<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                   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, 1996

                                       OR

      [ ]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                       THE SECURITIES EXCHANGE ACT OF 1934
                          Commission File Number 1-9434

                             PICTURETEL CORPORATION
             (Exact name of Registrant as specified in its Charter)

                  Delaware                                    04-2835972
         (State or other jurisdiction of                   (I.R.S. Employer
         incorporation or organization)                   Identification No.)

         100 Minuteman Road, Andover, MA                          01810
         (Address of Principal Executive Offices)               (Zip Code)

                  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
                                (Title and Class)

     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/A, or any
amendment to this Form 10-K/A. [ X ]

     The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant as of March 14, 1997 was $485,343,335. On such
date, the average of the high and low price of the Common Stock was $14.32 per
share. The Registrant has 34,150,462 shares of Common Stock outstanding as of
March 14, 1997.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive 1997 Proxy Statement in connection with the
Annual Meeting of Stockholders to be held June 12, 1997 are incorporated by
reference into Part III.

     A list of all Exhibits to this Annual Report on Form 10-K/A is located at
pages 43 through 45.


<PAGE>   2
 NOTE: This Form 10-K/A for the year ended December 31, 1996 is being filed,
together with Form 10-Q/A for the first quarter ended March 29, 1997 and Form
10-Q/A for the second quarter ended June 29, 1997 to reflect restatements of the
Company's financial statements for the third and fourth quarters of 1996 and the
first and second quarters of 1997. The items set forth below are amended: Items
1, 3, 6, 7, 8 and 14(a), (c) and (d) as well as, Exhibit 11. Other items are not
amended and are not included in this filing. In item 1, the only amendments are
in the "Sales, Marketing & Customer Service" paragraph on page 9 to reflect
revised percentages and backlog consistent with the restated Financial
Statements.



<PAGE>   3


ITEM 1. BUSINESS

     PictureTel develops, manufactures, markets and services visual
communications systems and collaboration software utilizing advanced video and
audio compression technology which permit users to hold face-to-face meetings at
a distance with the cost and convenience similar to the telephone.
Videoconferences may be held between two locations, or, using a multipoint
bridge, among multiple locations. PictureTel's compression technology permits
the transmission of "full-motion" color video with integrated full-duplex audio
at data rates as low as 56 kbps. By operating over such low speed switched
digital lines, PictureTel's systems have substantially reduced the cost and
increased the flexibility of videoconferencing. With high-speed (e.g. at 2 to 6
Mbps) videoconferencing solutions, which operate over dedicated (nondialed)
lines, the per-minute usage cost can be from 10 to 100 times higher. Flexibility
is achieved because the low speed digital switched lines have become available
from the long distance carriers in more and more geographic areas, thus leading
to greater potential use of videoconferencing in general and the PictureTel
systems in particular. The Company offers a range of products for group and
personal videoconferencing applications. PictureTel sells its products through a
number of telecommunication and personal computer distributors in the United
States and internationally as well as through a direct sales force. In 1996, 45%
of its revenues were generated from sales to customers outside the United
States.

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

INDUSTRY BACKGROUND

     The driving force behind the growth of the visual communications systems
market is the desire to achieve the effectiveness of face-to-face meetings with
the cost and convenience of the telephone. On a daily basis, workers routinely
exchange information in one-on-one or group meetings. Almost as frequently,
information is communicated between workers in geographically separate sites by
telephone or by sending or faxing written materials. Less frequently,
individuals travel to a common site to meet and exchange information that cannot
be transferred effectively by telephone or in writing. Face-to-face meetings
maximize the exchange of information, including written, verbal and non-verbal
communication.

     Visual communications systems, such as videoconferencing systems, can
improve worker productivity and reduce costs by eliminating or reducing travel,
speeding the decision making process by reducing the time needed to exchange
information between geographically dispersed work groups and leveraging the use
of scarce personnel resources located at a distance from coworkers needing their
expertise.

     Initial generations of videoconferencing products were relatively expensive
and typically required dedicated, high speed transmission facilities, trained
operators and special rooms, with customized lighting and acoustics. The price
and performance characteristics of these systems limited market demand to users
having large visual communications requirements between geographically separate
locations. Despite broad interest in videoconferencing, cost benefit analyses
led most potential users to conclude that an investment in the technology could
not be justified. In recent years, however, numerous factors have led to greater
use of videoconferencing. These factors include the rapid growth of world-wide
switched digital telephone services, the development of high speed switched
local area computer networks, development of corporate intranets, the
unprecedented growth of the worldwide Internet, the decreasing cost of these
services, technological improvements in both audio and video quality and the
availability of lower cost, easy to use turnkey visual communications systems,
and the steady increase in personal computer processing power.

     Global connectivity - the ability to call any location without special
equipment or arrangements - is the basis of the telephone's popularity. The
proliferation of switched digital networks, which transmit digital signals (as
compared to traditional telephone networks, which transmit analog signals) in
the United States and internationally has provided this key element of
connectivity to the visual communications market. Before switched digital
service was available, videoconferencing calls could only be completed over
dedicated transmission lines established between two fixed locations. At the end
of 1995, switched 56 kbps and ISDN (64 or 2 x 64 kbps) digital service was
available in most cities in the United States and from the United States to many
foreign countries. The majority of videoconferencing systems used on switched
digital networks in the United States operate at 112 or 128 kbps (two
multiplexed 56 or 64 kbps lines). Internationally, 64 kbps is the switched
digital standard. The majority of videoconferencing systems used on foreign
switched digital networks operate at 128 kbps (two multiplexed 64 kbps lines).
PictureTel's videoconferencing systems are fully compatible with one another
whether used within the United States or internationally. The Company's products
interoperate with H.320 compliant systems from other vendors.

     Coincident with the expansion of switched digital networks has been the
dramatic decrease in the cost to use these transmission services. A
coast-to-coast call at 128 kbps placed over the U.S. ISDN dial-up network
typically costs less than a local cellular phone call; calls at 384 kbps cost
less than twice as much.

     In order to transmit a video image over telephone circuits, video data
signals must be reduced or "compressed" to fit the capacity of digital telephone
lines, which are available in various capacities from 56 kbps to 2 Mbps. To
compress an audiovisual signal, information is dropped, causing the quality of
the video image to decrease. The quality of the transmitted video image depends
upon the data rate at which the signal is transmitted and the sophistication of
the compression algorithm (which removes redundant or perceptually less
important data from the audio and video signals).

     Video and audio quality have improved dramatically over the years with the
introduction of more sophisticated compression algorithms by PictureTel and
others. These algorithms compress 90 Mbps of information contained in a
television video signal down to as little as 20 kbps (over 4,000 to 1
compression ) for transmission over various telephony and computer networks, and
decompress that signal for display at the receiving end while achieving
acceptable picture quality and full duplex audio transmission. In addition,
proprietary advances in compression technologies have improved audio fidelity
from less than telephone quality in the mid-1980's to today's systems which
deliver sound which is difficult to distinguish from the voices of people
sitting in the same room as the listener.

     VLSI (Very Large Scale Integration) technology permits the placement of
large numbers of transistors and other components onto small chips of silicon,
thereby reducing significantly the size requirements for those components. With
the increasing use of 


<PAGE>   4

VLSI chip technology, the cost of videoconferencing systems has steadily
decreased as components have become smaller and systems more integrated, while
offering greater functionality to the user.

     Since the introduction of turnkey systems, videoconferencing equipment has
become more convenient to purchase and use. Previously, telecommunications
specialists acquired equipment from numerous vendors and integrated the various
components into a custom system. Since 1988, videoconferencing vendors such as
PictureTel have begun offering turnkey systems, which eliminate the need for
procurement and systems integration specialists. In addition, these systems
incorporate "user friendly" features that eliminate, in most cases, the need for
trained specialists in order to use the equipment.

     New networks are expanding the possibilities for videoconferencing. With
the new H.324 standard, videoconferencing can be conducted over POTS. That
reduces the cost of a video call to the cost of a traditional phone call. It
also brings the possibility of very low cost ($500 or less) personal computer
(PC)-based videoconferencing solutions. The level of quality of POTS
videoconferencing is below that required for normal business usage, but it is
adequate for home use and for business people on the road (to place a video call
from a hotel room, for example).

     Local area networks (LANs), used for data communication among computers in
a business office, have experienced a steady increase in speed over the past few
years. With faster routers, low-cost 100 Mbps interface cards, and other
technologies, most LANs can easily accommodate the slight additional traffic of
video calls. With the H.323 standard, interoperable products for
videoconferencing over LANs are being introduced this year. The main advantage
of LAN videoconferencing is that it removes the need to bring ISDN connections
to every desktop - it leverages the network cable that is already connected to
each PC. With H.323-to-H.320 gateways, videoconferencing systems in a LAN can
communicate with any ISDN system.

     The Internet has also been emerging lately as a network for
videoconferencing, in two forms. First as a way to interconnect
geographically-dispersed LANs within the same company (the so-called Intranets)
- in such cases usually high-speed portions of the Internet are used, to
maintain an adequate bandwidth and quality of service. Second, as a direct
connection among any computers or videoconferencing terminals connected to the
Internet - in such cases the quality is low, with frequent dropouts in video and
audio. Still, Internet videoconferencing allows for the lowest possible
connection cost: for the price of a local phone call, long-distance (even
international) video calls can be placed. Products for Internet conferencing
(audio, video, and data) have been introduced in the past couple of years,
including Microsoft's Netmeeting(TM), which incorporates PictureTel application
sharing technology.

TECHNOLOGY

PROPRIETARY

     The Company's primary technological contributions have been in the areas of
video compression, audio compression, echo cancellation, automatic volume
control, noise suppression, speaker localization for automatic camera
positioning, information sharing protocols/applications, and system
architecture. For definitions of technical terms see the brief glossary at the
end of the "Technology" section.

     A standard broadcast video signal is comprised of 90 million bits of
information per second. Transmission of this amount of data is costly and, in
most cases, it is unnecessary to send 100% of the information in order to
recreate the original picture, or an acceptable representation of it. The
purpose of a video compression algorithm is to reduce the amount of information
required to describe an image, including movement for objects within the image,
without significant loss of accuracy. The effectiveness of an algorithm is
measured by the amount of bandwidth needed to provide "acceptable" picture
quality. Subjective measures consider the smoothness of the moving images and
the lack of artifacts due to the compression.

     Since its inception, the Company has developed increasingly sophisticated
algorithms capable of compressing a video signal 800-1600 times to enable the
transmission of video images over low bandwidth dial-up networks. In 1986,
PictureTel introduced its first codec utilizing its proprietary algorithm, MCT,
which was the first commercially available product using motion compensated
discrete cosine transform video compression technology. In 1988, PictureTel
introduced HVQ, hierarchical vector quantization, a more advanced compression
technique which, among other improvements, replaced the discrete cosine
transform in MCT with a multiresolution pyramid and a vector quantizer.

     PictureTel's third generation algorithm, SG3, which the Company first
shipped in the first quarter of 1991, further advanced low bandwidth video
compression technology. SG3 replaced the vector quantizer in HVQ with a more
efficient vector quantizer. SG3 was also the first commercial product to
incorporate background estimation, which dramatically improves picture quality
in scenes where objects frequently include complex backgrounds. SG3's background
estimator permits it to dedicate more bandwidth to coding moving objects by
storing views of non-moving objects at the receiving end so they need not be
retransmitted. The Company believes that SG3 made it possible to deliver
acceptable business quality video and audio at approximately 80 kbps,
representing a 90% reduction in the required bandwidth from 1985. SG3 uses the
additional bandwidth beyond 80 kbps available on a 112 kbps or higher data rate
network to provide still better video and audio quality.

     PictureTel's latest video compression algorithm, SG4, introduced in 1995 in
the Concorde 4500 platform, has several improvements over SG3. The most
important are improved encoding of the motion vectors, resulting in smoother
motion rendition, and the PicturePlus video enhancement system, which
compensates for variations in the video quality caused by poor light conditions
and camera noise. Furthermore, the SG4 compressed data is transmitted using the
standard H.221 protocol, which allows multipoint conferencing with SG4 video
quality through standard H.320 MCUs.

     The Company has invested significantly to develop state of the art audio
compression and echo cancellation technologies in order to produce a more
"natural" sound in its videoconferencing systems. The Company believes that to
produce audio quality which approximates that of a face-to-face meeting, systems
must feature wideband audio and full-duplex operation, which, unlike half-duplex
speakerphones, allow people at all ends of a video call to be heard at the same
time.

     When conducting a videoconference at 112 kbps, typically no more than 28
kbps are available for audio transmission. In 1986, audio compression technology
could only deliver 2.5 KHz of audio fidelity. With advancements incorporated
into HVQ, audio


<PAGE>   5

fidelity improved to 3.5 KHz, comparable to regular telephone audio quality.
Proprietary advancements in SG3 improved audio quality available with the same
28 kbps to 7.0 KHz. The perceptual difference between 3.5 KHz and 7 KHz audio is
similar to the difference between sound on AM and FM radios.

     An effective face-to-face meeting requires full-duplex audio. However, in a
videoconference, transmitting sound into microphones and out through speakers
introduces the possibility of echo feedback. Commercial echo cancelers in
conventional speakerphones reduce echo feedback, but are not effective for
videoconferencing because of the relatively long processing delay caused by
compressing and decompressing the video. This delay can approach up to one
second round trip over low speed channels (128 kbps and less). Commercially
available echo cancelers at the time typically only operated at telephone
bandwidths (3.5 KHz). Therefore, the Company developed IDEC, its patented echo
cancellation technology, which substantially eliminates all echo feedback and is
standard in all group and personal videoconferencing system products. IDEC has
been steadily refined and improved since its introduction.

     Another audio technology, introduced by the Company in 1996, brings a new
level of comfort to videoconferencing: the LimeLightTM microphone array, which
is mounted together with the PowerCam camera on top of the video monitor. With
only four microphones, LimeLight uses sophisticated proprietary signal
processing algorithms to locate, in three dimensions, the head and shoulders of
the person who is currently speaking. The localization information is used to
automatically control the pan, tilt, and zoom of PowerCam to optimally frame the
person speaking. LimeLight also employs intelligent decision-making algorithms
in order to frame multiple persons who engage in a conversation. LimeLight
brings a competitive edge to the Company, since no other videoconferencing or
video camera manufacturer has an equivalent technology.

     In 1994 the Company introduced its LiveLAN product for LAN
videoconferencing. Besides audio and video compression technologies, LiveLAN
introduced additional components necessary to cope with the variable bandwidth
of LANs and the variable computing power of the host PC. Such technologies
include appropriate video and audio packetization protocols and techniques to
minimize artifacts due to packet losses. Appropriate management protocols were
also introduced, to allow network managers to control and limit video traffic
within any segment of their networks. Starting in 1997, the LiveLAN and
LiveGateway products will fully support to H.323 LAN videoconferencing
standards.

     As the number of videoconferencing systems has expanded in the marketplace,
there has been an increasing demand to link multiple locations into a single
call, in much the same way that audio conference calls occur today. This demand
has led to the development of video bridges, or multipoint control units
("MCU"). In a multipoint videoconference, each location transmits its compressed
audio and video signal to the bridge. The MCU contains audio bridging technology
which permits it to parse, or "strip out" the audio signal, decode it, determine
which signals represent speech, combine them, and then re-encode the combined
audio signal and transmit it to all locations on the call. In this sense, the
MCU acts similarly to a typical audio conferencing bridge. Beyond this
capability, however, is the need to synchronize the transmission of the audio
with the video image which accompanies it and the ability to switch between
various video images.

     Research and development in MCU technology is centered around improving the
audio detection algorithms to better distinguish speech from other noise in the
audio signal, improving the audio quality by increasing the audio bandwidth,
developing the technology to permit multiple sites to be viewed simultaneously
in separate windows in the same screen and transcoding technology which permits
callers operating at different bandwidths and using different compression
algorithms to participate in the same call.

STANDARDS

     The rate of expansion of the visual communications systems market is
influenced by the establishment of standard communication protocols for visual
communications.

     In December 1990 the ITU-T (the International Telecommunication Union -
Telecommunication standardization sector, formerly CCITT) formally adopted a
standard for video telecommunications (H.320) to ensure that equipment from
different manufacturers will be capable of interoperating. Compatibility of
codecs is particularly important for communication via switched digital networks
(ISDN) because the advantage of these services is dial-up communications without
regard to the type of equipment being used at the receiving end of the
transmission.

     Beginning in the late 1980s the ITU-T (International Telecommunication
Union) defined the initial proposals for a new standard, T.120, which was
subsequently approved in 1995. The Company actively participated in the ITU-T
discussions developing T.120. This standard defines the exchange of data and
graphical images among personal computers, videoconferencing systems and other
graphical communication devices such as electronic white boards and overhead
projectors. This standard is presently being included in the Company's group
products and will be included in the personal system products. The technology
for computer application sharing, jointly owned by PictureTel and Microsoft
Corporation, will become part of the T.120 suite.

     As technological evolution enables other networks besides ISDN to carry
effective videoconferencing calls, new standards are emerging to define the
protocols for them. The Company maintains a strong level of participation in the
ITU-T, and has been driving such new standardization efforts. In particular,
PictureTel served as the editor of the H.324 standard for POTS multimedia
conferencing, initially approved by the ITU-T in November of 1995, and is a
major technical contributor of the H.323 standard for LAN videoconferencing, to
be determined by the ITU-T in mid 1997. PictureTel has also many chairman and
vice-chairman positions within the most important standard bodies, such as the
ITU-T, ANSI (American National Standards Institute), and IMTC (International
Multimedia Telecommunication Consortium).

     The H.320, H.323 and H.324 standards incorporate technologies that have
been developed and patented by certain codec manufacturers, including the
Company and certain of its competitors. These codec manufacturers have agreed
with the ITU-T to grant licenses, on nonexclusive nondiscriminatory bases and on
fair and reasonable terms to all manufacturers who wish to comply with the
standards. The Company has obtained some licenses, and it believes that it will
obtain all necessary licenses at reasonably low costs.


<PAGE>   6

GLOSSARY

     ACCUNET - the first commercially available switched digital communication
network, which allowed dialed digital connection at rates of 56 and 112 kbps,
using a combination of existing telephone lines and new network equipment.

     codec - combination of a coder and decoder. A coder uses a compression
algorithm to reduce the number of bytes needed to represent an audio or video
segment. A decoder recovers the original raw bytes from the compressed bytes
generated by the coder. In video and audio compression, the recovery does not
need to be exact; a good approximation of the original information is
appropriate for practical purposes.

     compression algorithm - a set of procedures (usually specified by
mathematical equations and implemented in software within a particular computing
architecture) that reduce the number of bytes necessary to represent some piece
of information, such as a video or audio segment.

     compression ratio - the average number of bytes at the input of codec that
will produce one byte at the output of the coder. The higher the ratio the lower
the necessary channel speed to transmit the information, and therefore the lower
the transmission cost.

     discrete cosine transform, DCT - a mathematical transformation used in
standards and some proprietary video compression algorithms. The DCT maps a set
of original image sample values into frequency components that can more
efficiently be compressed. DCTs are used in all H.3xx standards.

     echo cancellation - the process of removing the acoustic echo that would
result from a full-duplex audio communication system. When the person at point A
talks and his voice is reproduced by the loudspeaker at point B, the microphone
at B would pick it up and send it back (with a delay due to the communication
system) to the loudspeaker at point A. An acoustic echo canceler eliminates such
a return signal.

     full-duplex - characteristic of a communication system in which signals can
be simultaneously transmitted in both directions. For example, in audio or
audio/video calls, it means that people at both ends of a call can speak and be
heard simultaneously.

     H.320 - Standard for videoconferencing on narrowband switched digital
networks, such as Accunet and ISDN. Can be used from 56 kbps to 2 Mbps.

     H.323 - Standard for multimedia (audio, video, data) conferencing over
traditional packet-switched networks. It can be used for conferencing over LANs
and the Internet.

     H.324 - Standard for multimedia conferencing over unmodified analog phone
lines (POTS).

     half-duplex - characteristic of a communication system in which signals can
be transmitted in both directions, but not simultaneously. For example, in an
audio call, it means that only one person can speak at any given time (a typical
mode of operation for inexpensive speakerphones).

     internet - the worldwide network that interconnects many local area
networks. Initially funded entirely by the U.S. government, there are now many
commercial companies investing on expanding the Internet, adding more access
points, switching equipment, and communication links.

     IP - Internet protocol. The most popular packet data communication
protocol, used in many LANs and the Internet.

     ISDN - integrated services digital network, an international switched
digital communication network (also leveraging existing telephone wires, similar
to ACCUNET) that provides multiples of kbps per channel, up to a maximum of 2
Mbps. ISDN is available in many countries.

     kbps - kilobits per second, 1 kbps = 1,000 bits per second.

     LAN - local area network, in which computer data communication involving
several sources and destinations flow concurrently through the same wires, by
means of a packet-based time-division multiplexing.

     MBPS - megabits per second, 1 Mbps = 1,000,000 bits per second.

     MCU - multipoint control unit, also referred to as a bridge. A piece of
equipment that is connected to multiple communication channels, making possible
multipoint audio or audio/video calls (i.e. calls in which several sites can
communicate).

     motion compensation, MC - a component of most video compression algorithms.
MC leads to higher compression ratios because it allows a video frame to be
partially reconstructed from modifications on the previously received frame
using motion estimates.

     POTS - "plain old telephone system," see PSTN.

     PSTN - public switched telephone network; the traditional twisted-pair
network used for analog telephony.

     quantization - the process for approximating a continuous variable by its
nearest value from a table.

     vector quantization, VQ - the process of approximating a collection of
continuous values ( a vector), by its nearest vector from a table. 
<PAGE>   7

PRODUCTS

     The Company develops and manufactures the products listed below for the
videoconferencing industry. They range from high end group systems for many
people, to personal systems for one-on-one videoconferencing. The Company also
offers products that complement these systems, such as multipoint bridges and
various software options and peripherals.

GROUP SYSTEMS

     The Company develops, manufactures, markets and supports three families of
group videoconferencing systems: the Performance Family, the Value Family, and
the Compact Family. All group videoconferencing products are comprised of five
basic modules or components: an electronics module, a video module, an audio
module, a user interface and a WAN interface. The electronics module or CODEC
(compression/decompression) includes all the necessary functionality required
for video compression, audio compression and video switching. The video module
is comprised of a pan, tilt, and zoom camera (or cameras), an NTSC or PAL color
display and associated video electronics. The audio module consists of a
microphone, speaker(s), and associated audio electronics which facilitate echo
cancellation, noise suppression, and gain control. The user interface is
comprised of a keypad and menus that assist in placing a call and managing the
videoconference with features such as camera control keys, camera preset keys,
video source selection keys, mute and Picture-in-Picture. The WAN interface
includes standard interfaces such as V.35, RS-449 or X.21, permitting
communication over switched or dedicated digital networks that operate from 56
Kbps up to T1 (1.544 Mbps) and E1 (2.048 Mbps) speeds.

     All the Company's group systems are interoperable and collectively, the
Performance, Value, and Compact products, span a price/performance range from
$8,995 to $50,000+ providing a viable solution for both the price sensitive and
performance oriented users.

     PERFORMANCE GROUP SYSTEMS. The Performance Family is PictureTel's premier
line of products. The Performance Family supports both PictureTel's most recent
proprietary compression algorithm, SG4, optimized for low bandwidth
applications, and an enhanced version of the industry standard ITU-T H.320
algorithm. The Performance Family currently includes the Concorde 4500ZX and
4200ZX products. List prices range from $35,000 to $50,000+ fully configured.
The Concorde 4500ZX, introduced in April 1995, is the Company's flagship
product. The standard system includes an infrared based keypad, camera and
Look-At-Me-Button (LAMB), a unique device to facilitate distributed control
within a videoconference call. The Concorde 4500ZX also comes standard with a
WorldCart supporting color NTSC or PAL displays up to 32" in size and an
integrated speaker system, optimized for voice, developed exclusively for
PictureTel by BOSE Corporation. Both the 4200ZX and the Concorde 4500ZX offer 30
FPS (frames per second) performance. This feature provides "30 frames per second
quality" video at bandwidths starting as low as 256 Kbps (kilobits per second)
and as high as 768 Kbps. In July 1996, PictureTel introduced a new feature,
"Limelight," on the System 4000 Family. Limelight is an automatic audio sensing
intelligent camera positioning system.

     VALUE GROUP SYSTEMS. The Value Family is PictureTel's answer for price
sensitive users. The Value Group Systems provide interoperability via the
industry standard ITU-T H.320 algorithm and support a wide range of data rates.
The Value line is represented by the Venue 2000 system, including the
low-cost-of-entry Venue Model 30, and the higher-functionality Venue Model 50.
All models offer options for higher data rates (T1/E1 speeds) and higher frame
rates. The Venue list prices range from $15,000 to over $30,000 for a fully
loaded Venue model.

     COMPACT SYSTEMS. In October 1996, the Company introduced SwiftSite, the
industry's first Compact conferencing system, a self-contained,
optimized-for-simplicity system with a list price ranging from $8,995 to
$10,345. SwiftSite features ITU-T H.320 algorithms, as well as PictureTel
enhancements. In addition, SwiftSite integrates a pan tilt zoom camera and a
superdirective microphone into the self-contained unit, and the capability to
download software over the ISDN link from PictureTel's Software Upgrade Server.
SwiftSite heralds a new category of group conferencing systems -- Compact
systems --that offer simple, portable and affordable solutions to PictureTel
customers.

PERSONAL SYSTEMS

     In July 1993, the Company introduced the PictureTel Live PCS 100, a
personal videoconferencing system designed for use with a personal computer
(desktop product). The PCS 100 consists of a video board, audio board, camera,
speakerphone and software. Utilizing the H.320 standard (described under
"Technology-Standards"), the PCS 100 is interoperable with all the Company's
conferencing and bridging products. It also provides information sharing
capabilities which allow users to simultaneously share files and applications
while conducting a videoconference. The system is designed to operate in an
ISA-bus, 386 or above personal computer running Microsoft Windows 3.1(R). It
lists for $4,995 and $5,995.

     In July 1994, the Company shipped its LiveShare collaboration software with
application sharing that allows users to share files and interact on an
application during a videoconference. In September 1994, the Company entered
into the Local Area Network market with its LiveLAN family of products which
enable videoconferencing across a corporate LAN. List prices for these products
start at $249.

     In January 1995, the Company announced the PictureTel Live PCS 50 which
complements the PCS 100. The product consists of a single audio/video board, a
fixed focus camera, a speakerphone or headset and associated software. As with
the PCS 100, the ITU-T H.320 compression standard is used, which provides
interoperability with all of PictureTel's other conferencing and bridging
products and any H.320 compatible system from other vendors. It also provides
the same information sharing capability as the PCS 100 which allows users to
simultaneously share files while conducting a videoconference. The system is
designed to operate on an ISA-bus, 386 or above personal computer running
Microsoft Windows 3.1(R). The product's list price ranges from $2,495 to $4,195.
While the PCS 100 remains the high end member of the PictureTel Live product
family, offering greater flexibility in terms of network support and expansion
options, the PCS 50 product line offers a more affordable solution for ISDN
networks.

     In October 1995, the Company introduced the Live 200i videoconferencing
product. This product consists of an audio/video board, camera, headset, and
software. It features the same interoperability and information sharing tools as
the PCS 50 and PCS 


<PAGE>   8

100. The system is designed to operate in a ISA-bus, 486 or above personal
computer and requires a VMC display controller. Unlike the PCS 50 and PCS 100,
the Live 200i runs using Microsoft Windows 95(R) operating system. The product
lists for $1,995.

     In May 1996, the Company shipped the Live200p. Unlike previous PictureTel
Desktop Video products, the Live200p is a single board solution that utilizes
the host computer's onboard or integrated graphics. The Live200p operates in a
PCI bus, 486 or Pentium personal computer running Microsoft Windows 95. The
Live200p consists of an audio/video board, camera, headset, speakers,
microphone, and software. The product's list prices range from $1,495 to $2,445.

     In September 1996, the LiveGateway began shipping. This product is part of
the LAN family of products, which run on a company's local area network. The
LiveGateway is a PC server add-on kit that provides LiveLAN clients access to
H.320 compliant systems. LiveGateway includes a board and a server software
application. It is an ISA bus board designed to run on a 486/66 or faster
personal computer. The LiveGateway list price is $2,995. With the introduction
of the LiveGateway came enhancements to LiveLAN, the desktop video conferencing
system for the LAN, and LiveManager, a software application that allows network
managers to tailor the use of video and audio within the local area network's
configurations and capacities. These three products together offer an end-to-end
solution for a company with both H.320 and H.323 systems.

     Also in September 1996, the Company announced follow-on releases in 1997 of
the LAN family of products that will provide functionality and performance
enhancements, such as full H.323 standards compliance, full CIF and full-screen
video, wideband audio with echo cancellation, and support of the T.120 standard
for multipoint data conferencing.

NETWORK SYSTEMS

     PictureTel's Network Systems could be described as the "glue" that joins
its videoconferencing systems products into a company-wide solution, commonly
known as an "enterprise solution". Multipoint bridges and reservation and
management systems software are the major revenue sources for the division.
These products deliver functionality that is "shared" among distributed
videoconferencing systems throughout a network. Multipoint bridges enable
videoconferences with more than two sites. Reservation and management systems
allow conference rooms, bridging resources and network facilities to be
scheduled and managed in advance of upcoming meetings by anyone, right from
their PC.

     The "Montage" Conferencing Server product line takes advantage of
"off-the-shelf" bridging hardware and differentiating software features that
make the products unique to the Company. Software features include the Company's
proprietary compression algorithms SG4 and PT724. Several major enhancements
including Continuous Presence and Audio only Conferencing were added to the
Montage Conference Server product line in 1996. The base Montage supports four
sites in a multipoint conference for about $90,000 list price. The largest
Montage systems support up to 48 sites in a single conference or any combination
of conferences up to a total of 48 sites. Over 2,000 sites can be in a single
conference using a capability called cascading, which joins multiple Montages
together. A fully loaded Montage Model 570 lists for over $300,000. Each Montage
system is fully upgradable so customers can take advantage of new
standards-based as well as proprietary features as they are released. In the
fall of 1996, over 10,000 people participated in a single multipoint call in
which approximately 1,000 sites were connected to 25 Montages networked
together.

     The "Prism" Conferencing Server product line, introduced in the summer of
1996, brings new levels of reliability and ease of use to multipoint
conferencing, while setting a new standard in price/performance. With Prism,
users of desktop and group videoconferencing systems can make spontaneous
multipoint calls using their own dedicated multipoint conferencing server (MCS).
Prism's premise switching capability also offers organizations an affordable way
to distribute expensive network resources to many videoconferencing users. Prism
is housed in a compact unit that can be located anywhere in the office
environment. It's delivered preconfigured to enable users to set up their own
multipoint calls without technical assistance. This minimizes the opportunity
for error in call setup, making Prism a highly reliable solution. List price
ranges from $20,000 to $70,000.

     LiveScheduler is PictureTel's enterprise scheduling and network control
solution and is among the industry's most advanced scheduling products.
Utilizing a client/server architecture, LiveScheduler provides simple,
effective, and yet powerful scheduling and management of conference rooms,
people and equipment, as well as videoconferencing network resources.
Availability of sites, rooms, equipment, and even people, are depicted
graphically to users through the Windows-based GUI application, while the
LiveScheduler server analyses the availability of any required supporting
resources, such as network equipment, multipoint bridge ports, and even network
bandwidth. The server can communicate with many globally dispersed clients
simultaneously, whether connected over a LAN or by dial-up modem, and process
all requests for meetings and schedules. Used in conjunction with PictureTel's
leadership Montage and Prism multipoint bridges, LiveScheduler can even
automatically set up and end a video conference by provisioning the required
network and instructing the bridge to dial directly to the sites to be
connected. List price ranges from $18,000 to $40,000.

SOFTWARE

     The Company's group and personal videoconferencing systems are software
based and can be upgraded by the user using standard floppy diskettes, a
removable memory cartridge, or remotely via server and modem. The Company also
sells a Developer's Toolkit, a set of software components, designed to give
programmers access to major functions for set up and control of video, audio,
windowing, data transfer, configuration and network communication.

OPTIONS AND PERIPHERALS

     The group and personal systems videoconferencing products are available
with a number of software and hardware options. Options available on some or all
products include NTSC or PAL video input standards, various network interfaces
such as RS449, V.35, RS232 or X.21, high resolution graphics capability and data
encryption for secure communications. Peripheral equipment used to supplement
the systems may include document cameras for transmission of still images,
additional video cameras to be placed in the conference rooms and video cassette
recorders. In 1996, the Company introduced two new videoconferencing
peripherals, Groupview and Groupboard. Groupview is an overhead projector
designed to handle documents in a videoconferencing environment. Groupboard is a
42" high resolution display and whiteboards solution. 


<PAGE>   9

RESEARCH AND DEVELOPMENT

     The Company believes that decreased size, cost and increased functionality
will characterize future product generations. The Company also believes that as
videoconferencing expands beyond group meetings into the personal communications
segment of the market, success will be dependent on the further development of
powerful video signal processing chips and further miniaturization of systems
components such as cameras and monitors. At such time, the Company expects
videoconferencing usage to expand to the desktop as part of a "multimedia"
workstation, or as a personal videophone. This technology will initially augment
and may eventually replace the telephone, leading to the development of the
residential market with a consumer videophone.

     The Company is working to develop products similar to the PictureTel Live
PCS 100, 50, and Live 200p. The Company believes that, in order to meet the
power, size and cost constraints of desktop products, more powerful signal
processing chips are required. The Company believes that video signal processing
chips already available or under development by the Company and others will
provide the basis for future generations of group and desktop videoconferencing
systems.

     With the increased availability of other networks (besides ISDN and
Switched-56) for reliable videoconferencing (such as LANs and corporate
Intranets), the Company believes that the interfacing capabilities of its
products should be expanded to accommodate such networks, as is discussed in the
Technology section. Therefore the Company will continue to invest toward that
goal, as well as continue to invest in further developments to its LiveLAN
family of videoconferencing products. The LiveLAN family of products will have
an increasing presence in videoconferencing solutions delivered by the Company.
The transition from an ISDN-centric videoconferencing market to one with a
mixture of ISDN, LANs, Intranets, and the Internet will be somewhat slow for
business applications, where a minimal level of audio, video, and data
throughput quality is necessary for continued use of the technology.

     The Company spent $66,013,000, $50,431,000 and $41,243,000 on research and
development, including capitalized software costs, in 1996, 1995 and 1994,
respectively. The Company had 424 full-time employees in research and
development at December 31, 1996.

     The Company has entered into joint development agreements with Microsoft,
NTT and others for product and software development that will further expand the
desktop market. These companies retain non-exclusive rights under license from
PictureTel to distribute the products that result from the development work.

SALES, MARKETING AND CUSTOMER SERVICE

     The Company and its subsidiaries currently distribute PictureTel products
worldwide by direct sales and indirect channels of distribution.

     As the market for videoconferencing systems expands, the Company expects to
increase its reliance on joint selling and distribution through a combination of
transmission carriers, telecommunication equipment distributors, personal
computer distributors and resellers and value-added resellers, and has currently
developed relationships with companies in each of these indirect channels. In
1996, the Company derived approximately 25% of its worldwide product revenues
from direct selling activities, and 75% from indirect channels. At December 31,
1996 and 1995, the Company had a product backlog approximately $12,481,000 and
$14,100,000, respectively. Backlog consists of purchase orders for which a
delivery schedule within six months has been specified by the customer. Since
orders generally may be canceled or rescheduled by the customer without
significant penalty, backlog as of any particular date may not be indicative of
PictureTel's actual sales in any succeeding period.

UNITED STATES

     Indirect Channels. To address the market below the Fortune/Service 500 (the
largest businesses in the United States as published annually by Fortune
magazine) and expand the Company's presence in the Fortune/Service 500 market,
the Company has increased the number of telecommunication equipment
distributors, regional Bell Operating Companies ("RBOCs"), value-added resellers
("VARs") and dedicated dealers who distribute the Company's products. Telecom
distributors, or interconnects, act as dealers for the Company and typically
distribute other communications equipment such as PBX systems, voice processing
equipment and multiplexors, as well as network services to large, medium and
small size companies. The RBOCs typically sell third party manufactured systems
which leverage the use of their switched and dedicated network services. To
expand its coverage of the Fortune/Service 500 companies, the Company has
entered into distribution agreements with Lucent Technologies, Inc., CompuCom,
MCI, GTE, Southwestern Bell, Ameritech, Pacific Bell, and Ingram Micro.

     The Company believes that, as system prices decrease, additional
applications for sales to vertical markets, such as distance learning,
telemedicine and remote interviewing, will develop. VARs typically have
expertise in a particular market and the Company plans to utilize this expertise
to stimulate the Applications Developers Program. Under this program, PictureTel
sells developers, VARs, original equipment manufacturers and systems integrators
its Video Modem products and the PictureTel Developer's Tool Kit. Together these
products provide the building blocks to allow developers to write applications
and incorporate PictureTel's visual communications technology into unique
vertical market products. With the introduction of the PictureTel Live PCS 100,
Live PCS 50 and Live200p products, the Company continues to develop
relationships with established personal computer distributors and resellers.

     Direct Sales Organization. The Company directly markets its
videoconferencing systems principally to the Fortune/Service 500. 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.

     The Company maintains five regional sales and support offices and twenty
additional branch sales and support offices. Regional offices typically include
demonstration equipment as well as a number of customer and technical sales
representatives and field support personnel.



<PAGE>   10

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.

     In the third quarter of 1991 the Company established its first
international subsidiary, and currently the Company has operating subsidiaries
in the Australia, Brazil, Germany, Italy, Japan, Mexico, Sweden, Switzerland and
the United Kingdom, and branch offices in Canada, France, Spain, Hong Kong,
Korea, Malaysia, Netherlands, People's Republic of China and Singapore.
International distributors include companies such as British Telecom (BT),
Deutsche Telekom, Nippon Telephone & Telegraph (NTT), Alcatel, EGT (France
Telecom), Telecom Italia, Siemens, and Mercury Communication (Cable & Wireless).
These international units provide sales and support services locally. Sales to
international distributors are usually made in U.S. dollars in order to minimize
the risks associated with fluctuating foreign currency rates. Sales by the
Company's operating subsidiaries to customers are generally made in the
subsidiary's local currency.

     The Company's revenues from sales to foreign markets represent
approximately 45%, 43%, and 42%, respectively, of the Company's total revenues
in 1996, 1995, and 1994. Additional information with respect to the Company's
international business is included in Note 11 to the Consolidated Financial
Statements.

ENTERPRISE SERVICES DIVISION

     The Company believes that the quality and reliability of its systems and
services is important to customer satisfaction. As proof points, the Company's
Enterprise Services Division is ISO9002 registered, and continues to maintain
its certification. The Company also regularly measures customer satisfaction,
and implements corrective actions to improve the quality of its service. The
delivery of service is backed by the launch of the Company's Certification
Program (Certified Videoconferencing Engineer), the first in the
videoconferencing industry, which will test and certify the technical abilities
of all support personnel dealing with the Company's videoconferencing products.

     The Company provides warranty support for parts and software media on all
its products. The warranty period is generally one year for hardware, 90 days
for software media, and 90 days for repaired parts. Estimated costs related to
warranty are accrued at the time of revenue recognition.

     The Company helps customers implement and manage its technology on a global
basis through a comprehensive portfolio of maintenance, professional and
conference services, which address each phase of the product life cycle.
Consulting services provide planning and needs analysis to customers. Design
services, like room design and custom solutions, provide customized
videoconferencing solutions to meet each customer's unique needs. Project
management, installation and training provide customers with effective
implementation of the Company's products. For the on-going operation of
customers' videoconferencing environment, the Company provides conference
services and maintenance services.

     Conference Services facilitate the customer's use of the videoconferencing
technology by providing conference room scheduling, call launching, and
end-to-end problem resolution during conferences. In addition, the Company
supports customers' multipoint needs including managing the customer's bridges,
either on the Company's premises or remotely, and offering bridging services to
customers who do not own a bridge.

     All these services are sold both directly to customers and through the
Company's distributors. Service programs for local and international
distributors range from reselling the Company'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. The Company 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 located in the United
States, United Kingdom, and Singapore. The Company delivers professional
services and training through consultants, project managers and instructors. In
addition, the Company offers electronic support via the World Wide Web.

     The Company's revenues from services represent less than 10% of the total
revenues in 1996.

COMPETITION

     The Company is engaged in an industry that, as a result of extensive
research and development efforts, has new, more technologically advanced
products introduced on a regular basis. If the Company is not in a position to
exploit and obtain technological advancements, its products may become obsolete
or priced above competitive levels. Moreover, unforeseen technical or other
difficulties may interfere with the development or production of its products,
or prevent or create delays in marketing such products.

     A number of companies, including British Telecom ("BT"), Compression
Laboratories, Inc. ("CLI"), VTEL Corporation ("VTEL") and NEC continue to
dominate the high bandwidth transmission (from 384 Kbps to 2.048 Mbps)
videoconferencing market. Currently, switched ISDN service is the most widely
available switched digital service in the United States.

     The Company also faces competition from a number of companies with
currently available or announced visual communications products designed for low
bandwidth videoconferencing. Currently, three United States companies, CLI,
VTEL, and Intel Corporation are among the companies marketing low bandwidth
full-motion video modems and complete videoconferencing systems. In addition,
outside the United States, low bandwidth videoconferencing systems and video
modems are available from a 


<PAGE>   11

number of suppliers in Europe and the Far East including Canvis Visual
Technologies, Philips Kommunikations Industries AG, Tandberg Telecom AS,
Mitsubishi Ltd., NEC, Hitachi, Ltd., Sony Corporation, Fujitsu Ltd. of Japan and
Panasonic.

     Some of the companies which now offer products that compete with the
Company's products, such as Intel Corporation and Sony Corporation, have
significantly greater financial and other resources than the Company. However,
the Company competes primarily on the basis of video and audio quality, and data
collaboration, as well as on favorable features and the price of its systems.
The Company believes that its products are competitive in each of these areas.

     In the personal (one-on-one) visual communications segment, the Company
expects that competition will continue to intensify and competitive price
reductions may adversely affect the Company's revenues and profitability. The
competitive landscape has shifted substantially in 1996. As in 1995, Intel was
the primary competitor on the low end of the desktop market while several new
entrants have focused on high end solutions. Companies such as VCON, Zydacron
and RSI have competitive high end solutions but lack the breadth of products and
distribution network that the Company enjoys.

     Previously, purchasers of videoconferencing systems must have purchased the
videoconferencing systems from the same vendor to ensure the interoperability.
However, as a result of the adoption of standards, products from the Company and
other manufacturers are interoperable. Consequently, customers have the freedom
to purchase products from several vendors and are not locked into a single
vendor for videoconferencing equipment.

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 our customers. This strategy allows the Company to
reduce costly investment in manufacturing capital, and to leverage the expertise
of our vendors.

     The Company's manufacturing operation consists of final assembly and
testing of complete videoconferencing systems. Subassemblies of large systems
that support networks and room conferencing, including tested printed circuit
boards, are assembled into complete systems. These final systems are tested to
ensure they meet all functional requirements.

     Desktop 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.

     Certain components and parts used in the Company's products are procured
from a single source. The Company obtains parts only from one vendor, even where
multiple sources are available, to maintain quality control and enhance the
working relationship with suppliers. These purchases are made under existing
contracts or purchase orders. The failure of a supplier, including a
subcontractor, to deliver on schedule could delay or interrupt the Company's
delivery of products and thereby adversely affect the Company's revenues and
profits.

     In 1996, the Company opened a European Distribution Center in Holland to
centralize shipments to its customer base in Europe. PictureTel will look to
source components from local vendors in Europe to support proper stocking levels
in Holland and maintain timely customer shipments. This will be developed by
incorporating the same working relationships and policies with vendors in Europe
as it currently does in America.

PATENTS AND COPYRIGHTS

     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. The Company has been issued a number of United States patents relating
to the above described technology, which expire at various dates from 2007 to
2013. 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.

     The Company also protects its copyrightable software and related technology
under U.S. and other countries' copyright laws by placing appropriate copyright
notices that comply with provisions of the U.S. copyright treaties and entering
into written agreements with its licensees.

EMPLOYEES

     At December 31, 1996, the Company had 1,496 full-time employees, of whom
700 were employed in sales, marketing and customer support, 424 in product
development and engineering, 143 in manufacturing and 229 in administration and
finance. The Company had 237 employees in foreign countries at December 31,
1996.

     The Company's continued 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.


<PAGE>   12


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
alleges that certain of the Company's products infringe patent rights allegedly
owned by Datapoint. Datapoint has been joined as plaintiff by John Frassanito
and David Monroe, two individuals who claim to have rights to Datapoint's
patents. The plaintiffs seek approximately $100 million to $170 million in
damages for alleged past infringement and an injunction against alleged future
infringement. The Company believes that it has meritorious defenses to the
allegations of the complaint and is vigorously defending against the lawsuit.
The case had been scheduled for trial on October 6, 1997; however, the trial was
delayed by the Court until early 1998.

     In the event the Company is found to be infringing a valid patent or
patents, the Company could be required to pay damages for past infringement and
cease the sale of products incorporating the infringing feature (or be required
to obtain a license and pay royalties with respect to such patents). There can
be no assurance that the Company will prevail. The Company believes that an
adverse outcome of the lawsuit would have a material adverse effect on the
business or the financial position, results of operations and cash flows of the
Company.

B.  Class Action Litigation

     Since September 23, 1997, seven class action shareholders' complaints have
been filed against the Company, Norman E. Gaut, 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, who brought these actions on behalf of themselves
and others similarly situated, are: (1) Faith Egli, Civil Action No.
97-12135-DPW; (2) Jerome H. Lipman, IRA, Civil Action No. 97-12238-DPW; (3)
Daniel Frucher, Civil Action No. 97-12310-DPW; (4) Edmond J. Proulx and James
Harris, Civil Action No. 97-12345-DPW; (5) Marvin Barab and Thomas J. Curley,
Civil Action No. 97-12338-DPW; (6) Mark Szen and Nancy Szen, Civil Action No.
97-12439-DPW; and (7) Michael D. Kugler, Civil Action No. 97-12537 PBS.

     The Complaints were filed following the Company's announcement on September
19, 1997 that it would restate its financial results for the first quarter of
fiscal 1997 and the last two quarters of fiscal 1996. The Complaints allege that
the defendants violated Sections 10(b) and 20(a) of the Securities and Exchange
Act of 1934 and Rule 10b-5, promulgated thereunder, during the period from
October 17, 1996 through September 18 or 19, 1997, inclusive, through the
alleged preparation and dissemination of materially false and misleading
financial statements which artificially inflated the prices of PictureTel common
stock. Each Complaint seeks to recover an unspecified amount of damages,
including attorneys' and experts' fees and expenses. The Company is currently
investigating the allegations in the Complaints and will respond to the
allegations in a timely fashion when responses become due. It is too early to
determine the likely outcome of this litigation.




<PAGE>   13



ITEM 6:  SELECTED FINANCIAL DATA

                             SELECTED FINANCIAL DATA
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                       1996          1995          1994          1993          1992
                                                   (Restated)
                                                   ----------------------------------------------------------------
<S>                                                <C>           <C>           <C>           <C>           <C>     
STATEMENT OF INCOME DATA:
Revenues ....................................      $467,805      $346,758      $255,193      $176,252      $141,409
Income before extraordinary
  credit and cumulative effect of
  change in accounting principle ............        30,716        19,626         4,579         7,384         8,387
Extraordinary credit, tax benefit of
  net operating loss and tax credit
  carryforwards .............................            --            --            --            --         2,272
Cumulative effect of change in
accounting principle ........................            --            --            --         1,042            -- 
                                                   --------      --------      --------      --------      --------
Net income ..................................        30,716        19,626         4,579         8,426        10,659
                                                   ========      ========      ========      ========      ========
Net income per common and
  common equivalent
  share (1)(2):
Income before extraordinary
  credit and cumulative effect of
  change in accounting principle ............      $   0.85      $   0.56      $   0.15      $   0.24      $   0.26

Extraordinary credit ........................            --            --            --            --          0.07
Cumulative effect of change in
accounting principle ........................            --            --            --          0.03            --
                                                   --------      --------      --------      --------      --------
Net income ..................................      $   0.85      $   0.56      $   0.15      $   0.27      $   0.33
                                                   ========      ========      ========      ========      ========
Weighted average shares
  outstanding (1)(2) ........................        36,054        35,014        31,354        31,486        31,868

BALANCE SHEET DATA:
Working  capital ............................      $196,902      $139,396      $118,922      $ 48,399      $ 55,334
Total assets ................................       372,779       288,141       216,699       187,425       165,713
Total short-term debt .......................         3,813         2,840        10,452         6,651         7,643
Total long-term debt ........................        13,934        12,804         3,015         4,367         4,685
Stockholders' equity ........................       255,014       200,822       153,236       146,939       132,128
</TABLE>

(1) Net income per common and common equivalent share is based on the weighted
average number of shares of Common Stock and dilutive Common Stock equivalents
outstanding during the period. All common and common equivalent share and per
share amounts in 1995 and years prior have been retroactively restated to
reflect the two-for-one common stock split effected by a 100% common stock
dividend paid during the fourth quarter of 1995.

(2) The Company has not paid dividends on its Common Stock since its inception.
The Company intends to reinvest earnings for use in its business and to finance
future growth. Accordingly, the Board of Directors does not anticipate declaring
any cash dividends in the foreseeable future.

<PAGE>   14

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS


         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATIONS

     The following table sets forth, for the periods indicated, the percentage
of Revenues for certain items in the Company's Statement of Income for each
period:


<TABLE>
<CAPTION>
                                                   YEARS ENDED DECEMBER 31,
                                                  1996        1995        1994
                                               --------------------------------
                                               (Restated)
<S>                                              <C>         <C>         <C>   
Revenues .....................................   100.0%      100.0%      100.0%
Cost of sales ................................    52.6        50.5        50.6
Gross margin .................................    47.4        49.5        49.4
Selling, general and administrative ..........    26.4        29.2        32.4
Research and development .....................    12.8        13.3        15.0
Total operating expenses .....................    39.2        42.5        47.4
Operating income .............................     8.2         7.0         2.0
Interest income, net .........................     0.9         0.9         0.7
Other income, net ............................     0.7          --          --
Income before provision for income taxes .....     9.8         7.9         2.7
Provision for income taxes ...................     3.2         2.2         0.9
Net income ...................................     6.6         5.7         1.8
</TABLE>

FORWARD-LOOKING STATEMENTS

     This section, as well as other portions of this document, includes certain
forward-looking statements about the Company's business and new products, sales
and expenses, effective tax rate and operating and capital requirements. In
addition, forward-looking statements may be included in various other Company
documents to be issued in the future and in various oral statements by Company
representatives to security analysts and investors from time to time. Any such
statements are subject to risks that could cause the actual results to vary
materially. These risks are discussed below in "Factors Affecting Future
Results"


YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995

     Revenues. The Company's revenues increased $121,047,000, or 35%, in 1996
from 1995. The increase in revenue was primarily a result of increased
videoconferencing system unit shipments. This growth was partially offset by a
reduction in the average selling price of videoconferencing systems resulting
from a shift towards lower priced models, especially in the personal desktop
products, as well as a shift in distribution channel mix with approximately 75%
of product revenue now coming from the indirect channels compared with 67% in
1995. Videoconferencing system sales accounted for approximately 82% and 85% of
the Company's revenues in 1996 and 1995, respectively. Sales of group and
desktop videoconferencing products accounted for 66% and 16%, respectively, of
revenues for 1996, compared with 70% and 15%, respectively, for 1995. In
addition, sales of bridge products accounted for approximately 8% of the
Company's revenues for 1996 compared to approximately 7% for 1995. The balance
of the revenues in 1996 and 1995 were primarily from maintenance services,
licensing/development agreements and the sales of stand-alone codecs and video
modems.

     The Company's revenues from sales to foreign markets were approximately
$213,122,000 in 1996 compared to approximately $147,981,000 in 1995 representing
45% and 43%, respectively of total revenues. The Company expects that
international revenues will continue to account for a significant portion of
total revenues.

<PAGE>   15

     Gross Margin. The Company's gross margin increased $50,017,000 or 29%, in
1996 compared to 1995. Gross margin as a percentage of revenues was 47% in 1996
compared to 50% in 1995. Gross margin as a percentage of revenues decreased as a
result of the reduction in the average selling price of videoconferencing
systems and the increased percentage of volume through the indirect channels.
The two trends are expected to continue and may impact future gross margins.

     Selling, General and Administrative. Selling, general and administrative
expenses increased $22,291,000 or 22% from 1995 and decreased as a percentage of
revenues to 26% from 29%. The dollar increase in spending resulted primarily
from the worldwide marketing focus associated with expanding indirect channels
and from new product launches, as well as increased commission expense. In
addition, the Company has provided additional sales, general and administrative
personnel in order to support the Company's overall growth.

     Research and Development. Research and development expenses increased
$13,905,000, or 30% in 1996 from 1995 and were 13% of revenues for 1996 and
1995. Research and development expenditures, prior to the capitalization of
software costs, were $66,013,000 in 1996 and $50,431,000 in 1995 or 14% and 15%
of revenues, respectively. The dollar increase in expenditures primarily
reflects the Company's continuing investment in new product and software
development for existing and future videoconferencing products. The Company
capitalized software costs of $5,924,000 in 1996 and $4,247,000 in 1995
representing 9% and 8% of aggregate research and development expenditures,
respectively.

     Operating Income. Although gross margin as a percentage of revenues has not
increased over 1995, operating income as a percentage of revenues increased 14%
from 7% to 8% due to a decline in operating expenses as a percentage of
revenues.

     Net Interest Income. Net interest income increased to $4,413,000 in 1996
from $3,152,000 in 1995. The increase was primarily the result of higher
marketable securities portfolio balances and lower interest expense.

     Other Income (Expense). Other income (expense) of $3,147,000 in 1996
consists primarily of net gains on sales of securities. Other income (expense)
of $87,000 in 1995 consists primarily of net gains on foreign currency
transactions.

     Income Taxes. The Company's effective tax rate for 1996 and 1995 was 33%
and 29% respectively, and 1996 was lower than the federal statutory rate
primarily due to the benefits of the research and development credits, the
foreign sales corporation, and a decrease in the valuation allowance. The
valuation allowance primarily offsets the deferred benefit of certain federal
and state tax credit carryforwards whose benefit is uncertain.


YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994

     Revenues. The Company's revenues increased $91,565,000, or 36%, in 1995
from 1994. The increase in revenue was primarily a result of increased
videoconferencing system unit shipments. This growth was partially offset by a
reduction in the average selling price of videoconferencing systems resulting
from a shift towards lower priced models, especially in the personal desktop
products, as well as a shift in distribution channel mix with approximately 67%
of revenue now coming from the indirect channels. Videoconferencing system sales
accounted for approximately 85% of the Company's revenues in 1995 and 1994.
Sales of group and desktop videoconferencing products accounted for 70% and 15%,
respectively, of revenues for 1995, compared with 76% and 9%, respectively, for
1994. In addition, sales of bridge products accounted for approximately 7% of
the Company's revenues for 1995 compared to approximately 6% for 1994. The
balance of the revenues in 1995 and 1994 were primarily from maintenance
services, licensing/development agreements and the sales of stand-alone codecs
and video modems.

     The Company's revenues from sales to foreign markets were approximately
$147,981,000 in 1995 compared to approximately $108,118,000 in 1994 representing
43% and 42%, respectively of total revenues. The Company expects that
international revenues will continue to account for a significant portion of
total revenues.


<PAGE>   16

     Gross Margin. The Company's gross margin increased $45,561,000 or 36%, in
1995 compared to 1994. Gross margin as a percentage of revenues was 50% and 49%
in 1995 and 1994, respectively. Gross margin as a percentage of revenues
remained consistent primarily as a result of continued product material cost
reductions and decreasing overhead costs offset by an increased percentage of
volume through the indirect channels and a higher percentage of revenues coming
from the Company's lower-margin videoconferencing system products. The latter
two trends are expected to continue and may impact future gross margins.

     Selling, General and Administrative. Selling, general and administrative
expenses increased $18,611,000 or 23% from 1994 and decreased as a percentage of
revenues to 29% from 32%. The dollar increase in spending resulted primarily
from the worldwide marketing focus associated with expanding indirect channels
and new product launches, as well as increased commission expense. In addition,
the Company has provided additional sales, general and administrative personnel
in order to support the Company's overall growth.

     Research and Development. Research and development expenses increased
$7,857,000, or 21% in 1995 from 1994 and were 13% and 15%, respectively, of
revenues for 1995 and 1994. Research and development expenditures, prior to the
capitalization of software costs, were $50,431,000 in 1995 and $41,243,000 in
1994 or 15% and 16% of revenues, respectively. The dollar increase in
expenditures primarily reflects the Company's continuing investment in new
product and software development for existing and future videoconferencing
products. The Company capitalized software costs of $4,247,000 in 1995 and
$2,916,000 in 1994 representing 8% and 7% of research and development
expenditures, respectively.

     Operating Income. Although gross margin as a percentage of sales has not
increased over 1994, operating income as a percentage of sales increased, due to
a decline in operating expenses as a percentage of sales.

     Net Interest Income (Expense). Net interest income increased to $3,152,000
in 1995 from $1,841,000 in 1994. The increase was primarily the result of higher
marketable securities portfolio balances.

     Other Income (Expense). Other income of $87,000 in 1995 consists primarily
of net gains on foreign currency transactions. Other expense of $101,000 in 1994
consists primarily of net losses on foreign currency transactions.

     Income Taxes. The Company's effective tax rate for 1995 and 1994 was 29%
and 34% respectively, and 1995 was lower than the federal statutory rate
primarily due to the change in deferred asset valuation allowance.

<PAGE>   17
                         LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1996 the Company had $62,957,000 in cash and cash
equivalents, $38,918,000 in short-term marketable securities and $9,118,000 in
long-term marketable securities. During the year ended December 31, 1996 the
Company generated $45,626,000 in cash from operating activities. The primary use
of cash during 1996 was to fund the net growth in working capital items such as
accounts receivable of $40,819,000 net of increases in accounts payable of
$27,690,000, as well as additions to property and equipment. Accounts receivable
increased more than revenues as a percentage in 1996 compared with 1995 due to
increased foreign sales and sales through indirect channels to distributors and
dealers which typically have longer collection cycles.

     The Company has available for borrowing up to $40,000,000 under its
revolving credit agreement and approximately $4,400,000 available under local
foreign guaranteed lines of credit to certain of its foreign subsidiaries. At
December 31, 1996 there was $9,242,000 in debt and $18,319,000 in a standby
letter of credit outstanding under the revolving credit agreement and $519,000
outstanding under the foreign lines of credit. At December 31, 1996, the Company
had $7,986,000 outstanding under various leasing lines.

     The Company believes that funds from operations, equipment lease financing,
available borrowings under its various credit agreements and existing cash, cash
equivalents and marketable securities will be sufficient to meet the Company's
foreseeable operating and capital requirements.

FACTORS AFFECTING FUTURE RESULTS

     New Products, Cost Reductions and Technological Change. The Company is
engaged in an industry that, as a result of extensive research and development
efforts, has new, more technologically advanced products introduced on a regular
basis, and the Company continues to seek improvement in operating results
through new products and cost reductions. In addition, new technologies and
networks for delivering videoconferencing and data collaboration services, such
as the Internet and corporate intranets or LANS, have opened new opportunities
for videoconferencing. Industry standards for such new technologies are still
being developed. There can be no assurance that the Company will be successful
in obtaining cost reductions or in developing and marketing suitable new
products for these new technologies and networks that are competitive and
accepted by the marketplace.

     Competition. In its established businesses of group systems and desktop
systems, the Company competes with a number of larger corporations, such as Sony
and Intel, which have greater financial and marketing resources than the
Company. In the developing businesses of videoconferencing over networks such as
the Internet and LANs, a number of new companies have begun to offer competitive
products. In addition, alliances between companies which compete with the
Company and companies which develop and market network products as well as
mergers among competitors are intensifying competition in the marketplace. This
increased competition may lead to decreases in average selling prices and
margins in both group and desktop videoconferencing systems or a lower segment
market share for newer products and services in the emerging areas of
network-based videoconferencing products and services. These factors may impact
the Company's growth.

     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 so that forecasting of revenue is complex
and difficult to predict. 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 expectations may not
evidence itself until late in the quarter and any resulting impact on earnings
may not be determinable until some weeks after the end of the quarter.

     Manufacturing. Some key subassemblies and products are currently available
only from one vendor and some vendors are smaller companies with less financial
resources than the Company. In some cases these are sourced from only one
vendor, even where multiple sources are available, to maintain quality control
and enhance the working relationship with the vendor. The Company's business
could be adversely affected by delays or interruptions of supplies,
subassemblies or products from such key vendors.

     Newly Issued Accounting Standards. In February 1997, the Financial
Accounting Standards Board issued Statement No. 128 ("SFAS 128"), "Earnings per
Share," which is effective for fiscal years ending after December 15, 1997,
including interim periods. SFAS 128 requires the presentation of basic and
diluted 


<PAGE>   18

earning per share (EPS). Basic EPS, which replaces primary EPS, excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. Diluted EPS is computed similarly to fully diluted EPS under the
existing rules. SFAS 128 requires restatement of all prior-period earnings per
share data presented after the effective date. The Company will adopt SFAS 128
in 1997 and has not yet determined the impact of adoption.



<PAGE>   19

ITEM 8:  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:

         PICTURETEL CORPORATION

         Index to Financial Statements and Supplementary Data

         Financial Statements:                                            PAGE
                                                                          ----
              Report of Independent Accountants                            22
              Consolidated Statements of Income                            23
              Consolidated Balance Sheets                                  24
              Consolidated Statements of Stockholders' Equity              25
              Consolidated Statements of Cash Flows                        26
              Notes to Consolidated Financial Statements                   27

         Supplementary Data:
              Report of Independent Accountants                            40
              Schedule II Valuation and Qualifying Accounts                41

<PAGE>   20



REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of 
   PICTURETEL CORPORATION:

     We have audited the accompanying consolidated balance sheets of PictureTel
Corporation as of December 31, 1996 and 1995, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1996. 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of PictureTel
Corporation as of December 31, 1996 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996 in conformity with generally accepted accounting
principles.

     As discussed in Note 1 to the accompanying consolidated financial
statements, the Company has restated its financial statements for the year ended
December 31, 1996.


COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
November 13, 1997 


<PAGE>   21
                             PICTURETEL CORPORATION
                                        
                       CONSOLIDATED STATEMENTS OF INCOME
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                Years Ended December 31,
                                                        -------------------------------------
                                                           1996          1995          1994
                                                           ----          ----          ----
                                                        (Restated)
<S>                                                      <C>           <C>           <C>     
Revenues ..............................................  $467,805      $346,758      $255,193
Cost of sales .........................................   246,073       175,043       129,039
                                                         --------      --------      --------
Gross margin ..........................................   221,732       171,715       126,154

Operating expenses:
Selling, general and administrative ...................   123,520       101,229        82,618
Research and development ..............................    60,089        46,184        38,327
                                                         --------      --------      --------
Total operating expenses ..............................   183,609       147,413       120,945
                                                         --------      --------      --------
Income from operations ................................    38,123        24,302         5,209

Other income (expense):
Interest income .......................................     5,337         4,123         2,826
Interest expense ......................................       924           971           985
Other income (expense), net ...........................     3,147            87          (101)
                                                         --------      --------      --------
Income before provision for income taxes ..............    45,683        27,541         6,949
Provision for income taxes ............................    14,967         7,915         2,370
                                                         --------      --------      --------
Net income ............................................  $ 30,716      $ 19,626      $  4,579
                                                         ========      ========      ========
Net income per common and common equivalent share: ....  $   0.85      $   0.56      $   0.15
                                                         ========      ========      ========

Weighted average common and common equivalent 
shares outstanding ....................................    36,054        35,014        31,354
                                                         ========      ========      ========
</TABLE>

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



<PAGE>   22
                             PICTURETEL CORPORATION

                           CONSOLIDATED BALANCE SHEETS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                    -------------------------
                                                                                       1996            1995
                                                                                       ----            ----
                                                                                    (RESTATED)
                                     ASSETS

<S>                                                                                  <C>             <C>     
Current assets:
Cash and cash equivalents .....................................................      $ 62,957        $ 39,476
Marketable securities .........................................................        38,918          20,463
Accounts receivable less allowance for doubtful accounts of $3,284
    and $1,791  at December 31, 1996 and 1995, respectively ...................       138,554          97,735
Inventories ...................................................................        48,848          43,791
Deferred taxes, net ...........................................................         5,950           6,665
Other current assets ..........................................................         5,506           5,781
                                                                                     --------        --------
   Total current assets .......................................................       300,733         213,911
Marketable securities .........................................................         9,118          34,084
Deferred taxes, net ...........................................................         5,088           6,000
Property and equipment, net ...................................................        44,217          22,515
Capitalized software costs, net ...............................................         6,832           5,073
Other assets ..................................................................         6,791           6,558
                                                                                     --------        --------

   Total assets ...............................................................      $372,779        $288,141
                                                                                     --------        --------

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Short-term borrowings .........................................................      $    519        $    557
Accounts payable ..............................................................        53,329          25,639
Accrued compensation and benefits .............................................         8,906           9,881
Accrued expenses ..............................................................        18,673          16,646
Current portion of capital lease obligations ..................................         3,294           2,283
Deferred revenue ..............................................................        19,110          19,509
                                                                                     --------        --------
    Total current liabilities .................................................       103,831          74,515
Long- term borrowings .........................................................         9,242          12,226
Capital lease obligations .....................................................         4,692             578
Commitments and contingencies (Notes 6, 7 and 13)
Stockholders' equity:
Preference stock, $.01 par value; 15,000,000 shares authorized;
    none issued ...............................................................            --              --
Common stock, $.01 par value; 80,000,000 shares authorized;
    34,036,186 and 32,723,444 shares issued and outstanding at
    December 31, 1996 and 1995 ................................................           341             328
Additional paid-in capital ....................................................       196,249         173,379
Retained earnings .............................................................        58,138          27,422
Cumulative translation adjustment .............................................          (602)           (531)
Unrealized gain on marketable securities, net .................................           888             224
                                                                                     --------        --------
   Total stockholders' equity .................................................       255,014         200,822
                                                                                     --------        --------
   Total liabilities and stockholders' equity .................................      $372,779        $288,141
                                                                                     ========        ========
</TABLE>

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


<PAGE>   23

                             PICTURETEL CORPORATION

                       STATEMENTS OF STOCKHOLDERS' EQUITY
                FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, 1994
                             (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                                          Unrealized  
                                                                                                         (Loss) Gain  
                                                                                                             on       
                                                         Additional                           Cumulative  Marketable      Total
                                       Common Stock       Paid-in    Retained     Unearned   Translation  Securities,  Stockholders'
                                    Shares    Par Value   Capital    Earnings  Compensation   Adjustment     Net         Equity
                                    ------    ---------   -------    --------  ------------   ----------     ---         ------
<S>                               <C>            <C>     <C>          <C>          <C>         <C>         <C>         <C>
Balance, December 31, 1993 .....  30,297,690     $303    $143,978     $ 3,217      $(40)       $(519)         --       $146,939
Exercise of employee stock                                                                                            
  options and related tax                                                                                             
  benefit ......................     420,110        4       2,021          --        --           --          --          2,025
Amortization of unearned                                                                                              
  compensation .................          --       --          --          --        40           --          --             40
Foreign currency translation                                                                                          
  adjustment ...................          --       --          --          --        --           67          --             67
Unrealized loss on marketable                                                                                         
  securities, net ..............          --       --          --          --        --           --       $(414)          (414)
Net income .....................          --       --          --       4,579        --           --          --          4,579
                                  ----------     ----    --------     -------      ----        -----       -----       --------
Balance, December 31, 1994 .....  30,717,800      307     145,999       7,796        --         (452)       (414)       153,236
Exercise of employee stock                                                                                            
  options and related tax                                                                                             
  benefit ......................   1,873,650       19      26,229          --        --           --          --         26,248
Employee stock purchase plan                                                                                          
  shares .......................     131,994        2       1,151          --        --           --          --          1,153
Foreign currency translation                                                                                          
  adjustment ...................          --       --          --          --        --          (79)         --            (79)
Unrealized gain on marketable                                                                                         
  securities, net ..............          --       --          --          --        --           --         638            638
Net income .....................          --       --          --      19,626        --           --          --         19,626
                                  ----------     ----    --------     -------      ----        -----       -----       --------
Balance, December 31, 1995 .....  32,723,444      328     173,379      27,422        --         (531)        224        200,822
Exercise of employee stock                                                                                            
  options and related tax                                                                                             
  benefit ......................   1,238,915       12      20,992          --        --           --          --         21,004
Employee stock purchase plan                                                                                          
  shares .......................      73,827        1       1,878          --        --           --          --          1,879
Foreign currency translation                                                                                          
  adjustment ...................          --       --          --          --        --          (71)         --            (71)
Unrealized gain on marketable                                                                                         
  securities, net ..............          --       --          --          --        --           --         664            664
Net income .....................          --       --          --      30,716        --           --          --         30,716
                                  ----------     ----    --------     -------      ----        -----       -----       --------
Balance, December 31, 1996
  (Restated) ...................  34,036,186     $341    $196,249     $58,138      $ --        $(602)      $ 888       $255,014
                                  ==========     ====    ========     =======      ====        =====       =====       ========
</TABLE>

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



<PAGE>   24

                             PICTURETEL CORPORATION

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                 Years Ended December 31,
                                                          -------------------------------------
                                                             1996          1995          1994
                                                             ----          ----          ----
                                                          (Restated)
<S>                                                        <C>           <C>           <C>     
Cash flows from operating activities:
  Net income ............................................  $ 30,716      $ 19,626      $  4,579
Adjustments to reconcile net income to net cash
  provided by (used in) operating activities:
  Depreciation and amortization .........................    21,521        17,906        18,345
  Deferred taxes, net ...................................     1,627        (2,127)       (1,162)
  Other non-cash items ..................................      (348)          (79)           53

Changes in operating assets and liabilities:
  Accounts receivable ...................................   (40,819)      (32,707)      (16,682)
  Inventories ...........................................    (5,057)      (12,130)       (7,384)
  Other assets ..........................................      (682)       (2,401)       (3,364)
  Accounts payable ......................................    27,690         7,423         7,481
  Accrued compensation and benefits and
      accrued expenses ..................................     3,023         9,472         5,693
  Income taxes, net .....................................     8,354         8,056           660

Deferred revenue ........................................      (399)        5,786         5,384
                                                           --------      --------      --------

Net cash provided by operating activities ...............    45,626        18,825        13,603

Cash flows from investing activities:
  Purchase of marketable securities .....................   (20,115)      (71,772)      (19,014)
  Proceeds from marketable securities ...................    25,987        70,902        38,182
  Additions to property and equipment ...................   (38,547)      (16,251)      (14,335)
  Proceeds from disposals of property and equipment .....       387            --            --
  Capitalized software costs ............................    (5,924)       (4,247)       (2,916)
  Purchase of intangible asset ..........................      (565)           --            --
  Proceeds from sale of intangible asset ................     2,050            --            --
                                                           --------      --------      --------
Net cash provided by (used in) investing activities .....   (36,727)      (21,368)        1,917

Cash flows from financing activities:
   Payments on short-term borrowings ....................        38        (6,412)        4,944
   Proceeds from long-term borrowings ...................     2,803        12,226            --
   Principal payments on long-term borrowings ...........    (5,787)           --         2,483
   Principal payments under capital lease obligations ...    (3,367)       (3,482)       (5,533)
   Proceeds from capital leases .........................     8,492            --            --
   Proceeds from exercise of stock options ..............    10,676        13,786         2,025
   Proceeds from employee stock purchase plan ...........     1,878         1,153            --
                                                           --------      --------      --------

Net cash provided by financing activities ..............     14,733        17,271         3,919

Effect of exchange rate changes on cash ................       (151)          401        (2,013)
                                                           --------      --------      --------
Net increase in cash and cash equivalents ..............     23,481        15,129        17,426
Cash and cash equivalents at beginning of year .........     39,476        24,347         6,921
                                                           --------      --------      --------
Cash and cash equivalents at end of year ...............   $ 62,957      $ 39,476      $ 24,347
                                                           ========      ========      ========
Supplemental cash flow information:
   Interest paid .......................................   $    895      $    958      $    938
   Income taxes paid ...................................   $  1,632      $  2,893      $  2,782
</TABLE>

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


<PAGE>   25

                             PICTURETEL CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  NATURE OF THE BUSINESS:

     PictureTel Corporation (the "Company"), operates in one business segment,
the development, manufacture, marketing and servicing of videoconferencing
equipment.

RESTATEMENT OF FINANCIAL STATEMENTS

     On September 19, 1997, after the Company's reexamination (with assistance
from its outside auditors) of leasing and other indirect channel transactions,
the Company announced that it would reverse revenue related to certain of these
transactions and, as a result, the Company intended to restate its financial
statements for the third and fourth quarters of 1996 and the first quarter of
1997. On November 13, 1997, after completion of its reexamination, the Company
announced that it would also restate the second quarter of 1997. The
restatements were required to reverse product sales recorded which contained
rights of return, contingent liabilities, payment contingencies, payment
uncertainties or product sales for which delivery did not occur at the end of
the period. The restatements were required to record such product sales in the
period in which the rights of return lapsed, contingencies or uncertainties were
resolved, or delivery was completed. Certain transactions which were reversed
have not been re-recorded as revenues in later periods. The financial statements
and related notes to consolidated financial statements set forth in this Form
10-K/A reflect all such restatements. A summary of the impact of such
restatements for the year ended December 31, 1996 is as follows:

                                                  Year Ended
                                               December 31, 1996
                                           Previously          As
                                            Reported        Restated
                                                    ($000's)

     Revenues                               $482,532        $467,805
     Gross margin                            227,760         221,732
     Income before taxes                      51,711          45,683
     Income tax expense                       16,938          14,967
     Net income                               34,773          30,716
     Net income per common and common
       equivalent share                     $   0.96        $   0.85


                                                December 31, 1996
                                           Previously          As
                                            Reported        Restated
                                            --------        --------
                                                     ($000's)

     Total assets                           $376,047        $372,779
     Total liabilities                      $116,989        $117,765
     Total stockholders' equity             $259,058        $255,014


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

     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 period. Actual results could differ from those estimates.


<PAGE>   26

PRINCIPLES OF CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
and all of its subsidiaries. All material inter-company accounts and
transactions have been eliminated in consolidation.

FOREIGN CURRENCY TRANSLATION

     The financial statements of the Company's non-U.S. subsidiaries, where the
local currency is the functional currency, are translated using exchange rates
in effect at the end of the year for assets and liabilities and average exchange
rates during the year for results of operations. Related translation adjustments
are reported as a separate component of stockholders' equity.

FOREIGN EXCHANGE CONTRACTS

     The Company and its subsidiaries have entered into foreign currency forward
contracts as a hedge against specific inter-company and foreign currency
receivable transactions. Forward contracts involve agreements to purchase or
sell foreign currencies at specific rates at future dates. The Company's hedging
activities do not subject the Company to exchange rate risk because the gains
and losses on these contracts offset the losses and gains on the assets,
liabilities, and transactions being hedged. The contract premiums or discounts
are amortized over the life of the foreign exchange contracts and are recognized
in other income. At December 31, 1996 and 1995 the Company had contracts
maturing through May 7, 1997 to purchase $18,534,000 and $21,779,000,
respectively, in foreign currency (British pounds, French francs, German marks,
Japanese yen, Swiss francs, Swedish krona and Australian dollars). Cash flows
resulting from hedging contracts are classified in the same category as the cash
flows from the items being hedged. The carrying amount of the foreign currency
forward contracts is the fair value which is determined by obtaining market
prices.

CASH EQUIVALENTS AND MARKETABLE SECURITIES

     The Company classifies all debt and equity securities as available for
sale. They are carried at their fair value, based on quoted market prices, with
the unrealized gains and losses, net of tax, reported in a separate component of
stockholders' equity. The Company considers all highly liquid investments with a
maturity of three months or less at the date of purchase to be cash equivalents.
Those instruments with maturities between three months and twelve months, along
with equity securities, are considered to be short-term marketable securities
and investments with maturities of greater than one year are classified as
long-term marketable securities. At December 31, 1996 and 1995 cash equivalents
and marketable debt securities primarily consist of U.S. government securities,
corporate and municipal issues and commercial paper. The amortized cost of
marketable securities is adjusted for the amortization of premiums and accretion
of discounts over the life of the security. Such amortization and interest are
included in interest income. For the purpose of determining gain or loss, the
specific identification of securities method is used. Realized gains and losses
are included in other income.

INVENTORIES

     Inventories are stated at the lower of cost or market. Cost is determined
on the first-in, first-out basis.

PROPERTY AND EQUIPMENT

     Property and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the following estimated useful
lives:

<TABLE>
<S>                                               <C>       
Equipment..........................................2-5 years
Equipment and furniture under capital leases.......3-5 years
Furniture and fixtures.............................3-5 years
Leasehold improvements.............................Estimated useful life or term of the lease, if shorter
</TABLE>
<PAGE>   27

     Maintenance and repairs are charged to expense as incurred. Significant
improvements are capitalized and depreciated. Upon retirement or sale, the cost
of the assets disposed of, and the related accumulated depreciation, are removed
from the accounts and any resulting gain or loss is included in the
determination of net income.

RESEARCH AND DEVELOPMENT AND CAPITALIZED SOFTWARE COSTS

     Costs incurred prior to the establishment of technological feasibility are
charged to research and development expense. Software production costs incurred
subsequent to the establishment of technological feasibility are capitalized
until the product is available for general release to customers. Amortization is
based on the greater of (i) the ratio that current gross revenues for a product
bear to the total of current and anticipated future gross revenues for that
product or (ii) the straight-line method over the remaining estimated life of
the product.

     During the years ended December 31, 1996, 1995, and 1994, the Company
capitalized approximately $5,924,000, $4,247,000, and $2,916,000, respectively,
of software costs. During the years ended December 31, 1996, 1995, and 1994, the
Company amortized approximately $4,165,000, $3,337,000, and $3,973,000,
respectively, of software costs.

OTHER ASSETS

     Included in other assets are intangible assets which consist primarily of
intellectual property rights and non-compete agreements which are amortized over
their estimated useful life, which range from eighteen to thirty-six months.
Accumulated amortization on intangible assets was $3,771,000 and $3,203,000 at
December 31, 1996 and 1995, respectively. Also included in other assets are
prepaid royalties and investments accounted for under the cost method. The
Company reviews other long-term assets for any impairment in accordance with the
Statement of Financial Accounting Standard No. 121 "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121).

REVENUE RECOGNITION

     Revenue from product sales is recognized upon shipment in accordance with
contractual acceptance terms or upon completion of all significant obligations,
whichever is later. Revenue from maintenance contracts is recognized ratably
over the term of the contract. Allowances for estimated future product returns
and price protection under the Company's agreements with its distributors and
resellers are provided in the same period as the related revenues.

WARRANTY

     The Company provides a warranty for parts and labor on its products.
Warranty periods are generally one year from installation date on sales to
end-users and one year from delivery date on sales to distributors. In addition,
warranty periods for certain software products, repairs, and upgraded parts are
90 days upon receipt. Estimated costs related to warranty are accrued at the
time of revenue recognition.

INCOME TAXES

     The Company provides for the recognition of deferred tax liabilities and
assets for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, deferred
tax liabilities and assets are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
The measurement of deferred tax assets is reduced by a valuation allowance if,
based upon the weighted available evidence, it is more likely than not that some
or all of the deferred tax assets will not be realized.



<PAGE>   28

NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE

     Net income per common and common equivalent share is based on the weighted
average number of shares of common and common equivalent shares (stock options)
outstanding during the period.

     Fully diluted earnings per common and common equivalent share did not
differ materially from primary earnings per common and common equivalent share.

CONCENTRATIONS

Credit Risk

     Financial instruments which potentially subject the Company to
concentration of credit risk include cash, cash equivalents, marketable
securities and trade receivables. The Company sells its products to a variety of
customers, including end users, dealers and distributors, in a variety of
different industries and geographic regions. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potential credit losses.
With respect to its cash, cash equivalents and marketable securities, the
Company invests its excess cash primarily in deposits with a commercial bank,
U.S. government securities, corporate and municipal issues, and commercial paper
and has established guidelines relative to credit ratings, diversification and
maturities that maintain safety and liquidity. The Company has not experienced
any significant losses on these financial instruments.

Suppliers

     Certain components and parts used in the Company's products are procured
from a single source. The Company obtains parts from one vendor only, even where
multiple sources are available, to maintain quality control and enhance the
working relationship with suppliers. These purchases are made under existing
contracts or purchase orders. The failure of a supplier, including a
subcontractor, to deliver on schedule could delay or interrupt the Company's
delivery of products and thereby adversely affect the Company's revenues and
profits.

NEWLY ISSUED ACCOUNTING STANDARDS

     In February 1997, the Financial Accounting Standards Board issued Statement
No. 128 ("SFAS 128"), "Earnings per Share," which is effective for fiscal years
ending after December 15, 1997, including interim periods. SFAS 128 requires the
presentation of basic and diluted earning per share (EPS). Basic EPS, which
replaces primary EPS, excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity. Diluted EPS is computed
similarly to fully diluted EPS under the existing rules. SFAS 128 requires
restatement of all prior-period earnings per share data presented after the
effective date. The Company will adopt SFAS 128 in 1997 and has not yet
determined the impact of adoption.

3. INVENTORIES:

     Inventories consist of the following (in thousands):

<TABLE>
<CAPTION>
                                        DECEMBER 31,
                                  1996               1995
                                (RESTATED)
                                ---------------------------

<S>                             <C>                <C>    
Purchased parts                 $ 6,409            $11,492
Work in process                   2,018              3,252
Finished goods                   40,421             29,047
                                $48,848            $43,791
                                =======            =======
</TABLE>


4.  MARKETABLE SECURITIES:

     At December 31, 1996 and 1995, marketable securities can be summarized as
follows (in thousands):

<TABLE>
<CAPTION>
                                    AVAILABLE FOR SALE SECURITIES
                           -------------------------------------------
                                   1996                     1995
                           AMORTIZED      FAIR      AMORTIZED    FAIR
                             COST        VALUE        COST       VALUE
                           ---------     -----      ---------    -----

<S>                         <C>         <C>         <C>         <C>    
U. S. Government
  and its agencies          $42,992     $42,956     $45,983     $46,252

Municipal Issues              3,352       3,353       8,217       8,295
                            -------     -------     -------     -------

  Total Debt Securities      46,344      46,309      54,200      54,547


Equity Securities               482       1,727          --          --
                            -------     -------     -------     -------
                            $46,826     $48,036     $54,200     $54,547
                            =======     =======     =======     =======
</TABLE>

     Unrealized holding gains of $1,210,000 for 1996 and $347,000 for 1995 are
included as a separate component of stockholders' equity, net of tax. Realized
gains of approximately $3,000,000, $107,000 and $84,000 from the sales of
available for sale securities are included in other income for the years ended
December 31, 1996, 1995 and 1994, respectively.

     At December 31, 1996 $37,192,000, or 58% of the Company's marketable
securities have stated maturity dates within one year of the balance sheet date,
the remaining securities have stated maturity dates within two years of the
balance sheet date.

5.  PROPERTY AND EQUIPMENT:

     Property and equipment consist of the following (in thousands):

<TABLE>
<CAPTION>
                                         DECEMBER 31,
                                      1996        1995
                                      ----        ----
<S>                                 <C>          <C>    
Equipment                           $ 79,795     $49,526
Equipment and furniture
   under capital leases               11,410       7,867
Furniture and fixtures                 6,865       6,166
Leasehold improvements                 5,081       2,735
                                    --------     -------
                                     103,151      66,294
Less:  Accumulated depreciation
          and amortization            58,934      43,779
                                    --------     -------
                                    $ 44,217     $22,515
                                    ========     =======
</TABLE>

     At December 31, 1996 and 1995 accumulated amortization amounted to
$3,618,000 and $5,907,000 on equipment and furniture under capital leases.
Depreciation expense for the years ended December 31, 1996, 1995, and 1994 was
$16,807,000, $13,112,000 and $12,426,000, respectively.

6. DEBT:

     On December 19, 1996, the Company amended its unsecured revolving credit
agreement to increase the borrowing capacity from $17,000,000 to $40,000,000
with an expiration date of October 4, 1999. This agreement requires interest
payable at either the bank's base rate, or the adjusted eurocurrency rate plus
applicable margin. The applicable margin ranges from seven-eighths percent to
one and three-eighths percent based on certain financial ratios. Commitment fees
are payable on any unused portion and range from 0.225% to 0.375% based upon
certain financial ratios. The amended agreement contains no demand feature and
provides that the principal portion of the borrowings be  


<PAGE>   29
paid by the expiration date. Accordingly, the borrowings under the amended
agreement are classified as long-term borrowings.

     In addition, the Company has $18,319,000 of outstanding standby letters of
credit under this agreement. Fees for letters of credit outstanding against this
revolving credit line were payable at one percent per annum of the face amount.
Each letter of credit issued subsequent to the amendment date will be calculated
at a fee equal to the applicable margin times the face amount of such letter of
credit.

     The unsecured revolving credit agreement contains certain financial
covenants, including the maintenance of certain ratios including total
liabilities to tangible net worth and operating cash flow to total debt
services. At December 31, 1996 and 1995, $9,242,000 and $12,226,000,
respectively, were outstanding under this credit agreement and the Company was
in compliance with all covenants.

     Local lines of credit are available for short-term advances of up to
$4,400,000 to certain of the Company's foreign subsidiaries. Most of these lines
are guaranteed by the Company. The agreements require interest payable ranging
from the bank's base rate plus one to one and one half of a percent per annum,
and facility fees of up to one eighth of one percent of the facility amount per
annum. A total of $519,000 and $557,000 was borrowed against these local lines
of credit at December 31, 1996 and 1995, respectively. At December 31, 1996 and
1995, the weighted average interest rate on outstanding short-term borrowings
was 4.6% and 6.8%, respectively. The carrying amount of the short-term and
long-term borrowings is a reasonable estimate of the fair value because of the
short maturity of those instruments and because the interest rate in effect at
December 31, 1996 approximates the current market rate, respectively.

7. COMMITMENTS:

     The Company has commitments under operating leases for office and
manufacturing space. The facilities leases are for terms ranging from one to
eighteen years. The leases usually contain provisions which allow for expansion,
extension and termination. Total rent expense for operating leases was
$9,114,000, $6,757,000 and $5,724,000 for the years ended December 31, 1996,
1995, and 1994, respectively. The Company entered into an eighteen year lease
agreement for an additional building in Andover, Massachusetts. Beginning in
August, 1997 the Company expects to occupy the new building which will be
accounted for as a capital lease. The future lease payments aggregate
$42,352,000.

     The Company is lessee under several capital lease and sale-leaseback
agreements with third parties for certain leasehold improvements, equipment and
furniture.

     Future minimum lease payments under capital and operating leases with
initial or remaining terms of one year of more are (in thousands):

<TABLE>
<CAPTION>
                                                      Capital    Operating
                                                      Leases       Leases
                                                      ------       ------
<C>                                                   <C>         <C>     
1997 ...............................................  $3,785      $  8,905
1998 ...............................................  3,180          8,601
1999 ...............................................  1,822          7,005
2000 ...............................................                 5,418
2001 ...............................................                 5,247
Thereafter .........................................                75,704
                                                      ------      --------
Total future minimum lease payments ................  $8,787      $110,880
                                                      ======      ========

Less amount representing interest ..................     801
                                                      ------
Present value of net future minimum
      lease payments ...............................   7,986
Less current portion ...............................   3,294
                                                      ------
Long-term obligation under capital leases ..........  $4,692
                                                      ======
</TABLE>
<PAGE>   30

8. CAPITAL STOCK:

PREFERENCE STOCK

     The Company's Board of Directors is empowered to fix the terms and rights
of the Preference Stock. Issuance of the Preference Stock limits the rights of
the Common Stockholders.

COMMON STOCK

     On September 28, 1995, the Board of Directors authorized a two-for-one
split of the Company's outstanding Common Stock (the "Stock Split") by means of
a 100% stock dividend. All Common Stock and Common Stock equivalents and per
share amounts have been retroactively restated to reflect the two-for-one split.

STOCKHOLDERS' RIGHTS AGREEMENT

     On March 25, 1992, the Board of Directors of the Company declared a
dividend of one purchase right (a "Right") for every outstanding share of the
Company's Common Stock. After giving effect to the split, each Right entitles
the holder to purchase from the Company one two-hundredths of a share of Junior
Preference Stock at a price of $90 per one two-hundredths of a share, subject to
adjustment. The Rights will become exercisable on the fifteenth business day
following the date of a public announcement that an acquiring person (as defined
in the Rights Agreement, the definition of which provides for certain limited
exclusions) has acquired, or obtained the right to acquire, beneficial ownership
of 15% or more of the Company's outstanding Common Stock or on the fifteenth
business day following the commencement of a tender offer or exchange offer that
would result in an acquiring person owning 15% or more of the Company's
outstanding Common Stock.

     If the Company were acquired in a merger or other business combination, or
more than 25% of its assets or earning power were sold, each holder of a Right
would be entitled to exercise such Right and thereby receive common stock of the
acquiring company with a market value of two times the exercise price of the
Right. If an acquiring person has acquired or obtained the right to acquire 15%
of the Company's Common Stock, each holder of a Right, other than the acquiring
person, will be entitled to receive shares of the Company's Common Stock having
a market value of two times the exercise price of the Right. At any time the
Company may redeem the Rights at a redemption price of $0.005 per Right. The
Rights expire March 25, 2002.

STOCK-BASED COMPENSATION PLANS

     The Company has adopted the disclosure requirements of Statement of
Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based
Compensation." The Company continues to recognize compensation costs using the
intrinsic value based method described in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." No compensation costs were
recognized in 1996, 1995, and 1994.

     Net income and net income per share as reported in these consolidated
financial statements and on a pro forma basis, as if the fair value based method
described in SFAS No. 123 had been adopted, are as follows (in thousands, except
per share amounts):

<TABLE>
<CAPTION>
                                                    Year Ended December 31,
                                                        1996        1995
                                                     (Restated)
                                                     ----------   -------   
<S>                                  <C>              <C>         <C>       
Net income                           As reported      $30,716     $19,626   
                                     Pro forma         25,963      18,395

Primary net income per share         As reported      $  0.85     $  0.56
                                     Pro forma           0.72        0.53

Fully diluted net income per share   As reported      $  0.85     $  0.56
                                     Pro forma           0.72        0.52
</TABLE>
<PAGE>   31

     The effects of applying SFAS No. 123 for the purpose of providing pro forma
disclosures may not be indicative of the effects on reported net income and net
income per share for future years, as the pro forma disclosures include the
effects of only those awards granted after January 1, 1995 and additional awards
in future years are anticipated.

EMPLOYEE STOCK PURCHASE PLAN

     On April 15, 1994 the Company adopted an Employee Stock Purchase Plan (the
"Plan") under which eligible employees are able to purchase shares of the
Company's Common Stock at 85% of the market value at the date of the start of
each six month option period or the end of such period, whichever is lower.
Under the provisions of the Plan up to 1,000,000 shares are authorized after the
Stock Split. Shares purchased under the Plan in 1996 and 1995 totaled 73,827 and
131,994, respectively. The weighted average grant date fair value of the shares
purchased was $7.86 and $4.43 in 1996 and 1995. There are 794,179 shares
available under the Plan at December 31, 1996.

     For the purpose of providing pro forma disclosures, the fair values of
share purchased were estimated using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for purchases in 1996 and 1995,
respectively: a risk-free interest rate of 5.23% and 5.89%, an expected life of
6 months, expected volatility of 50%, and no expected dividends.

STOCK OPTION PLANS

     Under the Company's 1984 Amended and Restated Stock Option Plan, employees
and other persons who are in a position to make significant contributions to the
success of the Company may be granted either non-statutory or incentive stock
options to purchase up to 2,094,174 shares of Common Stock after the Stock
Split. The options are exercisable as stipulated by the Board of Directors (or a
Committee thereof) and will expire no more than ten years from the date of the
grant. The incentive option price per share will not be less than the fair
market value at the date of the grant. No new options will be issued as the Plan
has been terminated.

     On February 18, 1997, the Compensation Committee of the Board of Directors
granted replacement options, at an exercise price of $16.875 per share, to all
employees other than the executive officers and directors (and other than those
few who did not consent) holding outstanding options exercisable at a price of
$20.00 or more. The replacement options become exercisable (unless accelerated
by the Compensation Committee) over a four-year period, and to the extent the
canceled option had already become exercisable, such portion of the new option
will become exercisable in six months from the date of re-grant and the
remaining options will become exercisable over a four-year period commencing in
February 1998.

     On November 14, 1989, the Company's shareholders approved the PictureTel
Equity Incentive Plan. As of December 31, 1996 shareholders have authorized the
issuance of up to 9,000,000 shares of post Stock Split Common Stock under the
Plan. The Equity Incentive Plan permits the granting of non-statutory and
incentive stock options, a variety of stock and stock-based awards and related
benefits, and cash performance awards, which are in addition to option grants
under the 1984 Amended and Restated Stock Option Plan, to employees and other
persons who are in a position to make significant contributions to the success
of the Company.

     Effective October 23, 1992, the Board of Directors adopted the 1992
Non-Employee Directors' Stock Option Plan. As of December 31, 1996 shareholders
have authorized the issuance of up to 430,000 shares of Common Stock under the
Plan to eligible non-employee directors. Under this Plan each non-employee
director at October 23, 1992 and each non-employee director subsequently elected
receives, at October 23, 1992 or the director's first election date, a
non-statutory option to purchase 40,000 shares of post Stock Split Common Stock
at an exercise price equal to the fair market value of the stock on the
effective date of grant. The Plan was amended at the Annual Meeting on June 17,
1996 so as to increase the aggregate number of shares available for issuance
under the Plan from 280,000 to 430,000, and to further provide, as of August 1,
1996, for the automatic grant of 


<PAGE>   32

a non-statutory option to purchase 20,000 shares of Common Stock to directors
who have been directors for more than two years on August 1, 1996, and on the
later date of first election of any other director and thereafter, for the
annual grant of stock options to purchase 5,000 shares of the Company's Common
Stock on August first of each year, commencing on August 1, 1997, so long as
such individual is serving as a director on the applicable August first date,
provided that no such annual option for 5,000 shares shall be granted to a
director who first became a director of the Company within six months prior to
August first of said year. All options expire ten years after the effective date
of grant, and such options become exercisable over a four year period. At
December 31, 1996 there were 1,239,297 shares available for future grant under
these plans.

     The following table summarizes the Company's stock option plans at December
31, 1996, 1995, and 1994, and changes during the years then ended:

<TABLE>
<CAPTION>
                                               1996                           1995                         1994
                                      -----------------------       ------------------------       ---------------------
                                                    Weighted-                      Weighted-                   Weighted-
                                                    Average                        Average                     Average
                                                    Exercise                       Exercise                    Exercise
                                         Shares      Price              Shares      Price             Shares    Price
<S>                                   <C>           <C>             <C>             <C>            <C>          <C>  
Outstanding at beginning of year       4,908,811    $11.56           5,863,550      $8.00          4,961,036    $7.77
Granted at fair market value           1,439,350     34.65           1,089,524      23.37          2,102,300     8.32
Exercised                             (1,238,915)     8.64          (1,873,650)      6.74           (420,110)    4.15
Forfeited                               (343,973)    14.49            (170,613)     10.63           (779,676)    9.55
                                      ----------                    ----------                     ---------

Outstanding at end of year             4,765,273    $19.08           4,908,811     $11.56          5,863,550    $8.00
                                      ==========                    ==========                     =========

Options exercisable at year-end        1,805,678    $10.54           1,811,854     $ 7.67          2,529,068    $6.84

Weighted-average grant-date fair                                                                  
  value of options granted during                                                                 
  the year at fair market value                     $15.74                         $10.65         
</TABLE>


     The following table summarizes information about stock options outstanding
at December 31, 1996:

<TABLE>
<CAPTION>
                                               Options Outstanding                                     Options Exercisable
                           ----------------------------------------------------------         ---------------------------------
                                                Weighted-Average
                              Number               Remaining              Weighted-             Number              Weighted
       Range of            Outstanding         Contractual Life            Average            Exercisable            Average
   Exercise Prices         at 12/31/96            (In years)           Exercise Price         at 12/31/96        Exercise Price
 
<S>                          <C>                      <C>                  <C>                   <C>                <C>   
   $ 1.125 - 8.625           584,075                  4.4                  $ 5.64                348,245            $ 4.39
        8.875                805,353                  5.2                    8.88                313,032              8.88
     8.94 - 9.625            734,949                  6.4                    9.51                677,297              9.55
     9.75 - 18.44            439,318                  6.1                   11.30                244,638             11.04
    21.31 - 24.88            739,205                  8.0                   23.81                150,515             23.34
    25.815 - 34.50           768,100                  7.9                   31.54                 64,226             27.65
    35.00 - 40.50            694,273                  8.0                   38.48                  7,725             35.13
                           ---------                                                           ---------           
                                                                                                                   
    $1.125 - 40.50         4,765,273                  6.5                  $19.08              1,805,678            $10.54
                           =========                                                           =========          
</TABLE>
                                                                         
     For the purpose of providing pro forma disclosures, the fair values of
options granted were estimated using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants in 1996 and 1995,
respectively: a risk-free interest rate of 6.08% and 5.83%, an expected life of
4 years, expected volatility of 50%, and no expected dividends.
<PAGE>   33

9.  INCOME TAXES:

     Significant items making up total net deferred tax assets are as follows
(in thousands): 

<TABLE>
<CAPTION>
                                                           December 31,
                                                       1996            1995
                                                     ------------------------
<S>                                                  <C>              <C>         
Net operating loss and tax credit carryforwards      $10,125          $9,434      
Inventory reserves                                     2,185           2,889
Deferred revenue                                           0           1,110
Other temporary differences                            3,495           5,916
Valuation allowance                                   (4,767)         (6,684)
                                                     -------         -------   
Total net deferred tax assets                        $11,038         $12,665   
                                                     =======         =======
</TABLE>

     The valuation allowance primarily offsets the deferred benefit of certain
federal and state tax credit carryforwards whose benefit is uncertain. The
Company has recorded a deferred tax asset of approximately $6,856,000 reflecting
the benefit of deductions from the exercise of stock options. This deferred tax
asset is partially offset by a valuation allowance of $3,726,000 until it is
more likely than not that the benefit from the exercise of stock options will be
realized. The benefit from this valuation allowance will be recorded as a credit
to additional paid in capital when realized.

The provision for income taxes consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                    YEARS ENDED DECEMBER 31,
                            1996            1995              1994
                         (RESTATED)
                         ------------------------------------------
<S>                      <C>             <C>                <C>   
Federal income taxes:
  Currently payable      $ 7,304         $ 7,311            $1,613
  Deferred                 2,813          (1,840)             (595)
State income taxes:
   Currently payable         501           1,301               671
   Deferred                1,292            (119)             (567)
Foreign taxes:
  Currently payable        3,593           1,430             1,248
  Deferred                  (536)           (168)               --
                         -------         -------            ------
Total                    $14,967         $ 7,915            $2,370
                         =======         =======            ======
</TABLE>

     The differences between the statutory federal income tax rate and the
Company's effective income tax rate were as follows:

<TABLE>
<CAPTION>
                                                                      YEARS ENDED DECEMBER 31,
                                                                     1996       1995       1994
                                                                    ---------------------------
<S>                                                                  <C>        <C>        <C>  
Statutory federal income tax rate                                    35.0%      35.0%      35.0%
State income tax, net of federal tax benefit                          3.0        5.1        0.8
Federal and state tax credits from research and development          (1.4)      (1.9)     (30.1)
Difference between foreign and US tax rates and the benefit of
  the foreign sales corporation                                      (1.7)      (1.0)      (5.1)
Change in deferred asset valuation allowance                         (2.6)      (8.8)      31.5
Other                                                                 0.5        0.3        2.0
                                                                     ----       ----       ---- 

Effective tax rate                                                   32.8%      28.7%      34.1%
                                                                     ----       ----       ---- 
</TABLE>


     At December 31, 1996, the Company had remaining net operating loss ("NOL")
carryforwards available of approximately $8,344,000 to offset future federal
taxable income. The Company also has unused federal research and development tax
credits of approximately $2,348,000. The NOL and tax credit carryforwards expire
at various dates through the year 2009 and 2010, respectively. As a result of
prior equity issuances, the Company's use of NOL carryforwards incurred prior to
July 1988 is subject to certain annual limitations. At December 31, 1996,
approximately $4,637,000 of the available NOL carryforwards have an annual
limitation amount of approximately $662,000 that may be used to reduce the
Company's taxable income in the future.


<PAGE>   34

10. EMPLOYEE BENEFIT PLANS:

     The Company has a defined contribution profit sharing plan, including
features under Section 401(k) of the Internal Revenue Code, which will provide
retirement benefits to its employees. The Plan covers substantially all
employees of the Company and eligible participants may contribute up to 15% of
their pay on a pretax basis subject to annual dollar limits established by the
Internal Revenue Code and plan limitations. In 1994, the Company contributed
$353,000 to the Plan. In 1995, the Company agreed to provide a 50% matching
contribution up to the first 3% of each participant's eligible compensation. The
Company's matching contribution to the Plan was $857,000 and $661,000 in 1996
and 1995, respectively.

11. GEOGRAPHIC DATA & MAJOR CUSTOMERS:

     The Company's operations involve a single industry segment - the
development, manufacture, marketing and servicing of videoconferencing
equipment. The Company has subsidiaries in various foreign countries which sell
and service the Company's products in their respective geographic areas.
Revenues are reflected in the geographic areas from which the sales are made.
Financial information, summarized by geographic area, is as follows (in
thousands):

<TABLE>
<CAPTION>
                                   United                   Asia/
                                   States       Europe      Pacific    Eliminations  Consolidated
<S>                               <C>          <C>          <C>         <C>            <C>     
YEAR ENDED DECEMBER 31, 1996:
  Total revenues
   Unaffiliated customers         $298,998     $111,l58     $57,649            --      $467,805
   Inter-company transfers         101,230          630          --     $(101,860)           --
                                  --------     --------     -------     ---------      --------
      Total                       $400,228     $111,788     $57,649     $(101,860)     $467,805
                                  ========     ========     =======     =========      ========
Income (loss) from operations     $ 26,093     $  6,201     $ 3,383     $   2,446      $ 38,123
                                  ========     ========     =======     =========      ========
Identifiable assets               $248,709     $ 54,136     $25,691     $ (23,984)     $304,552
                                  ========     ========     =======     =========              
Corporate assets                                                                       $ 68,227
                                                                                       --------
Total assets                                                                           $372,779
                                                                                       ========

YEAR ENDED DECEMBER 31, 1995:
  Total revenues
   Unaffiliated customers         $231,740     $ 79,010     $36,008           --       $346,758
   Inter-company transfers          80,300          701          --     $(81,001)            --
                                  --------     --------     -------     ---------      --------
       Total                      $312,040     $ 79,711     $36,008     $(81,001)      $346,758
                                  ========     ========     =======     =========      ========
Income (loss) from operations     $ 23,131     $ (1,515)    $ 1,037     $  1,649       $ 24,302
                                  ========     ========     =======     =========      ========
Identifiable assets               $193,496     $ 42,196     $17,434     $(26,254)      $226,872
                                  ========     ========     =======     =========              
Corporate assets                                                                         61,269
                                                                                       --------
Total assets                                                                           $288,141
                                                                                       ========


YEAR ENDED DECEMBER 31, 1994
  Total revenues
   Unaffiliated customers         $164,176     $62,876      $ 28,141           --      $255,193
   Inter-company transfers          59,268          --            --    $ (59,268)           --
                                  --------     --------     -------     ---------      --------
       Total                      $223,444     $62,876      $ 28,141    $ (59,268)     $255,193
Income from operations            $  4,026     $   604      $    926    $    (347)     $  5,209
                                  ========     ========     =======     =========      ========
Identifiable assets               $134,515     $ 29,919     $14,642     $(20,429)      $158,647
                                  ========     ========     =======     =========               
Corporate assets                                                                         58,052
                                                                                       --------
Total assets                                                                           $216,699
                                                                                       ========
</TABLE>
<PAGE>   35


     The United States inter-company transfers primarily represent shipments of
systems to international subsidiaries. The inter-company transfers of systems
are made at transfer prices which approximate cost to distributors plus an
appropriate mark up, and are eliminated from consolidated revenues. Corporate
assets consist primarily of marketable securities.

Export sales to unaffiliated customers from the Company's United States
operations were as follows (in thousands):

<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                                    1996         1995         1994
                                                    ----         ----         ----
<S>                                               <C>          <C>          <C>    
Europe .....................................      $ 1,026      $ 2,693      $ 2,552
Canada .....................................        8,319        8,341        5,989
Asia/Pacific ...............................       19,332       13,220        4,703
Other ......................................       15,638        8,709        3,857
                                                  -------      -------      -------
                                                  $44,315      $32,963      $17,101
                                                  =======      =======      =======
</TABLE>

In 1996, 1995 and 1994 no customer accounted for 10% or more of total revenues.

12.  UNAUDITED INTERIM FINANCIAL INFORMATION

Quarterly financial information is as follows (in thousands, except per share
data):

<TABLE>
<CAPTION>
                                                         FIRST         SECOND       THIRD         FOURTH
                                                        QUARTER       QUARTER      QUARTER        QUARTER
                                                                                  (Restated)     (Restated)
<S>                                                     <C>           <C>          <C>            <C>     
1996
Revenues                                                $105,001      $116,082     $114,161       $132,561
Gross margin                                              50,892        55,739       54,172         60,929
Net income                                                 7,469         8,488        6,118          8,641
Net income per common and common equivalent share       $   0.21      $   0.24     $   0.17       $   0.24

1995
Revenues                                                $ 74,156      $ 80,489     $ 90,098       $102,015
Gross margin                                              37,798        41,039       44,335         48,543
Net income                                                 3,088         4,155        5,223          7,160
Net income per common and common equivalent share       $   0.09      $   0.12     $   0.15       $   0.20
</TABLE>

13.  LITIGATION

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
alleges that certain of the Company's products infringe patent rights allegedly
owned by Datapoint. Datapoint has been joined as plaintiff by John Frassanito
and David Monroe, two individuals who claim to have rights to Datapoint's
patents. The plaintiffs seek approximately $100 million to $170 million in
damages for alleged past infringement and an injunction against alleged future
infringement. The Company believes that it has meritorious defenses to the
allegations of the complaint and is vigorously defending against the lawsuit.
The case had been scheduled for trial on October 6, 1997; however, the trial was
delayed by the Court until early 1998.

     In the event the Company is found to be infringing a valid patent or
patents, the Company could be required to pay damages for past infringement and
cease the sale of products incorporating the infringing feature (or be required
to obtain a license and pay royalties with respect to such patents). There can
be no assurance that the Company will prevail. The Company believes that an
adverse outcome of the lawsuit would have a material adverse effect on the
business or the financial position, results of operations and cash flows of the
Company.

B.  Class Action Litigation

     Since September 23, 1997, seven class action shareholders' complaints have
been filed against the Company, Norman E. Gaut, Chairman of the Board and Chief
Executive Officer, and Les Strauss, the 


<PAGE>   36

former Vice President and Chief Financial Officer, in the United States District
Court for the District of Massachusetts. The plaintiffs, who brought these
actions on behalf of themselves and others similarly situated, are: (1) Faith
Egli, Civil Action No. 97-12135-DPW; (2) Jerome H. Lipman, IRA, Civil Action No.
97-12238-DPW; (3) Daniel Frucher, Civil Action No. 97-12310-DPW; (4) Edmond J.
Proulx and James Harris, Civil Action No. 97-12345-DPW; (5) Marvin Barab and
Thomas J. Curley, Civil Action No. 97-12338-DPW; (6) Mark Szen and Nancy Szen,
Civil Action No. 97-12439-DPW; and (7) Michael D. Kugler, Civil Action No.
97-12537 PBS.

     The Complaints were filed following the Company's announcement on September
19, 1997 that it would restate its financial results for the first quarter of
fiscal 1997 and the last two quarters of fiscal 1996. The Complaints allege that
the defendants violated Sections 10(b) and 20(a) of the Securities and Exchange
Act of 1934 and Rule 10b-5, promulgated thereunder, during the period from
October 17, 1996 through September 18 or 19, 1997, inclusive, through the
alleged preparation and dissemination of materially false and misleading
financial statements which artificially inflated the prices of PictureTel common
stock. Each Complaint seeks to recover an unspecified amount of damages,
including attorneys' and experts' fees and expenses. The Company is currently
investigating the allegations in the Complaints and will respond to the
allegations in a timely fashion when responses become due. It is too early to
determine the likely outcome of this litigation.



<PAGE>   37



                        REPORT OF INDEPENDENT ACCOUNTANTS

     Our report on the consolidated financial statements of PictureTel
Corporation is included in Item 8 of this Form 10-K/A. In connection with our
audits of such financial statements, we have also audited the related financial
statement schedule listed in Item 14(a) of the Form 10-K/A.

     In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.


COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
November 13, 1997




<PAGE>   38


                                     PART IV

ITEM 14:  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  1. FINANCIAL STATEMENTS

        -Report of Independent Accountants
        -Consolidated Statements of Income for the Years ended December 31,
         1996, 1995 and 1994 -Consolidated Balance Sheets as of December 31,
         1996 and 1995
        -Consolidated Statements of Stockholders' Equity for the years ended 
           December 31, 1996, 1995 and 1994
        -Consolidated Statements of Cash Flows for the years ended December 31,
           1996, 1995 and 1994 -Notes to Consolidated Financial Statements

     2. FINANCIAL STATEMENT SCHEDULE

        -Report of Independent Accountants
        -Schedule II -- Valuation and Qualifying Accounts
        -Schedules other than those listed above have been omitted since they
are either not required, not applicable, or the information is otherwise
included.

(c)  Exhibits (additional)

     11   Calculation of Earnings per Share (Filed herewith)

(d)  FINANCIAL STATEMENT SCHEDULE

     The Company hereby files as part of this Annual Report on Form 10-K/A the
financial statement schedule listed on Item 14(a)2 as set forth above.


<PAGE>   39

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.




                                           PICTURETEL CORPORATION


                                           By   /s/  Norman E. Gaut
                                              ----------------------------------
                                                       Norman E. Gaut
                                                  Chief Executive Officer

                                           Date     January 12, 1998
                                               ---------------------------------

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.


/s/ Norman E. Gaut           Chairman of the Board,             January 12, 1998
---------------------------  Chief Executive Officer            
Norman E. Gaut               and Director (Principal            
                             Executive Officer)                 
                                                                
                                                                
/s/ David B. Levi            Director                           January 12, 1998
---------------------------                                     
David B. Levi                                                   
                                                                
                                                                
/s/ Vinod Khosla             Director                           January 12, 1998
---------------------------  
Vinod Khosla

                                                                
/s/ Robert T. Knight         Director                           January 12, 1998
---------------------------                                     
Robert T. Knight                                                
                                                                
                                                                
/s/ Enzo Torresi             Director                           January 12, 1998
---------------------------                                     
Enzo Torresi                                                    
                                                                
                                                                
/s/ Richard B. Goldman       Vice President, Chief Financial    January 12, 1998
---------------------------  Officer (Principal Financial       
Richard B. Goldman           Officer & Principal Accounting Officer)