EX-99 3 doc2.txt PETERSON SULLIVAN PLLC 601 UNION STREET SUITE 2300 SEATTLE WA 98101 (206) 382-7777 FAX 382-7700 CERTIFIED PUBLIC ACCOUNTANTS INDEPENDENT AUDITORS' REPORT To the Shareholders Cybernet Internet Services International, Inc. We have audited the accompanying consolidated balance sheet of Cybernet Internet Services International Inc. and its subsidiaries as of December 31, 2002, and the related consolidated statements of operations, comprehensive loss, changes in shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of Cybernet Internet Services International Inc. and its subsidiaries as of December 31, 2001 and 2000, were audited by other auditors whose report dated April 15, 2002, included an explanatory paragraph that referred to conditions raising substantial doubt about the Company's ability to continue as a going concern. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2002, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses and used significant amounts of cash to operate the Company. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. [GRAPHIC OMITED] [GRAPHIC OMITED] Peterson Sullivan P.L.L.C. March 13, 2003 Seattle, Washington CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS December 31, 2002 and 2001 (In Thousands of Euros)

The accompanying notes are an integral part of these consolidated financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros, Except Per Share Data)

The accompanying notes are an integral part of these consolidated Financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros) CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros)

The accompanying notes are an integral part of these consolidated financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros)

The accompanying notes are an integral part of these consolidated financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros)

The accompanying notes are an integral part of these consolidated financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) For the Years Ended December 31, 2002, 2001 and 2000 (In Thousands of Euros)

The accompanying notes are an integral part of these consolidated financial statements. CYBERNET INTERNET SERVICES INTERNATIONAL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note 1. The Company and Summary of Significant Accounting Policies Cybernet Internet Services International, Inc. ("the Company") is a U.S. corporation incorporated in Delaware. The amounts in the notes are rounded to the nearest thousand except per share amounts. Going Concern -------------- The Company, through its European subsidiaries, offered a variety of Internet related telecommunication and systems integration services to corporate customers located in Europe. However, the Company has incurred significant losses from operations resulting in a shareholders' deficiency of (137,994) at December 31, 2002. The Company does not expect to achieve sufficient revenues to support future operations without additional financing. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The Company is in the process of reviewing its strategic options including seeking additional financing, restructuring its debt, sales of assets and liquidation. However, there are no assurances that management's review of these options will result in a plan which can be accomplished or will provide sufficient cash to fund the Company's operations or satisfy its creditors in the future. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. Accordingly, these consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. The Company sold subsidiaries and assets during 2002 to raise cash and reduce operating losses. The Company sold two subsidiaries and the stock of an equity method investee for cash of 1,128 resulting in a loss of (1,170) and also sold assets for cash amounting to 37,336 resulting in a gain of 18,345. Subsequent to December 31, 2002, the Company sold assets for cash amounting to 2,700 resulting in a gain of 2,415 and also sold three subsidiaries for cash of 10 resulting in a gain of 2. Estimates --------- The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. ------ Principles of Consolidation ----------------------------- The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Investments in entities where the Company owns at least a 20% interest, but does not have control, are accounted for under the equity method. Significant intercompany accounts and transactions have been eliminated. Reclassifications ----------------- Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation. Foreign Currency ----------------- The functional currency for the Company and its subsidiaries is the local currency of the country in which the subsidiary is located. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation," the assets and liabilities for the Company's international subsidiaries are translated into the Euro using current exchange rates at the balance sheet dates. Revenue and expenses are translated at average exchange rates prevailing during the applicable period. The gains and losses resulting from the changes in exchange rates from year to year are reported in accumulated other comprehensive income. Foreign currency transaction gains or losses are included in the calculation of net loss. Cash and Cash Equivalents ---------------------------- Cash and cash equivalents include highly liquid investments with an original maturity of three months or less. The Company maintains cash balances in financial institutions in excess of insured limits. Restricted Cash ---------------- Restricted cash consists of cash in bank for bank guarantees used to secure miscellaneous obligations. Goodwill and Other Intangible Assets ---------------------------------------- Prior to January 1, 2002, the Company had been amortizing goodwill and other intangible assets to expense. Based on a new accounting standard, amortization of goodwill and other intangible assets with indefinite lives are no longer to be amortized beginning January 1, 2002. However, during 2001, management determined, based on estimated future cash flows, that the remaining carrying value of goodwill and other intangible assets should be written off. Therefore, no amount for goodwill and other intangible assets are reflected in the December 31, 2002 and 2001, consolidated balance sheets. ------ Properties ---------- Depreciable properties are stated at cost unless the estimated undiscounted cash flows that result from either the use of an asset or its eventual disposition are less than its carrying amount. In that situation, an impairment loss is recognized based on the fair value of the asset. Depreciation is based on the estimated useful lives of the assets (four to ten years) and is computed using the straight-line method. Repairs and maintenance are charged to expense incurred. Based on management's analyses, impairment losses on properties were recorded during 2002, 2001 and 2000 in amounts of 5,629, 3,937 and 1,620, respectively. Revenue Recognition -------------------- The Company offers Internet telecommunication and system integration products, data center services, network services and voice telephony products. The Company recognizes revenue pursuant to Securities & Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." In accordance with SAB No. 101, revenue is recognized when all four of the following criteria are met: (i) persuasive evidence that arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is both fixed and determinable; and, (iv) collectibility is reasonably probable. Revenues from Internet telecommunication and system integration products, which includes equipment sales, are recognized upon completion of the related project and receipt of customer acceptance. Revenues from ongoing network services, voice telephony and data center services, including co-location, are recognized when services are provided. All payments received in advance of providing services are deferred until the period that such services are provided which amounted to 1,162 and 594 at December 31, 2002 and 2001, respectively. These amounts are included in other accrued liabilities on the consolidated balance sheets. The Company enters into multiple element arrangements, which may include any combination of monthly network services, professional consulting services and/or equipment sales. Each element of a multiple element arrangement is evaluated to determine whether it represents a separate earnings process. If a multiple element arrangement can be segmented, revenue is allocated among the multiple elements based upon the fair value of the elements. If an undelivered element is essential to the functionality of a delivered element, no revenue allocated to the delivered element is recognized until that undelivered element is delivered. Direct Cost of Services -------------------------- Direct cost of services consists of 1) telecommunications expenses, which mainly represent the cost of transporting Internet traffic from a customer's location through a local telecommunications carrier to one of the Company's access nodes, transit and peering costs, and the cost of leasing lines to interconnect the Company's backbone nodes, and 2) the cost of hardware and software sold. The Company mainly utilizes leased lines for its backbone network, and to connect its network to its major customers premises. Network Operations ------------------- Network operations mainly consist of 1) the personnel costs of technical and operational staff and related overhead, 2) the rental of premises solely or primarily used by technical staff, including premises used to generate our co-location services revenue, and 3) consulting expenses in the area of network and software development. General and Administrative Expenses -------------------------------------- General and administrative expenses consist principally of salaries and other personnel costs for our administrative staff, office rent and maintenance of office equipment. Sales and Marketing Costs ---------------------------- Marketing costs include the costs of all personnel engaged in marketing activities, the costs of advertising and public relations activities (e.g. trade shows), and other related costs. Advertising costs are expensed as incurred. Advertising expense was approximately 553, 1,706 and 3,095 in the years ended December 31, 2002, 2001 and 2000, respectively. Taxes on Income ----------------- The Company accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than enactments of changes in the tax laws or rates. Deferred Debt Issuance Costs ------------------------------- Deferred debt issuance costs are amortized to interest expense over the term of the related debt. Any remaining balance will be charged to expense if the debt is retired early. Stock-Based Compensation ------------------------- The Company has a stock-based employee compensation plan, which is described more fully in Note 9. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation.

Earnings Per Share -------------------- Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding in the period. Diluted earnings per share takes into consideration common shares outstanding (computed under basic earnings per share) and potentially dilutive common shares. Segment Reporting ------------------ The Company operates primarily in one business segment, which is providing international Internet backbone and access services and related communication services for corporate customers. The Company's operations are in Europe and present management does not find it useful to segment operations any further. Therefore, no country segment data is provided in these consolidated financial statements. New Accounting Standards -------------------------- Statements of Financial Accounting Standards No. ("SFAS") 145 and 146 are generally modifications to previously adopted standards. A part of SFAS 145 is effective for years beginning after May 15, 2002, and SFAS 146 is effective for years beginning after December 31, 2002. These new standards do not have an effect on the Company's consolidated financial statements. Note 2. Goodwill and Other Intangible Assets The changes in the carrying amount of goodwill during 2001 and 2000 are summarized below:

The Company did not acquire any goodwill or other intangible assets during 2002. Other intangible assets consist of customer lists and management contracts and are summarized below:

In addition, impairments of other assets of 1,676, 4,756, and 645 were recorded for the years ended December 31, 2002, 2001 and 2000, respectively. The transitional disclosures required under Statement of Financial Accounting Standards No. 142 with respect to goodwill and other intangible assets are as follows:

Note 3. Restricted Investments Restricted investments were required as part of the Company's debt financing. These investments were classified as available-for-sale securities at December 31, 2001, and consisted of U.S. Treasury Notes which matured in 2002. There were no available-for-sale securities at December 31, 2002. Proceeds from the sales of available-for-sale securities amounted to 8,994, 10,194 and 21,014 during 2002, 2001 and 2000, respectively. Realized gains (losses) on the sales of these securities were (118), (290) and 46 in 2002, 2001 and 2000, respectively. The cost of these securities was 9,112 and 20,395 at December 31, 2001 and 2000, respectively, which resulted in unrealized losses of 57 and 300 being recorded in accumulated comprehensive income at December 31, 2001 and 2000, respectively. Cost is based on the specific identification method to determine realized gains or losses. Note 4. Receivables

Receivables are stated at their outstanding principal balances. Management reviews the collectibility of receivables on a periodic basis and determines the appropriate amount of any allowance. Based on this review procedure, management has determined that the allowances were adequate at December 31, 2002 and 2001. The Company charges off receivables to any allowance when management determines that a receivable is not collectible. The Company does not generally require collateral for any of its receivables. Note 5. Properties

NOTE 6. DEBT

During 2001 and 2000, the Company extinguished Senior Dollar Notes in the carrying amount of 7,933 and 51,591 for cash of 3,325 and 33,837 resulting in extraordinary gains. None of the warrants associated were acquired in the extinguishments. Note 7. Income Taxes The provision for income taxes (benefit) for years ended December 31 consists of the following:

Differences between the U.S. Federal Statutory and the Company's effective income tax rate for years ended December 31 are as follows:

Deferred income tax assets are composed of the following:

The tax loss carryforwards are subject to audit by the applicable tax authorities which may result in changes to the amounts above. Since the Company has incurred significant losses and does not expect to generate taxable income in the near future, a valuation reserve for all of the deferred income tax assets has been deemed appropriate by management. Losses from foreign source operations amounted to E(4,733), E(41,718) and E(35,077) for 2002, 2001 and 2000, respectively. The Company has U.S. total estimated net operating loss carryforward amounting to 101,612 at December 31, 2002, which, if not utilized, will expire in years ended 2022. Other tax loss amounts approximate 97,628 at December 31, 2002, result primarily from operations in Germany which may be carried forward indefinitely under current tax law. Note 8. Shareholders' Equity The Company is authorized to issue 50,000,000 shares of Preferred Stock with relative rights, preferences and limitations determined at the time of issuance. As of December 31, 2002, the Company has no issued and outstanding Series A and B and C Preferred Stock. All of the Company's previously issued Preferred Stock was converted to Common Stock. Series A Preferred Stock entitles the holder to receive dividends at a rate equal to US $0.01 per share per annum before any dividends are paid or set apart for payment upon any other series of Preferred Stock of the Company, other than Series B or Series C Preferred Stock, or on the Common Stock of the Company. Dividends on the Series A Preferred Stock are to be paid for each fiscal year within five months of the end of each fiscal year, subject to the availability of surplus or net profits. The dividends on the Series A Preferred Stock are not cumulative. The holders of the Series A Preferred Stock are not entitled to vote. The shares of Series A Preferred Stock may be redeemed by the Company at any time, at a redemption price of one share of the Common Stock of the Company for each share of Series A Preferred Stock plus any unpaid dividends earned provided that all and not less than all of the shares of Series A Preferred Stock are so redeemed. Upon the liquidation, dissolution or winding up, whether voluntary or involuntary, of the Company, the holders of the Series A Preferred Stock will be entitled to be paid the sum of US $3.00 per share plus an amount equal to any unpaid accrued dividends before any amount is paid to the holder of any other series of Preferred Stock, other than the Series B Preferred Stock or the Series C Preferred Stock, or to the holder of any Common Stock of the Company. After payment of these amounts to the holders of the Series A Preferred Stock, the remaining assets of the Company will be distributed to the holders of the Common Stock. The Series B Preferred Stock entitles the holder to receive dividends at a rate equal to US $0.01 per share per annum before any dividends are paid or set apart for payment upon any other series of Preferred Stock of the Company other than the Series C Preferred Stock or on the Common Stock of the Company. Dividends on Series B Preferred Stock are to be paid for each fiscal year within five months of the end of each fiscal year, subject to the availability of surplus or net profits. The dividends on the Series B Preferred Stock are not cumulative. The holders of the Series B Preferred Stock are entitled to one vote per share. The shares of Series B Preferred Stock may be redeemed by the Company at a redemption price of one share of the Common Stock of the Company for each share of Series B Preferred Stock plus any unpaid dividends earned thereon through the date of redemption; provided that all and not less than all of the shares of Series B Preferred Stock are so redeemed. A holder of Series B Preferred Stock may convert each share held into one share of the Common Stock of the Company provided, however, any conversion may not be for less than all of the Series B Preferred Shares held by the converting shareholder eligible for conversion at the time of the notice. Upon the liquidation, dissolution or winding up, whether voluntary or involuntary, of the Company, the holders of the Series B Preferred Stock will be entitled to be paid the sum of US $3.00 per share plus an amount equal to any unpaid accrued dividends before any amount is paid to the holder of any other series of Preferred Stock other than the Series C Preferred Stock or to the Common Stock of the Company. After payment of these amounts to the holders of the Series B Preferred Stock, the remaining assets of the Company will be distributed to the holders of the Common Stock. Note 9. Stock Based Compensation In 1998, the Company adopted a stock incentive plan that provides for the grant of stock options to purchase shares of the Company's common stock to employees and members of the Board of Directors. The Company has reserved 5,000,000 shares of common stock for issuances under the plan. The following table presents the changes in the stock options during the year.

Since plan inception through December 31, 2002, no options have been exercised and none have expired. The weighted-average remaining contractual life of options outstanding at December 31, 2002, was 7.30 years with a contractual life of 10 years. As of December 31, 2002, 2001 and 2000, the Company had 249,225, 1,079,049 and 568,869 options exercisable, respectively. The weighted-average exercise price of options exercisable as of December 31, 2002, is US $7.28. Options vest over a period of three years from the date of grant and become exercisable upon vesting. The Company has not recognized any compensation expense related to stock options in 2002, 2001 or 2000. The following table presents information about options outstanding as of December 31, 2002.

The fair value of each option granted is estimated at the date of grant using the Black-Scholes option-pricing model. The assumptions used in calculating the fair value of the options granted were as follows:

During 2000, the Company offered plan participants the opportunity to exchange stock options previously granted for new options at the current stock price. Approximately 1.07 million new options with an exercise price of US $9.02, the fair market value of the stock on the date of the exchange, were exchanged for previously issued options. This exchange is considered a re-pricing and changes the status of these options to variable options. These options are accounted for as variable from July 1, 2000, until the options are exercised, forfeited or expire unexercised. However, because the market price of the Company's stock decreased since July 1, 2000, the effect has had no impact on net loss. But, any future increases in the market price of the stock, above the exercise price of the options, will result in recognition of stock-based compensation expense in future reporting periods. Note 10. Earnings Per Share Earnings per share data for year ended December 31 is summarized as follows:

Warrants and options were not included in the computation of diluted earnings per share because they were anti-dilutive in each year. Note 11. Transactions with Related Parties The Company paid E242, E435 and E209 to a law firm for legal services where a former member of the board of directors is a partner in the years ended December 31, 2002, 2001 and 2000, respectively. The Company granted interest free loans totaling E356 to three former Italian management employees. The loans were due on December 31, 2000, and are denominated in Italian Lire. No payments have been made on the loans to date. Following the sale of stock of the subsidiary in 2002, the Company no longer has a receivable due from the former Italian management employees. During 2002, MFC Merchant Bank S.A., an affiliate of MFC Bancorp Ltd. ("MFC"), provided a revolving senior secured credit line to the Company of up to E7,000. At December 31, 2002, the Company had no balance outstanding on this line which bears interest at 14%, is due on March 12, 2003, and is secured by the Company's ownership in its subsidiaries. Interest expense of E177 was incurred and paid on the borrowing in 2002. The Company engaged MFC to provide strategic advisory and restructuring services. Beginning April 2002, the Company agreed to pay to MFC US $175 per month payable in advance. Additionally, pursuant to such agreement, the Company agreed to pay MFC a fee on the completion of a successful debt restructuring and on other specified transactions. The success fee is computed based on specified percentages received by the Company from: asset sales, security issuances and debt restructurings with a cap on total fees payable to MFC of US $5,500. An expense of E2,289 was recorded under this agreement in 2002. MFC is a related party because it maintains certain voting rights with respect to approximately 26% of the Company's outstanding common shares on behalf of two shareholders and an officer and director of MFC is also an officer and director of the Company. NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of financial instruments at December 31 is summarized below:

The fair value of cash and cash equivalents is based on reported market value. The fair value of restricted cash is equal to its carrying amount because it is in an account which bears a market rate of interest. The fair value of other receivables approximates carrying value due to the short-term maturity of the receivables. The fair value of capital lease obligations, which approximates carrying value, was estimated using discounted cash flow analyses based on the Company's incremental borrowing rates for similar types of borrowings. At December 31, 2002, no quoted market exists for the Company's long-term debt. Also, based on the Company's current financial position, management believes a discounted cash flow valuation is not appropriate. Therefore, no fair value information is presented for the Company's long-term debt at either December 31, 2002, or 2001. Note 13. Commitments and Contingencies The Company is subject to pending and threatened legal actions that arise in the normal course of business. In the opinion of management, no such actions are known to have a material adverse impact on the financial position of the Company. The Company has no lease commitments beyond December 31, 2002. Rental expense was E4,280, E3,504 and E12,171 for 2002, 2001 and 2000, respectively. The Company is economically dependent on the entities from which it leases their telecommunication lines comprising its network. It is probable that failure of these entities to honor their lease obligations or to renew leases under economically viable conditions would have a negative near-term impact on any Company growth and results of operations.

CYBERNET INTERNET SERVICES INTERNATIONAL INC 8-K