |  
|Net cash provided by financing activities                           |   | 561,015    |   |   | 94,704     |   |   | 2,039,606            |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                             |   | (67        | ) |   | 2,696      |   |   | 2,072                |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|NET INCREASE (DECREASE) IN CASH                                     |   | 2,522      |   |   | (25        | ) |   | 2,524                |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|CASH, BEGINNING                                                     |   | 5          |   |   | 30         |   |   | 3                    |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|CASH, ENDING                                                        | $ | 2,527      |   | $ | 5          |   | $ | 2,527                |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|SUPPLEMENTAL CASH FLOW INFORMATION
      AND NON-CASH TRANSACTIONS: |  
|                                                                    |   |            |   |   |            |   |   |                      |  
|Cash paid for:                                                      |   |            |   |   |            |   |   |                      |  
|Interest                                                            | $ | -          |   | $ | -          |   | $ | -                    |  
|Income
      taxes                                                  | $ | -          |   | $ | -          |   | $ | -                    |  

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

F-10

---

|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 1  NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Alternet Systems Inc. (Alternet or the Company)
  is in the development stage of operations which includes the design, marketing
  and ales of 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.

The 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, 2006, the Company
  had a working capital deficiency of $221,880. 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

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

Principles of ConsolidationThe 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 significant intercompany transactions and account balances
  have been eliminated.

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

Cash and Cash EquivalentsThe Company considers all liquid investments, with an original maturity
  of three months or less when purchased, to be cash equivalents.

License RightsThe 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.

EquipmentEquipment is recorded at cost and depreciated at the following rates:

Computer equipment and software - 30%
  declining balance basis 
  Equipment - 20% declining balance basis.

F-11

---

|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  (continued)

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 RecognitionThe 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 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 when collection
  is reasonably assured.

Foreign Currency TranslationThe financial statements are presented in United States dollars. In accordance
  with Statement of Financial Accounting Standards No. 52, Foreign Currency
  Translation, foreign denominated monetary assets and liabilities are translated
  to 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 deficit, whereas gains
  or losses resulting from foreign currency transactions are included in the results
  of operations.

Fair Value of Financial InstrumentsIn accordance with the requirements of SFAS No. 107, Disclosures about
  Fair Value of Financial Instruments, 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.

Stock-Based Compensation

Prior to January 1, 2006, the Company accounted for stock-based
  awards under the recognition and measurement provisions of Accounting Principles
  Board Opinion (APB) No. 25, Accounting for Stock Issued
  to Employees using the intrinsic value method of accounting, under
  which compensation expense was only recognized if the exercise price of the
  Companys employee stock options was less than the market price of the
  underlying common stock on the date of grant. Effective January 1, 2006, the
  Company adopted the fair value recognition provisions of SFAS No. 123R Share
  Based Payments, using the modified prospective transition method.
  Under that transition method, compensation cost is recognized for all share-based
  payments granted prior to, but not yet vested as of January 1, 2006, based on
  the grant date fair value estimated in accordance with the original provisions
  of SFAS No. 123, and compensation cost for all share-based payments granted
  subsequent to January 1, 2006, based on the grant-date fair value estimated
  in accordance with the provisions of SFAS 123R. Results for prior periods have
  not been restated.

All transactions in which goods or services are the consideration
  received for the issuance of equity instruments are accounted for based on the
  fair value of the consideration received or the fair value of the equity instrument
  issued, whichever is more reliably measurable. Equity instruments issued to
  employees and the cost of the services received as consideration are measured
  and recognized based on the fair value of the equity instruments issued.

The Company had not granted any options to December 31, 2005;
  therefore, no pro-forma disclosures are required.

F-12

---

|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  (continued)

Loss per ShareThe Company computes net earnings (loss) per share in accordance with SFAS
  No. 128, Earnings per Share. SFAS No. 128 requires presentation
  of both basic and diluted earnings per share (EPS) on the face of
  the statement of operations. Basic EPS is computed by dividing net loss available
  to common shareholders (numerator) by the weighted average number of common
  shares outstanding (denominator) during the period. Diluted EPS gives effect
  to all dilutive potential common shares outstanding during the period including
  warrants using the treasury stock method. Diluted EPS excludes all dilutive
  potential common shares if their effect is anti-dilutive. As the Company has
  net losses, it did not include common equivalent shares in the computation of
  diluted net loss per share because the effect would be anti-dilutive.

Risk Management 
  As the Company had no customers in the current year, the Company was not exposed
  to significant credit concentration. The Company is not exposed to significant
  interest rate risk.

The Companys functional currency is the United States dollar.
  The Company operates in foreign jurisdictions, giving rise to exposure to market
  risks from changes in foreign currency rates. The financial risk is the risk
  to the Company's operations that arises from fluctuations in foreign exchange
  rates and the degree of volatility of these rates. Currently, the Company does
  not use derivative instruments to reduce its exposure to foreign currency risk.

Recent Accounting PronouncementsIn February 2006, the FASB issued SFAS No. 155, Accounting for Certain
  Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140,
  to simplify and make more consistent the accounting for certain financial instruments.
  SFAS No. 155 amends SFAS No. 133, Accounting for Derivative Instruments and
  Hedging Activities, to permit fair value remeasurement for any hybrid financial
  instrument with an embedded derivative that otherwise would require bifurcation,
  provided that the whole instrument is accounted for on a fair value basis. SFAS
  No. 155 amends SFAS No. 140, Accounting for the Impairment or Disposal of Long-Lived
  Assets, to allow a qualifying special-purpose entity to hold a derivative financial
  instrument that pertains to a beneficial interest other than another derivative
  financial instrument. SFAS No. 155 applies to all financial instruments acquired
  or issued after the beginning of an entity's first fiscal year that begins after
  September 15, 2006, with earlier application allowed. This standard is not expected
  to have a significant effect on the Companys reported financial position
  or results of operations.

In March 2006, the FASB issued SFAS No. 156, Accounting
  for Servicing of Financial Assets. The Standard, which is an amendment
  to FAS No. 140, will simplify the accounting for servicing assets and liabilities,
  such as those common with mortgage securitization activities. The new Standard
  addresses the recognition and measurement of separately recognized servicing
  assets and liabilities and provides an approach to simplify efforts to obtain
  hedge-like (offset) accounting. This standard is not expected to have a significant
  effect on the Companys reported financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value
  Measurements,is effective for financial statements issued for
  fiscal years beginning after November 15, 2007. Under the standard, fair value
  refers to the price that would be received to sell an asset or paid to transfer
  a liability in an orderly transaction between market participants in the market
  in which the reporting entity transacts. The standard clarifies the principle
  that fair value should be based on the assumptions market participants would
  use when pricing the asset or liability. In support of this principle, the standard
  establishes a fair value hierarchy that prioritizes the information used to
  develop those assumptions. The fair value hierarchy gives the highest priority
  to quoted prices in active markets and the lowest priority to unobservable data,
  for example, the reporting entitys own data. Under the standard, fair
  value measurements would be separately disclosed by level within the fair value
  hierarchy. This standard is not expected to have a significant effect on the
  Companys reported financial position or results of operations.

In September 2006, the FASB issued SFAS No. 158, Employers
  Accounting for Defined Benefit Pension and Other Postretirement Plans.
  The standard requires an employer to recognize in its statement of financial
  position an asset for a plans overfunded status or a liability for a plans
  underfunded status; to measure a plans assets and its obligations that
  determine its funded status as of the end of the employers fiscal year
  (with limited exceptions), and to recognize changes in the funded status of
  a defined benefit postretirement plan in the year in which the changes occur.
  Those changes will be reported in comprehensive income of a business entity
  and in changes in net assets of a not-for-profit organization. This standard
  is not expected to have a significant effect on the Companys reported
  financial position or results of operations.

F-13

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|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  (continued)

Recent Accounting Pronouncements (continued)

In February 2007, the FASB issued SFAS No. 159, The Fair
  Value Option for Financial Assets and Financial Liabilities.The
  standard requires companies to provide additional information that will help
  investors and other users of financial statements to more easily understand
  the effect of the companys choice to use fair value on its earnings. It
  also requires entities to display the fair value of those assets and liabilities
  for which the company has chosen to use fair value on the face of the balance
  sheet. The new Statement does not eliminate disclosure requirements included
  in other accounting standards, including requirements for disclosures about
  fair value measurements included in FASB Statements No. 157, Fair Value
  Measurements, and No. 107, Disclosures about Fair Value of
  Financial Instruments. This standard is not expected to have a significant
  effect on the Companys reported financial position or results of operations.

NOTE 3 - EQUIPMENT

| |                    |   | 2006   |  |   | 2005         | 
| | ------------------ | - | ------ |  | - | ------------ | 
| |                    |   |        |  |   | Accumulated  | 
| |                    |   | Cost   |  |   | depreciation | 
| |                    |   |        |  |   |              | 
| | Computer equipment | $ | 16,768 |  | $ | 9,612        | 
| | Computer software  |   | 4,684  |  |   | 2,348        | 
| | Equipment          |   | 1,967  |  |   | 834          | 
| |                    | $ | 23,419 |  | $ | 12,794       | 

NOTE 4 - LICENSE SETTLEMENT

By agreement dated January 1, 2001, AI Systems entered into an
  agreement with Advanced Interactive Inc. (AII) whereby AI Systems
  acquired exclusive and non-exclusive rights and licenses to commercialize, distribute
  and market AII 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. 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.

On July 15, 2005, the Company executed a settlement agreement
  with AII and all other parties to the License Agreement, whereby the parties
  agreed to settle all outstanding issues related to court proceedings brought
  by the Company against AII and any counter claims by AII. The terms of settlement
  included the mutual full and final release of all outstanding debts, liabilities
  and obligations outstanding, a three year option whereby the Company or its
  nominees may acquire a total of 3,228,571 shares of the Companys stock
  held by AII for $10,000, and the retention by the Company of the software, code,
  trademarks and intellectual property relating to SchoolWeb and CommunityWeb.
  As at the date of the settlement agreement the Company had accrued license fees
  of $386,162 and royalties of $21,390 in respect of the License Agreement. As
  a result of this settlement the Company was not required to pay these amounts
  and has therefore recognized a gain in the amount of $407,552 in the year ended
  December 31,2005. The amount was offset by $9,000 due to a loss recorded by
  settling $7,000 of debt for shares valued at $16,000, resulting in a net gain
  of $398,552.

The Company has developed its own proprietary software and continues
  to market SchoolWeb and CommunityWeb in North America and internationally.

F-14

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|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 5  CAPITAL STOCK

During the year ended December 31, 2006, the Company filed an
  application under the registration exemptions available in Regulation D and
  Regulation S of the Securities Exchange Act of 1933, to sell up to 12,000,000
  shares of its common stock at a price of $0.05 per share of common stock. On
  February 20, 2006, the Company completed a private placement of 5,765,000 common
  shares at a price of $0.05 per share for total proceeds of $288,250 under these
  exemptions of which $161,808 was received during 2005. On June 1, 2006, the
  Company completed another private placement of 4,690,000 common shares at a
  price of $0.05 per share for total proceeds of $234,500 under these exemptions.

During the year ended December 31, 2006, the Company issued 6,690,000
  common shares valued at $913,100 for services to be provided pursuant to contracts
  entered into during 2006 and 237,000 common shares for settlement of debt valued
  at $31,410. During the year ended December 31, 2006, $384,128 of the services
  were charged to operations and the unamortized portion of the deferred compensation
  totalling $528,972 at December 31, 2006 will be amortized over the remaining
  term of the contacts. (refer to Note 7).

The Company has received $175,122 in respect of a further private
  placement of common stock at a price of $0.05 per share. These shares were not
  issued at December 31, 2006 and this amount is reported as private placement
  subscriptions within stockholders deficit.

Effective March 1, 2003, the Company adopted a Retainer Stock
  Plan for Employees, Directors and Consultants (the 2003 Plan) for
  the purpose of providing the Company with the means to compensate employees,
  directors and consultants for their efforts in furthering the business development
  of the Company. The 2003 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 common shares may be awarded under
  this plan. The 2003 Plan will terminate February 29, 2008. The Company filed
  a Registration Statement on Form S-8 to cover the 2003 Plan. To date, 4,876,000
  common shares valued at $1,066,160 relating to services provided in 2003, 2004
  and 2005 have been awarded leaving a balance of 124,000 shares which maybe awarded
  under this plan.

Effective January 21, 2005 the Company adopted a Retainer Stock
  Plan for Employees, Directors and Consultants (the 2005 Plan) for
  the purpose of providing the Company with the means to compensate employees,
  directors and consultants for their efforts in furthering the business development
  of the Company. The 2005 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 common shares may be awarded under
  this plan. The 2005 Plan will terminate January 21, 2010. The Company filed
  a Registration Statement on Form S-8 to cover the 2005 Plan. To date, 4,750,000
  common shares valued at $596,550 relating to services provided have been awarded
  leaving a balance of 250,000 shares which maybe awarded under this plan.

Effective May 3, 2006 the Company adopted a Retainer Stock Plan
  for Employees, Directors and Consultants (the 2006 Plan) for the
  purpose of providing the Company with the means to compensate employees, directors
  and consultants for their efforts in furthering the business development of
  the Company. The 2006 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 6,000,000 common shares may be awarded under this
  plan. The 2006 Plan will terminate April 23, 2011. The Company filed a Registration
  Statement on Form S-8 to cover the 2006 Plan. To date, 5,500,000 common shares
  valued at $790,000 relating to services provided or to be provided have been
  awarded under this plan.

Stock Options

To December 31, 2005, the Company had 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 years at an exercise price to be determined by the Directors.

On October 20, 2006, the Company granted a total of 200,000 stock
  options to a consultant at an exercise price of $0.10 per common share under
  the 2006 Plan. These options vested immediately and expire on September 18,
  2007. The Company estimated the fair value of stock options by applying the
  fair value method using the Black-Scholes option pricing model using an expected
  life of one year, a risk-free interest rate of 5.35% and an expected volatility
  of 113% resulting in a stock based compensation expense of $11,920. All of the
  stock options were exercised on October 25, 2006.

F-15

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|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 5  CAPITAL STOCK (continued)

A summary of the stock options are as follows:

2006Number of
      
      
      ExerciseOptions
      
      
      PriceOpening balance
      
      -
      
      $
      -Granted during the year
      
      200,000
      
      
      0.10Exercised during the year
      
      (200,000
      )
      
      -Closing balance
      
      -
      
      $
      -


Option pricing models require the input of highly subjective
  assumptions including their life and expected price volatility. Changes in these
  subjective input assumptions can materially affect the fair value estimate,
  and therefore the existing models do not necessarily provide a reliable measure
  of the fair value of the Companys share purchase options.

There were no warrants outstanding at December 31, 2006 or December
  31, 2005.

NOTE 6  RELATED PARTY TRANSACTIONS

At December 31, 2006, a total of $10,250 (December 31, 2005 -
  $5,299) was owed to directors. Amounts due to related parties are unscured,
  non-interest bearing and have no specific terms of repayment.

The following amounts were incurred to directors and officers
  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, | 
| | ------------------------- | - | ----------------------- | 
| |                           |   | 2006                    | 
| |                           |   |                         | 
| | Management and consulting | $ | 169,049                 | 
| | Marketing                 |   | 227,216                 | 
| |                           | $ | 396,265                 | 

Of the amounts above, $171,265 was paid in cash and $225,000
  was paid by way of common shares for services Refer to Note 7.

NOTE 7  DEFERRED COMPENSATION

On August 1, 2006, the Company entered into an agreement with
  three consultants who are also directors of the Company for a one-year term
  agreement whereby the consultants will provide marketing services to the Company
  (valued at $540,000 in aggregate) in exchange for 3,000,000 shares of the Companys
  common stock which were issued on August 4, 2006. The consultants will provide
  such services as developing sales channels of the Companys products, developing
  international marketing plans and maintaining customer relations and reporting
  to the Companys board of directors as determined by the board.

On August 15, 2006, the Company entered into an agreement with
  a consultant for a one-year term agreement whereby the consultant will provide
  marketing services to the Company (valued at $34,000) in exchange for 200,000
  shares of the Companys common stock which were issued on August 30, 2006.
  The consultants will provide such services as developing sales channels of the
  Companys products, developing marketing plans and maintaining customer
  relations and reporting to the Companys board of directors as determined
  by the board.

F-16

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|ALTERNET SYSTEMS INC.                     
|------------------------------------------
|(A Development Stage Company)             
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|December 31, 2006                         
|                                          

NOTE 7  DEFERRED COMPENSATION (continued)

On October 30, 2006, the Company entered into an agreement with
  a consultant for a one-year term agreement whereby the consultant will provide
  marketing services to the Company (valued at $200,000) in exchange for 2,000,000
  shares of the Companys common stock which were issued on October 30, 2006.
  The consultants will provide such services as developing sales channels of the
  Companys products, developing marketing plans and maintaining customer
  relations and reporting to the Companys board of directors as determined
  by the board.

On December 20, 2006, the Company entered into an agreement with
  a consultant for a one-year term agreement whereby the consultant will provide
  marketing services to the Company (valued at $50,000) in exchange for 500,000
  shares of the Companys common stock which were issued on December 22,
  2006. The consultants will provide such services as developing sales channels
  of the Companys products, developing marketing plans and maintaining customer
  relations and reporting to the Companys board of directors as determined
  by the board.

The Company recorded the fair value of the shares issued as deferred
  compensation and amortizes the costs of all these services on a straight-line
  basis over the respective terms of the contracts. During the year the company
  amortized $186,028 of deferred compensation to management and consulting fees
  and $109,000 to marketing expense.. At December 31, 2006, the unamortized portion
  of the deferred compensation totalled $528,972 of which $315,000 was incurred
  to directors of the Company.

NOTE 8  INCOME TAXES

The parent Company is subject to income taxes in the United States
  while its subsidiaries are subject to income taxes in Canada. U.S. federal net
  operating loss carryforwards of approximately $4,432,000, if not utilized to
  offset taxable income in future periods, expire between 2016 and 2026. Canadian
  net operating losses of approximately $4,000, if not utilized to offset taxable
  income in future periods, expire commencing in 2008. Management believes that
  the realization of the benefits from these deferred tax assets is uncertain
  and. accordingly, a full deferred tax asset valuation allowance has been provided
  and no deferred tax asset benefit has been recorded.

The significant components of the Companys net deferred
  tax assets are as follows:

| |                                              |   | Year ended   |   |   | Year ended   |  
| | -------------------------------------------- | - | ------------ | - | - | ------------ | -
| |                                              |   | December 31, |   |   | December 31, |  
| |                                              |   | 2006         |   |   | 2005         |  
| |                                              |   |              |   |   |              |  
| | Tax benefit relating to net operating losses | $ | 1,485,000    |   | $ | 1,178,000    |  
| | Valuation allowance                          |   | (1,485,000   | ) |   | (1,178,000   | )
| |                                              |   |              |   |   |              |  
| | Net deferred tax
      assets                | $ | Nil          |   | $ | Nil          |  

NOTE 9  SETTLEMENT OF LAWSUIT

On March 14, 2005, Native Investment and Trade Association (plaintiff)
  filed a Writ of Summons and Statement of Claim for non-payment of services provided.
  The matter was ultimately decided on by the Supreme Court of British Columbia
  on February 6, 2007 awarding to the plaintiff, a total of $54,317 in damages,
  court interest and court costs in addition to a specific performance of the
  obligation to issue 100,000 free standing shares of the Company (previously
  recorded at a value of $26,000). As a result of the settlement, the Company
  recorded a net gain of $8,443.

NOTE 10  SUBSEQUENT EVENTS

Effective January 8, 2007, the Company adopted a Retainer Stock
  Plan for Employees, Directors and Consultants (the 2007 Plan) for
  the purpose of providing the Company with the means to compensate employees,
  directors and consultants for their efforts in furthering the business development
  of the Company. The 2007 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 10,000,000 common shares may be awarded under
  this plan. The 2007 Plan will terminate on February 15, 2012. The Company filed
  a Registration Statement on Form S-8 to register the underlying shares included
  in the 2007 Plan.

F-17

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