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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549** **FORM 10-KSB**   þ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934****For the fiscal year ended December 31, 2005****OR**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934****For the transition period from ___to ___****Commission File No. 000-30013** **ASIA PAYMENT SYSTEMS, INC.**(Name of small business issuer in its charter)   **Nevada** **98-0204780**(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)   **800 5****th**Avenue, Suite 4100, Seattle, WA **98104**(Address of small business issuer’s executive officers) (Zip Code)Issuer’s Telephone Number: **(206) 447-1379**Securities registered pursuant to Section 12(b) of the Act:   **Title of each class** **Name of each exchange on which registered****None** **None**Securities registered pursuant to Section 12(g) of the Act:   **Common stock, par value $0.001** **Preferred stock, par value $0.001****Title of each class** **Title of each class**     Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) ofthe Exchange Act. o     Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the past 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirements for the past90 days. þ Yes o No     Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-Bcontained in this form, and no disclosure will be contained, to the best of registrant’s knowledge,in definitive proxy or information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. o     State the aggregate market value ofthe voting and non-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was sold, or the average bid and asked price of such commonequity, as of a specified date within the past 60 days. (See definition of affiliate inRule 12b-2 of the Exchange Act.)o     Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (§229.405 of this chapter) is not containedherein, and will not be contained, to the best of registrant’s knowledge,in definitive proxy or information statements incorporated by referencein Part III of this Form 10-K or any amendment to this Form 10-K o     Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of“accelerated filer and large accelerated filer”in Rule 12b-2 of theExchange Act. (Check one):                         Large accelerated filer o            Accelerated filer o            Non-accelerated filer o     Indicate by check mark whether the registrant is a shell company (as defined in Rule 126-2 ofthe Exchange Act.) o Yes þ No     State issuer’s revenues for its most recent fiscal year. **$43,949.**     The aggregate market value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was sold, or the average bid andasked price of such common equity, as of March 17, 2006 was approximately **$10,686,000.**     As of March 17, 2006, there were 35,619,765 shares of the issuer’s $.001 par value commonstock issued and outstanding. As of March 17, 2005 there were no shares of the issuer’s $.001 parvalue preferred stock issued and outstanding.     Documents incorporated by reference. None.  
 

 
**Table of Contents**     PART I  1 ITEM 1. DESCRIPTION OF BUSINESS  1 History  1 Services  2 Developments  7 Ongoing Developments  10 Other Developments  11 The Market and Competition  11 Government Regulation and System Certification  12 Employees  14 Our Facilities  14 Risk Factors  14 ITEM 2. DESCRIPTION OF PROPERTY  20 Property Held by Us  20 Our Facilities  20 ITEM 3. LEGAL PROCEEDINGS  20 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS  20 PART II  21 ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUERPURCHASES OF EQUITY SECURITIES  21 Dividends  21 Unregistered sales of securities  21 Securities authorized for issuance under equity compensation  23 Section 15(g) of the Securities Exchange Act of 1934  24 ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION  25 Forward-Looking Statements  25 Systems and Technology Implementation to meet our Business Needs  26 Marketing Strategy  32 Revenue  35 Staffing  38 Distribution  39 Significant Milestones  39 Critical Accounting Policies and Estimates  40 Financial Condition and Liquidity  41 ITEM 7. FINANCIAL STATEMENTS  43 Consolidated Financial Statements  44 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCE DISCLOSURE  63 ITEM 8A. CONTROLS AND PROCEDURES  63 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITHSECTION 16(a) OF THE EXCHANGE ACT  64 Executive Officers and Directors  64 Audit Committee and Charter  65 Audit Committee Financial Expert  66 Code of Ethics  66 ITEM 10. EXECUTIVE COMPENSATION  67 Compensation of Officers  67 Indemnification  70 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS  71 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS  72 ITEM 13. EXHIBITS  73 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES  73  Certification of Principal Executive Officer Pursuant to Rule 13a-15 Certification of Principal Financial Officer Pursuant to Rule 13a-15 Certification Pursuant to 18 U.S.C. Section 1350 Certification Pursuant to 18 U.S.C. Section 1350
 

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**PART I**We make forward-looking statements in this document. Our forward-looking statements aresubject to risks and uncertainties. You should note that many factors, some of which are describedin this Part I or discussed elsewhere in this document, could affect our company in the future andcould cause our results to differ materially from those expressed in our forward-lookingstatements, including those matters discussed under the heading “Risk Factors” below.Forward-looking statements include those regarding our goals, beliefs, plans or currentexpectations and other statements regarding matters that are not historical facts. For example, weuse the words “believe,” “expect,” “anticipate” or similar expressions to make forward-lookingstatements. We are not required to publicly release the results of any revisions to theseforward-looking statements we make to reflect future events or circumstances.**ITEM 1. DESCRIPTION OF BUSINESS**Asia Payment Systems, Inc., formerly Asian Alliance Ventures, Inc., was incorporated in theState of Nevada on October 2, 1998, and maintains its principal executive offices at 8005th Avenue, Suite 4100, Seattle, WA 98104.We offer credit card transaction processing and merchant acquiring services. We plan to offercredit card clearing services to merchants and financial institutions, primarily focusing on Chinaand Japan with later build out to other Asian countries. Our mission is to be a provider ofthird-party processing services in China to bankcard-accepting merchants, issuers of bank creditcards, issuers of petroleum station retail cards, and to issuers of merchandise and grocery retailcards.***History***In August 1999, we entered into a joint venture agreement with Shandong Hengtong ChemicalIndustrial Company, Ltd. (“Shandong Industrial”), a large, established company in Linyi City,partially owned by the People’s Republic of China (“China” or “PRC”) and located in the southeastof Shandong Province. Together with Shandong Industrial, we formed Shandong Hengtong DevelopmentChemical Co. Ltd (“Shandong Development”) as our joint venture enterprise. The purpose of the jointventure was to acquire and run the nitrogen fertilizer plant of Shandong Industrial, to expand thefertilizer operations by adding power generation plants and to acquire other fertilizer plants.From 1999 to mid 2003, our former management attempted unsuccessfully to raise $13 million, whichwas to be our contribution to the joint venture.In August 2003, we terminated the joint venture with Shandong Industrial and sought to acquire anew business to provide the credit card clearing services. We acquired WelWay Development Limited,a corporation organized under the laws of Hong Kong SAR, China, in consideration of 6,500,000restricted shares of our common stock. WelWay was developing a business to provide credit cardclearing services for merchants in China and throughout Asia, as well as providing third partycredit card clearing services to financial institutions and oil companies in China.In November 2003, we changed our name to Asia Payment Systems, Inc. In February 2004, we completedthe acquisition of WelWay. The management and assets of WelWay were transferred to us, and weceased to use the name WelWay Development. Subsequently, our common stock began trading on theOver-The-Counter Bulletin Board under the symbol “APYM.OB” in March 2004.
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***Strategy***Asia Pay’s strategy is to first focus on providing credit card processing services to retailmerchants in targeted markets. Once a critical mass of merchant accounts has been enrolled, wewill then market this merchant acquiring base to selected Chinese banks. At this stage — orearlier, based on available financing and opportunities — we will have established sufficientvolume, reputation and momentum to pursue credit card clearing customers and roll out our morelucrative credit card clearing services.We will support these markets using world-class technology platforms and maximize strategicpartnerships to accelerate market development. Initial focus is on China with expansion into otherAsian markets planned. Development objectives have been selected and are being deployed and anorganization for executing on those objectives has been put in place.Asia Pay intends to be one of the first major providers in China of world-class third-partyprocessing services serving merchants, suppliers of merchant processing services, issuers of creditcards (prepaid and charge cards), issuers of gas and fleet management cards, retail and loyaltycards.***Services***Our business plan targets two main service areas: 1. data processing services to merchants for credit and debit card payment transactions(“payment processing services”), and  2. credit card clearing services to card issuers (“credit card clearing services”).We are currently offering the payment processing services. We plan to offer credit card clearingservices during 2006.**Payment Processing Services**We started offering payment processing services to Japanese and U.S. merchants in 2004 and areable to offer payment processing services to international merchants via our Singapore hub. Weinitially planned to begin offering these services to Chinese merchants in the fourth quarter of2005 through partnership arrangements with long term Chinese partners, but the start-up of Chineseoperations has been delayed until mid-2006 pending the finalization of satisfactory Chinese partnerarrangements.We support two card markets for our payment processing services: 1. card present — physical card swipe by the consumer, magnetic stripe or EMV (astandard acronym used in the card industry), e.g. POS terminal, retail store sale  2. card not present — no physical card contact, card details given over phone orsubmitted electronically by the consumer, e.g. e-commerce, online store saleOur strategy is to provide merchants a turnkey payment solution in Asia, comprising merchant bankaccounts, reports and account management functions, payment processing terminals and Asia Pay’s ownthird-party payment processing platform with competitive rates and international-style features.We provide the data routing, support for merchant agreement approval processes, credit card Pointof Sale(“POS”), POS terminal installation (card present market)1 and related services asrequired by each merchant.
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For the card not present market, a secondary market for Asia Pay, it’s a lot more straightforwardin terms of deployment. There is no current significant market for e-commerce, m-commerce, kioskand MO/TO business in Asia but it is growing, enough for us to make it a secondary business lineand ensure our systems are fully capable of supporting it. The immediate cost-effective card notpresent business is for international merchants coming into Asia, predominately China, looking toconduct e- and m-commerce business.We also utilize the ClearCommerce e-commerce processing engine, from the US company eFunds, mostlyfor high volume international merchants, to whom we offer multi-currency domestic and offshoreprocessing services.In Asia we had to develop our own robust bankcard (credit and debit) payment transaction processingplatform (branded APAYcard). It has been designed to switch2 transactions received frommerchants to the relevant financial institutions and clearing houses, such as VISA/MasterCard, cardnetwork processors such as GP Net and China Union Pay and local banks, from where the transactionis sent on to the relevant card issuer for payment. This switching will also be done later on acost performance and features basis.We contract directly with the merchant for our services and receive a setup fee (low for massmarket, much higher for retail management systems) and a commission driven model for eachtransaction processed. The clearing house receives a fee from the financial institution. We donot owe any fees to the clearing house.We provide the remainder of the services required to confirm the customer bankcard sale within theagreed upon timeframe and provide the merchant with the ability to confirm funds receipt to theirmerchant bank account. In addition, we provide automated settlement features so that our merchantscan confirm real time sales as well as end of day/week/month sales.A regional point of presence (POP) will be established locally in each city where Asia Payundertakes marketing of POS terminals and related payment processing services to merchants. Theselocal POPs will enable merchants to connect their POS systems and provide call center support.In developing APAYcard, we have taken an open systems approach, using industry standardtechnologies and networks, off-the-shelf components and new generation POS transaction systems,deployed on fault-tolerant server clusters. Our system is efficient, practical, robust andscalable. We have no long term strategy to become a “software house.” Long term we’ll purchasehigher-end off-the-shelf products and/or partner with or acquire card systems’ companies foradditional card features. APAYcard fills a current opportunity gap, with the following reasonsjustifying the need for an in-house solution: **•** No good fit off-the-shelf product available to meet immediate known requirements in ourtarget Asian marketplace  **•** Must integrate with multiple disparate Asian networks banking networks  **•** Diversity of merchant POS technology (old and new) **•** High degree of control and flexibility needed  **•** Experience of CTO and technical team  **•** Long term strategic relationship 1 Card not present electronic transactions aresent to us over a secure electronic network. The customer end, e.g. mobilephone or web page is the POS. 2 Payment transaction data received on the frontend, in a common XML format, is centrally processed then routed on to theappropriate clearing house at the back end in the appropriate format. Here itis forwarded on to the necessary card issuer. In essence, APAYcard providesthe necessary switch to facilitate the payment transaction.
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Our system was built to meet the following key requirements: **•** Focused on core card functionality for card present and card not present markets  **•** Built with an open systems approach. Microsoft first, Linux later. Ability to integrate3rd party software.  **•** Ease of maintenance. Built by experts, enhanced and maintained by low cost local staff  **•** Strict security measures. Fraud detection capabilities.  **•** Accept merchant transactions from multiple access points  **•** Accept all payment types — including credit, debit, e-check, ACH, interbank transfer,batch (online and offline)  **•** Support wide range of payment terminal protocols (ISO8583, AS2805, EFT-POS, proprietary,XML, etc.) over private and public networks  **•** Support for legacy POS terminals  **•** Support for modern POS terminals with digital communications over TCP/IP  **•** Support for multi-lane retail management systems with multi-store multi-POS features(XML interface over TCP/IP)  **•** Web-based services (real-time reporting, admin, account management, billing,reconciliation, settlement, offline transactions, batch submittal, etc.) available to allcustomers; can also be downloaded in variety of formats.  **•** Web-based virtual payment terminal provided to merchants for MO/TOThe major factors which differentiate us as a company and give us an edge in markets such as Chinafor payment processing services, which include: **•** experience and expertise — card industry and technical  **•** international card features and services  **•** security  **•** processing speed  **•** flexibility, speed to marketOutside the standalone cash register used in the mass retail market, multi-lane retail managementPOS systems are available to the multi-lane multi-outlet retailers, which typically cost the largeretailer about US$500k for the installed system plus US$500k per lane and ongoing maintenance.There are lower cost low end versions available.These systems are typically PC-based, utilizing an integrated POS terminal, with a variety offeatures designed for the multi-lane environment delivering a modern, networked cash register in aclient/server model. Each networked cash register routes payment messages to a LAN-based POSserver on the back end, which tracks all sales activity and forwards the payment transaction on toa single card processor over TCP/IP on a secured line (leased line or Internet VPN).
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Multi-lane retail management systems are typically used by multi outlet retailers, especiallyinternational ones, such as DFS, Safeway, Carre Four, Wal-Mart, AS Watsons, Giant, etc. These arethe retailers that want to avoid using standalone POS terminals requiring a dedicated dial-upconnection per lane. They want an networked IP solution with integrated sub systems for obviousreasons. APAYcard is designed with these retailers in mind and Asia Pay is setup well to servetheir needs in Asia. These retailers will pay above cost (per transaction fees) in order to gain: **•** a single point of contact for their card processing needs in multiple Asian countriesfrom an industry expert who speaks their language  **•** aggregated volume to negotiate beneficial processing fees  **•** centralized payment processing for multiple country clearing houses with a singlepayment provider interface  **•** support for digital format payment messages (e.g. XML) generated by their product, withmulti-store, multi-lane, multi-operator features (write once, deploy multiple times)  **•** integration of POS terminals on a LAN with WAN capability for multi site locations  **•** reduced cost and efficiency from network communications vs. standalone (unreliable)dial-up connections  **•** overall efficiency, including centralized reconciliation, integrated data repositorywith central admin and reporting (via an access anywhere web interface)  **•** the capability for add on sub-systems such as inventory management, staffing, workflow;integration with existing high-end products such as SAPThis is especially important when these retailers are entering Asia, a continent of disparatecountries, financial rules and regulations, networks, systems, interfaces, banks, etc. – and ofcourse, China is the biggest issue and biggest opportunity of all, being the largest market with animmature card processing infrastructure. These retailers are rightfully concerned and they want tominimize risk and cost and operate as efficiently as possible while utilizing their existingsystems and processes. These retailers look for outside help with an inside presence. To justifygoing with such a provider and paying “above cost” in that market is a simple business case as wehave already proved.After initial success in this market space, we will target the vendors of multi-lane retailmanagement systems to work in partnership with them to enable their product Asia Pay readyout-of-the-box. This should give them a sales edge in selling their products into Asia, especiallycustomers targeting multi-country markets. It also creates immediate revenue opportunities for us.Our current average transaction time for processing card payments is under two seconds. We arecurrently producing some of the fastest card transaction times in Japan today on a consistentbasis. This, combined with our offering of Western style card services and technology to theJapanese marketplace, will enable us to build out our business in Japan; a significant potentialmarket given this approach.Our Japan processing program is operated from our server cluster platform currently located inOkinawa, Japan and is built around APAYcard which has been integrated with the GP Net bankcardclearing network. We use our servers in Japan to process all Japan transactions via GP Net andplan to roll out this service to additional merchants. We are currently progressing with the samesetup in China targeted to go live in 2006.We have recently established a new presence for processing transactions in Singapore in conjunctionwith NETS, a predominant bankcard clearing network provider there.
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**Credit Card Clearing Services**Since inception, Asia Pay has been planning and developing the ability to deploy card clearingservices of our own.This strategic card focused side of our business comprises three areas: 1. Card issuing (bank prepaid3 and charge cards, retail, loyalty and oil cards)  2. Full/partial card program outsourcing to our hub  3. Full/partial card program implementation and consulting for our customersOur aim is for our hub (“3rd Party Processing Hub”) to become a world class facility in Asia with3rd party processing services available to the Bank, Oil and Retail Card markets in our key zone ofdevelopment, China and SE Asia. By providing our clients with universal processing capabilities,we will continuously create value for our clients, and our investors.Ultimately the primary data center is expected to be located in Beijing or Shanghai with asecondary site providing redundancy. Later additional data centers will be deployed across Asia(since card present transactions cannot take place across international borders). Connections withdomestic and international card processing providers will be made from each of these locations.The development effort is currently centered in Shenzhen China with additional key staffparticipating from around the globe. Call centers will be co-located in each center.Our services are planned to include database marketing (from the banks’ own customer file),third-party card issuing and merchant acquiring outsourced services, transaction processingservices, loyalty programs, and cardholder help desk services. Where appropriate, we will partnerwith third-party companies to deliver elements of the outsourced solution, including cardmanufacturers, mailing houses and logistics companies.There are in excess of 100 banks in China with debit or credit card issuing and merchant servicesprograms. Many of these are small regional operators that have no significant investment in cardservices and that primarily use China Union Pay to process debit card transactions on their behalf.Typically, the smaller banks have no credit card program whatsoever and Beijing is pushing forthem to get on board.We believe that a card base of 200,000+ is required to generate an acceptable return on investment.This means many of the smaller “tier 2 and 3 banks” will not be able to participate in the creditcard business and will lose existing customers to larger banks. We believe these smaller banksmake up approximately 20% of the credit card clearing service market in China.We believe there is significant opportunity in this area for us to offer these smaller banks apartial or complete outsourcing service for their card clearing. We have had discussions withseveral of these banks, and they have indicated strong interest in our services. We are activelypursuing relationships in China to access these opportunities and have recently appointed one ofour current directors, Benny Lee (an ex card industry executive in China & SE Asia), to this taskas Executive Director.We plan to have our sales force vigorously pursue this market during 2006 while the bankingindustry in China opens to foreign service providers. 3 In an immature card market such as China, withno established credit bureau services, the prepaid, or secured, credit cardsdominate the market.
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***Developments*****e-Charge Processing Service Corporation**In April 2004, our wholly-owned subsidiary, Asia Payments, Inc., entered into a Credit CardTransaction Processing and Clearing Settlement Services Agreement with e-Charge Processing ServiceCorporation, a Japanese corporation, and e-Charge USA, Inc., a Delaware corporation. The term ofthe agreement began April 8, 2004, and will continue until terminated six months following noticeof termination given by either party. We are to provide to e-Charge credit payment processingservices that include the following: **•** payment transaction data submitted to Asia Pay by e-Charge via the Internet  **•** Asia Pay to establish accounts with banks selected by e-Charge to process “yen to yen”transactions; and  **•** payment verification data returned to e-Charge.We will process these transactions with ClearCommerce (see above), pursuant to an agreement betweene-Charge USA, Inc. and ClearCommerce (now eFunds) that was assigned by e-Charge USA to oursubsidiary, Asia Payment, Inc. Further, we are required to advise e-Charge regarding third-partyservices provided in connection with the transaction processing. e-Charge has paid Asia Pay aninitial set-up fee and is to pay a fee for each transaction processed, with an agreed monthlyminimum fee of US$10,000 per month. In return, we are required to pay e-Charge a monthly lease feetotaling US$100,000 over a twenty-four month period, should we continue this business. The critical“yen to yen” banking facility has not yet been established; accordingly, by agreement between theparties, the stipulated mutual payments have not been made pending further discussion and newarrangements planned for 2006. Initial discussions have been held regarding a new businessagreement with eCharge which will involve a complete review of all financial aspects. As a resultwe do not expect to continue with the same schedule of charges as shown above and do not anticipatehaving to make the payments identified above unless and until they are confirmed in a newagreement.**DFS Okinawa K.K.**In May 2004, we entered into a System Development and Services Agreement with DFS OkinawaK.K., a Japanese corporation, which operates retail stores in Japan under the name “Duty FreeShop.” The term of the agreement began May 1, 2004, and ends July 1, 2006. The term will beautomatically renewed for successive one (1) year terms unless notice is given by either party notlater than six (6) months prior to the end of the term. We are required to establish and maintaina hardware and software platform that permits processing of credit card transactions and reports oncustomer and merchant transaction histories. We are also required to establish vendorrelationships to allow the processing and payment of the transactions, including access to clearingservices (for example, our agreement with GP Network described below) and transaction processingwith banks (provided as part of the clearing services or by agreement directly with banks). InJuly 2004, we completed the development of this platform, APAYcard, and DFS’s multi-lane retailmanagement product, supplied by Triversity, was modified to support the Asia Pay interface andprocessing model. The APAYcard system commenced live operation in December 2004, at the opening ofthe 83 lane DFS Galleria store in Okinawa, Japan. DFS paid a one-time set-up fee in 2004 when theAPAYcard system became operational for the Japanese market and is obligated to pay to us a fee foreach transaction processed. The set-up fee was accounted for as an offset of our research anddevelopment expense in 2004. The DFS model is a good example of what we are looking to repeat inthe multi-national retail space.
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**GP Network Corporation (GP Net)**InAugust 2004, we entered into a Services Agreement with GP Network Corporation — a Japanbased bankcard clearing network jointly owned by several local banks, VISA and Total Systems — toimplement a merchant payment processing service in Japan. The term of the agreement began August28, 2004, and ends August 23, 2007. This term will be automatically extended for successive one(1) year terms unless notice is given by either party not later than six (6) months prior to theend of the term. GP Network provides clearing house services that are required for us to provideour payment processing services to merchants. We send GP Network payment processing data, and theyforward it to the appropriate financial institution for payment. We do not owe any fees inconnection with this agreement. Fees are paid by the financial institution to GP Network. The GPNet model is a good example of what we are looking to repeat in terms of interfacing with Asianbankcard clearing networks; it allows us to load up value-added services at the front end.**Shanghai CRC Telecom Co., Ltd.**In September 2004, we entered into an agreement with SCRC. We agreed to pursue a partnershipto conduct pilot projects with SCRC to provide two basic services in China: (1) to create andimplement an individual and business credit reference service platform that meets internationalstandards, such as that used by Equifax, Experian and Trans Union, and (2) to establish a paymentprocessing system for merchants in China. We spent US$150,000 to date out of an initial budget of$300,000. The stated objective of both parties was to cause the partnership to become a premierinternational payment system provider in China.Since the project was initially conceived the Chinese Government has mandated the Chinese centralbank (the Peoples Bank of China) to establish and operate a central credit database for Chinesecitizens. This is as the result of a stated policy to reduce bad loans, but it also serves thenational purpose of retaining databases on Chinese Citizens under official Chinese control. Inaddition, the minimum capital for obtaining a license to operate the business, as advised by SCRC,is RMB 100 million (USD 12.5 million). It is also doubtful if foreign owned companies will begranted with such business license. As a result of this government policy SCRC has recommended andwe have accepted that the credit reference project be suspended and we do not have any ongoing orunpaid liability for the remainder of the budget which was initially agreedSCRC operates in the telecommunication, call center and bills connection services in China. Weagreed to install our standard payment processing system in the secure data center owned by SCRC,although subsequently the use of leased facilities housed by China Telecom was recommended by SCRCas the better option. These facilities were subsequently leased by SCRC on behalf of thepartnership. SCRC was also responsible to negotiate a competitive rate with Union Pay, the soleclearing house currently available in China, and obtain all the necessary government licenses.The leased telecommunication facilities and equipment organized by SCRC were pursuant to a separateequipment lease contract entered into on March 17, 2005. The lease term is two (2) years, withautomatic three year renewal terms unless notice is given by either party not later than 15 daysprior to the end of the term. We have paid SCRC approximately US$64,000 for the use of thesefacilities as well as for use of SCRC’s access to a nationwide telecommunications backbone. In viewof the suspension of the credit reference project we informed SCRC that the leased facilities wouldnot be required in the near term and in January 2006 the remainder of the lease term was settledfor a one time payment of Rmb. 135,000 (approx. US$16,875) with no further payment being owed.We are continuing to work closely with SCRC to identify credit and payment services opportunitiesin China. We expect to focus this cooperation via our wholly-owned Chinese subsidiary (WOFE) whichis based in Shanghai. The primary objective of our planning is to identify viable opportunitiesfor card and payment processing services in the national Chinese market. Our target is to identifyan initial business
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opportunity by approximately mid-2006. One potential opportunity identified earlier, i.e. theproposal to provide payment services to the Chinese railways has been significantly delayed due tothe restructuring of the national railway ministry into eight separate operating companies. Thisrestructuring will bring fundamental changes to the Chinese railways and until it is implementedand the new companies establish their business policies we do not expect to be able to make anyfurther progress. However, we have not dropped our interest in this sector as the long-termpotential is still considered significant.**Max to One Co., Ltd.**In December 2004, we entered into a Service Agreement with Max to One Co., Ltd. (“MTO”), aJapanese company based in Tokyo, for credit card clearing services in Japan. The term of theagreement began December 14, 2004, and ends December 13, 2007. This term will be automaticallyextended for successive one (1) year terms unless notice is given by either party not later thansix (6) months prior to the end of the term. MTO is a Japanese company based in Tokyo thatprocesses e-commerce and POS-based credit card transactions for Tokyo merchants. MTO also servesas an agent for Japanese domestic credit card companies. We plan to process bankcard transactionson behalf of MTO for MTO customers from which Asia Pay will receive a transaction fee from MTO.MTO will market the APAYcard system to retail chain merchants in Japan. We have recently mutuallyagreed with MTO for a non-exclusive agreement to market Asia Pay services to merchants in Japan.We are pursuing several opportunities in Japan and hope to have new relationships establishedbefore the end of 2006.**Beijing Purple Stars Appraisal Co., Ltd.**In December 2004, we entered into a memorandum of understanding with Beijing Purple StarsAppraisal Co., Ltd. (“BPS”). Our primary objective with BPS was to provide credit bureau systemsand related applications. Since the Chinese Government has mandated the Peoples Bank of China toestablish and operate a central credit database, as we referred to above re. SCRC we are notpursuing any opportunities with BPS in this field. We have agreed with BPS to focus on identifyingother payment processing opportunities and we continue to monitor the market for viableopportunities which will provide a good fit with the resources and expertise of BPS.**ET-china Ltd.**In June 2005, we signed an agreement with ET-china Limited of Guangzhou, China to invest in anecommerce system for the purpose of processing China pin debit cards from customers of ET-china.ET-china Limited provides air and hotel booking services to individual and corporate travelersprimarily in Guangdong, China. The agreement between ET-china and us is for both companies tocooperate to build out an ecommerce system in Shenzhen, China so that both ET-china’s customers aswell as Asia Pay’s future merchant customers will have access to use this ecommerce paymentprocessing system.In late 2005 and early 2006, we concluded that the planned investment had not been implemented asagreed. We have consulted Chinese legal counsel in Guangzhou, China who has advised that theinvestment agreement was ineffective from the legal standpoint. As a result, in mid-February, 2006we sent a notice to Guangdong Et-China Limited to refund the investment funds previously advanced.With the uncertainty of the claim at the time of the financial statements being prepared, we havedetermined that such investment became impaired. We intend to vigorously pursue our claims by allappropriate legal means.
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**Neteller Plc.**In June 2005, we signed a credit card processing service agreement with Neteller Plc. based inthe Isle of Man in the UK. We began processing transactions under an initial arrangement in lateMay and June of 2005. Subsequently Neteller acquired a processor based in the United Kingdom withthe objective of doing their processing internally. Whether Neteller will decide to do so in Asiaon an exclusive basis is not clear to us at present, but we do not expect Neteller to be asignificant customer for us in 2006.**Network for Electronic Transfers (S) Pte. Ltd. (NETS)**In August 2005 we announced that we had finalized the establishment of a fully ownedsubsidiary in Singapore known as Asia Payments Systems Pte. Ltd. We established this company inrecognition of Singapore’s role as a regional hub for South East Asia and to address interest frommulti-national merchants for multi-currency processing and settlement services. In September 2005we announced that our Singapore subsidiary had concluded an agreement for online transactionprocessing for credit cards and debit cards in Singapore and China with Network for ElectronicTransfers (S) Pte. Ltd. (NETS). NETS is Singapore’s leading electronic payments provider for thepast 20 years and operates NETS, Singapore’s leading online payments provider for credit cards,direct debit and “virtual accounts.” The agreement with NETS provides us with added capacity andflexibility to process transactions throughout the Asian region and in 2006 we expect to work withNETS in both Singapore and Shanghai to identify processing opportunities.**InterPay International Group Ltd.**In December 2005 we announced we had signed a strategic alliance agreement with InterPayInternational Group Limited (”InterPay”), a Singapore company, which is involved in credit andloyalty card operations in Southeast Asia. Subsequently, in February 2006 we announced that we hadreached a non-binding agreement to acquire InterPay in a share exchange transaction which willrequire us to issue 17,500,000 common shares to InterPay’s shareholders. Interplay nominees willget two seats on our board and the management teams, information systems and operations of bothcompanies will be integrated into one organization.We intend to move rapidly to complete the due diligence and consummate the transaction and weexpect that the acquisition will have a major impact on our business operations and growth plans.We have a target of integrating operations during the second quarter of 2006.**Global Uplink Communications Ltd.**In March 2006 we announced a Strategic Alliance with Uplink, a Chinese company, based inGuangzhou, Guangdong Province. Uplink operates a business in customer relationship management(CRM) and related services, with a client base which includes financial institutions andcorporations in Guangdong province and elsewhere in China. We plan to work with Uplink to develoployalty card and other programs, initially in Guangdong Province and subsequently in other majormarkets in China.***Ongoing Developments***We did not recognize any operating revenue from inception through December 31, 2004. Ourrevenue for 2005 was almost entirely from our agreement with DFS Group of Japan. We plan to beginproviding our payment processing services to merchants in China and Singapore in 2006. However, wedo not currently have sufficient liquidity and capital resources to implement this plan.
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For the card present market in Asia, our payment processing services platform is in production inJapan and is soon to be released in China, awaiting clearing house agreements. In addition, wehave installed a payment processing platform in Singapore.We plan to setup host systems for international (card not present) transactions either in Singaporeor one of the off shore or open market countries with which we are currently investigating bankingrelationships.In May 2005, we announced the completion of the APAYcard platform for processing paymenttransactions in China. The APAYcard system is our primary payment processing platform targeted foruse in China and other countries of opportunity in Asia. We are also in the process of completingrelationship agreements to link the APAYcard system with debit card clearing houses in China.***Other Developments***In October 2005, John Fraser resigned as Chairman of the Board due to the need to focus onother management responsibilities in Canada. Mr. Fraser continues to serve as a Director. In hisplace we appointed Robert Clarke as Chairman of the Board, a position he had held previously.Also in October 2005, Matt Mecke, our President and CEO, relinquished his executive positions tomake way for key senior appointments to enable Asia Pay to focus greater attention on revenuegrowth and consolidate its approach to developing business in China as well as other priority Asianmarkets. We replaced Mr. Mecke by appointing Robert Clarke as CEO and Benny Lee as President.Mr. Mecke subsequently resigned from the board in January 2006. To replace him we appointed Ms.Rosaline Tam to the board in March 2006. Ms. Tam has over 25 years experience in financialservices technology including senior management positions with MasterCard International, Citibankand American Express.***The Market and Competition***Our primary market is the credit card processing market. Although we are currentlyproviding services to DFS Group in Japan, our initial focus is on China. We also see strongpotential for our card processing solutions through our agreement with NETS in Singapore. We areconsidering expansion into other Asian markets.The market for credit card clearing services in China, with a population of 1.3 billion, isexpected to grow over the next six years at a compounded annual rate of growth in total credit cardloans of 88%. We expect growth from US$300 million in 2003 to US$13.2 billion in 2009. Inaddition, we believe that around only 10% of the merchants in China are capable of accepting cardsas compared with around 80% of U.S. and Japanese markets. The current transaction processinginfrastructure in China is significantly immature and incapable of supporting the anticipatedrobust growth. We are aggressively pursuing this opportunity to provide an infrastructure to bothmerchants and banks as customers of our third-party processing systems.Presently, Chinese merchants who wish to accept credit cards from customers must contact eitherChina Union Pay Merchant Services or one of the 140+ China Union Pay accredited banks to begin theprocess of determining their qualification to accept domestic China bankcards. There are noindependent third-party processing companies currently operating in China; however, First DataCorp. recently announced an agreement to provide merchant and card issuing services to ChinaEverbright Bank in Shanghai along and several other major industry players are now active.
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No providers are currently dominant in our primary target area, the credit card processing marketin China. In debit card processing, China Union Pay has over 90% market share, but this is notseen as a significant revenue area for us because there is increasingly less revenue in theprocessing of debit cards than in credit cards. Still, it is a market we must participate in. Wedo not believe there is a dominant player in the credit card market, but there are no publishedstatistics regarding this. Credit card services are provided by several banks, but the cardpopulation is extremely low because it is difficult to find merchants that accept this form ofpayment. Many of these credit cards have been issued to high income Chinese and are used moreoverseas than in China. Competitors are expected to include First Data, China Union Pay,HSBC/BOCOM [Bank of Communications], Citibank, EDS, and other Chinese banks.***Government Regulation and System Certification***We need to procure business operating licenses in China where we intend to develop business.Partnerships with Chinese institutions are necessary for foreign companies that wish to compete forthe affluent card market. Since the card market is for all intents and purpose now closed toforeigners, such an alliance is the only way to get in early, become acclimated, and master theskills needed for success.What’s more, if market conditions change and the government alters its regulatory agenda with aview to limiting the expansion of foreign companies, partnerships are less likely to be affected.With them in place, the foreigners can pounce if opportunities arise early and stay ahead of thecurve if the markets develop according to script.Credit cards are a prime example of the benefits of partnership: of the retail-lending products inChina’s banking market, few will grow faster.Chinese banks, with their enormous pools of retail customers, extensive branch networks, andestablished brand names, seem well-placed to seize the opportunity in credit cards on their own.But they are held back by the traditional Chinese reluctance to lend money without collateral, by alack of the skills needed to market credit cards to the more attractive customers, and by thedifficulty of managing risk in a market where credit bureau data are largely absent outsideShanghai.As an illustration of these problems, consider card issuance and risk control. About four millionto five million cards now circulate in the Chinese market, but the number of active cardholders isprobably only one-third that. This reality reflects the marketing approach of Chinese banks.Instead of targeting individuals, these institutions push cards to employees of theircorporate-banking customers, without assessing the likelihood that the cards will be used.The untargeted approach is unavoidable for many domestic banks because they have little centralizedcustomer data and lack the modeling skills to mine what data they do have. In many banks, riskcontrol is decentralized and thus heavily dependent on the limited skills of the frontline staff inthe branches. A bank could suffer an enormous loss if its portfolio of millions of credit cardsturned sour because of an economic downturn or poor risk-assessment practices. In 2003 many ofSouth Korea’s biggest credit card issuers had to write off enormous losses resulting from unfocusedmarketing tactics and lax risk controls.Domestic banks could hire skilled people from Chinese-speaking markets such as Hong Kong andTaiwan. Some, including China Merchants Bank, have actually done so, but more will rely onalliances with foreign companies to acquire the skills needed to build and manage a credit cardbusiness. Foreign companies such as Asia Pay have the risk-taking mind-set and theproduct-development, marketing, and risk-management skills that Chinese banks lack.Asia Pay is currently developing several Joint Venture (JV) arrangement options throughout China ona regional and nationwide basis for providing our card processing and clearing services. This isthe onlycurrent acceptable formula to China’s powerful financial regulator, the China Banking RegulatoryCommission (CBRC).
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The key to making a card partnership work is making it function seamlessly within the Chinesebanking system, so that the operating license belongs to the Chinese bank, the cards bear itsbrand, and card balances appear on its balance sheet. In reality, though, Asia Pay will run muchof the card operation.Given the uncertainties surrounding regulation and partnerships, we are working to create aportfolio of options covering a range of entry methods and products.4While it may be several years before the credit card market takes off in China, foreign companiesthat wait until the market opens up in 2007 may find that they are too late. Chinese banks lookingto compete with their foreign competitors are actively looking for acceptable partners andsolutions now to help then do so. Asia Pay has had significant ramp up time to develop theserelationships.In addition to the normal business operating licenses, we will be required to submit our systemsfor review and testing by VISA and MasterCard, as well as other card industry associations (e.g.AMEX, JCB, Diners, Discover, China Union Pay) to receive approval as a third-party technologyvendor of payment processing and clearing services to these credit card industry associations.With China business licenses held by our China partners and with international payment industryassociation certification, we plan to begin providing merchant bankcard payment processing andclearing services by cooperating with local banks and with the payment industry (China Union Pay)in China. Chinese financial transactions are administered and are overseen by the People’s Bank ofChina which operates and owns the China Union Pay network. The People’s Bank of China may alsodecide at any time that they would like to enforce additional certification of the security andsoundness of our systems. We do not assume that we will be able to process across all sectors ofthe China payments market, but we will undertake to develop relationships through our existingChina business partners and with the China Credit Card Processing Industry administrators and thePeople’s Bank of China. We will continue to build relationships with appropriate city, local,provincial and Central Government authorities to provide information about our credit cardprocessing operations and capabilities and seek approval from the authorities to perform additionalservices as required by our customers in the future.**Shanghai WOFE**In November 2005, we established a wholly-owned subsidiary in China. The new company,incorporated in Shanghai, is set up under legislation which permits wholly foreign ownedenterprises (often referred to as “WOFE”). The Shanghai WOFE, whose name in English is AsiaPayment Systems (China) Co., Ltd., gives us greater flexibility in implementing our programs andstrategies in China with or without local Chinese partners, as circumstances may require. As well,in situations where a Chinese joint venture is required our WOFE will make it easier toestablish the joint venture structure.For 2006 we expect to make the Shanghai company the main focus of our Chinese activities and as aconsequence will not continue with representative offices in Shenzhen and Beijing. Fullyfunctional business offices will be established in major Chinese cities as we build out ouroperations.Once potential joint ventures are concluded with Chinese partners, and we have determined the mostappropriate shareholding and management structures for such China opportunities, we will registerand file the required applications with the various governmental and business license agencies where weintend to operate our business. 4 HSBC has negotiated a partnership with Bank ofShanghai, teamed up with Ping An Insurance to acquire a small bank in Fujianprovince (SE China) and entered into partnership with the Shanghai-based Bankof Communications. HSBC’s portfolio of partnerships covers the attractivesegments of retail banking and insurance and focuses on players with a strongpresence in the more attractive coastal cities.
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Our business in China may be adversely affected by changes in political and social conditions.This may include changes in governmental policies with respect to laws and regulations,inflationary measures, currency conversion and remittance abroad as well as rates and methods oftaxation. While China’s government is expected to continue its economic reform policies, many ofthe reforms are new or experimental and may be refined or changed. It is possible that a change inthe PRC leadership could lead to changes in economic policy.***Employees***As of December 31, 2005, we had ten (10) employees. None of our employees are represented by alabor union and we believe that our employee relations are good.***Our Facilities***We rent corporate service located at 800 5th Avenue, Suite 4100, Seattle, WA andThe Chrysler Building, 405 Lexington Avenue, 26th Floor New York, NY. We also rent an 800 squarefoot finance and administration office at the Ocean Centre, Rm. 1430, Kowloon, Hong Kong for a oneyear term expiring March 2006 at a monthly rental of $1,282, which will be on month to monththereafter. We have a representative office located at 15C Sea View Square, 18 Tauzin Road, Shekou,Shenzhen, China for 1,400 square feet for a one year term expiring July 2006 at a monthly rental of$1,025. In February 2006 in anticipation of organizational changes expected as a result of theplanned acquisition of InterPay International and the transition of our main Chinese activities toShanghai we made the decision to close the Shenzhen representative office and terminate the NewYork corporate service as of the end of March 2006.***Risk Factors*****We have a limited history of operations, and we do not have enough liquidity and capitalresources to implement our full plan of operation.**We have a limited history of operations. We currently do not have sufficient capital or customersto implement our plan of operation. If we are unable to raise sufficient additional capitalthrough the sale of debt or equity, or a combination or both, within the next three to six months,we will likely not be able to implement our current business plan and may not succeed in thismarket.Our industry involves establishing credit card processing/banking systems with mature and stabletechnology. We have recently observed changes in technology as evidenced by the Internet andInternet-related services and applications, new and better software, faster computers, and modemsbut the basic systems for the payment processing industry have not changed significantly. Astechnology changes, our customers will expect more and better services. Our success will depend onour ability to use existing technology and to develop and market new services. The costs andexpenses associated with such an effort will be significant. Currently, we do not have sufficientcapital and customers to carry out our full business plan. There is no assurance that we will beable to obtain the funds necessary to acquire the necessary technology. Even if such funds becomeavailable, we cannot assure that we can successfully develop new services for the Chinese creditcard market. Any failure to provide state of the art technology to our customers or delays inproviding services could cause us to lose customers to our competitors.
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**We are currently dependent upon our relationship with one customer, DFS, for revenue and upon ourrelationship with Asian partners for future potential revenue.**The loss of either of these relationships would negatively impact our business plan.**We require additional financing to be able to meet our current liabilities, and we have doubtsabout our ability to continue as a going concern.**Our auditors’ report on our consolidated financial statements for the fiscal year ended December31, 2005 raises substantial doubt about our ability to continue as a going concern. We needadditional cash during the next twelve months to finance operations and to pay approximately$386,000 of existing payables and our additional commitments of approximately $80,000 per month.We had revenue of $43,949 in 2005. At December 31, 2005, we had cash of $110,566. This has beenreduced during 2006. If we are unable to generate significant cash flow before the end of thesecond quarter of 2006, we will be required to curtail operations substantially, and seekadditional capital. There is no assurance that we will be able to obtain additional capital onterms and conditions favorable to us, if at all.**Our results of operations are subject to significant foreign economic and political risks.**Our operations are being established in the People’s Republic of China (“PRC”). Accordingly, ourbusiness, financial condition and results of operations may be influenced by the political,economic and legal environments in the PRC, and by the general state of the PRC economy.Our operations in the PRC are subject to special considerations and significant risks not typicallyassociated with companies in the North America and Western Europe. These include risks associatedwith, among others, the political, economic and legal environment and foreign currency exchange.Our results may be adversely affected by changes in the political and social conditions in the PRC,and by changes in governmental policies with respect to laws and regulations, anti-inflationarymeasures, currency conversion, remittances abroad, and rates and methods of taxation, among otherthings.**We have no history of operations in China to predict the level of market acceptance we can expectfor our services.**Our success and growth will depend upon our ability to market our payment processing services inChina. We have no experience in this market and we cannot reliably predict the time it will takefor our services to be accepted by Chinese merchants, if at all.**Most of our competitors have substantially greater financial, technical and marketing resourcesthan us.**Information is very limited on the size and capabilities of most of our competitors in China. Ourcompetitors are large established companies with far greater financial resources than us; however,their technical and marketing resources in China may not be as focused on our target market. Localbanks have large sales teams but they are typically unmotivated and provide poor service levels. Inthe area of technical resources, we believe there is little knowledge in the card processing area.We believe that wehave a good understanding of prevailing technologies. In most cases, we do not believe that ourcompetitors can deliver the same quality of service and software as we can; however, ourcompetitors can use their financial advantage to update their cumbersome internal systems tocompete with us.
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**We are substantially dependent upon the continued service of our key technical and managerialpersonnel.**Our success has been and will continue to be dependent on the services of our key technical andmanagerial personnel. We also believe that our success depends on our ability to continue to beable to attract, retain and motivate highly skilled technical and management employees andconsultants who are in great demand. There is no assurance that we will be able to attract andretain such employees, and our failure to do so could adversely affect our business.**We may be required to indemnify our officers and directors for liability to shareholders or thepublic.**Our articles of incorporation and bylaws provide that we will indemnify any director, officer,agent and/or employee for liabilities on the terms and conditions permitted by the corporate lawsof the State of Nevada. We may purchase and maintain insurance on behalf of any such personswhether or not we would have the power to indemnify such person against the liability insured.This could result in substantial expenditures by us and prevent our recovery from such officers,directors, agents and employees for losses incurred by us as a result of their actions. We havebeen advised that, in the opinion of the Securities and Exchange Commission, such indemnificationis against public policy as expressed in the Securities Act of 1933, as amended, and is, therefore,unenforceable.**We do not plan to pay dividends and shareholders may not receive any return on their investment.**We do not plan to pay dividends, cash or otherwise, on our common stock in the foreseeable future.Future dividends will depend on earnings, if any, our financial requirements and other factorsbeyond our control.**Our disclosure contains forward-looking statements that are subject to risks, uncertainties, andassumptions; our actual results may differ materially from those anticipated in the forward-lookingstatements.**Our disclosure contains forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. These include statements about our expectations, beliefs,intentions or strategies for the future, which we indicate by words or phrases such as“anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “our company believes,” “managementbelieves” and similar language. The forward-looking statements are based on our currentexpectations and are subject to certain risks, uncertainties and assumptions, including those setforth in this annual report. Our actual results may differ materially from results anticipated inthese forward-looking statements. We base the forward-looking statements on information currentlyavailable to us, and we assume no obligation to update or revise them, whether as a result of newinformation, future events or otherwise. In addition, our historical financial performance is notnecessarily indicative of the results that may be expected in the future and we believe that suchcomparisons cannot be relied upon as indicators of future performance.
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**The market price for shares of our common stock could be volatile and you may be unable to resellyour shares in the market.**The market price for the shares of our common stock may fluctuate in response to a number offactors, many of which are beyond our control. Such factors may include, without limitation, thegeneral economic and monetary environment and the open-market trading of our shares in particular.Such market trading may include speculative short-selling by speculators. Investors may be unableto resell their shares in the market due to variations in trading volume or other marketconditions.**We cannot guarantee the continued existence of an established public trading market.**Although our common stock is quoted on the OTC Bulletin Board, a regular trading market for oursecurities may not be sustained in the future. The NASD has enacted recent changes that limitquotations on the OTC Bulletin Board to securities of issuers that are current in their reportsfiled with the Securities and Exchange Commission. We cannot determine the effect of these andother recent changes on the OTC Bulletin Board at this time. The OTC Bulletin Board is aninter-dealer, over-the-counter market that provides significantly less liquidity than the NASD’sautomated quotation system (the “Nasdaq Stock Market”). Quotes for stocks included on the OTCBulletin Board are not listed in the financial sections of newspapers as are those for the NasdaqStock Market. Therefore, prices for securities traded solely on the OTC Bulletin Board may bedifficult to obtain and holders of common stock may be unable to resell their securities at or neartheir original offering price or at any price. Market prices for our common stock will beinfluenced by a number of factors, including: **•** the issuance of new equity securities pursuant to a future offering;  **•** changes in interest rates;  **•** competitive developments, including announcements by competitors of new products orservices or significant contracts, acquisitions, strategic partnerships, joint ventures orcapital commitments;  **•** variations in quarterly operating results;  **•** change in financial estimates by securities analysts;  **•** the depth and liquidity of the market for our common stock;  **•** investor perceptions of our company and the payment processing services and credit cardclearing services industries generally; and  **•** general economic and other national conditions.**Broker-dealer requirements may affect the trading and liquidity of shares of our common stock.**Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny stocks to provide potential investors witha document disclosing the risks of penny stocks and to obtain a manually signed and dated writtenreceipt of the document before effecting any transaction in a penny stock for the investor’saccount. Potential investors in our common stock are urged to obtain and read such disclosurecarefully before purchasing any shares that are deemed to be “penny stock.” Moreover, Rule 15g-9requires broker-dealers in penny stocks to approve the account of any investor for transactions insuch stocks before selling any penny stock to that investor. This procedure requires thebroker-dealer to (i) obtain from the investor information concerning his or her financialsituation, investment experience and investment objectives; (ii) reasonably determine, based onthat information, that transactions in penny stocks are suitable for the investor and
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that the investor has sufficient knowledge and experience as to be reasonably capable of evaluatingthe risks of penny stock transactions; (iii) provide the investor with a written statement settingforth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive asigned and dated copy of such statement from the investor, confirming that it accurately reflectsthe investor’s financial situation, investment experience and investment objectives. Compliancewith these requirements may make it more difficult for holders of our common stock to resell theirshares to third parties or to otherwise dispose of them in the market.**Existing shareholders may experience some dilution upon the exercise of outstanding warrants.**The holders of some of our warrants have up to four years from their issuance date to exercisetheir warrants with exercise prices ranging from $0.16 to $1.75 per share. Exercise of thesewarrants may cause dilution in the interests of other shareholders as a result of the additionalcommon stock that would be issued upon exercise. In addition, sales of the shares of our commonstock issuable upon exercise of the warrants could have a depressive effect on the price of ourstock, particularly if there is not a coinciding increase in demand by purchasers of our commonstock. Further, the terms on which we may obtain additional financing during the period that anyof the warrants remain outstanding may be adversely affected by the existence of these warrants.Moreover, we will need to raise additional funds in the future to finance our existing operations.If we raise additional funds through the issuance of new equity or equity-linked securities, otherthan on a pro rata basis to our existing shareholders, the percentage equity ownership of theexisting shareholders will be reduced. Existing shareholders may experience subsequent dilution,and such newly issued securities may have rights, preferences and privileges senior to those of theexisting shareholders.**Our principal shareholders, current executive officers and directors own a significant percentageof our company and will be able to exercise significant influence over our company.**Our principal shareholders, current executive officers and directors together beneficially own over38% of our common stock. Accordingly, if acting together, these shareholders may be able toeffectively determine the composition of our board of directors, may retain the effective votingpower to approve all matters requiring shareholder approval, may prevail in matters requiringshareholder approval, including, in particular the election and removal of directors, and maycontinue to have significant influence over our business. As a result of their ownership andpositions, our directors and executive officers collectively are likely able to influence allmatters requiring shareholder action, including approval of significant corporate transactions. Inaddition, sales of significant amounts of shares held by our directors and executive officers, orthe prospect of these sales, could adversely affect the market price of our common stock.**We face chargeback liability if our merchants refuse or cannot reimburse chargebacks resolved infavor of their customers, and we face liability to our merchant customers.**Our merchant processing operations include merchant acquiring, where we are a direct party tocontracts with merchants regarding our provision of card processing services for the merchant, andwe are subject to the associated risk that a cardholder billing dispute will be resolved in favorof the cardholder (referred to as a cardholder “chargeback”).In our merchant acquiring business, if we are unable to collect the chargeback amounts from ourmerchant customer’s account, or if the merchant refuses or is financially unable to fund theseamounts due to insolvency or bankruptcy or other reasons, we must bear the credit risk for the fullamount of therefund paid to the cardholder’s financial institution. We require cash deposits and other types ofcollateral from certain merchants to minimize any such risk.
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In addition, we utilize a number of systems and procedures to manage merchant risk and believe thatthe diversification of our merchant portfolio among industries and geographic regions minimizes ourrisk of loss. We recognize a reserve for estimated merchant credit losses based on historicalexperience and other relevant factors. This reserve amount is subject to the risk that actuallosses may be greater than our estimates.**If the security of our databases is compromised, our reputation could suffer and our business couldbe adversely affected.**We collect personal consumer data, such as names and addresses, social security numbers, driver’slicense numbers, checking and savings account numbers, and payment history records. Unauthorizedaccess to our databases could result in the theft or publication of personal confidentialinformation and the deletion or modification of personal records or otherwise cause interruptionsin our operations. These concerns about security are increased when we transmit information overthe Internet. A security or privacy breach could: **•** deter customers from using our products and services;  **•** harm our business and reputation;  **•** expose us to liability; or  **•** increase our operating expenses to correct problems caused by the breach.**Any one or more of the foregoing occurrences could have a material adverse effect on our business,financial condition, and results of operations.**If we experience system failures, the products and services we provide to our customers could bedelayed or interrupted, which could harm our business and reputation and result in the loss ofcustomers.Our ability to provide reliable service largely depends on the efficient and uninterruptedoperations of our computer network systems and data centers. Our systems and operations could beexposed to damage or interruption from fire, natural disaster, power loss, telecommunicationsfailure, unauthorized entry, and computer viruses. Although we have taken steps to prevent systemfailures, we cannot be certain that our measures will be successful. Further, our property andbusiness interruption insurance may not be adequate to compensate us for all losses or failuresthat may occur. Any significant interruptions could: **•** increase our operating expenses to correct problems caused by the interruption;  **•** harm our business and reputation;  **•** result in a loss of customers; or  **•** expose us to liability.Any one or more of the foregoing occurrences could have a material adverse effect on our business,financial condition, and results of operations.
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**Our recently announced agreement to acquire our strategic partner, InterPay International GroupLimited, may not be completed which will adversely affect our operations, future growth andfinancial results.**Our recently announced agreement to acquire our strategic partner, InterPay International GroupLimited, is subject to due diligence and the completion of final documentation and may not becompleted. Failure to complete this acquisition will adversely affect our future growth and willrequire us to find new strategic partners for our business plans in China and elsewhere.**ITEM 2. DESCRIPTION OF PROPERTY*****Property Held by Us***We do not own any real estate. We do not own any inventory. Our capital assets are primarilycomprised of computer equipment.***Our Facilities***We rent corporate service located at 800 5th Avenue, Suite 4100, Seattle,Washington and The Chrysler Building, 405 Lexington Avenue, 26th Floor New York, NY. We also renta finance office at the Ocean Centre, Rm. 1430, Kowloon, Hong Kong. . We have a representativeoffice located at 15C Sea View Square, 18 Tauzin Road, Shekou, Shenzhen, China for 1,400 squarefeet for a one year term expiring July 2006 at a monthly rental of $1,025 with early termination ofone month notice. We made the decision to close the Shenzhen representative office and terminatethe New York corporate service as of the end of March 2006.**ITEM 3. LEGAL PROCEEDINGS**None**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**None
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**PART II****ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASESOF EQUITY SECURITIES**On March 9, 2006, we had 104 shareholders of record. In February 2004, our securitiescommenced trading on the OTC Bulletin Board operated by the National Association of SecuritiesDealers, Inc. under the symbol “APYM.OB”.The following table sets forth the closing high and low bid prices of the common stock for eachquarter within the last two years, from February 2004 through December 2005. The quotations reflectinter-dealer prices and do not represent retail mark-ups, markdowns, commissions, and may notreflect actual transactions.                   2005  2004   High  Low  High  Low Quarter ended                                 March 31 $2.33  $0.43  $0.85  $0.10                  June 30 $2.65  $0.81  $0.74  $0.22                  September 30 $1.59  $0.71  $0.51  $0.12                  December 31 $0.77  $0.26  $0.48  $0.09 Emerging companies and the stock market generally have experienced significant price and volumefluctuations. Similarly, the market price of our common shares may fluctuate related to a numberof events and reasons, often not related to or consistent with operating performance.***Dividends***We have not declared any cash dividends, nor do we intend to do so in the foreseeable future.***Unregistered sales of securities***On or about January 6, 2005, we issued 375,000 shares of common stock for a contract with anaccredited investor to perform strategic planning, public relations and marketing services providedover the following four months, subject to completion of the services. The shares were valued at$0.47 per share, the closing market price of our common stock on the date of the transaction for atotal offering of $176,250. The offer and sale of the shares was exempt from the registration andprospectus delivery requirements of the Securities Act of 1933 by virtue of Section 4(2) and Rule506 of Regulation D. Thesale did not involve a public offering or general solicitation. No commissions were paid on theoffer and sale of the shares. The stock certificates issued contained a restrictive legend inaccordance with Rule 144. The offer was closed on or about January 6, 2005.
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On or about January 6, 2005, we issued 250,000 shares of common stock for a contract with anaccredited investor to perform strategic planning, public relations and marketing services providedover the following three months, subject to completion of the services. The shares were valued at$0.47 per share, the closing market price of our common stock on the date of the transaction for atotal offering of $117,500. The offer and sale of the shares was exempt from the registration andprospectus delivery requirements of the Securities Act of 1933 by virtue of Section 4(2) and Rule506 of Regulation D. The sale did not involve a public offering or general solicitation. Nocommissions were paid on the offer and sale of the shares. The stock certificates issued containeda restrictive legend in accordance with Rule 144. The offer was closed on or about January 6,2005.On or about February 17, 2005, we issued 500,000 shares of common stock for a contract with anaccredited investor to perform strategic planning, public relations and marketing services over thefollowing six months, subject to completion of the services. We are also obligated to issue anadditional 1,500,000 shares over the next seven months as follows: 500,000 shares on February 17,2005, 1,000,000 shares on May 1, 2005, and 500,000 shares on September 17, 2005, all subject tocompletion of the services The shares were valued at $1.07 per share, the closing market price ofour common stock on the date of the transaction, for a total offering price of $2,140,000. Theoffer and sale of the shares was exempt from the registration and prospectus delivery requirementsof the Securities Act of 1933 by virtue of Section 4(2) and Rule 506 of Regulation D. The sale didnot involve a public offering or general solicitation. No commissions were paid on the offer andsale of the shares. The stock certificates issued contained a restrictive legend in accordancewith Rule 144. The offer was closed on or about February 17, 2005.On or about January 20, 2005, we issued 62,500 shares of common stock to one accredited investorat $0.40 per share for total cash proceeds of $25,000. The offer and sale of the shares wasexempt from the registration and prospectus delivery requirements of the Securities Act of 1933 byvirtue of Section 4(2) and Rule 506 of Regulation D. The sale did not involve a public offering orgeneral solicitation. No commissions were paid on the offer and sale of the shares. The stockcertificates issued to the purchaser contained a restrictive legend in accordance with Rule 144.The offer was closed on or about January 20, 2005.On or about February 15, 2005, we issued 50,334 shares of common stock to three accreditedinvestors at $0.60 per share for total cash proceeds of $30,200. The offer and sale of the shareswas exempt from the registration and prospectus delivery requirements of the Securities Act of 1933by virtue of Section 4(2) and Rule 506 of Regulation D. The sale did not involve a public offeringor general solicitation. No commissions were paid on the offer and sale of the shares. The stockcertificates issued to the purchaser contained a restrictive legend in accordance with Rule 144.The offer was closed on or about February 15, 2005.On or about February 18, 2005, we issued 149,254 shares of common stock to one accredited investorat $0.67 per share and warrants to purchase 150,000 shares for total cash proceeds of $100,000.The warrants are exercisable until March 10, 2008 at an exercise price of $1.20 per share. Theoffer and sale of the shares was exempt from the registration and prospectus delivery requirementsof the Securities Act of 1933 by virtue of Section 4(2) and Rule 506 of Regulation D. The sale didnot involve a public offering or general solicitation. No commissions were paid on the offer andsale of the shares. The stock certificates issued to the purchaser contained a restrictive legendin accordance with Rule 144. The offer was closed on or about February 18, 2005.On or about March 18, 2005, we issued 113,332 shares of common stock to four accredited investorsat $0.75 per share for total cash proceeds of $85,000. The offer and sale of the shares was exemptfrom the registration and prospectus delivery requirements of the Securities Act of 1933 by virtueof Section 4(2) and Rule 506 of Regulation D. The sale did not involve a public offering orgeneral solicitation. Nocommissions were paid on the offer and sale of the shares. The stock certificates issued to thepurchaser contained a restrictive legend in accordance with Rule 144. The offer was closed on orabout March 8, 2005.
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On or about March 18, 2005, we issued 252,305 shares of common stock to 18 accredited investors at$0.85 per share and warrants to purchase 252,305 shares for total cash proceeds of $214,495. Thewarrants are exercisable until March 15, 2007, at an exercise price of $1.75 per share. The offerand sale of the shares was exempt from the registration and prospectus delivery requirements of theSecurities Act of 1933 by virtue of Section 4(2) and Rule 506 of Regulation D. The sale did notinvolve a public offering or general solicitation. No commissions were paid on the offer and saleof the shares. The stock certificates issued to the purchaser contained a restrictive legend inaccordance with Rule 144. The offer was closed on or about March 18, 2005.In July and August 2005, the Company issued 1,088,159 shares of common stock to 13 accreditedinvestors at $0.95 per share and warrants to purchase 1,088,159 shares for net cash proceeds of$900,375. The warrants are exercisable until July and August, 2009, at an exercise price of $1.50to $2.00 per share. Warrants to purchase 1,000,000 shares of common stock were issued to theplacement agent. The warrants are exercisable until July and August 2010 at an exercise price of$0.7125 per share. The offer and sale of the shares was exempt from the registration andprospectus delivery requirements of the Securities Act of 1933 by virtue of Section 4(2) and Rule406 of Regulation D. The sale did not involve a public offering or general solicitation. Thestock certificates issued to the purchaser contained a restrictive legend in accordance with Rule144. The offer was closed on or about August 10, 2005.Strasbourger Pearson Tulcin Wolff, Inc. acted as our placement agent in the financing and receivedthe following remuneration: **•** a cash selling commission equal to 8% of the gross sales proceeds of theoffering ($82,700);  **•** a cash non-accountable expense allowance equal to 2% of the gross salesproceeds of the offering ($20,675) plus $30,000, a total of $50,675; and  **•** warrants to purchase a total of 1,000,000 shares of common stock at anexercise price per share of 75% of the price paid in the offering ($0.7125)exercisable through July – August 2010.In December 2005, the Company issued 312,500 shares of common stock for the settlement of amountsdue to consultant for the consultancy contract of $100,000. The shares were valued at $0.32 pershare, which was the closing market price of the Company’s common stock on the date of thesettlement. The offer and sale of the shares was exempt from the registration and prospectusdelivery requirements of the Securities Act of 1933 by virtue of Section 4(2) and Rule 406 ofRegulation D. The sale did not involve a public offering or general solicitation. The stockcertificates issued to the purchaser contained a restrictive legend in accordance with Rule 144.The offer was closed on or about December 12, 2005.We did not repurchase any of our common stock during the fourth quarter of the fiscal year coveredby this report.***Securities authorized for issuance under equity compensation***In 2004 we adopted the 2004 Nonqualified Stock Option Plan (the “Plan”) as described in ourForm S-8. The Plan provides for the issuance of stock options for services rendered by officers,directors, employees and consultants. The Board of Directors is vested with the power to determinethe terms and conditions of the options. The Plan includes 5,000,000 shares. During the year endedDecember 31, 2005, the company granted 370,000 stock options pursuant to the Plan at exerciseprices ranging from
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$0.001 to $2.24 per share, of which 300,000 stock options were granted to non-employees. 2,275,000options were exercised and 12,000 options were forfeited. Under the Plan, 1,188,000 options areoutstanding and 20 options are available for issuance as at December 31, 2005.                                 **Number of securities**  **Number of**     **remaining available**  **securities to be**     **for future issuance**  **issued upon** **Weighted-average** **under equity**  **exercise of** **exercise price of** **compensation plans**  **outstanding options,** **outstanding options,** **(excluding securities**  **warrants and rights** **warrants and rights** **reflected in column**  **(a)** **(b)** **(a))**Equity compensationplans approved bysecurity holders  0   0   0              Equity compensationplans not approvedby security holders  1,188,000  $0.288   20 In 2005 we adopted the 2005 Nonqualified Stock Option Plan (the “Plan”) as described in our FormS-8. The Plan provides for the issuance of stock options for services rendered by officers,directors, employees and consultants. The Board of Directors is vested with the power to determinethe terms and conditions of the options. The Plan includes 5,000,000 shares. During the year endedDecember 31, 2005, the Company granted 4,590,000 stock options pursuant to the Plan at exerciseprices ranging from $0.001 to $1.12 per share, of which 3,790,000 stock options were granted tonon-employees. 850,000 options were exercised and no options were forfeited. Under the Plan,3,740,000 options are outstanding and 410,000 options are available for issuance as at December 31,2005.                       Number of securities          remaining available for  Number of securities to Weighted-average future issuance under  be issued upon exercise exercise price of equity compensation  of outstanding options, outstanding options, plans (excluding  warrants and rights warrants and rights securities reflected in  (a) (b) column (a))Equity compensationplans approved bysecurity holders  0   0   0              Equity compensationplans not approvedby security holders  3,740,000  $0.78   410,000 ***Section 15(g) of the Securities Exchange Act of 1934***Our shares are covered by section 15(g) of the Securities Exchange Act of 1934, as amended,that imposes additional sales practice requirements on broker/dealers who sell such securities topersons other than established customers and accredited investors (generally institutions withassets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 or annualincome exceeding $200,000 or $300,000 jointly with their spouses). For transactions covered by theRule, the broker/dealer must make a special suitability determination for the purchase and havereceived the purchaser’s writtenagreement to the transaction prior to the sale. The Rule may affect the ability of broker/dealersto sell our securities and also may affect your ability to sell your shares in the secondarymarket.
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Section 15(g) also imposes additional sales practice requirements on broker/dealers who sell pennysecurities. These Rules require a one page summary of certain essential items. The items include: **•** the risk of investing in penny stocks in both public offerings and secondary marketing;  **•** terms important to in understanding of the function of the penny stock market, such as“bid” and “offer” quotes, a dealers “spread” and broker/dealer compensation;  **•** the broker/dealer compensation,  **•** the broker/dealers duties to our customers, including the disclosures required by anyother penny stock disclosure rules;  **•** the customers rights and remedies in causes of fraud in penny stock transactions;  **•** the NASD’s toll free telephone number and  **•** the central number of the North American Administrators Association, for information onthe disciplinary history of broker/dealers and their associated persons.**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION*****Forward-Looking Statements***You should read the following discussion of our financial condition and operations inconjunction with the consolidated financial statements and the related notes included elsewhere inthis prospectus. This prospectus contains forward-looking statements (within the meaning ofSection 27A of the Securities Act and Section 21E of the Exchange Act). These include statementsabout our expectations, beliefs, intentions or strategies for the future, which we indicate bywords or phrases such as “anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “ourcompany believes,” “management believes” and similar language. The forward-looking statements arebased on our current expectations and are subject to certain risks, uncertainties and assumptions,including those set forth in the discussion under the sections of “Business,” “Risk Factors”, and“Management’s Discussion and Analysis.” The actual results may differ materially from resultsanticipated in these forward-looking statements. We base the forward-looking statements oninformation currently available to us, and we assume no obligation to update them. In addition, ourhistorical financial performance is not necessarily indicative of the results that may be expectedin the future and we believe that such comparisons cannot be relied upon as indicators of futureperformance.Currently, we do not have sufficient capital to implement our entire plan of operations. Theinformation contained herein reflects a prospective plan of future operation. There is noassurance that the plan will be implemented.
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***Systems and Technology Implementation to meet our Business Needs***Asia Pay’s strategy is to first focus on providing credit card processing services to retailmerchants in our key zone of development, China and SE Asia and then once a critical mass ofmerchant accounts has been enrolled, we will then market this merchant acquiring5base to selected banks (mostly Chinese). At this stage — or earlier, based on availablefinancing and opportunities — we will have established sufficient volume, reputation and momentumto pursue credit card clearing customers and roll out our more lucrative credit card clearingservices (card issuing and card program outsourcing).There is a short discussion on our credit card issuing service below but the focus of this sectionis on our current payment processing service offering.Our systems and technology are implemented to meet the requirements of the two main focus areas ofour business: 1. payment processing services  2. credit card clearing servicesAs an “acquiring processor,” Asia Pay provides bankcard6transaction7 processing and merchant acquiring services to our customers. We performauthorization and settlement8 of bankcard payments, handling many types of credit andpayment cards (such as Visa, MasterCard, and American Express) for local and international cardsand currencies.If merchants wish to sell their products to cardholders, they retain the services of one or moreprocessors who handle the credit cards that the merchant wishes to accept. When a merchant retainsthe services of a credit card processor, it is issued a merchant ID. A commission fee (discountrate) is charged on each transaction, as well as a setup/installation fee.A merchant has an account with an acquiring bank9  which deposits the value ofthe day’s credit card sales to the merchant’s bank account once settled. Acquirers buy (acquire)the merchant’s sales slips and credit the tickets’ value to the merchant’s account. Asia Payprocess the credit card sales in real-time and typically performs settlement on the agreed upondaily schedule.To supplement our payment processing services, we provide online real-time adjustments,reconciliation, currency conversion (where applicable), reporting and operational services, as wellas advanced settlement, disbursement and billing service options. Asia Pay offers 24 hour accessto all transaction information and since Asia Pay’s database captures transaction data inreal-time, all reports provide an accurate reflection of account activity. In addition, our securebrowser-based reporting tools allows searching and sorting by multiple points including, date,credit card, order number and reference number and our database maintains complete retention oftransaction details. 5 Acquirer: a bank or company that acquiresdata relating to transactions from a merchant or card acceptor forprocessing. 6 Bankcard: a financial transaction card(credit, debit, etc.) issued by a financial institution. 7 Transaction: a transaction is considered bymost credit card processors to take place when a request for authorization orcapture is passed through to them. Therefore, each authorization request andeach capture request is a separate transaction. 8 Settlement: as the sales transaction valuemoves from the merchant to the acquiring bank, to the issuer, each party buysand sells the sales ticket. Settlement is what occurs when the acquiring bankand the issuer exchange data or funds during transactions. 9 A bank that receives the credit cardtransactions and then settles with the issuing banks. Bank that signs up /enables the merchant to process transactions.
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Wesupport two card markets for our payment processing services: 1. card present — physical card swipe by the consumer e.g. Point Of Sale (POS)terminal, typical retail store sale  2. card not present — no physical card contact, card details given over phone orsubmitted electronically by the consumer, e.g. e-commerce, typical online store saleAsia Payprovides a variety of card payment solutions for merchants — not just POS terminal paymentprocessing. One of our differentiators is that our systems have been designed to accept paymentsfrom a variety of access points in Asia, including **•** e-commerce  **•** m-commerce (payment transactions originating from a mobile phone)  **•** online billing, e.g. telco or utility billing service  **•** transactions generated from most customer systems such as kiosks, IVR or CRM  **•** a web based virtual POS terminal used for capturing bankcard transactions by call center staffBut it’s the card present market which is the focus of for our payment processing business. Tomeet our business objectives in this space and establish Asia Pay as a market leader we aredeveloping a wide variety of POS bankcard processing solutions to meet the diverse requirements ofthe Asian market — which includes new and legacy card systems, local and international retailers,standalone and sophisticated multi-lane systems, varied encryption and card types, multipleregulations, languages, currencies and cultures.We will partner with competitors where appropriate to implement solutions that are superior intechnological terms to those currently offered in China and in Asia by local banks. Rapiddeployment of our services in China is a major differentiator. Our foreign competitors will bringin large scale proprietary systems which require significant implementation time, resources,integration issues and costs.For Asia we had to develop our own robust bankcard payment transaction processing platform (brandedAPAYcard) and since it was built from the ground-up for this market we are able to bringinternational technology and card features to our customers while providing a single point ofinterface to an extensive network of banks, bankcard networks, clearing houses and card serviceproviders.It has been designed to switch10 transactions received from merchants to the relevantfinancial institutions and clearing houses, card network processors (such as GP Net in Japan andChina Union Pay) and local banks, from where the transaction is sent on to the relevant card issuerfor payment. This switching will also be done later on a cost performance/features basis and toprovide Direct Currency Conversion (DCC)11 features to our merchants.Currently Asia Pay supports the following currencies: **•** Chinese Yuan  **•** Singapore Dollar  **•** Hong Kong Dollar  **•** Japanese Yen  **•** US Dollar  **•** all major European currencies (card not present environment only) 10 Payment transaction data received onthe front end, in a common XML format, is centrally processed then routed on to theappropriate clearing house at the back end in the appropriate format. Here itis forwarded on to the necessary card issuer. In essence, APAYcard providesthe necessary switch to facilitate the payment transaction. 11 For merchants who wish to offer theircustomers the ability to pay in their own currency which in turn enables themerchant to make a little money on the exchange rate
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In developing APAYcard, we have taken an open systems approach, using industry standardtechnologies and networks, to produce a system which is fast, efficient, robust and scalable. Ourinitial versions are built on a Microsoft platform and we plan Linux versions in the near future.We have no long term strategy to become a “software house.” Long term we’ll purchase higher-endoff-the-shelf products and/or partner with or acquire card systems’ companies for additional cardfeatures. APAYcard will then be part of a suite of product offerings. In the meantime it fills anopportunity gap, with the following reasons justifying the need for an in-house solution: **•** No good fit off-the-shelf product available to meet immediate known requirements in ourtarget Asian marketplace  **•** Must integrate with multiple disparate Asian networks banking networks  **•** Diversity of merchant POS technology (old and new)  **•** High degree of control and flexibility needed  **•** Experience of CTO and tech. team  **•** Support from Microsoft, long term strategic relationshipIt was built to meet the following key requirements: **•** Focused on core card functionality for card present and not present markets  **•** Built with an open systems approach. Microsoft first, Linux later. Ability to integrate3rd party software.  **•** Ease of maintenance. Built by experts, enhanced and maintained by low cost local staff  **•** Strict security measures. Fraud detection capabilities.  **•** Accept merchant transactions from multiple access points  **•** Accept all payment types  **•** Support wide range of payment terminal protocols  **•** Support for legacy POS terminals  **•** Support for modern POS terminals with digital communications over TCP/IP  **•** Support for multi-lane retail management systems with multi-store multi-POS features  **•** Provide web-based services (reporting, admin, account management, billing,reconciliation, offline transactions, batch submittal, etc.)  **•** Provide a web-based virtual payment terminal for mail/telephone orders
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Our technology platforms, comprising servers, sub systems, security and communication systems, willbe capable of being fully integrated with the existing payment infrastructure of China Union Payand also those of other financial institutions. We have used IP (Internet Protocol) basedtechnology throughout our network to ensure our services can be easily deployed. China has manymature domestic Internet networks available and we will utilize VPN technology to deploy ourservices securely and cost effectively to this infrastructure as much as possible.Our major differentiators — as a company and with APAYcard — which give us a leading edge inmarkets such as China for payment processing services include: **•** experience and expertise – card industry and technical  **•** established presence  **•** international card features and services  **•** security  **•** processing speed  **•** flexibility, speed to marketOutside the standalone cash register used for collecting payment in the mass retail market,multi-lane retail management systems are available to the multi-lane multi-outlet retailers, whichtypically cost the large retailer about US$500k for the installed system plus US$500k per lane longwith ongoing maintenance fees.Retail management systems are typically used by multi-outlet retailers, especially theinternational ones, such as DFS, B&Q, Carrefour, Wal-Mart, AS Watsons and Giant. These retailersare the target market for Asia Pay, offering higher volume from fewer customers while paying ushigher fees. DFS are already using the Triversity retail management product in Okinawa withsignificant investment already made to support the Asia Pay processing interface.These retail management systems comprise back office servers and PC-based cash registers with anintegrated POS terminal, incorporating a variety of features designed for the multi-laneenvironment, delivering a modern networked retail system in a client/server model. Each networkedcash register routes payment messages to a local back office server, which tracks all salesactivity and forwards the bankcard payment transaction on to the payment processor over a securedline. (DFS needed to bring in Asia Pay in Japan in order to use their retail management system inOkinawa. Without Asia Pay, the local clearing house, GP Net, could not offer DFS this solution.)These sophisticated retail management systems must interface with a processor that uses a digitalmessage format such as XML over TCP/IP and supports advanced multi-lane multi-store features. Thelarge retailers who use these products look to avoid using standalone POS terminals which require adedicated dial-up connection per lane. They want a networked solution with integrated sub systemsfor obvious reasons.APAYcard is designed with these retailers in mind and Asia Pay is setup well to serve their needsin Asia. These retailers will pay above cost for transaction fees for Asia in order to gainjustifiable benefits, which include: **•** a single point of contact for their card processing needs in multiple Asian countriesfrom an industry expert who speaks their language  **•** aggregated volume to negotiate beneficial fees with banks and card networks
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 **•** centralized payment processing for multiple country clearing houses with a singlepayment processor interface  **•** support for the digital format payment messages (e.g. XML) generated by their product,with multi-store, multi-lane, multi-operator features (their developers write once, deploymultiple times)  **•** network integration of payment terminals on a LAN with WAN capability for multi sitelocations  **•** reduced costs and efficiencies from network communications vs. standalone (unreliable)dial-up connections  **•** overall efficiency, including centralized reconciliation, integrated data repositorywith central admin and reporting (via an access anywhere web interface)  **•** the capability for add-on sub-systems such as inventory management, staffing, workflow;integration with existing high-products such as SAPTheseretailers are currently entering China — with a rapidly growing affluent consumer base — inlarge numbers and they are looking for help. The market is there for them and the timing is rightfor Asia Pay to ramp its business in this space and ensure we are well established to serve theirneeds.Asia is a difficult market for the international retailers — a continent of disparate countries,financial rules and regulations, networks, systems, interfaces, banks, etc. – and of course, Chinais the biggest issue and opportunity of all, being the largest market with an immature cardprocessing infrastructure with the fastest growing card base. These retailers are rightfullyconcerned and they want to minimize cost and risk while operating as efficiently as possible whileutilizing their existing systems and processes. These retailers look for outside help with aninside presence. To justify going with such a provider and paying “above cost” in this market is asimple business case as we have already proved.After initial success in this market space, we will target the vendors of retail management systemsto work in partnership with them to enable their product Asia Pay ready out-of-the-box. Thisshould give them a sales edge in selling their products into Asia, especially customers targetingmulti-country markets. It also creates immediate revenue opportunities for us.Our current average transaction time for processing bankcard payments is under two seconds. Infact, we are currently producing some of the fastest card transaction times in Japan today on aconsistent basis. This combined with our offering of Western style card services and technology tothe Japanese marketplace, where there is current demand for these, will enable us to build out ourbusiness in Japan; a significant potential market given this approach.Our Japan processing program is operated from our processing platform currently located in Okinawaand is built around APAYcard which has been integrated with the GP Net bankcard clearing network.We use our servers in Japan to process all Japanese transactions via GP Net and plan to roll outthis service to additional merchants. We are currently progressing with the same setup in Chinatargeted to go live in 2006. The primary data center is expected to be located in Beijing orShanghai with a secondary site providing redundancy. Later additional data centers will bedeployed across Asia (since card present transactions cannot take place across internationalborders). Connections with domestic and international card processing providers will be made fromeach these locations. Call centers will be co-located in each center.We have recently established a new presence for processing transactions in Singapore in conjunctionwith NETS, a predominant bankcard clearing network provider there.
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**Credit Card Clearing**Since inception, Asia Pay has been planning and developing the ability to deploy card clearingservices firstly in China, followed by other Asian markets. This area of our business requiressignificantly more investment — in terms of systems and operations – along with significantlyhigher revenues and profits. During the rollout of our payment processing services we willundertake low investment card program outsourcing as they arise.Card clearing services are the long term strategic side of our business and comprise 3 focus areas: 1. Card issuing (bank prepaid12 and charge cards, retail, loyalty and oil cards)  2. Full/partial card program outsourcing to our hub (“3rd Party Processing Hub”)  3. Full/partial card program implementation and consulting for our customersWe willprovide 3rd party services to issuers of debit and credit cards — includingcredit card transaction, settlement and operational services for financial institutions, oilcompanies and retailers (including loyalty programs); for example a Chinese bank looking to providea card program to its customers for the 1st time or a retail chain looking to market itsown branded credit card. Customers will be able to outsource partial functions or we can implementtheir entire card program at our hub. Our aim is for our hub to become a world class facility inAsia.This will be achieved by deploying high-end off-the-shelf card processing packages from the majorsuppliers. These systems are capable of providing the entire suite of applications required for aninternational-style card service program. Initially we will implement one card processing packagefor our China hub, e.g. VisionPLUS from PaySys of First Data, a consumer card processing solutionthat handles retail, bankcard and consumer loans all in one system. Later we will implementseveral card processing packages (from the likes of First Data, Total Systems, Oasis, EDS) underthe umbrella of a universal front-end so our customers have only one common interface tocommunicate with. This gives us the ability to leverage the features and fees from each of theunderlying systems which in turn enables us to present a matrix of features and pricing options toour customers.Our services are planned to include database marketing (from the banks’ own customer file),3rd party card issuing and merchant acquiring outsourced services, transactionprocessing services, loyalty programs, and cardholder help desk services. Where appropriate, wewill partner with third-party companies to deliver elements of the outsourced solution, includingcard manufacturers, mailing houses and logistics companies.There are in excess of 100 banks in China with debit or credit card issuing and merchant servicesprograms. Many of these are small regional operators that have no significant investment in cardservices and that primarily use China Union Pay to process debit card transactions on their behalf.Typically, the smaller banks have no credit card program whatsoever and Beijing is pushing forthem to get on board.We believe that a card base of 200,000+ is required to generate an acceptable return on investment.This means many of the smaller “tier 2 and 3 banks” will not be able to participate in the creditcard business and will lose existing customers to larger banks. We believe these smaller banksmake up approximately 20% of the credit card clearing service market in China. 12  In an immature card market such as China, withno established credit bureau services, the prepaid, or secured, credit cardsdominate the market.
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We believe there is significant opportunity in this area for us to offer these smaller banks apartial or complete outsourcing service for their card clearing. We have had discussions withseveral of these banks, and they have indicated strong interest in our services. We are activelypursuing relationships in China to access these opportunities and have recently appointed one ofour current directors, Benny Lee (an ex card industry executive in China and SE Asia), to this taskas Executive Director. We plan to have our sales and marketing force vigorously pursue this marketwhile the banking industry in China opens to foreign service providers.***Marketing Strategy***As mentioned, Asia Pay’s strategy is to first focus on providing payment processing servicesto retail merchants in our key zone of development, China and SE Asia. Rollout of our credit cardclearing services to the same markets will follow.In terms of payment processing, there are key drivers for each of our target markets, each withtheir areas of opportunity, including:China: **•** credit card processing does not really exist today in any significant numbers(primarily debit card only)  **•** either antiquated technology and/or card features and support services  **•** expert partner needed — we have a cross section of Asian and Western personnelSE Asia: **•** multi-national retailers with modern POS systems looking for a processor to support them  **•** a single point of contact needed across the region  **•** they need a common front end for multiple countries and financial back endsJapan: **•** existing POS terminal model is front end heavy with many limitations  **•** need to move this out to the back end to gain Western style card features and services  **•** multi-national retailers with modern POS systems looking for a processor to support themFor each of these markets there are immediate domestic opportunities as well as major opportunitieswith the international retailers coming in who are looking for a processor with a local presenceand international expertise.Although we are currently providing services to DFS Group in Japan, our initial focus is on China.We also see strong potential for our card processing solutions through our agreement with NETS inSingapore and we are actively seeking opportunities in other Asian markets.The market for credit card clearing services in China, with a population of 1.3 billion, isexpected to grow over the next six years at a compounded annual rate of growth of 88% in totalcredit card loans. We expect massive card based revenue growth, from US$300 million in 2003 toUS$13.2 billion in 2009. In addition, we believe that currently only about 10% of the merchants inChina are capable of accepting credit cards as compared with around 80% of U.S. and Japanesemarkets. The current transaction processing infrastructure in China is significantly immature andincapable of supporting the anticipated robust growth. We are aggressively pursuing this opportunity to provide an infrastructure to bothmerchants and banks as customers of our 3rd party processing systems.
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Presently, Chinese merchants who wish to accept credit cards from customers must contact eitherChina Union Pay Merchant Services or one of the 140+ China Union Pay accredited banks to begin theprocess of determining their qualification to accept domestic China bankcards. China Union Pay isthe core monopoly provider of transaction routing services for ATM transactions between Chinesemember banks. China Union Pay has recently started to provide all of the front-end data systems toaccept all of the China merchant transaction requests. They are then routed for approval andsettlement either by China Union Pay on behalf of member banks or by member banks themselves wherethey have in house credit card processing systems. Some banks may elect to do settlement directlyand can build a direct interface to a merchant for credit cards — similar to what we plan on doing.There are no independent third-party processing companies currently operating in China; however,First Data Corp. recently began working to provide merchant and card issuing services to ChinaEverbright Bank in Shanghai and several other major industry players are now active. Still, noproviders are currently dominant in our primary target area, the credit card processing market inChina, and the available market base is huge. This market will support a significant number ofplayers. Competitors are expected to include First Data, China Union Pay, HSBC/BOCOM [Bank ofCommunications], Citibank, EDS, and other Chinese banks.In terms of debit card processing, China Union Pay has over 90% market share. The debit cardmarket is not seen as a significant revenue area for us because there is increasingly less revenuein the processing of debit cards than in credit cards. Still, it is a market we must participatein. Credit card services are provided by several banks, but the card numbers are still extremelylow because it is difficult to find merchants that accept this form of payment. Many of thesecredit cards have been issued to high income Chinese and are used more overseas than in China.Still, this is changing.We need to procure business operating licenses in Chinese provinces where we intend to developbusiness. We have already secured Representative Office licenses for Beijing (November 2004) andShenzhen (February 2005).Partnerships with Chinese institutions are necessary for foreign companies that wish to compete forthe affluent card market. Since the card market is for all intents and purpose now closed toforeigners, such an alliance is the only way to get in early, become acclimated, and master theskills needed for success. What’s more, if market conditions change and the government alters itsregulatory agenda with a view to limiting the expansion of foreign companies, partnerships are lesslikely to be affected.With them in place, the foreigners can pounce if opportunities arise early and stay ahead of thecurve if the markets develop according to script. Credit cards are a prime example of the benefitsof partnership: of the retail-lending products in China’s banking market, few will grow faster.Chinese banks, with their enormous pools of retail customers, extensive branch networks, andestablished brand names, seem well-placed to seize the opportunity in credit cards on their own.But they are held back by the traditional Chinese reluctance to lend money without collateral, by alack of the skills needed to market credit cards to the more attractive customers, and by thedifficulty of managing risk in a market where credit bureau data are largely absent outsideShanghai.As an illustration of these problems, consider card issuance and risk control. About four millionto five million cards now circulate in the Chinese market, but the number of active cardholders isprobably only one-third that. This reality reflects the marketing approach of Chinese banks.Instead of targeting individuals, these institutions push cards to employees of theircorporate-banking customers, without assessing the likelihood that the cards will be used.
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The untargeted approach is unavoidable for many domestic banks because they have little centralizedcustomer data and lack the modeling skills to mine what data they do have. In many banks, riskcontrol is decentralized and thus heavily dependent on the limited skills of the frontline staff inthe branches. A bank could suffer an enormous loss if its portfolio of millions of credit cardsturned sour because of an economic downturn or poor risk-assessment practices. In 2003 many ofSouth Korea’s biggest credit card issuers had to write off enormous losses resulting from unfocusedmarketing tactics and lax risk controls.Domestic banks could hire skilled people from Chinese-speaking markets such as Hong Kong andTaiwan. Some, including China Merchants Bank, have actually done so, but more will rely onalliances with foreign companies to acquire the skills needed to build and manage a credit cardbusiness. Foreign companies such as Asia Pay have the risk-taking mind-set and theproduct-development, marketing, and risk-management skills that Chinese banks lack.Asia Pay is currently developing several Joint Venture (JV) arrangement options throughout China ona regional and nationwide basis for providing our card processing and clearing services. This isthe only current accept formula to China’s powerful financial regulator, the China BankingRegulatory Commission (CBRC).The key to making a card partnership work is making it function seamlessly within the Chinesebanking system, so that the operating license belongs to the Chinese bank, the cards bear itsbrand, and card balances appear on its balance sheet. In reality, though, Asia Pay will run muchof the card operation.Given the uncertainties surrounding regulation and partnerships, we are working to create aportfolio of options covering a range of entry methods and products.13 While it may beseveral years before the credit card market takes off in China, foreign companies that wait untilthe market opens up in 2007 may find that they are too late. With the doors opening up to foreignbanks in the next few years, more pressure is being applied to local banks to be competitive inproducts and services at the risk of being swept aside by the newcomers. Chinese banks looking tocompete with their foreign competitors are actively looking for acceptable partners and solutionsnow to help then do so. Asia Pay has had significant ramp up time to develop these relationships.In addition to the normal business operating licenses, we will be required to submit our systemsfor review and testing by VISA and MasterCard, as well as other card industry associations (e.g.AMEX, JCB, Diners, Discover, China Union Pay) to receive approval as a third-party technologyvendor of payment processing and clearing services to these credit card industry associations.With China business licenses held by our China partners and with international payment industryassociation certification, we plan to begin providing merchant bankcard payment processing andclearing services by cooperating with local banks and with the payment industry (China Union Pay)in China. Chinese financial transactions are administered and are overseen by the People’s Bank ofChina which operates and owns the China Union Pay network. The People’s Bank of China may alsodecide at any time that they would like to enforce additional certification of the security andsoundness of our systems. We do not assume that we will be able to process across all sectors ofthe China payments market, but we will undertake to develop relationships through our existingChina business partners and with the China Credit Card Processing Industry administrators and thePeople’s Bank of China. We will continue to build relationships with appropriate city, local,provincial and Central Government authorities to provide information about our credit cardprocessing operations and capabilities and seek approval from the authorities to perform additionalservices as required by our customers in the future. 13   HSBC has negotiated a partnership with Bank ofShanghai, teamed up with Ping An Insurance to acquire a small bank in Fujianprovince (SE China) and entered into partnership with the Shanghai-based Bankof Communications. HSBC’s portfolio of partnerships covers the attractivesegments of retail banking and insurance and focuses on players with a strongpresence in the more attractive coastal cities.
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Once potential joint ventures are concluded with Chinese partners, and we have determined the mostappropriate structure to hold such China opportunities, we will register and file the requiredapplications with the various governmental and business license agencies where we intend to operateour business.Our business in China may be adversely affected by changes in political and social conditions.This may include changes in governmental policies with respect to laws and regulations,inflationary measures, currency conversion and remittance abroad as well as rates and methods oftaxation. While China’s government is expected to continue its economic reform policies, many ofthe reforms are new or experimental and may be refined or changed. It is possible that a change inthe PRC leadership could lead to changes in economic policy.***Revenue***We contract directly with the merchant for our services and receive an implementation fee (lowfor mass market, much higher for customers with retail management systems) and we have flexiblepricing options including transaction-level pricing. This will depend upon the requirements andsales volume of each merchant. The merchant is charged a single fee which includes our rate aswell as that of the financial institution (acquiring bank and maybe clearing house), who has to payan interchangefee14. Wedo not owe any fees to any of the financial institutions. We did notreceive any implementation fees in 2005, and the implementation feesin 2004 were used to offset amounts incurred for research anddevelopment.Profits gained from our payment processing services are relatively low whereas for the credit cardclearing side of our business they will be relatively high. This is one of the reasons we willengage in credit card clearing projects as they arise while we are deploying our payment processingservices, especially the low investment outsourcing ones. Long term establishment of our cardclearing hub is a significant investment.Our international services will generate US Dollars (USD) to be used to settle expenses owed in USDincurred during the normal course of business. Revenue received in Chinese Yuan (RMB) willgenerally be utilized to develop our business in China. When there is a need to convert ChineseRMB funds into USD or other international currencies, we cooperate with the government of China andthe Bank of China to obtain all required licenses and approvals for the transfer of funds fromChinese RMB into an approved overseas foreign currency account.Going forward, the key for is to market our differentiators and value added services to our targetcustomers at the high end where the market demand exists and the revenues are justified. We cannotcompete at the low end where acquiring banks will offer merchants loss leading discount rates inorder to gain their deposits.The business of running a credit card business requires considerable investment in operations andtechnology. Typically 200,000 to 500,000 card accounts is the minimum to break even. This will behigher in China. This presents a great opportunity for us to provide such services for thefinancial institutions in China. Many financial institutions want to provide these services totheir cardholders and merchants just to retain their business, especially with foreign competitioncoming in. However, they do not want all the exposure that running this business can bring. Wewill provide these services for them and we plan to compete by providing: **•** faster implementation  **•** better reporting and customer service  **•** competitive pricing  **•** better security 14  Interchange Fee: **a**fee paid by the acquiringbank/merchant bank to the issuing bank. The fee compensates the issuer for thetime after settlement with the acquiring bank/merchant bank and before itrecoups the settlement value from the cardholder.
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**Faster Implementation**Implementationof our own payment processing platform — built on an open systems platform thatis easy to scale for volume, extend for features and maintain — allows us to take advantage of thecurrent opportunity and provide world-class transaction processing services where they are indemand in a difficult and emerging market. This approach has been essential, in order to rapidlydeploy our services in a continent of disparate countries, financial rules and regulations,networks, systems, interfaces, banks, etc.For faster uptake we will present our merchant customer prospects with a complete turnkey paymentsolution, including everything required. This will comprise merchant bank account setup services,reports and account management functions, payment processing terminals and our own paymentprocessing platform, APAYcard. The key is delivering a rich set of features and services and inmarket where they simply don’t exist.Another important factor which cannot be overlooked is that we have a strong Asian presence, wehave established the connections, we are developing the relationships and we are deploying ourinfrastructureWe believe most other international competitors currently have virtually no access into the Chinesemerchant processing market. We believe we will be one of the first U.S. companies to be able toprovide this service in China.**Better Reporting and Customer Service**Customer Service in any form is practically non existent in China and offering internationallevels of service is one of the keys to increasing market share, a long term future in the marketand attracting the international clients. We have a commitment to supporting our customers withprofessionalism from the onset and we will continually improve our customer service offerings asour business grows. We see it as key.In terms of reporting and support services, our goal is to use our knowledge of international cardprocessing systems to provide merchants in China with (a) greater access to their data, and (b)reporting capabilities currently not available in this market. Again, this is a key differentiatorfor us and a significant requirement of the international customers coming in.We plan to provide greater flexibility within APAYcard by expanding the functionality to includeloyalty schemes. These loyalty systems, riding on the back of the transaction processing system,will allow merchants to produce better customer statements, marketing mailings, and rewardredemptions. The goal of the loyalty system is to provide merchants with increased customerretention and, therefore, to grow their transaction volume with our company.**Competitive Pricing**We anticipate offering competitive transaction pricing models for card features and servicesin markets where they are practically non existent today. When considering the cost of ourservices for doing business our customers have already indicated their willingness to pay them.
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There are additional factors to us offering competitive transaction pricing models including theability to aggregate merchant transaction volumes and negotiate more favorable wholesale ratesthrough clearing houses, such as China Union Pay, and the card companies and we believe we willhave a lower cost of operations in China, allowing us to offer our services at lower prices.In China, credit card transaction rates currently vary from 3-5% and in Japan they can be evenhigher. In both markets we believe we can negotiate more favorable rates or present competitiverates for providing improved card features and services.As discussed already, the international retailers coming into our market space offer the morelucrative return on investment. With our differentiators and value added services we are alreadyfinding a market for merchants who will pay a premium. In fact, to many of the larger merchantsour relatively higher domestic transaction fees are easily justified by the numerous areas of costssavings they gain.Still, at the end of the day, we cannot over emphasize enough that the Chinese card market is inits infancy and many merchants today cannot accept credit card payments even if they wanted to.This is especially important in terms of the ever growing number of tourists coming to China wherethis problem presents a loss in terms of missed revenue. With the Beijing Olympics just around thecorner, foreign competition soon to be allowed into the market and the number of cardholders everincreasing, the demand for card services and solution providers right now is high. Asia Pay iswell placed to tap into the opportunity.**Better Security**The business of credit card processing requires extensive and stringent security measures tobe implemented which are mandatory to ensure the protection of sensitive financial data and allparties involved. It is vital that we plan for zero security breaches and establish a reputationas a professional and trustworthy company with an impeccable track record. This is doublyimportant since we are a relatively new company offering our services to international clientsentering a market with a high degree of risk.When it comes to the Chinese card market, security is paramount. In fact Malaysia has onlyrecently moved out of the top three in terms of the number of credit card fraud instancesworldwide, where line tapping and credit card fraud were rampant. The card market in China isdeveloping rapidly and along with it comes a high level of fraud activity. We must ensure oursecurity measures stay ahead of it.As part of Asia Pay’s continuing efforts to implement best practice solutions for all aspects ofour card business we will ensure strict security measures are implemented across the board, interms of systems, networks, operations, policies, personnel and physical access.Our entire infrastructure is built with stringent security requirements in mind and incorporatesindustry standard fraud detection and prevention systems throughout.Security features and services we have already implemented or plan to deploy include the following: **•** Dual managed firewall appliances at each data center location  **•** Intrusion Prevention Systems  **•** Integrated Anti-Virus systems  **•** Remote management of all systems and networks, including security components, from our NOC  **•** Multi level alert notification  **•** Sensitive data encrypted in our databases with active IPS monitoring
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 **•** Card data encrypted in transmission when ever possible  **•** Industry standard fraud detection systems (including card verification, risk management,sales screening rules, merchant checks, consumer tracking, etc.)  **•** Compliance with VISA and MasterCard security programs  **•** Personal secure key token with 2-stage authentication for all PCs and laptops  **•** All servers housed in high level security facilitiesWe will continue to engage external agencies to conduct regular detailed audits of our systems andoperations. It is paramount that external agencies are engaged for these services in order toutilize industry expertise and ensure the highest levels of protection are in place for ourselvesand our clients.Our criteria for selection of our data centers and our requirements for the setup of these involvethe highest security measures. In fact, adherence to strict security procedures and policies aremandatory requirements when working with banks and other financial intuitions. With dedicatedsecurity personnel, we will maintain all applicable certifications, including VISA and MasterCard,and adhere to and exceed industry security standards for all aspects of our business.***Staffing***Our senior executives are well-known and respected in the transaction processing industrythroughout the Asia-Pacific region. Our directors have extensive international and public companyexperience and have successful experience building startups. We are continuing to compliment ourboard and executive management team with strategic appointments not only to lead and oversee thecompany but add value in terms of expansion relating to markets, industry and key customers.We have a strong sales and marketing focus and we are continuing to attract and recruit keypersonnel in key markets across the region. We have already identified personnel to help us landstrategic projects and customers and we will continue this approach.For the initial design and rollout of the systems required, our CTO is leading the effort and isresponsible for the architecture, utilizingproject-based contract staff for the implementationdrawn from a network of highly-skilled personnel. These experts are required to get the complexaspects of the systems — such as design, security, redundancy and performance — implemented in atimely, get-it-right-first-time andcost-effective manner. It is extremely difficult to find suchpersons in the local markets.However, the contract staff have been supplemented by local staff for the management andadministration of systems, as well as the more time-consuming and standardized development efforts.We are currently training and incorporating local staff to be utilized going forward in allaspects of operations.Once the major technology development is concluded, the sales and marketing department will beincreased in staff numbers in Shanghai, Beijing and elsewhere, as appropriate, to bring on largermerchants and to establish an ISO (independent sales organization) network to target smallermerchants.This will be subsequently complimented by a service delivery organization in all three centers thatwill be responsible for the implementation of the POS platform (card reading devices and networkcommunications) into merchant premises and bringing the merchant online. This work force will bedeveloped inline with business growth and we are currently pursuing partnership opportunitiesacross China to facilitate the logistics. The deployment of personnel is dependent upon salesgrowth and capitalization.
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***Distribution***We are working to establish a sales network across our key zone of development to drive theproduct into the market place. This sales force will be both regionally and vertically oriented toensure strong coverage of the target customers.Using commercially available market data, we will identify and make direct approaches to the toptwenty merchants in each selected vertical market (e.g. travel, supermarket, department store, fastfood, the big e-commerce merchants, etc.) across China. In other markets, such as Japan, we willalso use 3rd party organizations to make these approaches.We’ll work with the right people to open the right doors. We’re working to expand our network ofstrategic contacts and this applies to our selection of directors and senior management where welook to maintain a good balance of Westerners and Asians. This is especially important in Chinawhere relationships are key.We are targeting clients that are multinational (e.g. Wal-Mart, Carrefour, B&Q), domestic Chineseretail merchants, small to middle-tier Chinese banks, and retail and oil card program issuers suchas BP and Sinopec (with around 30,000 gas stations in China). We will approach the largermerchants and banks directly and plan to implement a channel sales strategy via independent salesorganizations (ISOs) to address the enormous small-business mart across China.The ISOs will be located within the eastern sea board of China initially, covering Beijing,Shanghai, Guangzhou and Shenzhen, as this is where most of the cardholders will be located whereincomes are much higher than in western China.Our approach is to build it once and repeat it many times, in China and across Asia. While Chinadevelops at pace we will continue to pursue strategic opportunities which are realizable in theshort to medium term, such as in Japan, especially for merchants looking for multi-countrysolutions.***Significant Milestones***We have developed an operational plan, summarized below, for implementation as we acquire thenecessary resources.     **Target Date** **Principal Milestones** **Budget**Completed Shanghai WOFE $250,000 USD     Completed Singapore Processing Network $100,000 USD     2Q 2006 China Business License $150,000 USD     3Q 2005 China Joint Venture Approval $250,000 USD     Near Completion China Merchant Services Platform $950,000 USD     1Q 2007 Buildup Nation Wide HUB $350,000 USD     2Q 2007 Build/Acquire Multi-currency Merchant Acquiring Center $300,000 USD
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As of the date of this filing, we do not have sufficient funds to implement the foregoing plan ofoperations. There are no assurances as to when, if ever, we will have the funds to implement thisplan of operations.***Critical Accounting Policies and Estimates***We did not generate revenues from operations in 2004 and have generated nominal revenue fromoperations in 2005. We have recognized losses from operations, and the foregoing discussion of ourplan of operation is based in part on our consolidated financial statements. These have beenprepared in accordance with accounting principles generally accepted in the United States ofAmerica. The preparation of financial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expenses during the reporting period.Actual results could differ from those estimates. The estimates and critical accounting policiesthat are most important in fully understanding and evaluating our financial statements and resultsof operations are discussed below.**Revenue Recognition**The Company completed its phase I system development of its pilot project for credit and debitcard transaction processing and has started generating revenue from its pilot project in the firstquarter of 2005. The Company recognizes revenue in accordance with Securities and ExchangeCommission Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition in FinancialStatements.” Revenue is recognized when the price is fixed or determinable, persuasive evidence ofan arrangement exists, the service is performed, and collectibility is reasonably assured.In addition, the Company also generates revenues through special and trial projects. Such revenueis recognized when service is performed and collectibility is reasonably assured. Unearned revenuerepresents service partially performed for special and trial projects.**Stock Based Compensation**Prior to 2005, the Company has elected to apply the intrinsic value method of accounting inaccordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (APB 25). Under the intrinsic value method of accounting, compensation expense isrecognized if the exercise price of the Company’s employee stock options is less than the marketprice of the underlying common stock on the date of grant. Stock-based compensation for employeesis recognized on the straight-line basis over the vesting period of the individual options. Stockoptions granted to non-employees are accounted for under Statement of Financial AccountingStandards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation”, which establishes a fairvalue based method of accounting for stock-based awards, and recognizes compensation expense basedon the fair value of the stock award or fair value of the goods and services received, whichever ismore reliably measurable.Starting 2005, the Company has elected to apply the fair value based method of accounting inaccordance with Statement of Financial Accounting Standard No. 123 “Accounting for Stock-BasedCompensation” (SFAS 123), for stock based awards to both employees and non-employees.Under the provisions of SFAS 123 as amended by SFAS No. 148, companies that elect to account forstock-based awards in accordance with the provisions of APB 25 are required to disclose the proforma net income (loss) that would have resulted from the use of the fair value based method underSFAS 123.
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**Recent Accounting Pronouncements**In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised Statementof Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, whichsupersedes APB opinion No. 25, Accounting for Stock Issued to Employees, and its relatedimplementation guidance. This statement requires a public entity to recognize and measure the costof employee services it receives in exchange for an award of equity instruments based on thegrant-date fair value of the award (with limited exceptions). These costs will be recognized overthe period during which an employee is required to provide service in exchange for the award — therequisite service period (usually the vesting period). This statement also establishes thestandards for the accounting treatment of these share-based payment transactions in which an entityexchanges its equity instruments for goods or services. It addresses transactions in which anentity incurs liabilities in exchange for goods or services that are based on the fair value of theentity’s equity instruments or that may be settled by the issuance of those equity instruments.This statement shall be effective the first interim or annual reporting period that begins afterDecember 15, 2005 for small business public entities and non-public companies.We started the implementation of the above pronouncement for the year ended December 31, 2005 usingthe modified prospective application method which applied only to awards granted, modified orsettled after the adoption date. Accordingly, compensation cost for some previously granted awardsthat were not recognized under SFAS No. 123 will be recognized under the revised SFAS No, 123(Statement 123(R)). However, had the Company adopted Statement 123(R) in prior periods, the impactof that standard would have approximated the impact of SFAS No. 123 as described in the disclosureof pro-forma net loss and loss per share under Stock Based Compensation of the Notes to theFinancial Statements in Part II, Item 7 of our Annual Report on Form 10-KSB for the year endedDecember 31, 2005.***Financial Condition and Liquidity***Ourindependent registered public accounting firm has issued a going concern opinion on our consolidated financialstatements that raises substantial doubt about our ability to continue as a going concern.***Revenue and Operating Expenses***We have commenced generating nominal amount of revenue from our pilot project. Revenue forprocessing transactions for our DFS client in Okinawa totaled $43,949 for the year ended December31, 2005, with direct costs of revenues of $13,527 and gross profit of $30,422, a gross profitmargin of 69%.In June of 2005, we had an agreement with an online business company for credit card processing.In the process of implementing the agreement, fees received for processing transactions weretreated as unearned income and fees charged from processing transactions were treated as prepaidexpenses as the project was not fully implemented.We incurred operating expenses of $4,073,372 for the year ended December 31, 2005, as compared to$1,497,940 for the same period in 2004. The principal components of the $2,575,432 increase for theyear ended December 31, 2005, are the increase in stock-based compensation of $1,284,656 and losson investment impairment of $497,326. The remaining increase of $793,450 is the result ofprofessional fees, research and development and general and administrative expenses with theincreased level of business development and activities.
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***Liquidity and Capital Reserves***At December 31, 2005, we had cash of $110,566. At December 31, 2004, we had cash of $18,780.During the year of 2005, we were successful in selling unregistered equity securities as reportedin the Notes to the Consolidated Financial Statements for year ended December 31, 2005. ARegistration statement was filed with the SEC for unregistered securities of 4,139,412 commonshares and 4,361,992 warrants to purchase each common share in 2005. Funds from financingactivities were used for our operations.Net cash used in operating activities was $1,555,972 for the year ended December 31, 2005, and$710,529 for the same period in 2004. The increase in net cash used in operations reflects the costof implementing our card processing business plan, including system development, businessdevelopment, general administration and investments.Net cash provided from financing activities was $2,151,347 for year ended December 31, 2005, and$745,846 for the same period in 2004. The increase was mainly from the exercise of stock optionsand warrants, and the issuance of loans and common stock for cash.At December 31, 2005, total current liabilities exceeded total current assets by $540,879 comparedto $392,978 at December 31, 2004. Shareholders, directors and related party advances comprise$158,866 of the current liabilities, compared to $169,959 at December 31, 2004. Currentliabilities include $100,000 owing to our former JV partner, Shandong Hengtong Chemical IndustrialCompany Ltd. and loan payable of $70,000 (see Note 6 to the Financial Statements in Part II, Item 7of our Annual Report on Form 10-KSB for the year ended December 31, 2005.)The accompanying consolidated financial statements have been prepared on the basis that the Companywill continue as a going concern which assumes the realization of assets and settlement ofliabilities in the normal course of business. Since its inception, the Company has been engaged inorganizational and pre-operating activities. In the year of 2005, the Company has a net loss of$4,052,935 and a negative cash flow from operations of $1,555,972. At December 31, 2005, theCompany has a working capital deficit of $540,879 and an accumulated deficit of $6,522,138. Thesematters raise substantial doubt about the Company’s ability to continue as a going concern.Continuation of the Company’s existence is dependent upon its ability to obtain additional capitaland sustain profitable operations. The uncertainty related to these conditions also raises doubtabout the Company’s ability to continue as a going concern. The accompanying consolidated financialstatements do not include any adjustments that might result from the outcome of this uncertainty.We require additional cash to implement our business strategies. Management plans to raiseadditional capital through additional public or private financings, as well as borrowings and otherresources such as related party advances. To the extent that additional capital is raised throughthe sale of equity or equity-related securities, the issuance of such securities could result indilution of our stockholders. There can be no assurance that additional funding will be availableon favorable terms. If adequate funds are not available within the next 12 months, we will berequired to further curtail or suspend operations. In the alternative, we may seek funding througharrangements with collaborative partners or others that may require us to relinquish rights that wewould not otherwise relinquish.
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**ITEM7.  FINANCIAL STATEMENTS****Asia Payment Systems Inc. and Subsidiaries****(A Development Stage Company)** **Consolidated****Financial Statements****December 31, 2005 and 2004**
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**Asia Payment Systems Inc. and Subsidiaries****(A Development Stage Company)****Consolidated Financial Statements**   **Contents** Page   Report of Independent Registered Public Accounting Firm      F-1   Consolidated Balance Sheets      F-2   Consolidated Statements of Operations and Comprehensive Loss      F-3   Consolidated Statement of Stockholders’ Deficiency      F-4 - F-5   Consolidated Statements of Cash Flows      F-6   Notes to the Consolidated Financial Statements      F-7 - F-19
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**To the Board of Directors and Shareholders of****