1 EXHIBIT 99.2 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Performance Computing, Inc.: We have audited the accompanying balance sheets of Performance Computing, Inc. as of December 31, 1994 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Performance Computing, Inc. as of December 31, 1994 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Deloitte & Touche LLP Costa Mesa, California May 1, 1996 1 2 PERFORMANCE COMPUTING, INC. BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1995 - ------------------------------------------------------------------------------- 1994 1995 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 40,156 $ 45,352 Accounts receivable, net of allowances for doubtful accounts of $178,647 (1994) and $234,857 (1995) 43,732 190,985 Prepaid expenses and other current assets 33,162 18,785 -------- -------- Total current assets 117,050 255,122 EQUIPMENT AND IMPROVEMENTS, net (Note 2) 86,787 73,604 -------- -------- $203,837 $328,726 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 44,876 $ 58,478 Accrued payroll, taxes and benefits 48,765 133,176 Deferred tax liability (Note 4) 2,000 7,000 -------- -------- Total current liabilities 95,641 198,654 COMMITMENTS AND CONTINGENCIES (Note 5) STOCKHOLDERS' EQUITY: Common stock, no par value; 500 shares authorized 150 shares issued and outstanding 3,000 3,000 Retained earnings 105,196 127,072 -------- -------- Total stockholders' equity 108,196 130,072 -------- -------- $203,837 $328,726 ======== ======== See notes to financial statements. 2 3 PERFORMANCE COMPUTING, INC. STATEMENTS OF OPERATIONS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 - ------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 ---------- ---------- ---------- NET REVENUES $2,102,125 $2,424,931 $2,067,283 COSTS AND EXPENSES: Cost of sales and services 1,803,312 1,871,789 944,260 Selling and marketing 159,116 218,375 349,374 Research and development 111,381 311,965 449,196 General and administrative 47,734 93,590 306,000 ---------- ---------- ---------- Total costs and expenses 2,121,543 2,495,719 2,048,830 ---------- ---------- ---------- OPERATING INCOME (LOSS) (19,418) (70,788) 18,453 OTHER INCOME, net 1,652 15,189 8,423 ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAX EXPENSE (BENEFIT) (17,766) (55,599) 26,876 INCOME TAX EXPENSE (BENEFIT) (Note 4) (3,300) (8,300) 5,000 ----------- ---------- ---------- NET INCOME (LOSS) $ (14,466) $ (47,299) $ 21,876 ========== ========== ========== See notes to financial statements. 3 4 PERFORMANCE COMPUTING, INC. STATEMENTS OF STOCKHOLDERS' EQUITY FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 - ------------------------------------------------------------------------------ COMMON STOCK ------------------ RETAINED SHARES AMOUNT EARNINGS TOTAL ------- ------- --------- -------- BALANCE, January 1, 1993 150 $3,000 $166,961 $169,961 Net loss (14,466) (14,466) ---- ------ -------- -------- BALANCE, December 31, 1993 150 3,000 152,495 155,495 Net loss (47,299) (47,299) ---- ------ -------- -------- BALANCE, December 31, 1994 150 3,000 105,196 108,196 Net income 21,876 21,876 ---- ------ -------- -------- BALANCE, December 31, 1995 150 $3,000 $127,072 $130,072 === ====== ======== ======== See notes to financial statements. 4 5 PERFORMANCE COMPUTING, INC. STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 - ------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, --------------------------------------- 1993 1994 1995 -------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (14,466) $(47,299) $ 21,876 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 21,930 40,022 44,147 Deferred income taxes (9,000) (10,000) 5,000 Provision for doubtful accounts receivable 61,093 74,774 56,210 Change in: Accounts receivable, net (76,383) 54,446 (203,463) Prepaid expenses and other current assets (6,931) (20,512) 14,377 Accounts payable and accrued liabilities 75,914 (18,242) 98,013 --------- -------- --------- Net cash provided by operating activities 52,157 73,189 36,160 CASH FLOWS FROM INVESTING ACTIVITIES - Capital expenditures (51,168) (66,217) (30,964) --------- -------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 989 6,972 5,196 CASH AND CASH EQUIVALENTS, beginning of year 32,195 33,184 40,156 --------- -------- --------- CASH AND CASH EQUIVALENTS, end of year $ 33,184 $ 40,156 $ 45,352 ========= ======== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION- Cash paid during the year for income taxes $ 8,400 $ 4,000 $ - ========= ======== ========= See notes to financial statements. 5 6 PERFORMANCE COMPUTING, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 - ------------------------------------------------------------------------------ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business - Performance Computing, Inc. (the Company) provides customized software development services on a contract basis. The Company also develops, manufactures and distributes personal computer-based video teleconferencing products. Substantially all of the Company's revenues through December 31, 1995 relate to contract services. Cash Equivalents - Cash equivalents are considered to be highly-liquid investments with initial maturities of three months or less. Accounts Receivable - The Company sells its products and services principally in the United States. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, and those losses have been within management's expectations. Equipment and Improvements - Equipment and improvements are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets, generally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. Revenue Recognition - The Company recognizes revenues from software development contracts as services are performed. The Company recognizes revenues from video teleconferencing products and technology as such products are shipped or as licensing agreements are entered into with customers. Income Taxes - The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company's financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Software Development Costs - Software development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. The Company considers technological feasibility to be established when all planning, designing, coding and testing has been completed according to design specifications. 6 7 PERFORMANCE COMPUTING, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 (CONTINUED) - ------------------------------------------------------------------------------ After technological feasibility is established, any additional costs are capitalized. Through December 31, 1995, software has been substantially completed concurrently with the establishment of technological feasibility, and accordingly, no costs have been capitalized to date. Fair Value of Financial Instruments - Pursuant to SFAS No. 107, Disclosures about Fair Value of Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheet at December 31, 1995. The Company considers the carrying value of such amounts in the financial statements to approximate their fair value due to: (1) the relatively short period of time between origination of the instruments and their expected realization, (2) interest rates which approximate current market rates, or (3) the overall immateriality of the amounts. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles 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 years. Actual results could differ from those estimates. 2. EQUIPMENT AND IMPROVEMENTS Equipment and improvements consist of the following: DECEMBER 31, ----------------------- 1994 1995 -------- --------- Machinery and equipment $140,045 $ 171,009 Vehicles 27,270 27,270 Office furniture and fixtures 2,400 2,400 --------- --------- 169,715 200,679 Less accumulated depreciation and amortization (82,928) (127,075) --------- --------- $ 86,787 $ 73,604 ======== ========= 7 8 PERFORMANCE COMPUTING, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 (CONTINUED) - ------------------------------------------------------------------------------ 3. MAJOR CUSTOMERS Sales to individual customers or customers under common control which amounted to more than 10% of the Company's net revenues in the year indicated were as follows: DECEMBER 31, ---------------------------------------- CUSTOMER 1993 1994 1995 -------- ---------- ---------- ---------- 1 $1,164,008 $1,037,239 $ 293,495 2 348,998 574,714 321,206 3 396,436 4 214,963 ---------- ---------- ---------- $1,513,006 $1,611,953 $1,226,100 ========== ========== ========== The Company has historically derived a significant portion of its revenues from a relatively small number of customers. A decision by a significant customer to substantially decrease or delay purchases from the Company or the Company's inability to collect receivables from these customers could have a material adverse effect on the Company's financial condition and results of operations. 4. INCOME TAXES A summary of income tax expense (benefit) is as follows: YEAR ENDED DECEMBER 31, -------------------------------------- 1993 1994 1995 ------- -------- ------ Current $ 5,700 $ 1,700 $ - Deferred (9,000) (10,000) 5,000 ------- -------- ------ $(3,300) $ (8,300) $5,000 ======= ======== ====== 8 9 PERFORMANCE COMPUTING, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1995 (CONTINUED) - ------------------------------------------------------------------------------ A reconciliation of the effective tax rate from the federal statutory tax rate (35%) is as follows: DECEMBER 31, ------------------------------------ 1993 1994 1995 ------- ------- -------- Income tax (benefit) expense at federal statutory rate $(6,200) $(19,500) $ 9,400 Surtax exemption and other 2,900 11,200 (4,400) ------- -------- -------- $(3,300) $ (8,300) $ 5,000 ======= ======== ======== The Company's net deferred tax liability consists primarily of accrual to cash differences at December 31, 1994 and 1995. 5. COMMITMENTS AND CONTINGENCIES Leases - The Company has a noncancelable operating lease for its operating facility. Future minimum rental commitments consist of the following: Year ending December 31: 1996 $48,991 1997 8,165 ------- $57,156 ======= Total rent expense was $19,875, $47,514 and $50,559 for the years ended December 31, 1993, 1994 and 1995, respectively. 6. EMPLOYEE BENEFIT PLAN The Company has a 401(k) Plan (the Plan) for all employees meeting minimum service requirements. There are no Company contributions to the Plan. 7. SUBSEQUENT EVENTS Effective March 14, 1996, the Company's stockholders entered into an agreement to sell all of the outstanding common shares of Performance Computing, Inc. (PCI) to Smith Micro Software, Inc. (Smith Micro). 9