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FORM 10-K/A

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1999

or

[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-9434

PICTURETEL CORPORATION

Registrant’s telephone number: (978) 292-5000

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

None

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

Common Stock

      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days.  Yes  [X]  No  [   ]

      Indicate by check mark if disclosure of delinquent filings pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.  [X]

      The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant as of March 10, 2000 was $540,814,422. On such date, the average of the high and low price of the Common Stock was $13.31 per share. The Registrant has 40,954,784 shares of Common Stock outstanding as of March 10, 2000.

Documents Incorporated by Reference

      Portions of the definitive 2000 Proxy Statement in connection with the Annual Meeting of Stockholders to be held June 16, 2000 are incorporated by reference into Part III.

      A list of all Exhibits to this Annual Report on Form 10-K is located at 50 through 54.

Item 1.  Business

      PictureTel Corporation (the “Company” or “PictureTel”) is the world leader in developing, manufacturing and marketing a full range of visual and audio collaboration solutions. Visual collaboration employs videoconferencing, video streaming and data collaboration technologies to facilitate productive meeting environments that may incorporate video, audio, and real-time and archived multimedia data. The Company’s products and services enable businesses, schools, medical facilities, government and other organizations to eliminate the barrier of distance so they can work together more effectively. PictureTel markets a complete line of videoconferencing systems, multi-location servers, peripheral equipment and a full suite of enterprise-wide services.

      PictureTel is organized into three distinct business segments, each responsible for its own profitability. The business segments are videoconferencing products, videoconferencing services, and audioconferencing products, which consists of its MultiLink®, Inc. subsidiary. During 1999, the Company transitioned from a common sales organization selling PictureTel’s entire range of video and audio products and services to stand-alone sales organizations within each business unit. The videoconferencing products’ direct sales organization and its worldwide sales channels currently also sell certain videoconferencing services’ offerings.

      PictureTel is a Delaware corporation organized in 1984, with executive offices at 100 Minuteman Road, Andover, Massachusetts 01810 (telephone: 978-292-5000).

Videoconferencing Products

      The core of PictureTel’s business since the Company’s inception in 1984 has been the development, manufacture and marketing of a complete line of full-featured videoconferencing systems. PictureTel’s videoconferencing systems deliver full-color video and high-fidelity, FM radio-caliber audio so customers can enjoy a natural, productive meeting environment whether they are in the same office complex or halfway around the world from each other. The video and audio signals are transmitted over either digital telephone lines, most often ISDN (Integrated Services Digital Network) lines, which are part of the public switched telephone network, or networks that use the Internet Protocol (IP). PictureTel has been and remains the world leader in its industry with more than twelve thousand organizations around the world using PictureTel systems to conduct face-to-face meetings with colleagues, partners, suppliers, customers and others. The Company’s videoconferencing systems consist of three categories: group, desktop/personal and network server systems.

      PictureTel’s group videoconferencing systems, the performance line Concorde 4500™ and the value line Venue 2000™ families of products, are dedicated conference-room systems that deliver high-quality video and audio performance at a variety of price points. Units include all equipment necessary to videoconference. PictureTel created the compact category of videoconferencing in 1996 with the introduction of SwiftSite™, the world’s first compact videoconferencing system. SwiftSite — and its follow-on SwiftSite II™ and PictureTel 760™ models — deliver high-quality performance in a simple, portable and affordable package. These compact-class products, which sit on top of the monitor to which they are connected, are optimized for use in smaller offices. They have proven popular in field sales offices, franchises and other similar locations where they can complement the larger group systems deployed at headquarters and other larger sites. The Company also markets Intel Corporation’s TeamStation™, a PC-based videoconferencing system capable of operating on ISDN and IP networks, under the terms of an exclusive distribution agreement.

      PictureTel also has a complete line of personal or desktop videoconferencing systems. These systems, which add videoconferencing capabilities to standard personal computers, are suited for use by individuals who not only need to videoconference with one or more sites, but also share any number of PC documents through the systems’ data-conferencing capabilities. PictureTel’s desktop systems run on the most popular Microsoft® operating systems. PictureTel introduced its first PC-based personal systems in 1994, when that segment of the market was emerging. PictureTel’s personal systems operate in much the same way as the Company’s group systems. PictureTel markets several different models of personal videoconferencing systems. The PictureTel Live200™ is an ISDN-based system. The PictureTel 550™ desktop system operates over both ISDN lines and networks that use the Internet Protocol. In addition, the Company distributes the Intel® ProShare® Video System 500. Using IP network capabilities enables the systems to operate over many

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      All of PictureTel’s group, desktop/personal and network server videoconferencing systems deliver 15 frames-per-second of video performance at 128 Kbps (Kilobits per second) over ISDN lines. Many PictureTel systems in all three categories also have the ability to deliver up to 30 frames per second of video performance — the same frame rate as broadcast television — at 384 Kbps. PictureTel IP-based systems also can deliver up to 30 frames per second of video performance.

      When business people need to collaborate with colleagues across a city or halfway around the world, they often require network products that enable more than two systems to participate in the same conference. PictureTel markets three ISDN-based multi-location conferencing server lines: Montage™, Prism™ and Accord™ MCG-100. The MCG-100 and Montage are designed for large, reservation-based videoconferencing networks. Prism is a smaller system designed for use with personal videoconferencing systems and in situations where users want to conduct multi-location conferences more spontaneously. In the IP-conferencing market, PictureTel provides PictureTel 330™ NetConference multipoint server software. With the PictureTel 330, organizations can create virtual conference rooms on a variety of local area networks and the Internet for videoconferencing and data conferencing. In addition to multi-location servers, PictureTel’s complete network products line includes scheduling software, gateway products that enable users to conduct conferences between ISDN- and IP-based videoconferencing systems, and management software that enables the user to control videoconference network traffic on their local area network.

      PictureTel systems support international standards for videoconferencing. H.320 is the international standard for ISDN-based videoconferencing and H.323 is the standard for IP-based videoconferencing. PictureTel products also support T.120, the international standard for data collaboration. PictureTel has been a staunch supporter of and contributor to worldwide videoconferencing standards. PictureTel co-authored the H.323 standard and has contributed portions of the H.320 and T.120 standards as well. PictureTel’s commitment to industry standards gives its customers the peace of mind that their PictureTel systems will interoperate with any other manufacturer’s standards-based systems. In a PictureTel-to-PictureTel operating environment, PictureTel systems are built to function in an above-standards mode using proprietary technology to deliver the highest possible video and audio performance.

      One of the key new technologies behind visual collaboration is streaming video. In 1998, PictureTel acquired Starlight Networks, Inc., a provider of streaming-media solutions for enterprise communications. PictureTel sees tremendous synergy between its traditional videoconferencing technologies and video-streaming technology. When businesses add video-streaming technology to their existing videoconferencing capabilities, they will be able to take some of their important intellectual capital — meetings involving technical, marketing, sales and other experts — and enable employees, suppliers, partners and customers anywhere in the world to experience these meetings first hand by viewing the streamed content over IP-based networks. They also can extend the reach of that information by providing on-demand access at a later time. The acquisition of Starlight is expected to enable the Company to address a wider set of customers’ visual collaboration needs with solutions for enterprise briefings, distance learning applications, and business television. The acquisition also provides the Company with a knowledge base of streaming technology, which is a natural extension of PictureTel’s interactive visual collaboration leadership and complements PictureTel’s IP-based videoconferencing technology. The first new product resulting from this acquisition, known as eVideo Application Server, was released for commercial sale in March 2000.

Intel Relationship

      In January 1999, PictureTel entered into a distribution and joint product development agreement to accelerate growth of videoconferencing worldwide. Under terms of the distribution and development agreement, Intel provided PictureTel with distribution rights to sell the Intel® ProShare® Video System 500, and exclusive worldwide distribution rights to sell and support the Intel® TeamStation™ System. In addition to its expertise in videoconferencing distribution, sales and marketing, PictureTel provides its complete line of

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      Intel and PictureTel also agreed to begin joint development of videoconferencing and collaboration products based on a common PC-based technology platform. The common platform will be the foundation for future products that will feature communication and multimedia capabilities such as collaboration over LANs, streaming audio and video, and real-time conferencing. The first products resulting from this joint development agreement are expected to be introduced starting the second quarter of 2000. These future products, which will operate over multiple networks, including IP, ISDN and asynchronous transfer mode (ATM), are expected to replace PictureTel’s existing product line over time and will be marketed under the PictureTel brand name. Both PictureTel and Intel will receive compensation for the sale of products or components featuring either company’s technology.

      Additionally, on February 18, 1999, Intel invested $30.5 million in the Company, acquiring approximately 10% of the Company’s equity through convertible preferred stock.

Videoconferencing Services

      PictureTel assists customers in implementing and managing their visual collaboration technology on a global enterprise-wide basis through a comprehensive portfolio of maintenance and professional services, which together address each phase of the product life cycle. Professional services include conferencing, consulting, education, design and project management services. Consulting services provide planning and needs analysis to customers. Design services, such as room design and custom solutions, provide customized videoconferencing solutions to meet each customer’s unique requirements. Project management, installation and training provide customers with effective implementation of videoconferencing systems. For the on-going operation of customers’ videoconferencing environments, PictureTel provides conference services and maintenance services. Conference services facilitate the customer’s use of the videoconferencing technology by providing conference room scheduling, call launching, bridging and end-to-end problem resolution during conferences. These services are delivered for point-to-point, as well as multipoint conferences on a global basis. All services are sold both directly to customers and through PictureTel’s distributors. Service programs for local and international distributors range from reselling PictureTel’s service offerings to providing back-end support for servicing end-users.

      All maintenance services are delivered on a worldwide basis from several integrated global support centers located in the United States, United Kingdom, Singapore and Japan. Spare parts are stocked around the world to meet response time commitments to customers and distributors. PictureTel utilizes direct field service staff as well as distributors and third party service providers to perform installation and on-site repairs. Conference services are delivered from geographically distributed Network Operations Centers. Major centers are in the United States, United Kingdom, and Singapore. PictureTel delivers professional services and training through conferencing engineers, consultants, project managers and instructors. In addition, PictureTel offers electronic support via the World Wide Web.

      PictureTel believes that the quality and reliability of its systems and services are important to customer satisfaction. Accordingly, PictureTel’s videoconferencing services are ISO9002 registered and PictureTel expects to continue to maintain its certification. PictureTel also regularly measures customer satisfaction and strives to implement corrective actions to improve the quality of its service. The delivery of service is backed by PictureTel’s certification program, which tests and certifies the technical abilities of all support personnel dealing with videoconferencing products. PictureTel provides warranty support for parts and software media on the majority of its products. The warranty period is generally one year for hardware, ninety days for software media, and ninety days for repaired parts.

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Audioconferencing Business

      In addition to its core visual collaboration products and services, PictureTel, through its MultiLink business unit, also is a leading worldwide provider of audioconferencing solutions. MultiLink, which PictureTel acquired in 1997, develops, manufactures and markets audioconferencing systems — commonly known as bridges — that allow multiple parties to participate in a telephone call simultaneously. MultiLink introduced its next generation audio bridge (System 700) in December 1999. Many of the world’s leading telecommunications service providers use MultiLink audioconferencing technology to support their multi-location audio conference call services. Corporate customers use MultiLink systems throughout their enterprise to conduct multi-location audio conference calls for a variety of business purposes, including but not limited to business meetings, shareholder services, public relations, project management, focus groups, teletraining, distance learning and crisis management. MultiLink also provides maintenance and other customer support services for its installed base.

Current Strategy

      In early 2000, the Company adopted and is now pursuing a three-pronged approach to meeting the anticipated needs of the developing multimedia collaboration marketplace. First, in conjunction with Intel, it is developing its next generation endpoint conferencing products for video, voice and data collaboration. Second, it is expanding its enterprise-wide solutions services beyond management of multipoint videoconferences to include streaming video services, custom integration, and outsourced management of enterprise conferencing. The last prong is the development of Internet-based, multimedia application services built around a network-neutral collaboration hub and streaming technology developed by its Starlight subsidiary.

      To focus these efforts, the Company is presently in the process of establishing independent business units within PictureTel built around the above initiatives. Each will be free to pursue its market and to seek strategic and financial partners to help them increase PictureTel’s value.

Research and Development

      PictureTel continues to invest a significant percentage of its annual revenue in its research and development activities. A strong investment in research and development since the Company’s inception has enabled PictureTel to become the world leader in videoconferencing and is the basis for the Company’s new visual collaboration strategy. PictureTel’s historic investments in research and development have earned the Company more than thirty patents for its video and audio technologies.

      The overall Company investment in research and development has been reduced and will continue at reduced levels in 2000 and beyond. While spending fewer dollars on research and development programs, PictureTel believes that effective management will result in the same level — if not a higher level — of productivity from its research and development investment.

Sales

      The Company and its subsidiaries currently distribute PictureTel products worldwide by direct sales and indirect channels of distribution. In 1999, the Company derived approximately 24% of its worldwide product revenues from direct selling activities, and 76% from indirect channels.

      Direct Sales Organization. The Company directly markets its videoconferencing products, videoconferencing services and audioconferencing principally to the Fortune 500® (the largest product and service businesses in the United States as published annually by Fortune magazine). These large companies typically have multiple locations in the United States as well as internationally and typically specify a single vendor to supply equipment on a world wide basis. The Company believes that it is important to maintain a close working relationship with these customers in order to meet their demands for sales and support on a multinational basis.

      Within the United States, the Company maintains eight regional sales and support offices, as well as five demonstration centers. Sales offices typically include demonstration equipment as well as a number of customer and technical sales representatives and field support personnel.

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      Indirect Channels. To address the market below the Fortune 500 and expand the Company’s presence in the Fortune 500 market, the Company utilizes telecommunication equipment distributors, value-added resellers (“VARs”) and dedicated dealers who sell the Company’s videoconferencing products and videoconferencing services.

      International Distribution. Outside of the United States the Company relies on a network of foreign market distributors and its own international subsidiaries. Agreements with the Company’s foreign market distributors generally provide for pricing, volume discounts, order lead times, a specific geographic territory and other terms and conditions and are typically for terms of one to three years with options to extend such terms by mutual agreement.

Competition

      In its established businesses of group systems and desktop systems, the Company competes with a number of larger corporations, which have greater financial and marketing resources than the Company. In the developing businesses of network-based videoconferencing systems and compact systems, a number of corporations have begun to offer competitive products. In addition, partnerships between corporations that compete with the Company and corporations that develop and market network products, as well as mergers among competitors, are intensifying competition in the marketplace. This increased competition, together with a slowdown in the growth of the general market for videoconferencing products, has led, and may continue to lead, to decreases in average selling prices and margins in both group and desktop videoconferencing systems, a lower segment market share by the Company for products and services in the emerging area of network-based visual collaboration, and to increases in the defection or dilution of the Company’s distribution channel partners to competitors.

      The Company competes primarily on the basis of video and audio quality and data collaboration, as well as on favorable features, support services and the pricing of those systems and services. The Company believes that its products and services are competitive in each of these areas. Moreover, in response to this competitive environment, the Company is increasing its investment in perceived growth areas such as visual, audio and data collaboration applications; web-based scheduling and call-launching tools; integration services; and other value-added offerings. The Company believes that these investments, combined with the launch of its new-generation products, will well position the Company in this competitive landscape.

      Additional risks with regard to competition may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under Risk Factors Which May Affect Future Results.

Manufacturing

      The Company has developed a supply chain that encompasses the Company’s subassemblies and products supplied by vendors to the delivery of finished goods to the customer. This effort has resulted in a cost effective and timely delivery of products to the Company’s customers. This strategy allows the Company to reduce costly investment in manufacturing capital and to leverage the expertise of its vendors.

      The Company’s manufacturing operation consists of final assembly and testing of complete video and audioconferencing systems. Subassemblies of large systems, including tested printed circuit boards, are assembled into complete systems. These final systems are tested to ensure they meet all functional requirements.

      Desktop/personal hardware products are purchased in final form from various vendors. The products have been subjected to PictureTel’s quality testing at the vendor site. These products are placed into inventory, and are shipped according to demand.

      The Company utilizes a European Distribution Center (EDC) in Holland to centralize videoconferencing product shipments to its customer base in Europe. PictureTel has sourced components from local vendors in Europe to support proper stocking levels in Holland and maintain timely customer shipments. The EDC incorporates the same working relationships and policies with vendors in Europe as the Company currently does in the United States.

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Patents

      The Company’s principal technology consists primarily of certain advances in video and audio compression algorithms, echo cancellation and audio signal processing, camera positioning, and automatic speaker location technology, implemented in software and hardware configurations for use in PictureTel products and unique product designs. In addition, the Company has recently applied for several new patents based on inventions developed by its Starlight business. The Company has been issued a number of United States patents relating to the above-described technology, which expire at various dates from 2004 to 2017. The Company has a number of additional patent applications issued and pending in various countries including the United States, Canada, Europe and Japan, and will continue to file additional applications. However, there can be no assurance that its current patents (or any additional patents that may be issued in the future) provide broad protection from the development of similar product technology by competitors of the Company. In the absence of broad patent protection, and despite the Company’s reliance upon its proprietary confidential information, competitors of the Company may be able to use algorithms similar to those used by the Company to design and manufacture products that are directly competitive with the Company’s products.

Employees

      At December 31, 1999, the Company had 1,113 full-time employees, of whom 609 were employed in sales, marketing and customer support, 243 in product development and engineering, 72 in manufacturing and 189 in administration and finance. The Company had 299 employees in foreign countries at December 31, 1999.

      The Company’s future success will depend in part on its ability to attract and retain highly skilled and motivated personnel who are in great demand throughout the industry.

      None of the Company’s employees are represented by a labor union. The Company believes its relations with its employees to be good.

Item 2.  Properties

      The Company has substantially reduced its real estate footprint over the past two years. PictureTel’s corporate offices and research, development and manufacturing facilities are currently located in two leased facilities in Andover, Massachusetts, one leased facility in Chelmsford, Massachusetts, and one leased facility in Mountain View, California, aggregating approximately 490,000, 69,940, and 30,000 square feet, respectively. The lease at 100 Minuteman Road in Andover, Massachusetts expires in 2014. The lease at 200 Minuteman Road in Andover, Massachusetts, which is accounted for as a capital lease, began in October 1998 and expires in 2016. The lease for the product distribution facility in Chelmsford, Massachusetts expires in 2002. The lease in Mountain View, California expires in 2003. The videoconferencing products and videoconferencing services segments share common office space, and the audioconferencing segment is located at the 200 Minuteman Road property.

      In June 1998, the Company subleased its property at 50 Minuteman Road for a period of ten years. This lease is accounted for as a capital lease. Effective July 1999, its property at 6 Riverside Drive in Andover was subleased for a period of five years. Additionally, the Company did not renew the lease at 100 Brickstone Square in Andover when it expired in August 1999.

      PictureTel also leases office space for its regional and branch sales and support offices in the United States and for similar offices of its subsidiary and branch operations worldwide.

Item 3.  Legal Proceedings

  A.  Datapoint Litigation

      In December 1993, PictureTel was sued by Datapoint Corporation in the United States District Court for the Northern District of Texas. Datapoint alleged that certain of PictureTel’s products infringed patent rights allegedly owned by Datapoint. On April 9, 1998, a jury returned a verdict in favor of PictureTel finding that PictureTel did not infringe the Datapoint patents and that the Datapoint patent claims raised against PictureTel were invalid. On May 3, 1999, an appeals hearing took place with regard to this litigation. On July 15, 1999, the United States Court of Appeals for the Federal Circuit issued a ruling in favor of

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  B.  Shareholder Litigation

      Since September 23, 1997, seven class action shareholders’ complaints have been filed against the Company, Norman E. Gaut, Director and former Chairman of the Board and Chief Executive Officer, and Les Strauss, the former Vice President and Chief Financial Officer, in the United States District Court for the District of Massachusetts. The plaintiffs filed a consolidated complaint on February 11, 1998.

      The original complaints were filed following the Company’s announcement on September 19, 1997 that it would restate its financial results for the first quarter of the fiscal year ending December 31, 1997 and the last two quarters of the fiscal year ending December 31, 1996 and were amended when the Company announced on November 13, 1997 that it would also restate the second quarter of the fiscal year ending December 31, 1997. The consolidated complaint alleges that PictureTel and Messrs. Gaut and Strauss violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, during the period from October 17, 1996 through November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the price of PictureTel Common Stock. The consolidated complaint seeks to recover an unspecified amount of damages, including attorneys’ and experts’ fees and expenses.

      On April 7, 1998, the Company filed a motion to dismiss the complaint. On October 28, 1998, the motion to dismiss Norman E. Gaut was granted and the motion to dismiss PictureTel and Les Strauss was denied.

      On June 17, 1999, the Company announced that it had entered into a settlement agreement with the Plaintiffs. The Settlement provides that the claim against PictureTel and Mr. Straus will be dismissed. In agreeing to the proposed settlement, the Company and Mr. Strauss specifically deny any wrongdoing. The settlement provided for a cash payment of $12 million by the Company, plus interest, after the settlement was final. More than 75% of the settlement amount was recovered by the Company from insurance proceeds. The settlement was subject to certain customary conditions, including preliminary and final approval by the United States District Court for the District of Massachusetts, and notice to the class. On July 29, 1999, the Court gave preliminary approval of the settlement. Formal notices with details of the settlement were sent to the purported class members by the Plaintiffs’ counsel. On November 4, 1999, the Court gave its final approval of the settlement. Since all appellate statue of limitations have now expired, this decision closes the lawsuit brought by the plaintiffs.

  C.  SEC Investigation

      In May 1999, the Company was informed that the Securities and Exchange Commission (SEC) had initiated a formal investigation of matters related to the Company’s 1997 restatement of its earnings. The Company has been cooperating with the SEC and will continue to do so. The Company expresses no opinion as to the likely outcome. While no assurances can be provided, the Company does not believe that the investigation will have a material adverse affect on its business, financial condition, results of operations or cash flows.

  D.  Revnet, Inc.

      On June 2, 1998, the Company was served with a complaint from a former distribution channel customer, Revnet, Inc., which has ceased operations. (Revnet, Inc., v. PictureTel Corporation. Civil Action 98092039, filed April 2, 1998, in the Circuit Court for Baltimore City, Maryland.) The complaint alleges that the Company breached an oral contract. Revnet is allegedly seeking $200 million in damages. Discovery is in process. The Company believes that the complaint and the claim for damages are without merit and intends to vigorously defend against them. In addition, after limited discovery under the above named suit, the Company on September 13, 1999 filed a related action in the Circuit Court for Baltimore City, Maryland against Revnet, Inc., Vuecom, Inc. (an entity related to Revnet, Inc.), George Harris IV, George Sandmann and Lou Brown, (PictureTel Corporation v. RevNet, Inc., et al. Civil Action 24-C99-004406) alleging among other things Breach of Contract, Fraudulent Inducement and Securities Fraud. The Company’s complaint is seeking more than $7 million in damages. While no assurance can be provided, the Company does not believe that the

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  E.  Patent Infringement

      In February 2000, the Company settled a patent infringement claim for the Company’s use of an ITU-U standard. The Company received a license to use the standard until 2007 for the payment of $1.3 million spread ratably over five years. In connection with this license the Company recognized approximately $0.4 million in amortization expense in 1999 and has recorded net prepaid royalties of approximately $0.9 million at December 31, 1999.

      In addition to the above, the Company has also been and is from time to time subject to claims, such as potential patent infringements, and suits incidental to the conduct of business. There can be no assurance that the Company’s insurance will be adequate to cover all liabilities that may arise out of such claims. Further, although the Company intends to defend itself vigorously against all such claims, the ultimate outcome of the claims cannot be accurately predicted. The Company does not believe that any claim of which it is aware, other than the claims listed above, could result in an outcome that will have a material adverse affect to its business, financial condition, results of operations or cash flows.

Item 4.  Submission of Votes

      There were no items submitted to the shareholders during the fourth quarter of 1999.

PART II

Item 5.  Market for Registrant’s Common Equity and related Stockholder Matters

PRICE RANGE OF COMMON STOCK

      The following table sets forth the high and low sale prices for the Company’s Common Stock for the periods indicated as reported by NASDAQ under the symbol PCTL.

      As of March 10, 2000 there were approximately 1,728 holders of record of the Company’s Common Stock.

DIVIDEND POLICY

      The Company has not paid any dividends on its Common Stock since its inception. The Board of Directors does not anticipate declaring any cash dividends in the foreseeable future.

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Item 6.  Selected Financial Data

SELECTED FINANCIAL DATA

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

      The following table sets forth, for the periods indicated, the percentages of revenue for certain items in the Company’s Statement of Operations for each period. The table and the following discussion reflect the other charges described in Note 15 of the Notes to Consolidated Financial Statements:

  Forward-Looking Statements

      This document includes forward-looking statements about the Company’s business, revenue and expenses, effective tax rate, operating and capital requirements, liquidity and management’s plans to introduce new products, negotiate an expanded credit facility, and seek additional equity investment. Forward-looking statements made or incorporated by reference herein are not guarantees of future performance. In addition, forward-looking statements may be included in various other PictureTel documents to be issued in the future and in various oral statements by PictureTel representatives to security analysts and investors from time to time. Any forward-looking statements are subject to risks that could cause the actual results to vary materially. Such risks are discussed in “Risk Factors Which May Affect Future Results” and in other related portions of this document.

  Business Developments

      On January 19, 1999, the Company announced it had entered into a distribution and joint development agreement with Intel Corporation. The two companies have jointly developed videoconferencing and collaborative products based on a common PC-based technology platform. Use of a single architecture is expected to improve ease of use and functionality, while reducing both product and associated support costs. The first of these new products, which will be marketed under the PictureTel name, is expected to be available in the second quarter of 2000. Also, under the terms of the agreement, the Company has distribution rights to sell the Intel® ProShare® Video System 500 and exclusive worldwide distribution rights to sell and support the Intel® TeamStation™ System. Additionally, on February 18, 1999, Intel invested $30,500 in the Company, acquiring approximately 10% of the Company’s equity through convertible preferred stock.

      On August 31, 1999, the Company announced that Dr. Norman Gaut had succeeded Bruce R. Bond as Chairman of the Board, Chief Executive Officer, and President of the Company following Mr. Bond’s resignation. While affirming the strategic direction developed by Mr. Bond, the Board of Directors and Mr. Bond were of the opinion that the Company would make faster progress toward execution of the strategy under different leadership.

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      In early 2000, the Company adopted and is now pursuing a three-pronged approach to meeting the anticipated needs of the developing multimedia collaboration marketplace. First, in conjunction with Intel, it is developing its next generation endpoint conferencing products for video, voice and data collaboration. Second, it is expanding its enterprise-wide solutions services beyond management of multipoint videoconferences to include streaming video services, custom integration, and outsourced management of enterprise conferencing. The last prong is the development of Internet-based, multimedia application services built around a network-neutral collaboration hub and streaming technology developed by its Starlight subsidiary.

      To focus these efforts, the Company is presently in the process of establishing independent business units within PictureTel built around the above initiatives. Each will be free to pursue its market and to seek strategic and financial partners to help them increase PictureTel’s value.

      On October 28, 1999, the Company announced it had retained an investment banker to represent it in the sale of MultiLink, Inc., the Company’s audioconferencing subsidiary. The Company intends to operate MultiLink, Inc. as a wholly-owned subsidiary while it considers a number of divestiture alternatives.

  Year ended December 31, 1999 Compared to the Year ended December 31, 1998

      Revenue. Total 1999 revenue of $323,279 decreased $82,873, or 20%, from prior year levels. Lower average selling prices and changes in the videoconferencing products sales mix to more products at the lower end of the product line principally account for the decline. The Company’s revenue from sales to foreign markets was approximately 46% and 43% of total revenue in 1999 and 1998, respectively. The Company expects that international revenue will continue to account for a significant portion of total revenue. Revenue from 1999 sales to foreign markets was principally comprised of sales originating in the United States of $27,822, the United Kingdom of $65,654 and Japan of $27,055. Revenue from sales to foreign markets in 1998 were principally comprised of sales originating in the United States of $35,618, the United Kingdom of $79,396 and Japan of $24,747.

      Gross Margin. Overall gross margin decreased $70,930, or 41%, to $102,136 in 1999 versus 1998. Gross margin as a percentage of revenue was 32% in 1999 compared to 43% in 1998. Both declines were primarily caused by lower average selling prices coupled with increased relative sales of lower margin products in the videoconferencing products segment. Higher videoconferencing services costs also contributed to the lower gross margin performance.

      Operating Expenses. Selling, general and administrative expenses decreased $4,372, or 3%, from 1998 but increased as a percentage of revenue to 39% from 32%. A 25% headcount decrease, partially offset by $2,554 of severance and related expense, $2,550 settlement cost of shareholder litigation, and $2,481 related to subleasing excess real estate, is responsible for the lower dollar expenses. Research and development expenses of $66,130 were essentially the same as in 1998 and represented 20% and 16% of revenue for 1999 and 1998, respectively. Research and development expenditures, prior to the capitalization of software costs, were $73,500 in 1998, or 18% of revenue. The Company capitalized software costs of $7,446 in 1998, excluding completed technology purchased as part of the Starlight acquisition. No such costs were capitalized in 1999, as no current projects in progress had achieved technological feasibility.

      Videoconferencing Products. The videoconferencing products segment develops, manufactures and markets visual communications systems and collaboration software. Videoconferencing products scale from personal/desktop systems to large conference room solutions. Additionally, the segment markets a wide range of network infrastructure products and peripheral devices. Videoconferencing product revenue decreased 28% to $232,533 in 1999 from $323,487 in 1998. The decrease can be attributed to lower average selling prices and significant changes in product sales mix. Trends toward lower average selling prices are expected to continue in response to increased competition. Shifts in sales mix from large room systems such as the Concorde and Venue product lines to compact class room systems, such as Swiftsite II and Intel® TeamStation™ System, continued in 1999. Traditional large room systems represented 36% of total room system sales in 1999 compared with 62% in 1998. Overall unit sales grew only 2% versus the prior year with room systems increasing 13% and personal systems decreasing 6%. Revenue was further impacted by a delay in releasing Swiftsite II, a next generation compact room system, until the second quarter of 1999, and lower investment in legacy product features and functionality. Significant resources have been redirected to next generation

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      The videoconferencing products segment generated an operating loss of $68,409 in 1999 compared to a $16,049 operating loss in 1998. Significant charges of $4,062 and $11,250 are included in the 1999 and 1998 losses, respectively. Severance and other workforce reduction related costs account for the 1999 charges. The 1998 charges included $4,442 for incomplete technology acquired in connection with the November 1998 acquisition of Starlight Networks plus $6,808 related to the write-down of inventory and capitalized software to their net realizable value plus other costs associated with discontinuance of a video network server product line.

      Absent these charges the videoconferencing product segment operating losses would have been $64,347 in 1999 versus $4,799 in 1998. Lower revenue, decreased software development cost capitalization, capitalized software amortization related to Swiftsite II, and amortization of goodwill and completed technology purchased as part of the Starlight acquisition were the primary contributors to the earnings decline. Ongoing operating expenses excluding capitalized software decreased approximately 12% versus 1998 as segment headcount was reduced by nearly 40% during the year in response to lower revenue expectations. Gross margin was 34% in 1999 excluding charges compared with a 1998 figure of 46%.

      Videoconferencing Services. The videoconferencing services segment provides maintenance as well as professional consulting and management services for videoconferencing products sold by the Company and its competitors. Segment revenue increased 18% from $59,760 in 1998 to $70,304 in 1999. Maintenance revenue was 10% higher than the prior year while professional services increased 35%. The professional services growth came largely from managing multipoint videoconferences for customers and from custom product integration sales and services.

      Operating profits were $2,976 in 1999, which represents a 59% decrease from the prior year’s $7,191 figure. Higher average costs for contracted services, increased provision for spare parts obsolescence, higher selling expenses, and development costs associated with new service offerings are responsible.

      Audioconferencing (MultiLink). The audioconferencing segment develops, manufactures, markets and services multipoint audio control units. Segment revenue decreased $2,463, or 11%, from 1998 to $20,442 in 1999. This decrease relates to the delayed introduction of MultiLink’s next generation product line, the System 700, which occurred in December 1999.

      The segment recorded a $2,880 operating loss during 1999 compared to a $7,334 operating profit the previous year. Charges of $2,481 related to the July 1999 sublease of MultiLink’s former facility at Riverside Drive in Andover, Massachusetts are included in 1999’s results. Decreased revenue and sharply increased research and development spending on enhancing current products and developing next generation products are the other major factors responsible for the profitability decline.

  Year ended December 31, 1998 Compared to the Year ended December 31, 1997

      Revenue. The Company’s revenue decreased $60,273, or 13%, in 1998 from 1997’s $466,425 level. The decrease in revenue was primarily a result of decreased unit shipments of videoconferencing products offset by increased videoconferencing services revenue. Sales to foreign markets accounted for approximately 43% of total revenue in both 1998 and 1997. Revenue from sales to foreign markets in 1998 were principally comprised of sales originating in the United States of $35,618, the United Kingdom of $79,396 and Japan of $24,747. Revenue from sales to foreign markets in 1997 was principally comprised of sales originating in the United States of $41,667, the United Kingdom of $76,318 and Japan of $36,689.

      Gross Margin. The Company’s 1998 gross margin of $173,066 decreased $17,448, or 9%, compared to 1997. Gross margin as a percentage of revenue was 43% in 1998 compared to 41% in 1997. Gross margin as a percentage of revenue increased due to decreased significant charges included in cost of revenue for the videoconferencing products segment in 1998 versus 1997, as discussed below.

      Operating Expenses. Selling, general and administrative expenses in 1998 of $130,662 decreased $37,179, or 22%, from 1997 and decreased as a percentage of revenue to 32% from 36%. Research and development expenses decreased $13,469, or 17%, in 1998 from 1997 and were 16% and 17% of revenue for

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      Videoconferencing Products. Segment revenue fell $69,425, or 18%, to $323,487 in 1998 compared to 1997, with a 16% decline in overall videoconferencing system unit volume primarily responsible for the decrease. Group system shipments were down 22%, mainly in the Concorde and Swiftsite lines, while desktop/personal system shipments decreased 12%. Network server product volume, which is driven largely by group and desktop/personal shipments, also declined. Average selling prices were generally lower across all products compared to 1997, but a shift in mix towards higher priced group and associated network products kept overall average selling prices nearly flat. Delayed introduction of Swiftsite II, the Company’s successor compact system to Swiftsite I, from the fourth quarter of 1998 to the second quarter of 1999 accounted for much of the group systems volume decline and the favorable mix as higher priced systems made up a larger proportion of revenue.

      The videoconferencing products segment generated a $16,049 operating loss during 1998 compared to a $30,533 loss the previous year. The losses for both years include significant charges, with $11,394 of the $14,484 operating loss reduction from 1997 to 1998 resulting from lower charges in 1998. The 1998 charges totaled $11,250, as discussed previously. Charges of $22,644 are included in the 1997 loss and include $4,940 for various write-downs of excess and obsolete inventory, $9,881 for capitalized software costs impaired as a result of canceled development projects, $1,122 for product retrofit accruals, $4,037 for severance charges and office closings, $1,880 for advances to vertical partners written off to reflect changing business conditions and shifts in distribution channels and $784 to write off other assets associated with the canceled development projects.

      Absent these significant charges, the videoconferencing product segment operating loss would have been $4,799 in 1998 compared to a $7,889 loss the previous year. For 1998, an 18% reduction in research and development expenditures along with an 18% reduction in other operating expenses due to management’s efforts to reduce the Company’s overall cost structure more than offset a gross margin decline caused by the lower segment revenue. Gross margin as a percent of revenue was approximately 46% in both years excluding charges.

      Videoconferencing Services. Segment revenue increased 22% from $48,988 in 1997 to $59,760 in 1998. Growth in professional service revenue, particularly from managing multipoint videoconferences for customers, was primarily responsible for the increase.

      Operating profits were $7,191 in 1998, which represents a 61% increase over the prior year’s $4,455 figure. Higher revenue and lower field operating expense account for the improvement.

      Audioconferencing. Segment revenue decreased $1,620, or 7%, from prior year levels to $22,905 in 1998. A decrease in average selling prices that was partially offset by increased unit shipments accounted for the decrease.

      The segment generated $7,334 of operating profit during 1998 compared to a $6,568 operating loss the previous year. Operating expenses in 1997 included $2,561 for investment banking and other advisory fees recorded when the Company acquired MultiLink as well as $3,431 to establish accruals for severance, sales tax and benefit liabilities. The 1997 loss would have been $576 without these charges. The year-over-year profitability improvement between 1997 and 1998 was driven largely by reductions in research and development and sales expenses due to lower headcount. Gross margin improved versus 1997, despite lower revenue, as a result of improved service profitability.

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  Other

      Net Interest Income (Expense). The Company had net interest expense of $375 in 1999 compared with net interest income of $1,948 and $2,518 in 1998 and 1997, respectively. The decrease from 1998 to 1999 resulted primarily from lower invested cash balances and a full year of interest expense on the 200 Minuteman facility’s capital lease. The lease began in October 1998. The $570 decrease from 1997 to 1998 was primarily the result of higher interest expense on capital lease obligations.

      Other Income (Expense). Other income of $10,517 in 1999 consists principally of net gains on foreign currency transactions and a $8,495 gain from the third quarter sale of RealNetwork shares acquired through an investment in a company later acquired by RealNetworks. Net gains on foreign currency transactions are also the primary component of 1998’s other income of $1,804. Both 1999 and 1998 figures also include net sublease income related to the 50 Minuteman facility. Other expenses of $1,158 in 1997 consisted primarily of a $3,000 write-off of an equity investment offset by net gains on foreign currency transactions and net gains on sales of securities.

      Income Taxes. The Company’s effective tax rate for 1999, 1998 and 1997 was 6%, 180%, and (29)%, respectively. The 1999 and 1998 rates differ from the federal statutory rate due to state and foreign taxes and an increase in the valuation allowance for deferred taxes. Due to uncertainty surrounding the Company’s ability to fully realize deferred tax assets, PictureTel established a full valuation allowance against its deferred tax assets in 1998 and recognized no deferred tax benefits in 1998 and 1999. The 1997 rate differs from the federal statutory rate due to state and foreign taxes offset by research and development tax credits and increased valuation allowances related to certain current year tax credits and net operating losses whose benefits are uncertain.

Liquidity and Capital Resources

      At December 31, 1999, the Company had $21,915 in cash and cash equivalents and $37,787 in short-term marketable securities. Operating activities used $65,369 of cash during 1999 and generated $55,550 of cash during 1998. The primary operating uses of cash during 1999 were to fund operating losses in excess of non-cash expense and to decrease accounts payable. During 1998, the Company had positive operating income before non-cash expense and also generated cash by reducing accounts receivable and inventories. The Company paid $2,010 of accrued severance and restructuring charges during 1999 and had a remaining accrual in the amount of $1,960 for such items as of December 31, 1999 that will be paid over the next year and eight months.

      Investing activities used $3,465 of cash in 1999 compared with a $39,102 usage the previous year. Capital spending totaled $12,591 and was partially offset by $8,495 of cash generated through selling the Company’s RealNetworks shares. Capital spending of $19,421 in 1998 included leasehold improvements at the 200 Minuteman facility while internal software development, securities purchases, and the Starlight acquisition are responsible for the balance of the 1998 investing cash usage.

      Financing activities generated $27,736 of cash in 1999, with the principal source being $30,500 of cash from the issuance of convertible preferred stock to Intel Corporation. Principal payments on capital leases were the major use of cash. Financing activities used $3,727 of cash in 1998, primarily to pay principal on capital leases.

      Cash utilization is of major concern to the Company. To reduce this usage, the Company has restructured several areas, reduced staffing, intensified programs to reduce working capital, and curtailed capital spending. However, without increased revenue these actions alone will not return the Company to a cash positive position.

      The Company has a revolving credit agreement, expiring June 15, 2001, as a source of funds. The Company has up to $35,000 available for borrowing under the credit agreement. At December 31, 1999, no borrowings were outstanding under this credit agreement. The Company currently has $30,595 of outstanding standby letters of credit issued under this agreement which reduces the amount available for borrowing on a dollar for dollar basis. Fees for letters of credit outstanding against this revolving credit line are payable at 125 basis points per annum of the face amount. The revolving credit agreement is collateralized by substantially all

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      The Company is currently seeking a waiver for not meeting its first quarter 2000 covenants and anticipates that its quarterly financial results for the balance of 2000 will likely be out of compliance with the current credit facility’s financial covenants. To address this and to provide necessary additional liquidity and borrowing capacity, the Company and its bank group are currently negotiating an expanded credit facility. In the event such efforts are unsuccessful, the Company’s cash could be reduced by the amount of the letters of credit.

      Local lines of credit are available for short-term advances of up to $979 to certain of the Company’s foreign subsidiaries. The agreements require interest payable up to one quarter of one percent per annum. Approximately $196 was outstanding against these local lines of credit at December 31, 1999.

      In June 1999, the Company entered into a short-term security agreement with BankBoston. Under this agreement, the Company pledged to the Bank certain amounts of cash and cash equivalents as collateral for obligations of the Company arising from use of the Bank’s cash management and foreign exchange services. The required collateral was $1,200 as of December 31, 1999.

      We have received a report from our independent accountants containing an explanatory paragraph stating that our recurring losses and requirement for additional financing raise substantial doubt about our ability to continue as a going concern. Moreover, management’s plans to continue as a going concern rely heavily on forecasted revenue from new products being jointly developed with Intel Corporation, new multi-media applications services, and enhanced compact videoconferencing systems, all of which are planned for delivery commencing in the second quarter of 2000. Under generally accepted auditing standards, the Company’s auditors have concluded that they are unable to rely on future revenue from these new products and services in evaluating the achievability of management’s plan to continue as a going concern. In addition to the revenue plan, management is currently negotiating an expanded credit facility and may seek additional equity investment. Management is also continuing to identify and implement internal actions to improve the Company’s liquidity. While there can be no assurances that these plans will be successful, management believes these actions, if successful, will provide sufficient financial resources for the next twelve months and beyond.

      The Company has operating leases for various rented properties. The Company signed an agreement to sublease MultiLink’s former facility at 6 Riverside Drive in Andover, Massachusetts in May 1999 as part of its space consolidation efforts. As of December 31, 1999, the remaining obligation under this operating lease was $8,135. After giving effect to expected sublease income, this obligation is $5,082. In addition, in June 1998, the Company subleased its property at 50 Minuteman Road for a ten-year term. After giving effect to expected sublease income, the remaining principal obligation under the capital lease was $16,694 at December 31, 1999.

      In October 1998, the Board of Directors authorized a plan to repurchase up to 1,000,000 shares of the Company’s Common Stock in open market, privately negotiated or other transactions. No shares were repurchased during 1998. The Company repurchased 70,000 shares during 1999 at a cost of $556 (approximately $7.94 per share). In addition, 22,065 shares were returned to the Company from shares held in escrow related to the MultiLink acquisition. There are no definitive plans to repurchase the additional shares under the plan.

Outlook

      The Company has begun to show its next generation videoconferencing products, which are expected to be released in the second quarter of 2000, to direct customers and distributors. As a result, it expects that some customers may defer purchasing decisions, particularly of group videoconferencing systems, until the new products are available. On April 4, 2000, the Company announced that it expects consolidated first quarter 2000 revenue to be between $63 and $66 million with a corresponding net loss of between $0.55 and $0.60 per share. The Company currently intends to continue investing in new product and service development and the

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      The Company expects to return to revenue growth once its new products are launched and management presently believes PictureTel will become profitable during the second half of 2000.

  Recently Issued Accounting Pronouncements

      In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement was originally effective for all fiscal year ends beginning after June 15, 1999. In June 1999, the FASB issued Statement 137, which delayed the effective date of Statement 133 by one year. Statement 133 will be effective for PictureTel’s fiscal year beginning January 1, 2001. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The Company is currently evaluating the effects of this change but anticipates that the adoption of SFAS 133 will not have a significant effect on the Company’s financial position or results of operations.

      In December 1998, the American Institute of Certified Public Accountants issued SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”, which addresses software revenue recognition as it applies to certain multiple-element arrangements. SOP 98-9 also amends SOP 98-4, “Deferral of the Effective Date of a Provision of SOP 97-2,” to extend the deferral of application of certain passages of SOP 97-2 through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. The Company will comply with the requirements of this SOP as they become effective and does not expect this to have a material effect on the Company’s result of operations.

      In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” (“SAB 101”) as amended by SAB 101A, which is effective no later than the quarter ending June 30, 2000. SAB 101 clarifies the Securities and Exchange Commission’s views regarding recognition of revenue. The Company will adopt SAB 101 in the second quarter of 2000 and is currently evaluating the effects it will have. The Company anticipates that the adoption of SAB 101 will have a material effect on the Company’s 2000 financial position and results of operations.

  Risk Factors Which May Affect Future Results

      The following risk factors relating to the business of PictureTel and certain forward-looking statements contained herein should be considered by current and prospective investors of PictureTel stock. These factors should be considered in conjunction with other information contained in this document.

      New Products, Cost Reductions, Technological Change, and Evolving Markets. The Company is engaged in an industry that is still emerging as a result of extensive research and development efforts and which continues to bring to market new, more technologically advanced products introduced on an accelerated basis. Simultaneously, the larger telecommunications market is in a heightened competitive state due to deregulation throughout the world. In order to maintain its market share in this fast-paced emerging market, the Company must continue to introduce, through internal development or by acquisition, joint venture or other collaborative arrangements, significant innovative, technologically leading and cost-competitive products. There can be no assurance that such new products will be introduced by the Company, or if introduced, will be accepted by the market and its customers. In November 1998, the Company acquired all of the common stock of Starlight Networks, Inc. Starlight develops, manufactures and markets streaming video that enables live, interactive multicast video-on-demand. There can be no assurance that the integration of Starlight will be successful or produce products that will be accretive to the Company’s results of operations and financial condition. In January 1999, the Company entered into a distribution and joint product development agreement with Intel Corporation. The two companies have jointly developed videoconferencing and collaborative products based on a common PC-based technology platform. There can be no assurance that the partnership will be successful or produce products that will be accretive to the Company’s results of

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      Competition. This increased competition resulting from such partnerships and acquisitions, together with mergers among competitors and a slowdown in the growth of the general market for visual collaboration products, has led and may continue to lead to increases in the defection or dilution of PictureTel’s distribution channel partners to competitors, decreases in average selling prices and margins in both group and desktop visual collaboration systems, and a lower segment market share by PictureTel for products and services in the emerging area of network-based visual collaboration. In some cases, PictureTel competes with its channel partners for various services, which increases the complexity of channel management. In addition, competitors may offer network-based visual collaboration software solutions or incorporate standard algorithms into processor chips free of additional charge, which may reduce the value PictureTel technology provides to the market, especially in its lower end visual collaboration products. In addition, the prices which PictureTel is able to charge for its visual collaboration products and services may further decrease from historical levels as a result of new product introductions by competitors, price competition, technological advances, or otherwise. Any of these factors could have a material adverse effect on PictureTel’s business, financial condition and results of operations.

      Manufacturing. Certain key subassemblies and products are currently available only from one vendor and several vendors are smaller corporations with limited financial resources that could prove to be inadequate. In some cases components are sourced from only one vendor, even where multiple sources are available, to maintain quality control and enhance the working relationship with the vendor. In addition, the Company from time to time enters into development arrangements with third parties to develop and incorporate new features and functions into the Company’s products. Failure of these third parties to fulfill their respective obligations under these development arrangements could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s business could also be adversely affected by delays or interruptions in delivery, and poor quality of supplies, subassemblies or products from key vendors. In addition, the Company designs and procures certain circuits, components and subassemblies from non-videoconferencing divisions of its competitors, such as Sony and Panasonic Corporation. The failure to obtain adequate supplies or the requirement to redesign and source supplies from another manufacturer may take substantial time and result in significant expense, each of which could adversely impact product shipments and materially and adversely affect the Company’s business, financial condition or results of operations.

      Recent History of Losses. The Company’s revenue decreased 20% during 1999 as compared to 1998 and decreased 13% between 1998 and 1997. Losses from operations were $90,284, $23,650 and $56,850 in 1999, 1998 and 1997, respectively. On April 4, 2000, the Company announced that it expects consolidated first quarter 2000 revenue to be between $63 and $66 million with a corresponding net loss of between $0.55 and $0.60 per share. Continued negative operating results could adversely impact the Company’s relationship with customers, vendors and employees, as well as its liquidity and ability to remain in compliance with covenants under its revolving credit agreement. We have received a report from our independent accountants containing

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      Product Protection and Intellectual Property. The Company’s success depends in part on its proprietary technology. The Company attempts to protect its proprietary technology through patents, copyrights, trademarks, trade secrets and license agreements. In absence of broad patent protection, which is not likely, and despite the Company’s reliance upon its proprietary confidential information, competitors of the Company have been able to use algorithms, or other features similar to those used by the Company, to design and manufacture products that are directly competitive with the Company’s products. The Company believes that due to the rapid pace of technological change in the visual collaboration industry, legal protection for its products is less significant than factors such as the Company’s use, implementation and enhancement of standards-based open architecture and the Company’s ongoing efforts in product innovation.

      Although the Company does not believe that its products infringe the proprietary rights of any third parties, third parties have asserted infringement and other claims against the Company from time to time. There can be no assurance that third parties will not assert such claims against the Company in the future or that such claims will not be successful. The Company could incur substantial costs and diversion of management resources with respect to the defense of any claims relating to proprietary rights, which in turn could have a material adverse effect on the Company’s business, financial condition and result of operations.

      Potential Fluctuations of Quarterly Operating Results. The majority of the Company’s revenues in each quarter result from orders booked in that quarter, and a substantial portion of the Company’s orders and shipments typically occur during the last weeks of each quarter such that forecasting of revenue and product mix is both complex and difficult. Unanticipated variations in the timing of receipt of customer orders in any quarter may produce significant fluctuations in quarterly revenues. As a result, a shortfall in revenue compared to internal expectations may not evidence itself until late in the quarter and any resulting impact on earnings may not be determinable until several weeks after the end of the quarter. The Company’s ability to maintain or increase net revenues depends upon its ability to increase unit volume sales. There can be no assurance that the Company will be able to increase or to maintain the current level of unit volume sales. Other factors which may cause period-to-period fluctuations in operational results include the timing of new product announcements and introductions by the Company and its competitors, market acceptance of new or enhanced versions of the Company’s products, changes in the product mix of sales, changes in the relative proportions of sales among distribution channels or among customers within each distribution channel, changes in manufacturing costs, and general economic factors such as the recent decline of currency values in the Asian markets.

      International Operations. Revenue related to international operations of the Company totaled approximately 46%, 43% and 43% of total revenues for the three years ended December 31, 1999, 1998 and 1997, respectively. Management of the Company expects international revenues to continue to constitute a significant portion of total revenues in future periods. However, there can be no assurance that the Company will be able to maintain or increase international market demand for its products and, to the extent the Company is unable to do so, its business, financial condition, results of operations or cash flows could be materially adversely affected. The Company’s sales to international distributors are denominated in U.S. dollars in order to minimize risks associated with fluctuating foreign currency rates. An increase in the value of the U.S. dollar relative to other currencies, however, could make the Company’s product more expensive and, therefore, potentially less competitive in foreign markets. Sales by the Company’s foreign subsidiaries are generally made in the foreign subsidiary’s local currency, in which case fluctuations in the value of the U.S. dollar relative to such other currencies could have a material adverse effect on the operating results of the Company. Currently, the Company employs various currency hedging strategies to reduce these risks. In addition, a significant portion of the Company’s revenue is derived from Asian markets. Given the

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      Volatility of Stock Price. As is frequently the case with the stocks of high technology corporations, the market price of PictureTel Common Stock has been, and may continue to be, volatile. Factors such as quarterly fluctuations in results of operations, increased competition, the introduction of new products by the Company and by its competitors, changes in the mix of products and sales channels, the timing of significant customer orders, and macroeconomic conditions generally, may have a significant adverse effect on the market price of the Company’s stock in any given period. In addition, the stock market has, from time to time, experienced extreme price and volume fluctuations, which have particularly affected the market price for many high technology corporations and which, on occasion, have appeared to be unrelated to the operating performance of such corporations. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant adverse effect on the market price of PictureTel Common Stock in any given period.

      Dependence on Key Personnel. On August 31, 1999, the Company announced that Dr. Norman Gaut had succeeded Bruce R. Bond as Chairman of the Board, CEO and President of the Company. In February 1998, Mr. Bond succeeded Dr. Gaut as Chief Executive Officer and President, and had been elected Chairman of the Board in June 1998. At that time, Dr. Gaut had retired as an active employee while remaining a member of the Board of Directors. Dr. Gaut accepted this 1999 position at a difficult time for the Company and there is no assurance that this transition will be successful. The Company depends on a limited number of key senior management personnel, including Norman Gaut; Arthur Fatum, Vice President and CFO; David Grainger, Group Vice President and General Manager of Services; Timothy Duffy, Group Vice President and General Manager of Conferencing Products; Robert Byrnes, Group Vice President for Emerging Products; Lawrence Bornstein, Vice President, Human Resources; and John Nye, President and General Manager, MultiLink. There has been and continues to be considerable turnover in the Company’s senior management team over the past several years, and the loss of the services of one or more of the Company’s senior management team or the inability to attract, retain, motivate and manage additional key personnel could have a material adverse effect on the business, financial condition or operating results of the Company. In addition, the Company continues to experience an increase in voluntary employee attrition from engineering and other departments. There is no assurance, given the competitive nature of the current job market, that the Company will be able to adequately fill the open positions.

      Year 2000 Compliance. In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.

      Euro. On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing sovereign currencies and established the euro, making the euro their common legal currency on that date. Based on a recent assessment, the euro conversion is not anticipated to have a material impact on the Company’s business.

Item 7a.  Quantitative and Qualitative Disclosures About Market Risk

      The Company and its subsidiaries face exposures to financial market risks, including adverse movements in foreign currency exchange rates and changes in interest rates. The Company’s primary currency exposure

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      The following table represents hypothetical changes in fair value in the Company’s foreign currency forward contracts. The modeling technique measures the fair value of the forward contract by currency type arising from potential changes in foreign currency rates. Movements in foreign currency rates of plus or minus 3% and 6% reflect hypothetical shifts in fair value of these forward contracts. “No change in currency rates” represents the market value of each market-rate sensitive currency as of December 31, 1999. All values are represented in U.S. dollar equivalents (in thousands):

      The Company’s investments include corporate obligations with various issuers and maturities. The Company’s primary market risk exposure for its investments relates to fluctuations in interest rates. Given the short maturities and investment grade quality of the portfolio holdings at December 31, 1999, a sharp rise in interest rates is not expected to have a material adverse impact on the fair value of the Company’s investment portfolio. As a result, the Company does not hedge these interest rate exposures.

      The following table represents hypothetical changes in fair value in the Company’s investment portfolio at December 31, 1999 that are sensitive to changes in interest rates. The modeling technique measures the change in fair value arising from selected potential changes in interest rates. Movements in interest rates of plus or minus 50 basis points (“BP”) and 100 BP reflect hypothetical shifts in the fair value of these investments. Fair value represents the market principal plus accrued interest and dividends of certain interest-rate-sensitive securities. “No change in interest rates” represents fair value at December 31, 1999. All dollars are presented in thousands:

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Item 8.  Financial Statements and Supplementary Data

PICTURETEL CORPORATION

Index to Financial Statements and Supplementary Data

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
  PICTURETEL CORPORATION:

      In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of redeemable convertible preferred stock and stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of PictureTel Corporation and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.

      The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has incurred recurring losses from operations and requires additional financing. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

      As discussed in Note 17, the Company has restated its 1999 financial statements to reclassify the presentation of preferred stock and to record the preferred stock beneficial conversion feature in the first quarter of 1999 rather than over the first three quarters of 1999.

	PRICEWATERHOUSECOOPERS LLP

Boston, Massachusetts

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

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

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

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