-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R0+uti8g3Wao3RDSP5SV5ldPXi3nOogw6YzhxS4Kl4f8oDKAg2M/bUKcissf9o1F bHd6d5T7ArVJK/neV/TpxA== 0000950135-98-005180.txt : 19980923 0000950135-98-005180.hdr.sgml : 19980923 ACCESSION NUMBER: 0000950135-98-005180 CONFORMED SUBMISSION TYPE: S-4 PUBLIC DOCUMENT COUNT: 14 FILED AS OF DATE: 19980922 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PICTURETEL CORP CENTRAL INDEX KEY: 0000755095 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 042835972 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4 SEC ACT: SEC FILE NUMBER: 333-63927 FILM NUMBER: 98712634 BUSINESS ADDRESS: STREET 1: 100 MINUTEMAN RD CITY: ANDOVER STATE: MA ZIP: 01810 BUSINESS PHONE: 5087625000 MAIL ADDRESS: STREET 1: 222 ROSEWOOD DR CITY: DANVERS STATE: MA ZIP: 01923 FORMER COMPANY: FORMER CONFORMED NAME: PICTEL CORP DATE OF NAME CHANGE: 19870505 S-4 1 PICTURETEL CORPORATION 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 21, 1998 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ PICTURETEL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 3661 04-2835972 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
100 MINUTEMAN ROAD, ANDOVER, MA 01810 (978) 292-5000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) W. ROBERT KELLEGREW GENERAL COUNSEL 100 MINUTEMAN ROAD, ANDOVER, MA 01810 (978) 292-5000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: HOWARD K. FUGUET, ESQ. JOHN B. GOODRICH, ESQ. ROPES & GRAY WILSON SONSINI GOODRICH & ROSATI, P.C. ONE INTERNATIONAL PLACE 650 PAGE MILL ROAD BOSTON, MASSACHUSETTS 02110 PALO ALTO, CALIFORNIA 94304
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE PUBLIC: At the effective time of the merger of an indirect wholly owned subsidiary of the Registrant with and into Starlight Networks Incorporated, which shall occur as soon as practicable after the effective date of this Registration Statement and the satisfaction or waiver of all conditions to closing of such merger as described in the enclosed Information Statement/Prospectus. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If the Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] ------------------------ CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF SECURITIES TO BE REGISTERED REGISTERED PER UNIT PRICE(1) REGISTRATION FEE(1) - ---------------------------------------------------------------------------------------------------------------------------- Common Stock, $0.01 par value(2)........ 1,331,914 shares N/A $7,903,124 $2,332 - ---------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------
(1) The Registration Fee was calculated in accordance with Rule 457(f)(2) based on the aggregate stated value of the capital stock of Starlight Networks Incorporated to be exchanged for the shares of common stock of the Registrant being registered pursuant to this Registration Statement. Starlight Networks Incorporated has an accumulated capital deficit and, in accordance with Rule 457(f)(2), the Proposed Maximum Aggregate Offering Price was calculated by dividing the aggregate stated value of the capital stock of Starlight Networks Incorporated by three. (2) Includes PictureTel Preferred Stock Purchase Rights. Prior to the occurrence of certain events, these rights will not be exercisable or evidenced separately from the PictureTel Common Stock. ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 STARLIGHT NETWORKS INCORPORATED 205 RAVENDALE DRIVE MOUNTAIN VIEW, CA 94043 September , 1998 To the Shareholders of Starlight Networks Incorporated: The Board of Directors of Starlight Networks Incorporated ("Starlight") has approved and is recommending that the shareholders of Starlight approve the acquisition of Starlight by PictureTel Corporation ("PictureTel"). In order to act upon approval of this transaction, Starlight is soliciting the written consent of the holders of Starlight Common Stock and the holders of Starlight Series A Preferred Stock, Starlight Series B Preferred Stock, Starlight Series C Preferred Stock, Starlight Series D Preferred Stock, Starlight Series E Preferred Stock, Starlight Series F Preferred Stock, and Starlight Series G Preferred Stock (collectively, the "Starlight Preferred Stock" and, together with the Starlight Common Stock, the "Starlight Stock"). Specifically, the holders of Starlight Common Stock and Starlight Preferred Stock (collectively referred to as the "Starlight Shareholders") will be asked to consent in writing to (i) a proposal to approve and adopt the Agreement and Plan of Merger dated as of August 14, 1998, by and among PictureTel, PictureTel Technology Corporation. ("PTC"), SNI Acquisition Corporation ("Merger Sub") and Starlight (the "Plan of Merger"), and to approve the merger (the "Merger") of Merger Sub, an indirect wholly owned subsidiary of PictureTel, with and into Starlight pursuant to the Plan of Merger, by which Starlight would become an indirect wholly owned subsidiary of PictureTel and (ii) a proposal to approve and adopt the Starlight 1998 Bonus Retention Plan Program (the "Bonus Retention Plan") for the purpose of, with respect to the holders of Starlight Preferred Stock, complying with Section 5(c)(x) of Article IV of Starlight's Amended and Restated Articles of Incorporation and approving certain payments to be made to two participants under such Bonus Retention Plan. Upon the effectiveness of the Merger (i) each outstanding share of Starlight Preferred Stock (other than shares of Starlight Preferred Stock held in treasury or held by PictureTel or any of its direct or indirect wholly owned subsidiaries) will be converted into the right to receive shares of PictureTel Common Stock in accordance with the exchange ratios described in the accompanying Information Statement/ Prospectus, (ii) each outstanding share of Starlight Preferred Stock held by PictureTel or any of its direct or indirect wholly owned subsidiaries will be converted into the right to receive one share of common stock, par value $0.01 per share, of the Surviving Corporation (as defined in the Information Statement/Prospectus) and (iii) each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration in accordance with Starlight's Amended and Restated Articles of Incorporation. The Plan of Merger also provides that 158,293 of the shares of PictureTel Common Stock to be issued in the Merger will be placed in escrow for up to twelve months to reimburse PictureTel for any breaches of Starlight's representations and warranties and certain other obligations in the Plan of Merger. THE BOARD OF DIRECTORS OF STARLIGHT HAS APPROVED THE PLAN OF MERGER AND THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE MERGER, AND RECOMMENDS THAT THE STARLIGHT SHAREHOLDERS CONSENT IN WRITING TO THE APPROVAL AND ADOPTION OF THE PLAN OF MERGER AND THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE MERGER. THE BOARD OF DIRECTORS OF STARLIGHT HAS ALSO APPROVED THE BONUS RETENTION PLAN AND THE PAYMENTS TO BE MADE THEREUNDER AND RECOMMENDS THAT THE STARLIGHT SHAREHOLDERS CONSENT IN WRITING TO THE APPROVAL AND ADOPTION OF THE BONUS RETENTION PLAN AND THE APPROVAL OF PAYMENTS TO BE MADE THEREUNDER. The record date for determining the Starlight Shareholders entitled to consent in writing to the proposals described in the accompanying Information Statement/Prospectus is September 14, 1998 (the "Starlight Record Date"). Starlight has set October , 1998 as the last date upon which written consents may be 3 submitted to Starlight. Starlight, however, may consummate the Merger prior to such date if the requisite consents to approve the Merger are obtained. Your written consents should be returned to the offices of our counsel, Wilson Sonsini Goodrich & Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304, Attention: Ronald A. Baker (Telephone: 650-493-9300; Facsimile: 650-493-6811). It is important that you provide your consent in writing to the proposals described in the accompanying Information Statement/Prospectus. Accordingly, we ask you to please complete, sign and date the accompanying form of written consent. The details of the proposed Merger and the Bonus Retention Plan appear in the accompanying Information Statement/Prospectus, which is being furnished to the Starlight Shareholders. You should consider carefully the investment considerations associated with the Merger discussed under "Risk Factors" in the accompanying Information Statement/Prospectus. Please note that one of the conditions to PictureTel's obligation to consummate the Merger (unless such condition is waived by PictureTel) is the requirement that the holders of at least 93% of the Starlight Stock shall not have dissented from the Merger. The approval and adoption of the Plan of Merger will require the written consent of the holders of a majority of the outstanding shares of Starlight Common Stock and Starlight Preferred Stock, acting together as a class, and the written consent of the holders of a majority of the outstanding shares of Starlight Preferred Stock, acting separately as a class. The approval and adoption of the Bonus Retention Plan will require the written consent of the holders of a majority of the outstanding shares of Starlight Preferred Stock. In addition, the approval of certain payments to be made to two participants in the Bonus Retention Plan will require the written consent of the holders of seventy-five percent (75%) of the outstanding shares of Starlight Stock, excluding shares held by those two participants. Further, pursuant to Section 310 of the California Corporations Code, the approval and adoption of each of the Plan of Merger and Bonus Retention Plan requires the written consent of the holders of a majority of the outstanding shares of Starlight Stock, exclusive of any shares of Starlight Stock deemed to be owned by any director of Starlight who has a material financial interest in such transaction. The management of Starlight appreciates the support that you have given us. Although the enterprise video market has developed considerably slower than we all had hoped, Starlight has made significant accomplishments. We are very enthusiastic about our acquisition by PictureTel and we believe it is in the best interest of our shareholders and employees. Sincerely, James E. Long Chairman Mountain View, California 4 STARLIGHT NETWORKS INCORPORATED INFORMATION STATEMENT ------------------------ PICTURETEL CORPORATION PROSPECTUS This Information Statement and Prospectus ("Information Statement/Prospectus") is being furnished to the holders of the (i) common stock, no par value (the "Starlight Common Stock"), (ii) Series A Preferred Stock, no par value (the "Starlight Series A Preferred Stock"), (iii) Series B Preferred Stock, no par value (the "Starlight Series B Preferred Stock"), (iv) Series C Preferred Stock, no par value (the "Starlight Series C Preferred Stock"), (v) Series D Preferred Stock, no par value (the "Starlight Series D Preferred Stock"), (vi) Series E Preferred Stock, no par value (the "Starlight Series D Preferred Stock"), (vii) Series F Preferred Stock, no par value (the "Starlight Series F Preferred Stock"), and (viii) Series G Preferred Stock, no par value (the "Starlight Series G Preferred Stock" and together with the Starlight Series A Preferred Stock, Starlight Series B Preferred Stock, Starlight Series C Preferred Stock, Starlight Series D Preferred Stock, Starlight Series E Preferred Stock, and Starlight Series F Preferred Stock, the "Starlight Preferred Stock") of Starlight Networks Incorporated, a California corporation ("Starlight"), in connection with the solicitation of written consents by Starlight from the holders of the Starlight Common Stock and the Starlight Preferred Stock. The Starlight Common Stock and Starlight Preferred Stock are referred to collectively in this Information Statement/Prospectus as the "Starlight Stock." The holders of the Starlight Common Stock and Starlight Preferred Stock are referred to collectively in this Information Statement/Prospectus as the "Starlight Shareholders." This Information Statement/Prospectus also constitutes the Prospectus of PictureTel Corporation, a Delaware corporation ("PictureTel"), with respect to the issuance of up to 1,331,914 shares of PictureTel common stock, par value $0.01 per share (the "PictureTel Common Stock"), to the holders of the Starlight Preferred Stock in connection with the Merger described herein. The stockholders of PictureTel will not be voting or consenting in writing to approve the Merger. PictureTel Common Stock is traded on The Nasdaq National Market ("Nasdaq") under the symbol "PCTL." This Information Statement/Prospectus relates to (i) the proposed merger (the "Merger") of SNI Acquisition Corporation, a California corporation and an indirect wholly owned subsidiary of PictureTel ("Merger Sub"), with and into Starlight pursuant to an Agreement and Plan of Merger dated as of August 14, 1998 (the "Plan of Merger") by and among PictureTel, PictureTel Technology Corporation, a Delaware corporation and a wholly owned subsidiary of PictureTel ("PTC"), Merger Sub and Starlight and (ii) the proposed Starlight 1998 Bonus Retention Program (the "Bonus Retention Plan") and the bonus payments to be made thereunder. Upon consummation of the Merger, Starlight will become a wholly owned subsidiary of PTC. The last day upon which your written consents may be submitted to Starlight is October , 1998. Written consents should be returned to Wilson Sonsini Goodrich & Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304, Attention: Ronald A. Baker (Telephone: 650-493-9300; Facsimile: 650-493-6811). This Information Statement/Prospectus and the accompanying form of written consent are first being mailed to the Starlight Shareholders on or about September , 1998. THE PROPOSED MERGER IS A COMPLEX TRANSACTION. STARLIGHT SHAREHOLDERS ARE STRONGLY URGED TO READ AND CONSIDER CAREFULLY THIS INFORMATION STATEMENT/PROSPECTUS IN ITS ENTIRETY, PARTICULARLY THE MATTERS REFERRED TO UNDER "RISK FACTORS" STARTING ON PAGE 9. ------------------------ THE SECURITIES OFFERED HEREBY HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS INFORMATION STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ The date of this Information Statement/Prospectus is September , 1998. 5 All information contained in this Information Statement/Prospectus with respect to PictureTel, PTC and Merger Sub has been provided by PictureTel. All information contained in this Information Statement/ Prospectus with respect to Starlight has been provided by Starlight. IN ACCORDANCE WITH CHAPTER 13 OF THE CALIFORNIA CORPORATION CODE (THE "CCC") STARLIGHT SHAREHOLDERS ARE ENTITLED TO DISSENTERS' RIGHTS IN CONNECTION WITH THE MERGER. SEE "THE MERGER -- APPRAISAL RIGHTS." ------------------------ NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN OR INCORPORATED BY REFERENCE IN THIS INFORMATION STATEMENT/PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION NOT CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. THIS INFORMATION STATEMENT/PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO PURCHASE, ANY OF THE SECURITIES OFFERED BY THIS INFORMATION STATEMENT/ PROSPECTUS, OR THE SOLICITATION OF A PROXY, IN ANY JURISDICTION TO OR FROM ANY PERSON TO OR FROM WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION OF AN OFFER, OR PROXY SOLICITATION. NEITHER THE DELIVERY OF THIS INFORMATION STATEMENT/PROSPECTUS NOR THE ISSUANCE OR SALE OF ANY SECURITIES HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE INFORMATION SET FORTH HEREIN OR INCORPORATED BY REFERENCE SINCE THE DATE HEREOF. THIS INFORMATION STATEMENT/PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO, AMONG OTHER THINGS, ESTIMATES OF ECONOMIC AND INDUSTRY CONDITIONS, SALES TRENDS, EXPENSE LEVELS AND CAPITAL EXPENDITURES. PICTURETEL'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS IN THIS INFORMATION STATEMENT/PROSPECTUS AND IN THE FORWARD-LOOKING STATEMENTS MADE FROM TIME TO TIME BY PICTURETEL ON THE BASIS OF MANAGEMENT'S THEN CURRENT EXPECTATIONS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE BUT ARE NOT LIMITED TO THOSE DISCUSSED OR REFERRED TO UNDER "RISK FACTORS" STARTING ON PAGE 9. 6 TABLE OF CONTENTS AVAILABLE INFORMATION....................................... 1 TRADEMARKS.................................................. 1 SUMMARY..................................................... 2 RISK FACTORS.............................................. 2 THE COMPANIES............................................. 2 The Business of PictureTel............................. 2 General.............................................. 2 Recent Developments.................................. 2 The Business of Starlight.............................. 3 THE MERGER................................................ 3 Conversion of Shares; Options and Warrants............. 4 Effective Time......................................... 4 Exchange of Certificates; Assumption of Warrants or Other Securities...................................... 4 Listing................................................ 5 Conditions to the Merger............................... 5 Escrow Agreement....................................... 5 Termination............................................ 6 STARLIGHT SHAREHOLDERS ACTIONS............................ 6 Matters To Be Acted Upon............................... 6 Last Date for Submission............................... 6 Record Date............................................ 6 Requisite Consent...................................... 7 RECOMMENDATION OF STARLIGHT'S BOARD OF DIRECTORS.......... 7 INTERESTS OF CERTAIN PERSONS IN THE MERGER................ 7 MATERIAL FEDERAL TAX CONSEQUENCES......................... 8 ANTICIPATED ACCOUNTING TREATMENT.......................... 8 COMPARATIVE RIGHTS OF STOCKHOLDERS........................ 8 APPRAISAL RIGHTS.......................................... 8 RISK FACTORS................................................ 9 SELECTED HISTORICAL FINANCIAL DATA.......................... 15 COMPARATIVE PER SHARE DATA.................................. 18 MARKET PRICE PER SHARE DATA................................. 19 Picturetel................................................ 19 Starlight................................................. 19 Dividend Policy........................................... 19 Recent Closing Prices..................................... 19 STARLIGHT SHAREHOLDERS ACTION............................... 20 Matters To Be Acted Upon.................................. 20 Last Date for Submission.................................. 20 Record Date; Requisite Consent............................ 20 Written Consents.......................................... 21 THE MERGER.................................................. 22 General................................................... 22 Conversion of Shares...................................... 22 Conversion of Starlight Options and Warrants.............. 23 Exchange of Certificates.................................. 23 Notification Regarding Starlight Warrants and Other Securities............................................. 24
-i- 7 Effective Time............................................ 24 Background of the Merger; Recommendation of Starlight's Board of Directors..................................... 25 Starlight's Reasons for the Merger........................ 25 PictureTel's Reasons for the Merger....................... 25 Certain Considerations.................................... 26 Interests of Certain Persons in the Merger................ 26 Material Federal Tax Consequences......................... 27 Anticipated Accounting Treatment.......................... 29 Governmental Filings...................................... 29 Certain Federal Securities Law Consequences; Affiliate Letters................................................ 29 Stock Exchange Listing.................................... 29 Dividends................................................. 29 Appraisal Rights.......................................... 30 THE PLAN OF MERGER.......................................... 32 Representations and Warranties............................ 32 Conduct of PictureTel's and Starlight's Business Prior to the Merger............................................. 32 No Solicitation........................................... 33 Conditions to the Merger.................................. 34 Termination............................................... 35 Termination Fee........................................... 36 Fees and Expenses......................................... 36 Indemnification........................................... 36 Escrow.................................................... 38 BUSINESS OF PICTURETEL...................................... 39 General................................................... 39 Industry Background....................................... 39 Technology................................................ 41 Proprietary............................................ 41 Standards.............................................. 43 Products.................................................. 43 Group Systems.......................................... 44 Systems for Desktop or Personal Meetings and Collaboration......................................... 44 Server Based Products.................................. 46 Software............................................... 46 Options and Peripherals................................ 47 Research and Development.................................. 47 Sales..................................................... 47 United States.......................................... 48 International Distribution............................. 48 Enterprise Services Division.............................. 49 Competition............................................... 49 Manufacturing............................................. 50 Patents and Copyrights.................................... 51 Employees................................................. 51 Properties................................................ 51 Legal Proceedings......................................... 52 Datapoint Litigation................................... 52 Shareholder Litigation................................. 52
-ii- 8 NV Holdings, Inc....................................... 53 Revnet, Inc............................................ 53 PICTURETEL -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.............. 54 Introduction.............................................. 54 Six Months Ended June 28, 1998 Compared to Six Months Ended June 29, 1997................................... 54 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996..................................... 55 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995..................................... 57 Liquidity and Capital Resources........................... 58 Year 2000 Compliance...................................... 59 Recently Issued Accounting Pronouncements................. 60 Quarterly Results and Seasonality......................... 61 BUSINESS OF STARLIGHT....................................... 62 General................................................... 62 Products and Services..................................... 62 The Starlight Solutions................................... 62 Products under Development................................ 62 Marketing and Sales....................................... 63 Competition............................................... 63 Employees................................................. 63 Properties................................................ 63 STARLIGHT -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............. 64 General................................................... 64 Six Months ended June 30, 1998 Compared to Six Months Ended June 30, 1997................................... 64 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996..................................... 65 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995..................................... 65 Liquidity and Capital Resources........................... 66 Impact of Year 2000....................................... 66 SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF PICTURETEL.................................. 68 SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF STARLIGHT................................... 70 MANAGEMENT -- PICTURETEL.................................... 74 Directors and Executive Officers of PictureTel............ 74 Executive Compensation.................................... 75 OPTION TABLES............................................... 76 Employment, Severance and Other Agreements................ 77 Director Compensation..................................... 78 DESCRIPTION OF CAPITAL STOCK OF PICTURETEL.................. 80 Common Stock.............................................. 80 Preferred Stock........................................... 80 Rights Plan............................................... 80 Delaware Law and Certain Charter and Bylaw Provisions..... 81 COMPARISON OF STOCKHOLDER RIGHTS............................ 81 Amendment of Starlight Articles and PictureTel Certificate............................................ 81 Amendment of Starlight and PictureTel By-laws............. 82 Voting Rights............................................. 82 Special Meetings of Shareholders and Stockholders......... 83 Actions by Written Consent of Stockholders and Shareholders........................................... 83
-iii- 9 Size of the Board of Directors............................ 83 Classification of the Board of Directors.................. 83 Cumulative Voting......................................... 84 Removal of Directors...................................... 84 Filling Vacancies in the Board of Directors............... 84 Dividends and Repurchases of Shares....................... 85 Appraisal Rights.......................................... 85 Inspection of Books and Records........................... 86 Limitation of Liability of Directors...................... 86 Indemnification........................................... 87 Stockholder and Shareholder Approval of Certain Business Combinations........................................... 87 Stockholder and Shareholder Voting on Mergers and Similar Transactions........................................... 88 Loans to Directors, Officers and Employees................ 89 Interested Director Transactions.......................... 89 Stockholder and Shareholder Derivative Suit............... 89 STARLIGHT 1998 BONUS RETENTION PLAN......................... 90 General Description....................................... 90 Approval of Certain Payments for Purposes of Section 280G and Section 4999 of the Code........................... 91 LEGAL MATTERS............................................... 92 EXPERTS..................................................... 92
-iv- 10 AVAILABLE INFORMATION PictureTel is subject to the informational reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files annual and quarterly reports, proxy statements, and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information filed by PictureTel with the Commission may be inspected and copied at the Public Reference Facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Judiciary Plaza, Washington, D.C. 20549, and at the Commission's Regional Offices located at Seven World Trade Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may be obtained from the Public Reference Facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Judiciary Plaza, Washington, D.C. 20549, at prescribed rates. In addition, PictureTel is required to file electronic versions of these documents with the Commission through the Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. The Commission maintains a World Wide Web site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The PictureTel Common Stock is listed on The Nasdaq National Market System and such reports, proxy statements and other information concerning PictureTel may be inspected at the offices of the National Association of Securities Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20006. PictureTel has filed with the Commission a Registration Statement on Form S-4 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities offered hereby. This Information Statement/Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain items of which are contained in schedules and exhibits to the Registration Statement as permitted by the rules and regulations of the Commission. Statements made in this Information Statement/Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. Items and information omitted from this Information Statement/Prospectus but contained in the Registration Statement may be inspected and copied at the Public Reference Facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Judiciary Plaza, Washington, D.C. 20549. TRADEMARKS PictureTel is a registered trademark of PictureTel and MCT, HVQ, SG3, SG4, Concorde, PicturePlus, PT724, IDEC, LimeLight, PowerCam, LiveLAN, LiveGateway, Look-At-Me-Button, WorldCart, System 4000, Venue, SwiftSite, Live50, Live100, Live200, LiveShare, Montage, Prism, LiveScheduler and DTK are trademarks of PictureTel. StarWorks and StarCast are registered trademarks of Starlight and Starlight, StarLive! and StarCenter are trademarks of Starlight. Other trademarks used in this Information Statement/ Prospectus are the property of their respective owners. 1 11 SUMMARY Reference is made to, and this summary is qualified in its entirety by, the more detailed information contained in, attached to or incorporated by reference in this Information Statement/Prospectus and the Annexes hereto. Starlight Shareholders are urged to read this Information Statement/Prospectus and the Annexes in their entirety. RISK FACTORS IN CONSIDERING WHETHER TO APPROVE THE PLAN OF MERGER AND THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE MERGER, STARLIGHT SHAREHOLDERS SHOULD CAREFULLY REVIEW AND CONSIDER THE INFORMATION CONTAINED HEREIN UNDER THE CAPTION "RISK FACTORS." THE COMPANIES THE BUSINESS OF PICTURETEL General PictureTel develops, manufactures, markets and services visual collaboration solutions. These solutions -- systems and collaboration software that employ advanced video and audio compression and interactive data technologies -- allow users to conduct face-to-face meetings at a distance with cost and convenience similar to the telephone. Visual collaboration sessions 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 and high-fidelity audio at data rates as low as 56 kbps. By operating over such low speed switched digital lines, PictureTel's systems reduce the cost and increase the flexibility of videoconferencing. In addition to providing visual collaboration solutions for use over switched digital lines, PictureTel also offers those solutions for use over Internet Protocol ("IP") networks. While high-speed (e.g., 2 to 6 Mbps) collaboration sessions can operate over dedicated (i.e. non-dialed) lines, the per-minute usage cost can range from 10 to 100 times higher than PictureTel solutions designed for use over switched digital lines or IP-based networks. PictureTel offers a range of visual collaboration solutions for group and personal use, as well as multipoint bridges for multi-location conferencing and a full suite of services. PictureTel sells its products through a number of telecommunication and personal computer distribution channels in the United States and internationally, as well as through a direct sales force. PictureTel was incorporated in Delaware in 1984. PictureTel's principal executive offices are located at 100 Minuteman Road, Andover, Massachusetts 01810 (Telephone: (978) 292-5000). Recent Developments In July, 1998, Richard B. Goldman resigned as Vice President and Chief Financial Officer of PictureTel. Mr. Goldman's employment terminated on September 11, 1998. No successor has yet been named. In February, 1998, Bruce R. Bond joined PictureTel as the President and Chief Executive Officer. See "Option Tables -- Employment, Severance and Other Agreements." On September 19, 1997, after PictureTel's reexamination, with assistance from its outside auditors, of leasing and other indirect channel transactions, PictureTel announced that it would reverse revenue related to certain of these transactions and, as a result, intended to restate its financial statements for the third and fourth quarters of the fiscal year ended December 31, 1996 and the first quarter of the fiscal year ended December 31, 1997. On November 13, 1997, after completion of its reexamination, PictureTel announced that it would also restate the second quarter of the fiscal year ended December 31, 1997 (such restatements, collectively, the "Restatements"). 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 relevant period. The Restatements were also required to record such product 2 12 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. On June 2, 1998, PictureTel was served with a complaint from a former distribution channel customer, Revnet, Inc., which has ceased operations. (Revnet, Inc. v. PictureTel Corporation. Civil Action 98092039, filed April 2, 1998, in the Circuit Court for Baltimore City, Maryland.) The complaint alleges that PictureTel breached an oral contract. Revnet is seeking $200,000,000 in damages. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome of this lawsuit. Since September 23, 1997, seven class action shareholders' complaints relating to the Restatements have been filed against PictureTel, Norman E. Gaut, the former Chairman of the Board and Chief Executive Officer, and Les Strauss, the former Vice President and Chief Financial Officer, in the United States District Court for the District of Massachusetts. The plaintiffs, 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. These plaintiffs have consolidated their complaints into one lawsuit and filed a consolidated complaint on February 11, 1998, encaptioned In re PictureTel Corporation Securities Litigation, Civil Action No. 97-12135-DPW. The original complaints were filed following PictureTel's announcement on September 19, 1997 that it would restate its financial results for the first quarter of the fiscal year ended December 31, 1997 and the last two quarters of the fiscal year ended December 31, 1996, and were amended when PictureTel announced on November 13, 1997 that it would also restate the second quarter of the fiscal year ended December 31, 1997. The consolidated complaint alleges that PictureTel and Messrs. Gaut and Strauss violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, during the period from October 17, 1996 through November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the price of the PictureTel Common Stock. The consolidated complaint seeks to recover an unspecified amount of damages, including attorneys' and experts' fees and expenses. On April 7, 1998, PictureTel filed a motion to dismiss the complaint. The Plaintiffs filed an amended complaint in response to PictureTel's motion to dismiss. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. THE BUSINESS OF STARLIGHT Starlight develops, installs and customizes streaming media applications for large enterprises. Starlight's current products provide corporate communications solutions that include Starlight's and other firms' streaming video engines, business communications applications and streaming applications management. Products in development are expected to provide more fully integrated streaming video and streaming applications management for a variety of corporate applications, including business briefings and event management, distance learning, business television and advertising/electronic commerce. Starlight was incorporated in California in 1990. Starlight's principal executive offices are located at 205 Ravendale Drive, Mountain View, CA 94043 (Telephone: (650) 967-2774). THE MERGER The Plan of Merger provides for the merger of Merger Sub, a wholly owned subsidiary of PTC and an indirect wholly owned subsidiary of PictureTel, with and into Starlight, with the result that Starlight, as the surviving corporation in the Merger (the "Surviving Corporation"), would become a wholly owned subsidiary of PTC and an indirect wholly owned subsidiary of PictureTel. For the Merger to be consummated, the Plan of Merger must be approved and adopted by the holders of Starlight Common Stock and Starlight Preferred Stock and the other conditions specified in the Plan of Merger must be satisfied or waived. See "The Merger" and "Starlight Shareholders Action." 3 13 CONVERSION OF SHARES; OPTIONS AND WARRANTS At the Effective Time (as defined below) of the Merger, each share of Starlight Preferred Stock (other than shares of Starlight Preferred Stock held in treasury or held by PictureTel or any of its direct or indirect wholly owned subsidiaries) issued and outstanding immediately prior to the Merger will be automatically converted into the right to receive shares of PictureTel Common Stock in accordance with the exchange ratios (the "Exchange Ratios") set forth in this Information Statement/Prospectus and cash in lieu of fractional shares (collectively, the "Merger Consideration"). In addition, at the Effective Time of the Merger, (i) each outstanding share of Starlight Preferred Stock held by PictureTel or any of its direct or indirect wholly owned subsidiaries will be converted into the right to receive one share of the common stock, par value $0.01 per share, of the Surviving Corporation and (ii) each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration therefor in accordance with Starlight's Amended and Restated Articles of Incorporation. The maximum number of shares of PictureTel Common Stock that may be issued in the Merger is 1,331,914. Based upon the capitalization of PictureTel as of August 1, 1998 and excluding shares of PictureTel Common Stock to be issued under the Bonus Retention Plan, the holders of Starlight Preferred Stock will acquire PictureTel Common Stock representing approximately 3.4% of the PictureTel Common Stock outstanding immediately after consummation of the Merger. See "The Merger -- Conversion of Shares." At the Effective Time of the Merger, each option to purchase Starlight Common Stock under the Starlight Networks Incorporated 1991 Stock Plan (the "Common Stock Option Plan") will be terminated or canceled in accordance with the terms and provisions of such Common Stock Option Plan. As a condition to the closing of the Merger, all other outstanding warrants and securities convertible into or exchangeable for shares of Starlight Common Stock or Starlight Preferred Stock must have been terminated or converted into or exchanged for shares of Starlight Common Stock or Starlight Preferred Stock, except for warrants and other securities of Starlight convertible into or exchangeable solely for shares of Starlight Preferred Stock and, in accordance with the Exchange Ratios, convertible into a maximum of 3,000 shares of PictureTel Common Stock. Those warrants and other securities of Starlight remaining outstanding as of the Effective Time, by virtue of the Merger and without any further action on the part of the holders thereof, shall be assumed by PictureTel and deemed to constitute a warrant or other security of PictureTel to acquire, on the same terms and conditions as were applicable under such warrant or other security immediately prior to the Effective Time, the number (rounded down to the nearest whole number) of shares of PictureTel Common Stock equal to the product of (i) the number of shares of Starlight Preferred Stock issuable upon exercise of such warrant or other security immediately prior to the Effective Time (not taking into account whether or not such warrant or other security or instrument was in fact exercisable, but excluding any Starlight Preferred Stock issued prior to the Effective Time pursuant to such warrant or other security) multiplied by (ii) the Exchange Ratio applicable to such series of Starlight Preferred Stock issuable upon exercise of such warrant or other security, at a price per share (rounded up to the next highest cent) equal to (i) the exercise price per share for the shares of Starlight Preferred Stock issuable upon exercise of such warrant or other security immediately prior to the Effective Time divided by (ii) the Exchange Ratio applicable to such series of Starlight Preferred Stock issuable upon exercise of such warrant or other security. See "The Merger -- Conversion of Starlight Options and Warrants." EFFECTIVE TIME Consummation of the Merger will occur upon the filing of the agreement of merger (the "Agreement of Merger"), together with any required related certificates, with the Secretary of State of the State of California or at such later time as is specified in such Agreement of Merger (the "Effective Time"). The filing of the Agreement of Merger will occur as soon as practicable after the satisfaction or waiver of all conditions to the closing of the transactions contemplated by the Plan of Merger. EXCHANGE OF CERTIFICATES; ASSUMPTION OF WARRANTS OR OTHER SECURITIES As soon as reasonably practicable after the Effective Time, a letter of transmittal with instructions will be mailed to each holder of Starlight Preferred Stock for use in exchanging Starlight Preferred Stock certificates 4 14 for PictureTel Common Stock certificates. See "The Merger -- Exchange of Certificates." HOLDERS OF STARLIGHT PREFERRED STOCK CERTIFICATES SHOULD NOT SUBMIT THEIR CERTIFICATES FOR EXCHANGE UNTIL THEY HAVE RECEIVED THE LETTER OF TRANSMITTAL AND INSTRUCTIONS REFERRED TO ABOVE. As soon as reasonably practicable after the Effective Time, PictureTel will issue to each holder of warrants and other securities of Starlight remaining outstanding as of the Effective Time in accordance with the Plan of Merger a document evidencing the assumption of such warrant or other security by PictureTel. Such assumption will be automatic and no action will be required on the part of the holder of such warrant or other security. See "The Merger -- Notification Regarding Starlight Warrants and Other Securities." LISTING The shares of PictureTel Common Stock to be issued in the Merger will be listed for quotation on The Nasdaq National Market. CONDITIONS TO THE MERGER The consummation of the Merger is subject to the satisfaction or waiver of certain conditions, including, but not limited to, (i) the approval and adoption of the Plan of Merger by a majority of the outstanding shares of Starlight Common Stock and Starlight Preferred Stock, acting together as a class, (ii) the approval and adoption of the Plan of Merger by a majority of the outstanding shares of Starlight Preferred Stock, acting separately as a class, (iii) the approval and adoption of the Plan of Merger by holders of at least 93% of the Starlight Stock, (iv) the termination of all options issued under the Common Stock Option Plan and the termination or conversion of all warrants and other securities convertible into or exchangeable for shares of any class of capital stock of Starlight, except for warrants and other securities convertible into or exchangeable solely for shares of Starlight Preferred Stock which, based on the Exchange Ratios, are convertible into a maximum of 3,000 shares of PictureTel Common Stock, (v) the absence of any injunction prohibiting consummation of the Merger, (vi) the absence of any action, statute, rule, regulation, or order which makes or would make consummation of the Merger illegal, (vii) the continuing accuracy of each party's representations and warranties made in the Plan of Merger on and as of the Effective Time, (viii) the performance by each party of its covenants and agreements required by the Plan of Merger, (ix) the receipt of a legal opinion from Wilson Sonsini Goodrich & Rosati, P.C. to the effect that the Merger will be treated for federal income tax purposes as a sale or exchange resulting in gain or loss recognition and (x) PTC and David A. Edwards shall have performed all of their respective obligations under the Stock Purchase Agreement dated August 14, 1998. See "The Plan of Merger -- Conditions to the Merger" and "The Merger -- Material Federal Tax Consequences." ESCROW AGREEMENT Pursuant to an escrow agreement (the "Escrow Agreement") to be entered into by and between PictureTel, James E. Long, as the representative of the holders of Starlight Preferred Stock (the "Stockholder Representative"), and State Street Bank & Trust Company (the "Escrow Agent"), 158,293 of the shares (the "Escrow Shares") of PictureTel Common Stock which the holders of the Starlight Preferred Stock are entitled to receive in the Merger will be withheld and deposited in escrow for twelve months, and will be held and disposed of in accordance with the terms of the Escrow Agreement. The Escrow Shares will be available to reimburse PictureTel for breaches of representations, warranties or covenants made by Starlight in the Plan of Merger and certain other obligations in the Plan of Merger if such claims are made within twelve months of the Effective Time. The Escrow Shares to be delivered to the Escrow Agent will be allocated pro rata among the holders of Starlight Preferred Stock based on the number of shares of PictureTel Common Stock to be received by such holders in the Merger. Unless otherwise determined in accordance with the terms of the Escrow Agreement, the holders of the Starlight Preferred Stock that receive PictureTel Common Stock in the Merger will retain and be entitled to all incidents of ownership including, without limitation, voting rights and rights to cash dividends, if any, payable in respect of such Escrow Shares. Under the terms of the Escrow 5 15 Agreement, the Stockholder Representative will be entitled to indemnification from the holders of Starlight Preferred Stock. See "The Plan of Merger -- Indemnification" and "-- Escrow." TERMINATION The Plan of Merger is subject to termination by mutual written consent of PictureTel and Starlight and, subject to certain limitations, at the option of either PictureTel or Starlight if the Merger is not consummated on or before November 30, 1998. The Plan of Merger is also subject to termination upon the occurrence of certain other events. Under certain circumstances specified in the Plan of Merger, PictureTel will be entitled to a $1.0 million fee from Starlight in the event of the termination of the Plan of Merger. See "The Plan of Merger -- Termination" and "-- Termination Fee." STARLIGHT SHAREHOLDERS ACTIONS MATTERS TO BE ACTED UPON The holders of Starlight Stock are being asked to consent in writing to the proposal to approve and adopt the Plan of Merger pursuant to which, among other things, at the Effective Time (i) Merger Sub will be merged with and into Starlight and Starlight will become an indirect wholly owned subsidiary of PictureTel, (ii) each outstanding share of Starlight Preferred Stock (other than shares of Starlight Preferred Stock held in treasury or held by PictureTel or any of its direct or indirect wholly owned subsidiaries) will be converted into the right to receive shares of PictureTel Common Stock in accordance with the Exchange Ratios, (iii) each outstanding share of Starlight Preferred Stock held by PictureTel or any of its direct or indirect subsidiaries will be converted into the right to receive one share of common stock, par value $0.01 per share, of the Surviving Corporation, and (iv) each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration in accordance with Starlight's Amended and Restated Articles of Incorporation. In addition, the Starlight Shareholders are being asked to consent in writing to the proposal to approve and adopt the Starlight 1998 Bonus Retention Program (the "Bonus Retention Plan") for the purpose of, with respect to the holders of Starlight Preferred Stock, complying with Section 5(c)(x) of Article IV of Starlight's Amended and Related Articles of Incorporation and approving certain payments to be made to two participants under such Bonus Retention Plan. LAST DATE FOR SUBMISSION The last date upon which written consents may be submitted to Starlight is October , 1998. Starlight, however, may consummate the Merger prior to such date if the requisite consents to approve the Merger are obtained. Written consents should be returned to Wilson Sonsini Goodrich & Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304, Attention: Ronald A. Baker (Telephone: 650-493-9300; Facsimile: 650-493-6811). RECORD DATE Holders of record of shares of Starlight Stock at the close of business on September 14, 1998 (the "Starlight Record Date") are entitled to consent in writing to the proposals described in this Information Statement/Prospectus. On the Starlight Record Date, there were outstanding 2,276,898 shares of Starlight Common Stock, 2,529,999 shares of Starlight Series A Preferred Stock, 1,577,120 shares of Starlight Series B Preferred Stock, 1,931,914 shares of Starlight Series C Preferred Stock, 1,743,134 shares of Starlight Series D Preferred Stock, 692,428 shares of Starlight Series E Preferred Stock, 1,201,880 shares of Starlight Series F Preferred Stock, and 8,106,983 shares of Starlight Series G Preferred Stock. Starlight Shareholders are entitled to one vote for each share of Starlight Common Stock or Starlight Preferred Stock held on (i) the proposal to approve and adopt the Plan of Merger and the transactions contemplated thereby, including the Merger, (ii) the proposal to approve and adopt the Bonus Retention Plan and (iii) the proposal to approve certain payments to be made under the Bonus Retention Plan. See "Starlight Shareholders Actions -- Record Date; Requisite Consent." 6 16 REQUISITE CONSENT The approval and adoption of the Plan of Merger and the transactions contemplated thereby, including the Merger, will require (i) the written consent of the holders of a majority of the outstanding shares of Starlight Common Stock and Starlight Preferred Stock, acting together as a class, and (ii) the written consent of the holders of a majority of the outstanding shares of the Starlight Preferred Stock, acting separately as a class. See "Starlight Shareholders Actions -- Requisite Consent; Record Date." In addition, PictureTel has required as a condition to its obligation to consummate the Merger that holders of at least 93% of the Starlight Stock entitled to vote on the Merger shall not have dissented from the Merger. In addition, the approval of certain payments to be made to two participants in the Bonus Retention Plan will require the written consent of the holders of seventy-five percent (75%) of the outstanding shares of Starlight Stock, excluding shares held by those two participants. Further, pursuant to Section 310 of the CCC, the approval and adoption of each of the Plan of Merger and Bonus Retention Plan requires the written consent of the holders of a majority of the outstanding shares of Starlight Stock, exclusive of any shares of Starlight Stock deemed to be owned by any director of Starlight who has a material financial interest in such transaction. As of August 1, 1998, giving effect to the conversion of all outstanding Subordinated Convertible Promissory Notes due August 15, 1998 into shares of Series G Preferred Stock, which conversion occurred on August 15, 1998, the directors and executive officers of Starlight and their affiliates owned 775,000 shares, or 34.0%, of the outstanding Starlight Common Stock, and 7,876,601 shares, or 44.2%, of the outstanding Starlight Preferred Stock. Assuming the conversion of the outstanding Starlight Preferred Stock, the directors and executive officers of Starlight and their affiliates owned 8,651,601 shares, or 43.1%, of Starlight Common Stock. See "Securities Ownership of Certain Beneficial Owners and Management of Starlight." In addition, certain holders of Starlight Common Stock and Starlight Preferred Stock have executed an irrevocable proxy in favor of PictureTel authorizing PictureTel to sign written consents for all the outstanding shares of Starlight Stock over which he, she or it has voting control in favor of the approval and adoption of the Plan of Merger. After giving effect to the irrevocable proxies, PictureTel has the right to sign written consents for 1,303,000 shares, or 57.2%, of the outstanding Starlight Common Stock and 15,785,256 shares, or 88.8%, of the outstanding Starlight Preferred Stock. Assuming the conversion of the outstanding Starlight Preferred Stock, PictureTel has the right to sign written consents for 17,088,256 shares, or 85.2%, of the Starlight Common Stock. RECOMMENDATION OF STARLIGHT'S BOARD OF DIRECTORS The Board of Directors of Starlight has approved the Plan of Merger and the transactions contemplated thereby, including the Merger, and recommends that the Starlight Shareholders consent in writing to approve and adopt the Plan of Merger and the transactions contemplated thereby, including the Merger. See "The Merger -- Background of the Merger; Recommendation of Starlight's Board of Directors." The Board of Directors of Starlight has also approved the Bonus Retention Plan and recommends that the Starlight Shareholders consent in writing to approve and adopt the Bonus Retention Plan and to approve certain payments to be made under the Bonus Retention Plan. See "Starlight 1998 Bonus Retention Plan." INTERESTS OF CERTAIN PERSONS IN THE MERGER In considering the recommendation of the Starlight Board of Directors with respect to the Plan of Merger and the transactions contemplated thereby, including the Merger, the Starlight Shareholders should be aware that certain executive officers and members of the Board of Directors have certain interests in the Merger that present these executive officers and members of the Board of Directors with conflicts of interest. See "The Merger -- Interests of Certain Persons in the Merger," and "Starlight 1998 Bonus Retention Plan." 7 17 MATERIAL FEDERAL TAX CONSEQUENCES The Merger has been structured to be a taxable transaction in which holders of Starlight Preferred Stock will generally recognize gain or loss on the exchange of their Starlight Preferred Stock for PictureTel Common Stock to the extent of the difference between the value of the PictureTel Common Stock received in the Merger and their adjusted tax basis in the Starlight Preferred Stock. See "The Merger -- Material Federal Tax Consequences." STARLIGHT SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING REQUIREMENTS AND THE APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL, AND OTHER APPLICABLE TAX LAWS. ANTICIPATED ACCOUNTING TREATMENT The transaction effected by the Merger is expected to be accounted for under the purchase method of accounting in accordance with generally accepted accounting principles, whereby the purchase price will be allocated based on the fair values of the assets acquired and the liabilities assumed. See "The Merger -- Anticipated Accounting Treatment." COMPARATIVE RIGHTS OF STOCKHOLDERS The rights of Starlight Shareholders are currently governed by the CCC, Starlight's Amended and Restated Articles of Incorporation and Starlight's By-laws. Upon consummation of the Merger, Starlight Shareholders will become stockholders of PictureTel, and their rights as stockholders of PictureTel generally will be governed by the Delaware General Corporation Law (the "DGCL"), PictureTel's Third Restated Certificate of Incorporation and PictureTel's By-laws. See "Comparison of Stockholder Rights." APPRAISAL RIGHTS Starlight Shareholders who object to the Merger may, under certain circumstances and by following procedures prescribed by the CCC, exercise dissenters' rights and receive cash for their shares of Starlight Stock in an amount equal to the fair value of the Starlight Stock as determined pursuant to such procedures. The failure of a dissenting shareholder of Starlight to follow the appropriate procedures will result in the termination or waiver of such rights. In the event that a Starlight Shareholder who attempts to exercise dissenters' rights should fail to make a proper demand for payment or otherwise lose his or her status as a dissenting shareholder, such Starlight Shareholder shall be entitled to receive from PictureTel the same number of shares of PictureTel Common Stock, if any, that such Starlight Shareholder would have received in the Merger if he, she or it had not attempted to exercise dissenters' rights. See "The Merger -- Appraisal Rights." 8 18 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS INFORMATION STATEMENT/PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING PICTURETEL AND ITS BUSINESS. STARLIGHT SHAREHOLDERS SHOULD CAREFULLY CONSIDER THESE RISK FACTORS PRIOR TO CONSENTING IN WRITING TO THE PLAN OF MERGER AND THE TRANSACTIONS CONTEMPLATED THEREBY, INCLUDING THE MERGER. THIS INFORMATION STATEMENT/PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO, AMONG OTHER THINGS, ESTIMATES OF ECONOMIC AND INDUSTRY CONDITIONS, SALES TRENDS, EXPENSE LEVELS AND CAPITAL EXPENDITURES. PICTURETEL'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS IN THIS INFORMATION STATEMENT/PROSPECTUS AND IN FORWARD-LOOKING STATEMENTS MADE FROM TIME TO TIME BY PICTURETEL ON THE BASIS OF MANAGEMENT'S THEN-CURRENT EXPECTATIONS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED OR REFERRED TO BELOW. New Products, Cost Reductions, Technological Change, and Evolving Markets. PictureTel is engaged in an industry that is still emerging as a result of extensive research and development efforts and which continues to bring to market new, more technologically advanced products introduced on an accelerated basis. Simultaneously, the larger telecommunications market is in a heightened competitive state due to deregulation throughout the world. In order to maintain its market share leadership role in this fast-paced emerging market, PictureTel must continue to introduce through internal development or by acquisition significant innovative, technologically leading and cost-competitive products. There can be no assurance that such new products will be introduced by PictureTel, or if introduced, will be accepted by the market and its customers. In addition to offering products that operate in an integrated service digital network (ISDN) environment, PictureTel and its competitors are exploring new technologies and networks, such as the Internet and corporate intranets or LANs, for delivering videoconferencing and data collaboration services. The industry standards for such new technologies and networks, however, are still in the early stages of development, which PictureTel believes has led to customer uncertainty and, accordingly, a slowdown in the growth of the general market for videoconferencing products. As a result of customer preferences, PictureTel has also experienced over the past year a shift in its sales model to videoconferencing systems with lower average selling prices. There can be no assurance that PictureTel will be successful in implementing cost reductions for all of its products or in developing and marketing suitable new products with attractive margins for these new technologies and networks. The possible transition, migration and/or convergence of technologies is difficult to predict and could have profound implications for the industry and the business of PictureTel. Further, there is significant risk that existing products could be rendered obsolete due to changing technology. The failure of PictureTel to develop and market new products or to enhance its existing products or to respond effectively to technological changes, new industry standards or product announcements by competitors could have a material adverse effect on PictureTel's business, financial condition and results of operations. Competition. In its established businesses of group systems and desktop systems, PictureTel competes with a number of larger corporations, such as Sony and Intel, which have greater financial and marketing resources than PictureTel. In the developing businesses of network-based videoconferencing systems and compact systems, a number of new corporations have begun to offer competitive products. In addition, partnerships between corporations which compete with PictureTel and corporations which develop and market network products, as well as mergers among competitors, are intensifying competition in the marketplace. This increased competition, together with a slowdown in the growth of the general market for videoconferencing products, has led and may continue to lead to increases in the defection or dilution of PictureTel's distribution channel partners to competitors, decreases in average selling prices and margins in both group and desktop videoconferencing systems, and a lower segment market share by PictureTel for products and services in the emerging area of network-based visual collaboration. In some cases, PictureTel competes with its channel partners for various services, which increases the complexity of channel management. In addition, corporations such as Microsoft or Intel, respectively, may offer network visual collaboration software solutions or 9 19 incorporate standard algorithms into processor chips free of additional charge, which may reduce the value PictureTel technology provides to the market, especially in its lower end videoconferencing products. In addition, the prices which PictureTel is able to charge for its videoconferencing products and services may further decrease from historical levels as a result of new product introductions by competitors, price competition, technological advances, or otherwise. Any of these factors could have a material adverse effect on PictureTel's business, financial condition and results of operations. Manufacturing. Certain key subassemblies and products are currently available only from one vendor and several vendors are smaller corporations with limited financial resources that could prove to be inadequate. In some cases components are sourced from only one vendor, even where multiple sources are available, to maintain quality control and enhance the working relationship with the vendor. In addition, PictureTel from time to time enters into development arrangements with third parties to develop and incorporate new features and functions into PictureTel's products. Failure of these third parties to fulfill their respective obligations under these development arrangements could have a material adverse effect on PictureTel's business, financial condition and results of operations. PictureTel's business also could be adversely affected by delays or interruptions in delivery and poor quality of supplies, subassemblies or products from key vendors. In addition, PictureTel designs and procures certain circuits, components and subassemblies from non-videoconferencing divisions of PictureTel's competitors, such as Sony and Panasonic. The failure to obtain adequate supplies or the requirement to redesign and source supplies from another manufacturer may take substantial time and result in significant expense, each of which could impact product shipments and materially and adversely affect PictureTel's business, financial condition or results of operations. Recent History of Losses. PictureTel reported a five percent decrease in revenues for the year ended December 31, 1997 as compared to revenues for the year ended December 31, 1996, and a decrease in net income from $32,172,000 for the year ended December 31, 1996 to a $39,398,000 net loss for the year ended December 31, 1997. These results have been adjusted for the restatement announced in September, 1997 and November, 1997 for the financial results for the first and second quarters of the year ended December 31, 1997 and the third and fourth quarters of the year ended December 31, 1996. See Note 1 to Notes to Consolidated Financial Statements included elsewhere in this Information Statement/Prospectus. PictureTel recorded other charges in the year ended December 31, 1997 to bring expenses into line with its lower level of revenues and a lower expected rate of growth. The decrease in revenues continued in the first and second quarters of the year ending December 31, 1998, and PictureTel reported a net loss of $8,854,000 for the six months ended June 28, 1998. Included in the six month results were charges totaling $11,018,000 related to discontinuing a video network server product line and the write-down of certain inventory and fixed assets. Revenues and prospects for growth have been impacted by, among other things, the decline in the average selling price for several PictureTel products, a decline in the profitability of the industry, and by a slowdown in the general market for videoconferencing products, in part resulting from the perceived uncertainty of customers with respect to the compatibility of existing products of PictureTel and its competitors with expected new multimedia videoconferencing products utilizing the Internet and LAN systems. Continued lower operating results could impact PictureTel's ability to remain in compliance with covenants under its existing revolving credit agreement and could also adversely impact the carrying value of deferred tax assets. Further, there can be no assurance that PictureTel can return to the level of profit in relation to net sales experienced in years prior to the year ended December 31, 1997. Product Protection and Intellectual Property. PictureTel's success depends in part on its proprietary technology. PictureTel attempts to protect its proprietary technology through patents, copyrights, trademarks, trade secrets and license agreements. In absence of broad patent protection, which is not likely, and despite PictureTel's reliance upon its proprietary confidential information, competitors of PictureTel have been able to use algorithms or other features similar to those used by PictureTel to design and manufacture products that are directly competitive with PictureTel's products. PictureTel believes that due to the rapid pace of technological change in the visual collaboration industry, legal protection for its products is less significant than factors such as PictureTel's use, implementation and enhancement of standards-based open architecture and PictureTel's ongoing efforts in product innovation. 10 20 Although PictureTel does not believe that its products infringe the proprietary rights of any third parties, third parties have asserted infringement and other claims against PictureTel from time to time. There can be no assurance that third parties will not assert such claims against PictureTel in the future or that such claims will not be successful. PictureTel could incur substantial costs and diversion of management resources with respect to the defense of any claims relating to proprietary rights, which in turn could have a material adverse effect on PictureTel's business, financial condition and result of operations. See "Business of PictureTel -- Legal Proceedings." Potential Fluctuations of Quarterly Operating Results. The majority of PictureTel's revenues in each quarter result from orders booked in that quarter, and a substantial portion of PictureTel's orders and shipments typically occur during the last weeks of each quarter such that forecasting of revenue and product mix is both complex and difficult. Unanticipated variations in the timing of receipt of customer orders in any quarter may produce significant fluctuations in quarterly revenues. As a result, a shortfall in revenue compared to internal expectations may not evidence itself until late in the quarter and any resulting impact on earnings may not be determinable until several weeks after the end of the quarter. PictureTel's ability to maintain or increase net revenues depends upon its ability to increase unit volume sales. There can be no assurance that PictureTel will be able to increase or to maintain the current level of unit volume sales. Other factors which may cause period-to-period fluctuations in operational results include the timing of new product announcements and introductions by PictureTel and its competitors, market acceptance of new or enhanced versions of PictureTel's products, changes in the product mix of sales, changes in the relative proportions of sales among distribution channels or among customers within each distribution channel, changes in manufacturing costs, and general economic factors such as the recent decline of currency values in the Asian markets. International Operations. Revenues related to international operations of PictureTel totaled approximately 45%, 43%, 44% and 42% of total revenues for the six months ended June 28, 1998 and for the three years ended December 31, 1997, 1996 and 1995, respectively. Management of PictureTel expects international revenues to continue to constitute a significant portion of total revenues in future periods. However, there can be no assurance that PictureTel will be able to maintain or increase international market demand for its products and, to the extent PictureTel is unable to do so, its business, financial condition, results of operations or cash flows could be materially adversely affected. PictureTel's sales to international distributors are denominated in U.S. dollars in order to minimize risks associated with fluctuating foreign currency rates. An increase in the value of the U.S. dollar relative to other currencies, however, could make PictureTel's product more expensive and, therefore, potentially less competitive in foreign markets. Sales by PictureTel's foreign subsidiaries are generally made in the foreign subsidiary's local currency, in which case fluctuations in the value of the U.S. dollar relative to such other currencies could have a material adverse effect on the operating results of PictureTel. Currently, PictureTel employs various currency hedging strategies to reduce these risks. In addition, a significant portion of PictureTel's revenues are derived from Asian markets. Given the current general weakness in the Asian markets, there can be no assurance that PictureTel will be able to sustain current revenue levels or growth in such markets. There can be no assurance that the above factors will not have a material adverse effect on PictureTel's future international sales and, consequently, on its business, financial condition, results of operations or cash flows. Volatility of Stock Price. In considering whether to approve the Plan of Merger and the transaction contemplated thereby, including the Merger, Starlight Shareholders should be aware that the price of PictureTel Common Stock at the Effective Time may vary significantly from the price as of the date of the execution of the Plan of Merger or the date of this Information Statement/Prospectus. As is frequently the case with the stocks of high technology corporations, the market price of PictureTel Common Stock has been, and may continue to be, volatile. Factors such as quarterly fluctuations in results of operations, increased competition, the introduction of new products by PictureTel and by its competitors, changes in the mix of products and sales channels, the timing of significant customer orders, and macroeconomic conditions generally, may have a significant adverse effect on the market price of PictureTel Common Stock in any given period. In addition, the stock market has, from time to time, experienced extreme price and volume fluctuations, which have particularly affected the market price for many high technology corporations and which, on occasion, have appeared to be unrelated to the operating performance of such corporations. Past 11 21 financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant adverse effect on the market price of PictureTel Common Stock in any given period. Dependence on Key Personnel. In February, 1998, Bruce R. Bond succeeded Dr. Norman Gaut as Chief Executive Officer and President. In June, 1998, Mr. Bond was elected Chairman of the Board and Mr. Gaut retired as an active employee while remaining a member of the Board of Directors. There can be no assurance that the transition from Dr. Gaut to Mr. Bond will be successful. In July 1998, Richard Goldman, Vice President and Chief Financial Officer, announced his resignation. Mr. Goldman's employment terminated on September 11, 1998. No successor has yet been named. PictureTel depends on a limited number of key senior management personnel, including Mr. Bond; David Grainger, Group Vice President of Field Operations; David Goselin, Vice President, Operations; Stephen Chambers, Vice President, Marketing; Lawrence Bornstein, Vice President, Human Resources; and Richard Baker, Vice President, Engineering and Chief Technical Officer. There has been considerable turnover in the PictureTel senior management team over the past several years, and the loss of the services of one or more of PictureTel's senior management team or the inability to attract, retain, motivate and manage additional key personnel could have a material adverse effect on the business, financial condition or operating results of PictureTel. In addition, over the past year, PictureTel has experienced an increase in voluntary employee attrition from engineering and other departments. There is no assurance, given the competitive nature of the current job market, that PictureTel will be able to adequately fill the open positions. Internal Accounting Controls. On September 19, 1997, after PictureTel's reexamination, with assistance from its outside auditors, of leasing and other indirect channel transactions, PictureTel announced that it would reverse revenue related to certain of these transactions and, as a result, intended to restate its financial statements for the third and fourth quarters of the fiscal year ended December 31, 1996 and the first quarter of the fiscal year ended December 31, 1997. On November 13, 1997, after completion of its reexamination, PictureTel announced that it would also restate the second quarter of the fiscal year ended December 31, 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 relevant period. The restatements were also 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. PictureTel has taken actions, including personnel changes, new internal control procedures and greater oversight by the Audit Committee of the Board of Directors, which PictureTel believes will strengthen its internal controls to the extent necessary to prevent the reoccurrence of the practices which led to PictureTel's restated financial reporting in the earlier periods. There can be no assurance, however, that these actions by PictureTel will be adequate. Year 2000 Compliance. PictureTel has formed an internal compliance team to evaluate its internal information technology infrastructure and application systems ("IT Systems") and other non-IT infrastructure systems ("Non-IT Systems") to determine whether such systems will operate correctly with regard to the import, export, and processing of date information, including correct handling of leap years, in connection with the change in the calendar year from 1999 to 2000 (the "Year 2000 Issue"), and to evaluate the Year 2000 Issue with respect to the systems of third party partners and suppliers with which PictureTel has a material relationship ("Third Party Systems"). PictureTel expects to complete an IT Systems inventory analysis and risk assessment by December 31, 1998. As previously planned and budgeted, PictureTel is actively upgrading its core IT Systems to incorporate additional desired features and functionality. PictureTel expects to complete these upgrades by June 30, 1999. In connection with such upgrades, PictureTel expects its core IT Systems will be Year 2000 compliant. PictureTel expects to complete the IT Systems initiative as planned and, accordingly, does not expect that any additional costs of addressing the Year 2000 Issue for its IT Systems will have a material adverse impact on PictureTel's financial position, results of operations or cash flows. 12 22 PictureTel also expects to complete a Non-IT Systems inventory analysis and risk assessment by December 31, 1998. Any remediation actions required in order to be Year 2000 compliant have not been budgeted to date. As PictureTel believes the number of Non-IT Systems is relatively small, PictureTel does not expect that any additional costs of addressing the Year 2000 Issue for Non-IT Systems will have a material adverse impact on its operations or its financial position, results of operations or cash flows. With the assistance of an independent Year 2000 solution provider, PictureTel is in the process of creating a plan to complete a Third Party Systems inventory and risk assessment. PictureTel expects to verify Year 2000 compliance of Third Party Systems using this independent Year 2000 solution provider. As PictureTel believes the number of material Third Party Systems is relatively small, PictureTel expects to be in a position to evaluate the risks in a timely manner. Until Year 2000 compliance of all Third Party Systems is ascertained and written assurances are received, the risk to PictureTel's operations and any additional costs relating to such Third Party Systems is unknown. For the year ending December 31, 1998, PictureTel estimates it will spend a total of $320,000 on inventory analysis and risk assessment. To date, PictureTel has incurred $68,000 of expense relating to inventory analysis and risk assessment. These Year 2000 expenditures are within PictureTel's planned organizational budgets and include the cost of independent Year 2000 solution providers. Year 2000 expenditures for IT Systems, Non-IT Systems and Third Party Systems do not reflect the cost to PictureTel of internal resources working on the Year 2000 Issue and do not reflect planned upgrades or planned replacement systems which may have a positive impact on resolving the Year 2000 Issue. PictureTel expects to complete its risk assessment and cost estimate relating to the Year 2000 Issue no later than December 31, 1998 and to establish a contingency plan relating to the remediation and prioritization of its IT Systems, Non-IT Systems and Third Party Systems shortly thereafter. As of September 21, 1998, no IT Systems projects have been deferred due to problems associated with the Year 2000 Issue. PictureTel has also tested its products for Year 2000 compliance and has determined that all PictureTel products currently available for sale have either successfully passed Year 2000 compliance testing or are not subject to Year 2000 compliance because such products do not import, export or process date information in any manner. A small number of PictureTel's installed base products, however, do not meet Year 2000 compliance testing. For these older, non-compliant versions of products, PictureTel has, with one exception, developed adequate workarounds that will be made available to customers and that will permit the products to continue to operate with full functionality. Risks Associated with Fixed Exchange Ratios. As a result of the Merger, each outstanding share of Starlight Preferred Stock will be converted into the right to receive shares of PictureTel Common Stock in accordance with the Exchange Ratios. Because the Exchange Ratios are fixed, they will not increase or decrease due to fluctuations in the market price of PictureTel Common Stock. The specific dollar value of the consideration to be received by holders of the Starlight Preferred Stock in the Merger will depend on the market price of the PictureTel Common Stock at the Effective Time. In the event that the market price of PictureTel Common Stock decreases or increases prior to the Effective Time, the market value at the Effective Time of the PictureTel Common Stock to be received by holders of the Starlight Preferred Stock in the Merger would correspondingly decrease or increase. PictureTel Common Stock historically has been subject to substantial price volatility. No assurance can be given as to the market price of PictureTel Common Stock at or prior to the Effective Time or as to the market price of PictureTel Common Stock at any time thereafter. See "-- Volatility of Stock Price" and "Market Price Per Share Data." Retention and Integration of Key Employees. The success of the Merger is dependent on the retention and integration of the key management, engineering and other technical employees of Starlight. Competition for qualified personnel in the visual collaboration industry is very intense, and competitors often use aggressive 13 23 tactics to recruit key employees during the period leading up to a merger and during the integration phase following a merger. While PictureTel has implemented retention arrangements for the key employees of Starlight, there can be no assurance that such key employees will remain with Starlight following the Merger. Shareholder Litigation. Since September 23, 1997, seven class action shareholders' complaints relating to the Restatements were filed against PictureTel, Norman E. Gaut, the former Chairman of the Board and Chief Executive Officer, and Les Strauss, the former Vice President and Chief Financial Officer, in the United States District Court for the District of Massachusetts. The plaintiffs, 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. These plaintiffs have consolidated their complaints into one lawsuit and filed a consolidated complaint on February 11, 1998, encaptioned In re PictureTel Corporation Securities Litigation, Civil Action No. 97-12135-DPW. The original complaints were filed following PictureTel's announcement on September 19, 1997 that it would restate its financial results for the first quarter of the fiscal year ended December 31, 1997 and the last two quarters of fiscal year ended December 31, 1996, and were amended when PictureTel announced on November 13, 1997 that it would also restate the second quarter of the fiscal year ended December 31, 1997. The consolidated complaint alleges that PictureTel and Messrs. Gaut and Strauss violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, during the period from October 17, 1996 through November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the price of the PictureTel Common Stock. The consolidated complaint seeks to recover an unspecified amount of damages, including attorneys' and experts' fees and expenses. On April 7, 1998, PictureTel filed a motion to dismiss the complaint. The plaintiffs filed an amended complaint in response to PictureTel's motion to dismiss. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. The legal costs incurred by PictureTel in defending itself and its officers and directors against this litigation, whether or not it prevails, could be substantial. Further, in the event that the plaintiffs prevail, PictureTel also could be required to pay substantial damages. This litigation may be protracted and may result in a diversion of management and other resources of PictureTel. The payment of substantial legal costs or damages, or the diversion of management and other resources, could have a material adverse effect on PictureTel's business, financial condition or results of operations. See "Business of PictureTel -- Legal Proceedings." Revnet, Inc. On June 2, 1998, PictureTel was served with a complaint from a former distribution channel customer, Revnet, Inc., which has ceased operations. (Revnet, Inc. v. PictureTel Corporation. Civil Action No. 98092039, filed April 2, 1998, in the Circuit Court for Baltimore City, Maryland.) The complaint alleges that PictureTel breached an oral contract. Revnet is seeking $200,000,000 in damages. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. 14 24 SELECTED HISTORICAL FINANCIAL DATA The following table sets forth PictureTel's selected historical balance sheet data as of December 31, 1996 and 1997 and selected historical statements of operations data for each of the three years in the period ended December 31, 1997, which have been derived from PictureTel's audited consolidated financial statements included elsewhere in this Information Statement/Prospectus. PictureTel's selected historical balance sheet data as of December 31, 1993, 1994 and 1995 and selected historical statements of operations data for each of the two years in the period ended December 31, 1994 have been derived from PictureTel's audited consolidated financial statements, which have not been included herein. PictureTel's unaudited selected historical balance sheet data as of June 29, 1997 and June 28, 1998 and selected historical statements of operations data for the six months ended June 29, 1997 and June 28, 1998 have been derived from the unaudited consolidated financial statements included elsewhere in this Information Statement/Prospectus and in the opinion of management of PictureTel contain all adjustments, consisting of only normal, recurring adjustments, except as discussed in Note 2 of the notes to the unaudited consolidated financial statements included elsewhere herein, necessary to present fairly PictureTel's financial position at June 28, 1998 and June 29, 1997 and the results for the six months ended June 28, 1998 and June 29, 1997. This information should be read in conjunction with PictureTel's "Management's Discussion and Analysis of Financial Condition and Results of Operations" and consolidated financial statements and notes thereto included elsewhere in this Information Statement/Prospectus. The selected historical financial data of Starlight as of December 31, 1996 and 1997 and for the three years ended December 31, 1997 have been derived from Starlight's Financial Statements, and should be read in conjunction with Starlight's "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Starlight's Financial Statements and Notes thereto included elsewhere in this Information Statement/Prospectus. The statement of operations data for the two years ended December 31, 1994 and the balance sheet data at December 31, 1993, 1994 and 1995 are derived from the audited financial statements of Starlight not included herein. The unaudited selected historical financial data of Starlight as of June 30, 1997 and 1998 and for the six month periods ended June 30, 1997 and 1998 are derived from unaudited financial statements of Starlight, which have been prepared on the same basis as the audited financial statements and in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments necessary for fair presentation of the operating results for such periods. The operating results for the six months ended June 30, 1998 are not necessarily indicative of the results to be expected for any other terms or future fiscal years. The following table does not give effect to PictureTel's proposed acquisition of Starlight because it is not significant for purposes of Rule 3-05 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, pro forma combined statements of operations and balance sheet data have not been provided. PICTURETEL
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, (1) (UNAUDITED) -------------------------------------------------------------- ------------------------ JUNE 28, JUNE 29, 1997 1996 1995 1994 1993 1998 1997(1) ------------- ------------- -------- -------- -------- -------- ------------- (RESTATED)(6) (RESTATED)(6) (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue............................... $466,425 $490,225 $363,799 $272,841 $188,338 $205,628 $239,901 Income (loss) before extraordinary credit and cumulative effect of change in accounting principle...... (39,398) 32,172 21,859 7,669 8,962 (8,854) (2,889) Extraordinary credit, tax benefit of net operating loss and tax credit carry forwards...................... -- -- -- -- 841 -- -- Cumulative effect of change in accounting principle................ -- -- -- -- 1,042 -- -- -------- -------- -------- -------- -------- -------- -------- Net income (loss)(2)(3)............... $(39,398) $ 32,172 $ 21,859 $ 7,669 $ 10,845 $ (8,854) $ (2,889) ======== ======== ======== ======== ======== ======== ======== Net income (loss) per common share -- basic (4)(5): Income (loss) before extraordinary credit and cumulative effect of change in accounting principle...... $ (1.04) $ 0.89 $ 0.64 $ 0.24 $ 0.27 $ (0.23) $ (0.08) Extraordinary credit.................. -- -- -- -- 0.03 -- -- Cumulative effect of change in accounting principle................ -- -- -- -- 0.03 -- -- -------- -------- -------- -------- -------- -------- -------- Net income (loss) -- basic............ $ (1.04) $ 0.89 $ 0.64 $ 0.24 $ 0.33 $ (0.23) $ (0.08) ======== ======== ======== ======== ======== ======== ========
15 25
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, (1) (UNAUDITED) -------------------------------------------------------------- ------------------------ JUNE 28, JUNE 29, 1997 1996 1995 1994 1993 1998 1997(1) ------------- ------------- -------- -------- -------- -------- ------------- (RESTATED)(6) (RESTATED)(6) (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income (loss) per common share -- diluted(4)(5): Income (loss) before extraordinary credit and cumulative effect of change in accounting principle...... $ (1.04) $ 0.81 $ 0.57 $ 0.22 $ 0.26 $ (0.23) $ (0.08) Extraordinary credit.................. -- -- -- -- 0.02 -- -- Cumulative effect of change in accounting principle................ -- -- -- -- 0.03 -- -- -------- -------- -------- -------- -------- -------- -------- Net income (loss) -- diluted.......... $ (1.04) $ 0.81 $ 0.57 $ 0.22 $ 0.31 $ (0.23) $ (0.08) ======== ======== ======== ======== ======== ======== ======== Weighted average shares outstanding -- basic(4)(5).......... 37,760 36,097 34,178 32,254 33,252 38,200 37,589 ======== ======== ======== ======== ======== ======== ======== Weighted average shares outstanding -- diluted(4)(5)....................... 37,760 39,598 38,428 34,739 34,457 38,200 37,589 ======== ======== ======== ======== ======== ======== ======== BALANCE SHEET DATA: Working capital....................... $152,973 $202,063 $143,130 $123,962 $ 50,819 $149,517 $192,035 Total assets.......................... 355,051 386,254 300,613 227,238 193,922 336,808 363,035 Total short-term debt................. 186 519 4,383 10,452 7,307 -- 1,946 Total long-term debt.................. 22,000 14,202 12,804 3,758 5,110 20,731 4,506 Shareholders' equity.................. $227,965 $264,846 $208,384 $156,842 $147,387 $221,459 $264,714
- --------------- (1) The effect of the MultiLink acquisition on July 22, 1997, which was accounted for as a pooling-of-interests, is included in all amounts presented. (2) Includes other charges totaling $42,664,000 before income tax benefit for the year ended December 31, 1997. See Note 14 of the notes to the audited consolidated financial statements included elsewhere herein. (3) Includes other charges totaling $11,018,000 before income tax benefit for the six months ended June 28, 1998. See "PictureTel -- Management's Discussion and Analysis of Financial Condition and Results of Operations." (4) Net income (loss) per share -- basic is computed based on the weighted average number of shares of PictureTel Common Stock outstanding during the period. Net income per share -- diluted is computed based on the weighted average number of shares of PictureTel Common Stock and dilutive PictureTel Common Stock equivalents outstanding during the period. Net loss per share -- diluted is computed based on the weighted average number of shares of PictureTel Common Stock outstanding during the period. All common and per share amounts for each of the three years in the period ended December 31, 1995 have been retroactively restated to reflect the two-for-one stock split effected by a one hundred percent (100%) PictureTel Common Stock dividend during the fourth quarter of the year ended December 31, 1995. (5) PictureTel has not paid dividends on its PictureTel Common Stock since its inception. PictureTel intends to reinvest earnings for use in its business and to finance future growth. Accordingly, the Board of Directors of PictureTel does not anticipate declaring any cash dividends in the foreseeable future. (6) See Note 1 of the notes to the audited consolidated financial statements included herein. 16 26 STARLIGHT
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, (UNAUDITED) --------------------------------------------------- ----------------- 1997 1996 1995 1994 1993 1998 1997 -------- -------- -------- -------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Total revenues........................ $ 8,074 $ 6,607 $ 7,802 $ 4,840 $ 1,478 $ 1,527 $ 3,206 Loss from operations.................. (3,481) (7,305) (3,087) (2,970) (4,079) (3,417) (2,851) Net loss.............................. (4,019) (7,387) (2,991) (2,897) (3,986) (3,659) (3,151) Net loss per share(1) Basic and diluted................... $ (0.37) $ (0.74) $ (0.34) $ (0.35) $ (0.53) $ (0.31) $ (0.30) Shares used in computing net loss per share Basic and diluted................... 10,796 9,960 8,771 8,179 7,462 11,939 10,460
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, (UNAUDITED) --------------------------------------------------- ------------------- 1997 1996 1995 1994 1993 1998 1997 -------- -------- -------- -------- ------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital..................... $ (2,100) $ (3,983) $ 5,035 $ 4,777 $ 5,976 $ (5,740) $ (3,524) Total assets........................ 5,452 5,524 10,336 6,569 7,278 2,549 5,774 Total long-term liabilities......... 1,271 1,876 2,860 6,034 4,234 995 1,687 Redeemable convertible preferred stock............................. 22,395 16,625 16,603 9,646 9,646 22,399 20,090 Total shareholders' equity (net capital deficiency)............... (24,617) (20,611) (13,233) (10,244) (7,352) (28,272) (23,757)
- --------------- (1) The Starlight Stock used in these calculations include Common Stock and Series A, Series B, Series C, Series D, Series E, Series F and Series G Preferred Stock. 17 27 COMPARATIVE PER SHARE DATA The following table sets forth certain historical per share data of PictureTel and Starlight. The following table does not give effect to PictureTel's proposed acquisition of Starlight because it is not significant for purposes of Rule 3-05 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, pro forma combined and equivalent pro forma combined net loss per share and book value per share data have not been provided. The information in the following table should be read in conjunction with the audited and unaudited consolidated financial statements of PictureTel and notes thereto and the audited and unaudited financial statements of Starlight and notes thereto, which are included elsewhere in this Information Statement/Prospectus.
SIX MONTH PERIOD ENDED YEAR ENDED JUNE 28, 1998 DECEMBER 31, 1997 ---------------------- ----------------- HISTORICAL PER PICTURETEL SHARE: Net income................................... $(0.23) $(1.04) Book value(1)................................ $ 5.78
SIX MONTH PERIOD ENDED YEAR ENDED JUNE 30, 1998 DECEMBER 31, 1997 ---------------------- ----------------- HISTORICAL PER STARLIGHT SHARE: Net loss..................................... $(0.31) $(0.37) Book value(1)................................ $(2.37)
- --------------- (1) Historical book value is computed by dividing stockholders' equity, in the case of PictureTel, or net capital deficiency, in the case of Starlight, by the number of shares of PictureTel Common Stock or Starlight Stock including Starlight Common Stock and Series A, Series B, Series C, Series D, Series E, Series F, and Series G Preferred Stock, as the case may be, outstanding at the end of each period. 18 28 MARKET PRICE PER SHARE DATA PICTURETEL PictureTel Common Stock is traded on The Nasdaq National Market ("Nasdaq") under the symbol "PCTL." As of September 1, 1998, PictureTel had approximately 2,047 stockholders of record. The following table sets forth the high and low sales prices per share of PictureTel Common Stock as reported on the Nasdaq for the quarterly periods presented below.
HIGH LOW ------- ------- FISCAL YEAR ENDED DECEMBER 31, 1996 First Quarter............................................. $44.734 $30.250 Second Quarter............................................ $40.063 $26.750 Third Quarter............................................. $41.250 $31.250 Fourth Quarter............................................ $37.875 $23.735 FISCAL YEAR ENDED DECEMBER 31, 1997 First Quarter............................................. $26.875 $11.875 Second Quarter............................................ $14.125 $ 8.250 Third Quarter............................................. $13.500 $ 8.813 Fourth Quarter............................................ $11.625 $ 5.625 FISCAL YEAR ENDING DECEMBER 31, 1998 First Quarter............................................. $ 8.250 $ 5.190 Second Quarter............................................ $11.940 $ 6.000 Third Quarter (through September 17, 1998)................ $11.125 $ 5.375
STARLIGHT There is not an established trading market for the Starlight Common Stock or Starlight Preferred Stock. On the Starlight Record Date, there were 67 holders of Starlight Common Stock, 12 holders of Starlight Series A Preferred Stock, 18 holders of Starlight Series B Preferred Stock, 23 holders of Starlight Series C Preferred Stock, 34 holders of Starlight Series D Preferred Stock, 32 holders of Starlight Series E Preferred Stock, 34 holders of Starlight Series F Preferred Stock, and 26 holders of Starlight Series G Preferred Stock. DIVIDEND POLICY Neither PictureTel nor Starlight has ever paid a cash dividend and PictureTel currently intends to retain all of its earnings for use in its business to finance future growth and, accordingly, does not anticipate paying cash dividends in the foreseeable future. RECENT CLOSING PRICES The high and low sale prices per share of the PictureTel Common Stock as reported on Nasdaq on July 21, 1998, the last trading day before the announcement of the proposed Merger, were $10.75 and $10.25, respectively. The last reported sale price per share of the PictureTel Common Stock on September , 1998, the latest practicable trading day before the printing of this Information Statement/Prospectus, was $ . Based upon the last reported sale price of PictureTel Common Stock on September , 1998, and the Exchange Ratios, each share of Starlight Series A Preferred Stock, Starlight Series B Preferred Stock, Starlight Series C Preferred Stock, Starlight Series D Preferred Stock, Starlight Series E Preferred Stock, Starlight Series F Preferred Stock, and Starlight Series G Preferred Stock would be converted in the Merger into the right to receive PictureTel Common Stock having a market value of $ , $ , $ , $ , $ , $ , and $ , respectively. Each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration in accordance with Starlight's Amended and Restated Articles of Incorporation. 19 29 Because the market price of PictureTel Common Stock is subject to fluctuation, the market value of the shares of PictureTel Common Stock that holders of Starlight Preferred Stock will receive in the Merger may increase or decrease prior to and following the Merger. SHAREHOLDERS ARE URGED TO OBTAIN CURRENT MARKET QUOTATIONS FOR PICTURETEL COMMON STOCK. NO ASSURANCE CAN BE GIVEN AS TO THE FUTURE PRICES OR MARKETS FOR PICTURETEL COMMON STOCK. See "Risk Factors -- Volatility of Stock Price" and "-- Risks Associated with Fixed Exchange Ratio." STARLIGHT SHAREHOLDERS ACTION MATTERS TO BE ACTED UPON The holders of Starlight Stock are being asked to consent in writing to the proposal to approve and adopt the Plan of Merger pursuant to which, among other things, at the Effective Time (i) Merger Sub will be merged with and into Starlight and Starlight will become an indirect wholly owned subsidiary of PictureTel, (ii) each outstanding share of Starlight Preferred Stock (other than shares of Starlight Preferred Stock held in treasury or held by PictureTel or any of its direct or indirect wholly owned subsidiaries) will be converted into the right to receive shares of PictureTel Common Stock in accordance with the Exchange Ratios, (iii) each outstanding share of Starlight Preferred Stock held by PTC will be converted into the right to receive one share of common stock, par value $0.01 per share, of the Surviving Corporation, and (iv) each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration in accordance with Starlight's Amended and Restated Articles of Incorporation. In addition, the holders of Starlight Stock are being asked to consent in writing to the proposal to approve and adopt the Bonus Retention Plan for the purpose of, with respect to the holders of Starlight Preferred Stock, complying with Section 5(c)(x) of Article IV of Starlight's Amended and Restated Articles of Incorporation and approving certain payments to be made to two participants under such Bonus Retention Plan. See "-- Record Date; Requisite Consent." The Board of Directors of Starlight has approved the Plan of Merger and the transactions contemplated thereby, including the Merger, and recommends the holders of Starlight Stock consent in writing to the approval and adoption of the Plan of Merger and the transactions contemplated thereby, including the Merger. The Board of Directors of Starlight has also approved the Bonus Retention Plan and the payments to be made thereunder and recommends the holders of Starlight Stock consent in writing to the approval and adoption of the Bonus Retention Plan and to the approval of certain payments to be made under the Bonus Retention Plan. LAST DATE FOR SUBMISSION The last date upon which written consents may be submitted to Starlight is October , 1998 (the "Consent Termination Date"). Starlight, however, may consummate the Merger prior to such date if the requisite consents to approve the Merger are obtained. Written consents should be returned to Wilson Sonsini Goodrich & Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304, Attention: Ronald A. Baker (Telephone: 650-493-9300; Facsimile: 650-493-6811). RECORD DATE; REQUISITE CONSENT The Starlight Board of Directors has fixed September 14, 1998 as the Starlight Record Date for the determination of the shareholders entitled to consent in writing to the proposals described in this Information Statement/Prospectus. Accordingly, only holders of record of shares of Starlight Stock on the Starlight Record Date will be entitled to consent in writing to the proposals described in this Information Statement/ Prospectus. As of such Starlight Record Date, there were outstanding 2,276,898 shares of Starlight Common Stock held by 67 holders of record, 2,529,999 shares of Starlight Series A Preferred Stock held by 12 holders of record, 1,577,120 shares of Starlight Series B Preferred Stock held by 18 holders of record, 1,931,914 shares of Starlight Series C Preferred Stock held by 23 holders of record, 1,743,134 shares of Starlight Series D Preferred Stock held by 34 holders of record, 692,428 shares of Starlight Series E Preferred Stock held by 32 holders of record, 1,201,880 shares of Starlight Series F Preferred Stock held by 34 holders of record, and 8,106,983 shares of Starlight Series G Preferred Stock held by 26 holders of record. Each holder of record of 20 30 Starlight Stock is entitled to one vote for each share of Starlight Stock held by such holder on (i) the proposal to approve and adopt the Plan of Merger and the transactions contemplated thereby, including the Merger, and (ii) subject to the next paragraph, the proposal to approve and adopt the Bonus Retention Plan and certain payments to be made under such Bonus Retention Plan. The approval and adoption of the Plan of Merger and the transactions contemplated thereby, including the Merger, will require (i) the written consent of the holders of a majority of the outstanding shares of Starlight Common Stock and Starlight Preferred Stock, acting together as a class, and (ii) the written consent of the holders of a majority of the outstanding shares of the Starlight Preferred Stock, acting separately as a class. In addition, PictureTel has required as a condition to its obligation to consummate the Merger that holders of at least 93% of the Starlight Stock entitled to vote on the Merger shall have consented in writing to approve the Merger. The approval and adoption of the Bonus Retention Plan will require the written consent of the holders of a majority of the outstanding shares of Starlight Preferred Stock. In addition, the approval of certain payments to be made to two participants under the Bonus Retention Plan will require the written consent of the holders of seventy-five percent (75%) of the outstanding shares of Starlight Stock, excluding shares held by those two participants. Further, pursuant to Section 310 of the CCC, the approval and adoption of each of the Plan of Merger and Bonus Retention Plan requires the written consent of the holders of a majority of the outstanding shares of Starlight Stock, exclusive of any shares of Starlight Stock deemed to be owned by any director of Starlight who has a material financial interest in such transaction. See "Securities Ownership of Certain Beneficial Owners and Management of Starlight." The approval of the Plan of Merger and the transactions contemplated thereby shall constitute approval and adoption by the holders of the Starlight Preferred Stock of the terms of the Escrow Agreement and the appointment and indemnification of Mr. James E. Long as the representative of the holders of the Starlight Preferred Stock under the Escrow Agreement. See "The Plan of Merger -- Indemnification" and "-- Escrow." As of August 1, 1998, giving effect to the conversion of all outstanding Subordinated Convertible Promissory Notes due August 15, 1998 into shares of Series G Preferred Stock, which conversion occurred on August 15, 1998, the directors and executive officers of Starlight and their affiliates owned 775,000 shares, or 34.0%, of the outstanding Starlight Common Stock and 7,876,601 shares, or 44.2%, of the outstanding Starlight Preferred Stock. Assuming the conversion of the outstanding Starlight Preferred Stock, the directors and executive officers of Starlight and their affiliates owned 8,651,601 shares, or 43.1%, of Starlight Common Stock. See "Securities Ownership of Certain Beneficial Owners and Management of Starlight." In addition, certain holders of the Starlight Common Stock and Starlight Preferred Stock have executed an irrevocable proxy in favor of PictureTel authorizing PictureTel to sign written consents for all the outstanding shares of Starlight Stock over which he, she or it has voting control in favor of the approval and adoption of the Plan of Merger. After giving effect to the irrevocable proxies and including its own equity interest in Starlight, Starlight has the right to sign written consents for 1,303,000 shares, or 57.2%, of the outstanding Starlight Common Stock and 15,785,256 shares, or 88.8%, of the outstanding Starlight Preferred Stock. Assuming the conversion of the outstanding Starlight Preferred Stock, PictureTel has the right to sign written consents for 17,088,256 shares, or 85.2%, of the Starlight Common Stock. See "The Merger -- Interests of Certain Persons in the Merger." WRITTEN CONSENTS All Starlight Shareholders who are entitled to approve and authorize those actions for which written consent is being sought and whose properly executed consents are received prior to the Consent Termination Date will grant consent to such actions in accordance with the instructions indicated on such consent. If any Starlight Shareholder has signed and returned a written consent, but no instructions are indicated, such consents will be deemed granted IN FAVOR of (i) the Plan of Merger and the transactions contemplated thereby, including the Merger, and (ii) the Bonus Retention Plan and certain payments to be made to two participants under such Bonus Retention Plan. 21 31 All expenses of this solicitation of written consents will be borne by Starlight, and each of PictureTel and Starlight will bear their costs of preparing this Information Statement/Prospectus. In addition to solicitation by use of the mails, written consents may be solicited by directors, officers and employees of Starlight in person or by telephone, telegram or other means of communication. Such directors, officers and employees will not be additionally compensated, but may be reimbursed for reasonable out-of-pocket expenses in connection with such solicitation. Arrangements will also be made with custodians, nominees and fiduciaries for forwarding of solicitation materials to beneficial owners of shares held of record by such custodians, nominees and fiduciaries, and Starlight will reimburse such custodians, nominees and fiduciaries for reasonable expenses incurred in connection therewith. STARLIGHT SHAREHOLDERS SHOULD NOT SUBMIT STOCK CERTIFICATES WITH THE ENCLOSED FORM OF WRITTEN CONSENT. THE MERGER GENERAL The Plan of Merger provides for the merger of Merger Sub, an indirect wholly owned subsidiary of PictureTel, with and into Starlight, with the result that Starlight would become an indirect wholly owned subsidiary of PictureTel. For the Merger to be consummated it must be approved by the holders of Starlight Stock as set forth elsewhere in this Information Statement/Prospectus and the other conditions specified in the Plan of Merger must be satisfied or waived. The discussion in this Information Statement/Prospectus of the Merger and the description of the principal terms and conditions of the Plan of Merger are subject to and qualified in their entirety by reference to the Plan of Merger, a copy of which is attached to this Information Statement/Prospectus as ANNEX A and is incorporated herein by reference. The holders of Starlight Stock are urged to read the Plan of Merger in its entirety. CONVERSION OF SHARES At the Effective Time of the Merger, each share of Starlight Preferred Stock (other than shares of Starlight Preferred Stock held in treasury or held by PictureTel or any of its direct or indirect wholly owned subsidiaries) issued and outstanding immediately prior to the Merger will be automatically converted into the right to receive shares of PictureTel Common Stock in accordance with the Exchange Ratios set forth below:
STARLIGHT PREFERRED STOCK EXCHANGE RATIO - ------------------------------------------------------------ -------------- Series A Preferred Stock.................................... 0.0368348 Series B Preferred Stock.................................... 0.0675307 Series C Preferred Stock.................................... 0.1023196 Series D Preferred Stock.................................... 0.1637115 Series E Preferred Stock.................................... 0.2046379 Series F Preferred Stock.................................... 0.0818551 Series G Preferred Stock.................................... 0.0500000
No fractional shares of PictureTel Common Stock will be issued in the Merger. Instead, the total number of shares of PictureTel Common Stock which each holder of Starlight Preferred Stock is entitled to receive in the Merger will be rounded down to the nearest whole number, and in lieu of any such fractional share, each holder of Starlight Preferred Stock shall be paid an amount of cash, without interest, equal to the product of $9.00 (the "Merger Price") and the fractional interest of PictureTel Common Stock to which such holder of Starlight Preferred Stock would otherwise be entitled. The maximum number of shares of PictureTel Common Stock that may be issued in the Merger is 1,331,914. Based upon the capitalization of PictureTel as of August 1, 1998 and excluding shares of PictureTel Common Stock to be issued under the Bonus Retention Plan, the holders of Starlight Preferred Stock will acquire PictureTel Common Stock representing approximately 3.4% of the PictureTel Common Stock outstanding immediately after consummation of the Merger. In addition, at the Effective Time of the Merger, each outstanding share of Starlight Preferred Stock held by PictureTel or any of its direct or indirect wholly owned subsidiaries will be converted into the right to 22 32 receive one share of the common stock, par value $0.01 per share, of the Surviving Corporation, and each outstanding share of Starlight Common Stock will be canceled and retired without the payment of any consideration therefor in accordance with Starlight's Amended and Restated Articles of Incorporation. CONVERSION OF STARLIGHT OPTIONS AND WARRANTS At the Effective Time of the Merger, each option to purchase Starlight Common Stock under the Common Stock Option Plan will be terminated or canceled in accordance with the terms and provisions of such Common Stock Option Plan. As a condition to the closing of the Merger, all other outstanding warrants and securities convertible into or exchangeable for shares of Starlight Common Stock or Starlight Preferred Stock must have been terminated or converted into or exchanged for shares of Starlight Common Stock or Starlight Preferred Stock, except for warrants and other securities of Starlight convertible into or exchangeable for shares of Starlight Preferred Stock and, in accordance with the Exchange Ratios, convertible into a maximum of 3,000 shares of PictureTel Common Stock. Those warrants and other securities of Starlight remaining outstanding as of the Effective Time, by virtue of the Merger and without any further action on the part of the holders thereof, shall be assumed by PictureTel and deemed to constitute a warrant or other security of PictureTel to acquire, on the same terms and conditions as were applicable under such warrant or other security immediately prior to the Effective Time, the number (rounded down to the nearest whole number) of shares of PictureTel Common Stock equal to the product of (i) the number of shares of Starlight Preferred Stock issuable upon exercise of such warrant or other security immediately prior to the Effective Time (not taking into account whether or not such warrant or other security or instrument was in fact exercisable, but excluding any Starlight Preferred Stock issued prior to the Effective Time pursuant to such warrant or other security) multiplied by (ii) the Exchange Ratio applicable to such series of Starlight Preferred Stock issuable upon exercise of such warrant or other security, at a price per share (rounded up to the next highest cent) equal to (i) the exercise price per share for the shares of Starlight Preferred Stock issuable upon exercise of such warrant or other security immediately prior to the Effective Time divided by (ii) the Exchange Ratio applicable to such series of Starlight Preferred Stock issuable upon exercise of such warrant or other security. As of September 21, 1998, there remained outstanding warrants and other securities of Starlight convertible into or exchangeable for 28,348 shares of Starlight Preferred Stock and, in accordance with the Exchange Ratios, convertible into 2,723 shares of PictureTel Common Stock. These amounts exclude warrants to acquire (i) 135,038 shares of Starlight Preferred Stock which, pursuant to separate agreements entered into with the holders of such warrants, will terminate at the Effective Time, (ii) 39,889 shares of Starlight Preferred Stock issued to Venture Lending & Leasing, Inc., which will be exercised immediately prior to the Effective Time and exchanged for 4,081 shares of PictureTel Common Stock at the Effective Time, and (iii) 128,571 shares of Starlight Common Stock issued to Venture Lending & Leasing, Inc., which will be canceled immediately prior to the Effective Time. EXCHANGE OF CERTIFICATES As soon as reasonably practicable after the Effective Time, a letter of transmittal with instructions will be mailed to each holder of Starlight Preferred Stock for use in exchanging Starlight Preferred Stock certificates for PictureTel Common Stock certificates. Upon surrender of a Starlight Preferred Stock certificate for cancellation to Boston Equiserve Limited Partnership, the exchange agent in connection with the Merger (the "Exchange Agent"), or such other agent or agents as may be appointed by PictureTel, together with such letter of transmittal, duly executed in accordance with the instructions thereto, the holder of such Starlight Preferred Stock certificate will be entitled to receive in exchange therefor a certificate representing the number of whole shares of PictureTel Common Stock equal to (i) the Exchange Ratio applicable to such series of Starlight Preferred Stock multiplied by the number of shares of Starlight Preferred Stock subject to such Starlight Preferred Stock certificate being exchanged less (ii) the pro rata portion of the Escrow Shares for which such holder of Starlight Preferred Stock is responsible under the Escrow Agreement. Pursuant to the terms of the Escrow Agreement, 158,293 of the shares of PictureTel Common Stock that the Starlight Preferred Stock are entitled to receive in the Merger will automatically be placed in escrow for twelve months and will be held and disposed of in accordance with the terms of the Escrow Agreement. The Escrow Shares will be available to reimburse PictureTel for breaches of representations, warranties or covenants made by 23 33 Starlight in the Plan of Merger and certain other obligations in the Plan of Merger. The Escrow Shares to be delivered to the Escrow Agent will be allocated pro rata among the holders of Starlight Preferred Stock based on the number of shares of PictureTel Common Stock to be received by such holders in the Merger. See "The Plan of Merger -- Indemnification" and "-- Escrow." Immediately after the Effective Time, each outstanding Starlight Preferred Stock certificate will be deemed for all corporate purposes, other than the payment of dividends, to evidence the ownership of the number of whole shares of PictureTel Common Stock into which the shares of Starlight Preferred Stock evidenced by such Starlight Preferred Stock certificate shall have been so converted as a result of the Merger. No dividends or other distributions with respect to PictureTel Common Stock with a record date after the Effective Time will be paid to the holder of any unsurrendered Starlight Preferred Stock certificate with respect to the shares of PictureTel Common Stock represented thereby until the holder of record of such Starlight Preferred Stock certificate surrenders such certificate. Subject to applicable law, following surrender of any such Starlight Preferred Stock certificate, there will be paid to the record holder of the certificates representing whole shares of PictureTel Common Stock issued in exchange therefor, without interest, the amount of any cash due in respect of fractional shares, the amount of any dividends or other distributions with a record date after the Effective Time theretofore payable with respect to such shares of PictureTel Common Stock, and, at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time and a payment date subsequent to such surrender. If any certificate for shares of PictureTel Common Stock is to be issued in a name other than that in which the Starlight Preferred Stock certificate surrendered in exchange therefor is registered, it will be a condition of the issuance thereof that the Starlight Preferred Stock certificate so surrendered be properly endorsed and otherwise in proper form for transfer and that the person requesting such exchange have paid to PictureTel or any agent designated by it any transfer or other taxes required by reason of the issuance of a certificate for shares of PictureTel Common Stock in any name other than that of the registered holder of the Starlight Preferred Stock certificate surrendered, or established to the satisfaction of PictureTel or any agent designated by it that such tax has been paid or is not payable. HOLDERS OF STARLIGHT PREFERRED STOCK CERTIFICATES SHOULD NOT SUBMIT THEIR CERTIFICATES FOR EXCHANGE UNTIL THEY HAVE RECEIVED FROM THE EXCHANGE AGENT THE LETTER OF TRANSMITTAL AND INSTRUCTIONS REFERRED TO ABOVE. NOTIFICATION REGARDING STARLIGHT WARRANTS AND OTHER SECURITIES As soon as reasonably practicable after the Effective Time, PictureTel will issue to each holder of warrants and other securities of Starlight remaining outstanding as of the Effective Time in accordance with the Plan of Merger a document evidencing the assumption of such warrant or other security by PictureTel. Such assumption will be automatic and no action will be required on the part of the holder of such warrant or other security. EFFECTIVE TIME Consummation of the Merger will occur upon the filing of the Agreement of Merger, together with any required related certificates, with the Secretary of State of the State of California or at such later time as is specified on such Agreement of Merger. The filing of the Agreement of Merger will occur as soon as practicable after the satisfaction or waiver of all conditions to the closing of the transactions contemplated by the Plan of Merger. The Plan of Merger may be terminated by any party thereto if the Merger shall not have been consummated on or before November 30, 1998. The Plan of Merger is also subject to termination upon the occurrence of certain other events. See "The Plan of Merger -- Conditions to the Merger" and "-- Termination." 24 34 BACKGROUND OF THE MERGER; RECOMMENDATION OF STARLIGHT'S BOARD OF DIRECTORS The Plan of Merger was executed by PictureTel and Starlight on August 14, 1998. The terms of the Plan of Merger are the result of arm's length negotiations between representatives of PictureTel and Starlight. The Board of Directors of Starlight has approved the Plan of Merger and the transactions contemplated thereby, including the Merger, and recommends that the Starlight Shareholders consent in writing to approve and adopt the Plan of Merger and the transactions contemplated thereby, including the Merger. See "The Merger -- Background of the Merger; Recommendation of Starlight's Board of Directors." The Board of Directors of Starlight has also approved the Bonus Retention Plan and the payments to be made thereunder and recommends that the Starlight Shareholders consent in writing to approve and adopt the Bonus Retention Plan and to approve certain payments to be made to two participants under such Bonus Retention Plan. See "Starlight 1998 Bonus Retention Plan." STARLIGHT'S REASONS FOR THE MERGER In approving the Plan of Merger and the transactions contemplated thereby, including the Merger, the Starlight Board of Directors considered a number of significant factors, including: (i) The business, results of operations and financial condition of Starlight, and its need for additional funding to continue business operations and product development. (ii) The prospects for financing from, or acquisition by, other entities. (iii) The information available to the Board of Directors of Starlight concerning PictureTel, including but not limited to its business and business line compatibility with Starlight, its size, the market price and other matters respecting the PictureTel Common Stock, which information was based in part on presentations made by Starlight management as a result of meetings with PictureTel's management. (iv) The financial resources of PictureTel, which are significantly greater than the financial resources of Starlight. (v) The terms of the Plan of Merger, including the opportunity to exchange the illiquid Starlight Preferred Stock for shares of PictureTel Common Stock traded on The Nasdaq National Market. The Starlight Board of Directors also identified and considered a number of potentially negative factors in its deliberations concerning the Merger, including, but not limited to: (i) the risk that the potential benefits sought in the Merger might not be fully realized, if at all; (ii) the possibility that the Merger would not be consummated; (iii) the risk that despite the efforts of PictureTel, key technical, marketing and management personnel might not choose to remain employed by PictureTel; and (iv) the other risks described above under "Risk Factors." The Starlight Board of Directors believed that certain of these risks were unlikely to occur, while others could be avoided or mitigated by PictureTel, and that, overall, these risks were outweighed by the potential benefits of the Merger. The Board did not assign relative weights to the factors or determine that any factor was of particular importance. Rather, the Board of Directors viewed its position and recommendations as being based upon the totality of the information presented to and considered by them. PICTURETEL'S REASONS FOR THE MERGER The PictureTel Board of Directors arrived at its unanimous decision to approve the Plan of Merger after consideration of a number of significant factors. Among those factors were: (i) The integrated streaming video applications management product currently being developed by Starlight has the potential to be highly complementary to PictureTel's business of providing visual collaboration solutions on telephony networks, which affords PictureTel an opportunity to potentially provide solutions such as meetings at a distance, distance learning, and enterprise/corporate briefings across IP and telephony-based networks for a broad array of markets, including telemedicine, business television, advertising/e-commerce, training on demand and corporate and marketing videos on demand. 25 35 (ii) PictureTel's expectation that the market for delivering a complete solution, including integrated third party products and professional services, for a range of visual collaboration applications across either a telephony-based network or an IP-based network will be one of the more rapidly growing segments of the visual collaboration market. (iii) PictureTel's belief that, following additional integration development work, its sales, distribution and support organizations can be utilized to increase sales of Starlight's streaming technology and corporate briefing applications, both domestically and internationally. (iv) Starlight's streaming technology is complementary to traditional visual collaboration systems. In addition, the PictureTel Board of Directors considered, among other matters (i) information concerning PictureTel's and Starlight's respective businesses, prospects, financial performance and condition, operations, technology, management and competitive position; (ii) the consideration to be received by the Starlight Preferred Stock in the Merger and the relationship between the market value of PictureTel Common Stock to be issued in exchange for each share of Starlight Preferred Stock and PictureTel's per share reported earnings, earnings before interest and taxes and certain other measures; (iii) the belief that the terms of the Plan of Merger, including the parties' respective representations, warranties, and covenants, and the conditions to their respective obligations, are reasonable; and (iv) the ability of PictureTel to devote management time and energy to the integration and assimilation of Starlight's business and organization should the Merger be consummated. The PictureTel Board of Directors also considered negative factors relating to the Merger, including (i) the risks that the benefits sought in the Merger would not be fully achieved, if at all (ii) the risk that the Merger would not be consummated, and (iii) other risks described above under "Risk Factors." The PictureTel Board of Directors believed that these risks were outweighed by the potential benefits to be gained by the Merger. In view of the wide variety of factors considered by the PictureTel Board of Directors, the PictureTel Board of Directors did not find it practicable to quantify or otherwise assign relative weight to the specific factors considered in approving the Plan of Merger and the transactions contemplated thereby, including the Merger. However, after taking into account all the factors set forth above, the PictureTel Board of Directors determined that the Plan of Merger and Merger were in the best interests of PictureTel and its stockholders and that PictureTel should proceed with the Plan of Merger and the transactions contemplated thereby, including the Merger. CERTAIN CONSIDERATIONS In considering whether to approve the Plan of Merger and the transactions contemplated thereby, the holders of Starlight Stock, particularly the holders of Starlight Preferred Stock, should be aware that the stock price of PictureTel Common Stock at the Effective Time may vary significantly from the price as of the date of execution of the Plan of Merger, the date hereof or the date on which the holders of Starlight Stock consent in writing to the Plan of Merger due to changes in the business, operations and prospects of PictureTel, general market and economic conditions, and other factors. Because the market price of PictureTel Common Stock is subject to fluctuation, the market value of the shares of PictureTel Common Stock that holders of Starlight Preferred Stock will receive in the Merger may increase or decrease prior to and following the Merger. STARLIGHT SHAREHOLDERS ARE URGED TO OBTAIN CURRENT MARKET QUOTATIONS FOR PICTURETEL COMMON STOCK. NO ASSURANCE CAN BE GIVEN AS TO THE FUTURE PRICES OR MARKETS FOR PICTURETEL COMMON STOCK. See "Risk Factors -- Volatility of Stock Price" and "-- Risks Associated with Fixed Exchange Ratios." INTERESTS OF CERTAIN PERSONS IN THE MERGER In considering the recommendation of the Starlight Board of Directors with respect to the Plan of Merger and the transactions contemplated thereby, including the Merger, the holders of the Starlight Stock should be aware that certain executive officers and members of the Board of Directors have certain interests in the 26 36 Merger, including those referred to below, that present such executive officers and members of the Board of Directors with conflicts of interest. The Starlight Board of Directors was aware of the potential conflicts associated with these matters and considered them along with the other matters described in "The Merger -- Starlight's Reasons for the Merger." Concurrently with the execution of the Plan of Merger, James E. Long, Chairman of Starlight, entered into an employment agreement with PictureTel that takes effect at the Effective Time. Pursuant to his employment agreement, Mr. Long will become a PictureTel Fellow and will receive an annual base compensation of $160,000. Mr. Long's employment agreement also provides that PictureTel will recommend to the Compensation Committee of its Board of Directors that Mr. Long be granted options to purchase 65,000 shares of PictureTel Common Stock, the vesting of which would be in accordance with the 1998 PictureTel Non-Qualified Option Plan. Mr. Long would also be eligible for bonus payments under the PictureTel Management Incentive Plan. In the event Mr. Long is terminated without cause, Mr. Long will continue to receive his then-current base salary for a period of six months, and if unemployed after the end of such six months, will be paid on a month-to-month basis for an additional period of no more than six months. In addition if Mr. Long is terminated without cause within six months of the date of the option grant, 18.75% of the options to purchase PictureTel Common Stock granted to Mr. Long will immediately vest. Further, certain executive officers and directors of Starlight will receive additional payments of PictureTel Common Stock and/or cash under the Bonus Retention Plan at the Effective Time of the Merger. The amounts are intended, in part, as an incentive for certain executive officers, directors and consultants to continue their service for Starlight through the closing of the Merger and are determined by the Starlight Board of Directors or the Compensation Committee of the Starlight Board of Directors. See "Starlight 1998 Bonus Retention Plan." Pursuant to the Plan of Merger, PictureTel has agreed that all rights to indemnification or exculpation now existing in favor of the employees, agents, directors or officers of Starlight as provided in its Amended and Restated Articles of Incorporation or By-laws shall continue in full force and effect for a period of not less than six years from the Effective Time. MATERIAL FEDERAL TAX CONSEQUENCES The following summary discusses the material United States federal income tax consequences of the Merger to the Starlight Shareholders. This summary is not a complete description of all the tax consequences of the Merger and does not address the tax consequences that may be relevant to particular categories of Starlight Shareholders subject to special treatment under certain federal income tax laws, such as dealers in securities, banks, insurance companies, tax-exempt organizations, corporate shareholders which are collapsible corporations, non-United States persons, shareholders who acquired shares of Starlight Common or Starlight Preferred Stock pursuant to the exercise of options or otherwise as compensation, shareholders who are subject to the alternative minimum tax provisions of the Internal Revenue Code of 1986, as amended (the "Code"), or shareholders who hold their Starlight Stock as part of a hedging, straddle, conversion or other risk reduction or constructive sale transactions. This summary is based upon the Code, currently applicable Treasury regulations (the "Regulations"), published administrative rulings and court decisions all as of the date hereof. All of the foregoing are subject to change either prospectively or retroactively, and any such change could affect the continuing validity of the tax consequences described below. No information is provided herein with respect to the tax consequences of the Merger arising under the laws of any state, local or foreign jurisdiction. This summary discusses only the federal income tax consequences of the Merger and does not discuss the tax consequences of any other transaction that may occur in connection with the Merger, including the forfeiture of Starlight Common Stock for no consideration, the termination of options under the Common Stock Option Plan or the termination of warrants or other securities of Starlight prior to the Merger. No ruling from the Internal Revenue Service (the "IRS") concerning the federal income tax consequences of the Merger will be requested. The tax consequences set forth in this discussion are not binding on the IRS or the courts and no assurance can be given that contrary positions will not be successfully asserted by the IRS or adopted by a court. 27 37 STARLIGHT SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE PARTICULAR TAX CONSEQUENCES TO EACH OF THEM OF THE MERGER, INCLUDING THE APPLICABILITY AND EFFECT OF ANY FOREIGN, STATE, LOCAL OR OTHER TAX LAWS. Taxable Sale of Starlight Preferred Stock. The exchange of Starlight Preferred Stock for PictureTel Common Stock pursuant to the Merger has been structured to be a taxable sale of the Starlight Preferred Stock. Accordingly, each Starlight Shareholder that exchanges Starlight Preferred Stock for PictureTel Common Stock will recognize gain or loss on the Closing Date equal to the difference between the shareholder's adjusted tax basis in the Starlight Preferred Stock and the fair market value of the PictureTel Common Stock received in exchange therefor, including the fair market value of the PictureTel Common Stock placed in escrow pursuant to the Escrow Agreement entered into in connection with the Merger. Any Starlight Shareholder that sells Starlight Preferred Stock to PictureTel for cash will realize gain or loss on the Closing Date equal to the difference between the shareholder's adjusted tax basis in such Starlight Preferred Stock and the amount of cash received in exchange therefor. The gain or loss realized by such Starlight Shareholders will be capital gain or loss if the Starlight Preferred Stock was held as a capital asset in the hands of the shareholder, and will be long-term capital gain or loss if the shareholder has held such Starlight Preferred Stock for more than one year. Under recently enacted legislation, long-term capital gain will in general be subject to a maximum federal tax rate of 20% for noncorporate taxpayers. A Starlight Shareholder's aggregate basis in the PictureTel Common Stock received will equal its fair market value as of the Closing Date and the holding period for such stock will begin the day after the Closing Date. Forfeiture of Escrow Shares. Pursuant to an escrow agreement (the "Escrow Agreement") to be entered into by and between PictureTel, the Stockholder Representative and State Street Bank and Trust Company, 158,293 of the shares (the "Escrow Shares") of PictureTel Common Stock which the holders of the Starlight Preferred Stock are entitled to receive in the Merger will be withheld and deposited in escrow for twelve months. The tax treatment of the forfeiture of any of the Escrow Shares to PictureTel (i.e., to satisfy an indemnification obligation of the holders of Starlight Preferred Stock) is not entirely clear. Starlight believes that each holder of Starlight Preferred Stock that had placed a portion of the PictureTel Common Stock received in exchange for Starlight Preferred Stock into escrow should recognize a loss equal to its basis in the forfeited Escrow Shares. Such loss, if recognized, will be a capital loss if the Starlight Preferred Stock exchanged for the Escrow Shares was held as a capital asset in the hands of the shareholder, and will be a long-term capital loss if the shareholder had held such Starlight Preferred Stock for more than one year as of the Effective Time. Alternatively, it is possible that the Internal Revenue Service might assert that no loss is recognized upon such a forfeiture and that the basis of the remaining PictureTel Common Stock held by a former shareholder of Starlight Preferred Stock should be increased by an amount equal to such shareholder's basis in the forfeited Escrow Shares. It is also possible that the Internal Revenue Service might assert that (i) gain or loss is recognized by a former shareholder of Starlight Preferred Stock on the forfeiture of Escrow Shares in an amount equal to the difference between (A) such shareholder's basis in the Escrow Shares (which will equal the fair market value of PictureTel Common Stock as of the Effective Time) minus (B) the amount of the indemnification obligation satisfied with the forfeited Escrow Shares (which would be based on the Merger Price) and (ii) the basis of the remaining PictureTel Common Stock held by such former shareholder of Starlight Preferred Stock should be increased by an amount equal to such shareholder's basis in the forfeited Escrow Shares, plus any gain or minus any loss recognized on the forfeiture. DUE TO THE UNCERTAIN TAX TREATMENT OF THE FORFEITURE, IF ANY, OF THE ESCROW SHARES, HOLDERS OF STARLIGHT PREFERRED STOCK ARE URGED TO CONSULT THEIR RESPECTIVE TAX ADVISORS AS TO THE PROPER REPORTING OF SUCH A FORFEITURE. Dissenting Shareholders. Starlight Shareholders who exercise their dissenters' rights under law with respect to their Starlight Stock and who do not own any shares of PictureTel Common Stock (either directly or constructively within the meaning of Section 318 of the Code), following the receipt of any cash in exchange for such shares of Starlight Stock will generally recognize gain or loss measured by the difference 28 38 between the amount of cash received and the shareholder's adjusted tax basis in the Starlight Stock. Such gain or loss will be a capital gain or loss if the Starlight Stock was held as a capital asset in the hands of the shareholder, and a long-term capital gain or loss if the shareholder held the Starlight Stock for more than one year. Under recently enacted legislation, long-term capital gain will in general be subject to a maximum federal tax rate of 20% for noncorporate taxpayers. Information Reporting and Backup Withholding. Certain noncorporate Starlight Shareholders may be subject to backup withholding at a rate of 31% on the gross proceeds received pursuant to the Merger. Backup withholding will not apply, however, to a shareholder who furnishes a correct taxpayer identification number ("TIN") and certifies that he, she or it is not subject to backup withholding on a Form W-9, or who provides a certificate of foreign status on Form W-8, or who is otherwise exempt from backup withholding. THE PRECEDING DISCUSSION IS INTENDED ONLY AS A SUMMARY OF CERTAIN FEDERAL TAX CONSEQUENCES OF THE MERGER AND DOES NOT PURPORT TO BE A COMPLETE ANALYSIS OR DISCUSSION OF ALL POTENTIAL TAX EFFECTS RELEVANT THERETO. THUS, STARLIGHT SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING REQUIREMENTS AND THE APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL, AND OTHER APPLICABLE TAX LAWS. ANTICIPATED ACCOUNTING TREATMENT The transaction effected by the Merger is expected to be accounted for under the purchase method of accounting in accordance with generally accepted accounting principles, whereby the purchase price will be allocated based on the fair values of the assets acquired and the liabilities assumed. GOVERNMENTAL FILINGS PictureTel and Starlight do not believe that any governmental filings in the United States are required with respect to the Merger, other than the filing of the Agreement of Merger, together with any related required certificates, required to be filed with the Secretary of State of the State of California in accordance with the CCC and the filing of the Registration Statement of PictureTel with the Commission of which this Information Statement/Prospectus is a part. CERTAIN FEDERAL SECURITIES LAW CONSEQUENCES; AFFILIATE LETTERS The PictureTel Common Stock to be issued in the Merger has been registered under the Securities Act, thereby allowing those shares to be traded without restriction under the Securities Act, except for those shares held by shareholders of Starlight who are deemed to control, are controlled by, or are under common control with Starlight ("Affiliates"). Affiliates of Starlight may not sell their shares of PictureTel Common Stock acquired in the Merger except pursuant to (i) an effective registration statement under the Securities Act covering such shares, (ii) the resale provisions of Rule 145 promulgated under the Securities Act or (iii) another applicable exemption from the registration requirements of the Securities Act. STOCK EXCHANGE LISTING The shares of PictureTel Common Stock to be issued in the Merger will be listed for quotation on The Nasdaq National Market. DIVIDENDS Starlight is not permitted under the terms of the Plan of Merger to declare, set aside or pay any dividend in cash, stock, property or otherwise in respect of its capital stock during the period from the date of the Plan of Merger until the earlier of the termination of the Plan of Merger or the Effective Time. Further, neither PictureTel nor Starlight has ever paid a cash dividend and PictureTel currently intends to retain all of its 29 39 earnings for use in its business to finance future growth and, accordingly, does not anticipate paying cash dividends in the foreseeable future. APPRAISAL RIGHTS Starlight Shareholders have the right to demand an appraisal of the fair value of their Starlight Stock in accordance with the provisions of Chapter 13 of the CCC ("Chapter 13"), which sets forth the rights and obligations of Starlight Shareholders demanding an appraisal and the procedures to be followed. Starlight Shareholders who perfect such rights will not be entitled to surrender their Starlight Stock for payment of the Merger Consideration in the manner otherwise described in this Information Statement/Prospectus. Starlight Shareholders should assume that Starlight will take no action to perfect the appraisal rights of any shareholder. Therefore, to exercise his, her or its appraisal rights, a shareholder should strictly comply with the procedures set forth in Chapter 13 and is urged to consult his, her or its legal advisor before electing or attempting to exercise such appraisal rights. Starlight Shareholders who sign and return the written consent included with this Information Statement/Prospectus voting IN FAVOR of the Merger will not be entitled to appraisal rights. In addition, Starlight Shareholders who sign and return written consents without instructions will not be entitled to appraisal rights because such consents will be deemed to be voted IN FAVOR of the Merger. Starlight Shareholders are not required to sign and return the written consent voting their shares of Starlight Stock against the Merger in order to obtain appraisal rights. The following is a summary of the procedures to be followed under Chapter 13, the text of which is attached to this Information Statement/Prospectus as ANNEX B. The summary does not purport to be a complete statement of, and is qualified in its entirety by reference to, Chapter 13 and to any amendments to such section after the date of this Information Statement/Prospectus. Failure to follow any Chapter 13 procedures may result in termination or waiver of appraisal rights under Chapter 13. Any shareholder who desires to exercise his appraisal rights should review carefully Chapter 13 and is urged to consult his, her or its legal advisor before electing or attempting to exercise such rights. The record holders of the shares of Starlight Stock that are eligible to, and do, exercise their dissenters' rights with respect to the Merger are referred to herein as "Dissenting Shareholders," and the shares of stock with respect to which they exercise dissenters' rights are referred to herein as "Dissenting Shares." Shares of Starlight Stock must satisfy each of the following requirements to qualify as Dissenting Shares under the CCC: (i) the shares of Starlight Stock must have been outstanding on the Starlight Record Date; (ii) the shares of Starlight Stock must not have been voted in favor of the Merger; (iii) the holder of such shares of Starlight Stock must make a written demand that Starlight repurchase such shares of Starlight Stock at fair market value; and (iv) the holder of such shares of Starlight Stock must submit certificates for endorsement. Pursuant to Chapter 13 of the CCC, holders of Dissenting Shares may require Starlight to repurchase their Dissenting Shares at a price equal to the fair market value of such shares determined as of the day before the first announcement of the terms of the Merger, excluding any appreciation or depreciation as a consequence of the proposed Merger, but adjusted for any stock split, reverse stock split or stock dividend that becomes effective thereafter. Within ten days following approval of the Merger by Starlight Shareholders, Starlight is required to mail to each holder of shares of Starlight Stock not voted in favor of the Merger a notice of the approval of the Merger, a statement of the price determined by Starlight to represent the fair market value of Dissenting Shares (which shall constitute an offer by Starlight to purchase such Dissenting Shares at such stated price), and a description of the procedures for such holders to exercise their rights as Dissenting Shareholders. Within thirty (30) days after the date on which the notice of the approval of the Merger by the outstanding shares of Starlight Stock is mailed to Dissenting Shareholders, a Dissenting Shareholder must demand that Starlight repurchase such shareholder's Dissenting Shares in a statement setting forth the number and class of Dissenting Shares held of record by such Dissenting Shareholder that the Dissenting Shareholder demands that Starlight purchase, and a statement of what the Dissenting Shareholder claims to be the fair market value of the Dissenting Shares as of the day before the announcement of the proposed Merger. The statement of fair market value in such demand by the Dissenting Shareholder constitutes an offer 30 40 by the Dissenting Shareholder to sell the Dissenting Shares at such price to Starlight. Such holder must also submit to Starlight certificates representing any Dissenting Shares that the Dissenting Shareholder demands Starlight purchase, so that such Dissenting Shares may either be stamped or endorsed with the statement that the shares are Dissenting Shares or exchanged for certificates of appropriate denomination so stamped or endorsed. If, upon the Dissenting Shareholder's surrender of the certificates representing the Dissenting Shares, Starlight and a Dissenting Shareholder agree upon the price to be paid for the Dissenting Shares and agree that such shares are Dissenting Shares, then the agreed price is required by law to be paid to the Dissenting Shareholder within the later of thirty (30) days after the date of such agreement or thirty (30) days after any statutory or contractual conditions to the consummation of the Merger are satisfied or waived. If Starlight and a Dissenting Shareholder disagree as to the price for such Dissenting Shares or disagree as to whether such shares are entitled to be classified as Dissenting Shares, such holder has the right to bring an action in California Superior Court, within six months after the date on which the notice of the approval of the Merger by Starlight Shareholders is first mailed, to resolve such dispute. In any such action, the California Superior Court may determine whether the shares of Starlight Stock held by such shareholder are Dissenting Shares, the fair market value of such shares of Starlight Stock, or both. The CCC provides, among other things, that a Dissenting Shareholder may not withdraw the demand for payment of the fair market value of Dissenting Shares unless Starlight consents to such request for withdrawal. Under the Delaware General Corporation Law ("DGCL"), PictureTel stockholders are not entitled to dissenters' or appraisal rights with respect to the proposed Merger. 31 41 THE PLAN OF MERGER The description of the Plan of Merger set forth below does not purport to be complete and is qualified in its entirety by reference to the Plan of Merger, a copy of which is attached to this Information Statement/ Prospectus as ANNEX A and incorporated herein by reference. Statements in this Information Statement/ Prospectus with respect to the terms of the Merger are qualified in their entirety by reference to the Plan of Merger. The holders of Starlight Stock are urged to read the full text of the Plan of Merger. REPRESENTATIONS AND WARRANTIES The Plan of Merger contains various representations and warranties of the parties, including representations and warranties by Starlight relating to (i) its organization and qualification to do business, (ii) the full force and effect of its Amended and Restated Articles of Incorporation and By-laws, (iii) its capitalization, (iv) its authority relative to the Plan of Merger, (v) the conflicts, required filings and consents arising from or necessitated by the Merger, (vi) its compliance with laws and agreements and the existence of required permits, (vii) its financial statements, (viii) the absence of certain changes or events, (ix) the absence of undisclosed liabilities, (x) the absence of litigation, (xi) its employee benefit plans and employment agreements, (xii) its labor matters, (xiii) the accuracy of information supplied in this Information Statement/ Prospectus and the Registration Statement on Form S-4 (the "Registration Statement") of PictureTel relating to Starlight, (xiv) the absence of restrictions on its business activities, (xv) its title to property, (xvi) the payment of its taxes and other tax matters, (xvii) its environmental matters, (xviii) its intellectual property, (xix) any interested party transactions, (xx) its insurance, (xxi) its notes and accounts receivable and inventories, (xxii) product warranties and defects, (xxiii) brokerage, finder's or other fees or commissions, (xxiv) the absence of change of control payments, (xxv) Year 2000 compliance; (xxvi) immigration compliance, (xxvii) outstanding indebtedness and guarantees, (xxviii) its employees, (xxix) the absence of illegal payments, (xxx) the absence of claims against directors and officers, (xxxi) its obligations with respect to the Bonus Retention Plan, (xxxii) its expenses and (xxxiii) the completeness of materials provided to PictureTel. The Plan of Merger also contains representations and warranties of PictureTel, PTC and Merger Sub as to (i) their organization and qualification to do business, (ii) the full force and effect of their respective charter documents and by-laws, (iii) the capitalization of PictureTel, (iv) their authority relative to the Plan of Merger, (v) the conflicts, required filings and consents arising from or necessitated by the Merger, (vi) the SEC filings and financial statements of PictureTel, (vii) the accuracy of information supplied in this Information Statement/Prospectus and the Registration Statement relating to PictureTel, PTC or Merger Sub, (viii) the absence of material changes or events, (ix) the validity of the PictureTel Common Stock and (x) the completeness of materials provided to Starlight. The representations and warranties made by PictureTel, PTC and Merger Sub and the representations and warranties of Starlight (other than representations and warranties of Starlight relating to its capitalization) will survive for a period of twelve months from the Effective Time of the Merger. CONDUCT OF PICTURETEL'S AND STARLIGHT'S BUSINESS PRIOR TO THE MERGER Under the terms of the Plan of Merger, Starlight has agreed that, during the period from the date of the Plan of Merger and continuing until the earlier of the termination of the Plan of Merger or the Effective Time, unless PictureTel otherwise agrees in writing, Starlight will conduct its business in, and shall not take any action except in, the ordinary course of business and in a manner consistent with past practice other than actions taken by Starlight in contemplation of the Merger. Starlight is also obligated to use all reasonable commercial efforts to preserve substantially intact the business organization of Starlight, to keep available the services of the present officers, employees and consultants of Starlight and to preserve the present relationships of Starlight with customers, suppliers and other persons with which Starlight has significant business relations. Starlight further agreed that it would not, during the period from the date of the Plan of Merger and continuing until the earlier of the termination of the Plan of Merger or the Effective Time, directly or indirectly do, or propose to do, any of the following without the prior written consent of PictureTel: (a) amend or otherwise change its Amended and Restated Articles of Incorporation or By-laws; (b) issue, sell, pledge, dispose of or encumber, or authorize the issuance, sale, pledge, disposition or encumbrance of, any shares of 32 42 capital stock of any class, or any options, warrants, convertible securities or other rights of any kind to acquire any shares of capital stock, or any other ownership interest (including, without limitation, any phantom interest) in Starlight (except for the issuance of shares of Starlight Common Stock and Starlight Preferred Stock upon exercise of options, warrants, convertible securities or other rights outstanding as of the date of the Plan of Merger); (c) sell, pledge, dispose of or encumber any assets of Starlight except for sales of assets in the ordinary course of business and dispositions of obsolete or worthless assets; (d) (i) declare, set aside, make or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of any of its capital stock, (ii) split, combine or reclassify any of its capital stock or issue or authorize or propose the issuance of any other securities in respect of, in lieu of or in substitution for shares of its capital stock, or (iii) amend the terms or change the period of exercisability of, purchase, repurchase, redeem or otherwise acquire any of its securities, including, without limitation, shares of Starlight Common Stock and Starlight Preferred Stock or any option, warrant or right, directly or indirectly, to acquire shares of Starlight Common Stock and Starlight Preferred Stock, or propose to do any of the foregoing; (e) (i) acquire (by merger, consolidation, or acquisition of stock or assets) any corporation, partnership or other business organization or division thereof; (ii) incur any indebtedness, except to PictureTel, for borrowed money or issue any debt securities or assume, guarantee or endorse or otherwise as an accommodation become responsible for, the obligations of any person or, except in the ordinary course of business consistent with past practice, make any loans or advances; (iii) enter into or amend any material contract or agreement involving obligations in excess of $50,000; (iv) authorize any capital expenditures or purchases of fixed assets; or (v) enter into or amend any contract, agreement, commitment or arrangement to effect any of the matters prohibited by this clause (e); (f) except for allocations under the Bonus Retention Plan, increase the compensation payable or to become payable to its officers or key employees or consultants, or increase the compensation payable or to become payable to its employees or consultants except in the ordinary course of business, or grant any severance or termination pay to, or enter into any employment or severance agreement with any director, officer or other employee, or establish, adopt, enter into or amend any collective bargaining, bonus, profit sharing, thrift, compensation, stock option, restricted stock, pension, retirement, deferred compensation, employment, termination, severance or other plan, agreement, trust, fund, policy or arrangement for the benefit of any current or former directors, officers or employees, except, in each case, as may be required by law; (g) except to the extent required by law, take any action to change accounting policies or procedures (including, without limitation, procedures with respect to revenue recognition, taxes, payments of accounts payable and collection of accounts receivable); (h) make any material tax election or settle or compromise any federal, state, local or foreign tax liability or agree to an extension of a statute of limitations; (i) pay, discharge or satisfy any claims, liabilities or obligations (absolute, accrued, asserted or unasserted, contingent or otherwise), other than the payment, discharge or satisfaction in the ordinary course of business and consistent with past practice of liabilities reflected or reserved against in the financial statements of Starlight, or incurred in the ordinary course of business and consistent with past practice; (j) commence any litigation; or (k) take, or agree in writing or otherwise to take, any of the actions described in clauses (a) through (j) above. NO SOLICITATION The Plan of Merger provides, subject to certain exceptions, that: (a) Starlight shall not, directly or indirectly, through any officer, director, employee, representative or agent (i) solicit, initiate or encourage the initiation of any inquiries or proposals regarding any merger, sale of substantial assets, sale of shares of capital stock (including without limitation by way of a tender offer) or similar transactions involving Starlight other than the Merger (each of the foregoing inquiries or proposals referred to herein as an "Acquisition Proposal"), (ii) engage in negotiations or discussions concerning, or provide any nonpublic information to any person relating to, any Acquisition Proposal or (iii) agree to, approve or recommend any Acquisition Proposal; (b) Starlight shall immediately notify PictureTel after receipt of any Acquisition Proposal, or any modification of or amendment to any Acquisition Proposal, or any request for nonpublic information relating to Starlight in connection with an Acquisition Proposal or for access to the properties, books or records of Starlight or by any person or entity that informs the Board of Directors of Starlight that it is considering making, or has made, an Acquisition Proposal, such notice to PictureTel to be made orally and in writing; 33 43 (c) Starlight was obligated to immediately cease and cause to be terminated any existing discussions or negotiations with any persons (other than PictureTel, PTC and Merger Sub) conducted prior to the execution of the Plan of Merger with respect to any of the foregoing and that Starlight shall not release any third party from the confidentiality provisions of any confidentiality agreement to which Starlight is a party; and (d) Starlight shall ensure that the officers, directors and employees of Starlight and any investment banker or other advisor or representative retained by Starlight are aware of the restrictions described in clauses (a) through (c) above. CONDITIONS TO THE MERGER Each party's respective obligation to effect the Merger is subject to, among other things, the satisfaction prior to the Effective Time of the following conditions: (a) the Commission having declared the Registration Statement effective, with no stop order suspending the effectiveness of the Registration Statement having been issued by the Commission and no proceedings for that purpose and no similar proceeding in respect of the Information Statement/Prospectus having been initiated or threatened by the Commission; (b) the Plan of Merger and the transactions contemplated thereby, including the Merger, having received the Requisite Approvals (defined below); (c) the absence of any temporary restraining order, preliminary or permanent injunction or other order issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Merger, or any pending proceeding brought by any administrative agency or commission or other governmental authority or instrumentality, domestic or foreign, seeking any of the foregoing or any action taken or any statute, rule, regulation or order enacted, entered, enforced or deemed applicable to the Merger, which makes the consummation of the Merger illegal; (d) the absence of any pending or threatened action, suit or proceeding relating to the Merger before any governmental authority, administrative agency or court of competent jurisdiction, wherein any unfavorable injunction, judgment, decree, order, ruling or charge would prohibit or limit PictureTel from exercising all material rights and privileges pertaining to its ownership of Starlight or the ownership or operation by PictureTel of all or a material portion of the business or assets of PictureTel; (e) the holders of Starlight Preferred Stock having received an opinion of Wilson Sonsini Goodrich & Rosati, P.C. to the effect that the transaction effected by the Merger will constitute a purchase of Starlight Stock treated for federal income tax purposes as a sale or exchange resulting in gain or loss recognition by the holders of the outstanding capital stock of Starlight; and (f) PTC and David A. Edwards, Vice President, Product Development of Starlight, having performed all of their respective obligations under the Stock Purchase Agreement dated August 14, 1998 for the purchase by PTC of 5,000 shares of Starlight Series B Preferred Stock, representing all of the issued and outstanding shares of Starlight Stock owned by Mr. Edwards, for $3,039 in cash. The obligations of PictureTel, PTC and Merger Sub to effect the Merger are also subject to, among others, the following conditions: (a) the accuracy, in all material respects, of the representations and warranties of Starlight as of the Effective Time with the same force and effect as if made at and as of such time, and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of Starlight; (b) the performance of and compliance with, in all material respects, the agreements and covenants required by the Plan of Merger to be performed or complied with by Starlight at or prior to the Effective Time, and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of Starlight; (c) Starlight having obtained all necessary consents, waivers, approvals, authorizations or orders, and having made all required filings, for the due authorization, execution and delivery of the Plan of Merger and the consummation of the transactions contemplated by the Plan of Merger; (d) the receipt by PictureTel of an opinion from Wilson Sonsini Goodrich & Rosati, P.C., counsel to Starlight, regarding the validity of certain actions taken by Starlight with respect to the Merger; (e) the receipt by PictureTel and the continuing full force and effect of a "Rule 145 Agreement" by each person who is identified as an "affiliate" of Starlight; (f) the termination of all existing registration rights, preemptive rights and rights of first refusal with respect to the purchase of the capital stock of Starlight and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of Starlight; (g) the execution and delivery to PictureTel of the Escrow Agreement by each of the Escrow Agent and the Stockholder Representative; (h) James E. Long and David A. Edwards shall each have entered into employment agreements with PictureTel and neither person shall have terminated his employment with Starlight prior to the Effective Time or indicated his intention to 34 44 terminate employment with Starlight following the Effective Time; (i) the termination of all stock options granted under the Common Stock Option Plan, and the termination or conversion of all warrants and other securities convertible into or exchangeable for shares of any class of capital stock of Starlight, except warrants and other securities of Starlight convertible into or exchangeable for shares of Starlight Preferred Stock and, in accordance with the Exchange Ratios, convertible into a maximum of 3,000 shares of PictureTel Common Stock, and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of Starlight; and (n) the receipt of written consents from 93% of the Starlight Common Stock outstanding immediately prior the Effective Time (assuming the conversion of all outstanding shares of Starlight Preferred Stock into Starlight Common Stock) approving the Plan of Merger. The obligation of Starlight to effect the Merger is also subject to the following conditions: (a) the accuracy, in all material respects, of the representations and warranties of PictureTel, PTC and Merger Sub as of the Effective Time with the same force and effect as if made at and as of such time and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of PictureTel; (b) the performance of and compliance with, in all material respect, the agreements and covenants required by the Plan of Merger to be performed or complied with by PictureTel, PTC and Merger Sub on or prior to the Effective Time, and the receipt of a certificate to such effect signed by the President or Chief Financial Officer of PictureTel; (c) PictureTel, PTC and Merger Sub having obtained all necessary consents, waivers, approvals, authorizations or orders, and having made all required filings, for the authorization, execution and delivery of the Plan of Merger and the consummation of the transactions contemplated by the Plan of Merger; and (d) the receipt by Starlight of the written opinion of Ropes & Gray, counsel to PictureTel, regarding the validity of certain actions taken by PictureTel, PTC and Merger Sub with respect to the Merger. TERMINATION The Plan of Merger may be terminated at any time prior to the Effective Time, notwithstanding approval thereof by the Starlight Shareholders: (a) by mutual written consent duly authorized by the Boards of Directors of PictureTel and Starlight; (b) by either PictureTel or Starlight if the Merger shall not have been consummated by November 30, 1998 (provided that the right to terminate the Plan of Merger under this clause (b) shall not be available to any party whose failure to fulfill any obligation under the Plan of Merger has been the cause of or resulted in the failure of the Merger to occur on or before such date); (c) by either PictureTel or Starlight if a court of competent jurisdiction or governmental, regulatory or administrative agency or commission shall have issued a nonappealable final order, decree or ruling or taken any other action having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger (provided that the right to terminate the Plan of Merger under this clause (c) shall not be available to any party who has not complied with its obligations under the Plan of Merger with respect to taking further actions and such noncompliance materially contributed to the issuance of any such order, decree or ruling or the taking of such action); (d) by PictureTel or Starlight if the Requisite Approvals shall not have been obtained by November 25, 1998; (e) by PictureTel, if (i) the Board of Directors of Starlight shall withdraw, modify or change its approval or recommendation of the Plan of Merger or the Merger in a manner adverse to PictureTel or shall have resolved to do so or (ii) the Board of Directors of Starlight shall have recommended to the shareholders of Starlight an alternative Acquisition Proposal; (f) by PictureTel or Starlight, (i) if any representation or warranty of Starlight or PictureTel, respectively, set forth in the Plan of Merger shall be untrue when made, or (ii) upon a breach of any covenant or agreement on the part of Starlight or PictureTel, respectively, set forth in the Plan of Merger, such that the conditions to the requisite obligations of Starlight or PictureTel, as the case may be, would not be satisfied (either (i) or (ii) above being a "Terminating Breach"), provided, however, that if such Terminating Breach is curable prior to November 30, 1998 by Starlight or PictureTel, as the case may be, through the exercise of its reasonable efforts and for so long as Starlight or PictureTel, as the case may be, continues to exercise such reasonable efforts, neither PictureTel nor Starlight, respectively, may terminate the Plan of Merger under this clause; or (g) by PictureTel or Starlight, (i) if any representation or warranty of Starlight or PictureTel, respectively, set forth in the Plan of Merger shall have become untrue such that the conditions to the requisite obligations of Starlight or PictureTel, as the case may be, would not be satisfied, in either case other than by reason of a Terminating Breach. 35 45 In the event of the termination of the Plan of Merger pursuant to the preceding paragraphs, the Plan of Merger shall forthwith become void and there shall be no liability on the part of any party thereto or any of its affiliates, directors, officers or shareholders except (i) for certain provisions of the Plan of Merger relating to confidentiality and fees and expenses, which shall survive any termination of the Plan of Merger and (ii) nothing in the Plan of Merger shall relieve any party from liability for any breach of the Plan of Merger. TERMINATION FEE If PictureTel terminates the Plan of Merger because the Board of Directors of Starlight shall have withdrawn, modified or changed its approval or recommendation of the Plan of Merger in a manner adverse to PictureTel or shall have resolved to do so or shall have recommended to the shareholders of Starlight an alternative Acquisition Proposal, then Starlight shall pay PictureTel $1.0 million within five days of notice by PictureTel to Starlight terminating the Plan of Merger. FEES AND EXPENSES All fees and expenses incurred in connection with the Plan of Merger and the transactions contemplated thereby will generally be paid by the party incurring such expenses, whether or not the Merger is consummated, except that in the event the Merger is consummated, Starlight shall only pay up to $400,000 of legal, accounting and investment banking fees incurred by Starlight in connection with the Plan of Merger and the consummation of the Merger and thereafter the holders of the Starlight Preferred Stock immediately prior to the Effective Time (other than PictureTel) shall be responsible for any fees and expenses incurred in excess of such amount to the extent of the Escrow Fund. INDEMNIFICATION Pursuant to the Plan of Merger, PictureTel has agreed that all rights to indemnification or exculpation now existing in favor of the employees, agents, directors or officers of Starlight (each, a "Starlight Indemnified Party") as provided in its Amended and Restated Articles of Incorporation By-laws shall continue in full force and effect for a period of not less than six years from the Effective Time, except, that, in the event any claim or claims are asserted or made within such six-year period, all rights to indemnification in respect of any such claim or claims shall continue until disposition of any and all such claims. Any determination required to be made with respect to whether an Starlight Indemnified Party's conduct complies with the standards set forth in the Amended and Restated Articles of Incorporation or Bylaws of Starlight or otherwise, in each case subject to California law, shall be made by independent counsel selected by the Starlight Indemnified Party reasonably satisfactory to the Surviving Corporation (whose fees and expenses shall be paid by the Surviving Corporation). The representations and warranties of Starlight and PictureTel made in the Plan of Merger (other than representations and warranties of Starlight with respect to its capitalization) and in the documents and certificates delivered in connection with the satisfaction of their closing conditions will survive the Merger for a period of twelve months from the Effective Time and will remain operative and in full force and effect regardless of any investigation made by or on behalf of any other party to the Plan of Merger, any person controlling any such party or any of their officers or directors, whether prior to or after the execution of the Plan of Merger. The representations and warranties of Starlight with respect to its capitalization, as well as claims based upon fraud, will survive until the expiration of the statutes of limitation applicable to such claims, subject to any extensions thereof, or if no statutes of limitation are applicable, indefinitely. Those claims made within the applicable time periods described above shall survive to the extent of such claim until such claim is finally determined and, if applicable, paid. By approving the Plan of Merger and their accepting the Merger Consideration, the holders of Starlight Preferred Stock (other than PictureTel) agree that the Escrow Fund established under the Escrow Agreement shall be available to indemnify, defend, protect, and hold harmless each of PictureTel, PTC, Merger Sub, the Surviving Corporation and each of their respective subsidiaries and affiliates (each in its capacity as an indemnified party, a "PictureTel Indemnitee") at all times from and after the date of the Plan of Merger from 36 46 and against all claims, damages, actions, suits, proceedings, demands, assessments, adjustments, costs and expenses (including specifically, but without limitation, reasonable attorneys' fees and expenses of investigation) (collectively "Damages") incurred by such PictureTel Indemnitee as a result of or incident to (i) any breach of any representation or warranty of Starlight set forth in the Plan of Merger or in any certificate or other document delivered in connection with the satisfaction of its closing conditions (as such representation or warranty would read if all qualifications as to knowledge and materiality and were deleted from it) with respect to which a claim for indemnification is brought by a PictureTel Indemnitee within the applicable survival period described above, (ii) any breach or nonfulfillment by Starlight, or any noncompliance by Starlight with, any covenant, agreement, or obligation contained in the Plan of Merger or in any certificate or other document delivered in connection with the satisfaction of its closing conditions, (iii) any claim by a holder or former holder of the capital stock of Starlight or options, warrants or other securities convertible into or exercisable for shares of the capital stock of Starlight (the "Convertible Securities") or any other person or entity, seeking to assert, or based upon: (A) ownership or rights of ownership to any shares of the capital stock of Starlight; (B) any rights under Convertible Securities, preemptive rights, or rights to notice or to vote; (C) any rights under the Amended and Restated Articles of Incorporation or By-laws of Starlight; (D) any rights of a shareholder arising under the appraisal rights provisions of the CCC; or (E) any claim that his, her or its shares were wrongfully repurchased by Starlight. PictureTel has agreed to indemnify the holders of Starlight Preferred Stock (other than PictureTel) (the "Starlight Indemnitees") after the Effective Time from and against any and all Damages incurred or suffered by the Starlight Indemnitees as a result of or incident to (i) any breach of any representation or warranty of PictureTel, PTC or Merger Sub set forth in the Plan of Merger or in any certificate or other document delivered in connection with the satisfaction of its closing conditions (as such representations or warranty would read if all qualifications as to knowledge and materiality were deleted from it) with respect to which a claim for indemnification is brought by such Starlight Indemnitees within the applicable survival period described above and (ii) any breach or nonfulfillment by PictureTel, PTC or Merger Sub, or any noncompliance by PictureTel, PTC or Merger Sub with, any covenant, agreement, or obligation of PictureTel, PTC or Merger Sub, as the case may be, contained in the Plan or Merger or in any certificate or other document delivered in connection with the satisfaction of their closing conditions (the "Stockholder Damages"). Notwithstanding anything to the contrary, the aggregate liability of PictureTel to the Starlight Indemnitees shall not exceed $1,000,000. Promptly after a PictureTel Indemnitee has received notice of or has knowledge of any claim by a person not a party to the Plan of Merger (a "Third Person") or the commencement of any action or proceeding by a Third Person, the PictureTel Indemnitee shall, as a condition precedent to a claim with respect thereto being made against the Escrow Funds, give the Stockholder Representative written notice of such claim or the commencement of such action or proceeding; provided, however, that the failure to give such notice will not affect the PictureTel Indemnitee's right to indemnification pursuant to the Plan of Merger with respect to such claim, action or proceeding, except to the extent that the Stockholder Representative has, or the holders of Starlight Preferred Stock have, been actually prejudiced as a result of such failure. If the Stockholder Representative notifies the Indemnitee within thirty (30) days from the receipt of the foregoing notice that he wishes to defend against the claim by the Third Person and if the estimated amount of the claim, together with all other claims made against the Escrow Fund that have not been settled, is less than the remaining balance of the Escrow Fund, then the Stockholder Representative shall have the right to assume and control the defense of the claim by appropriate proceedings with counsel reasonably acceptable to the PictureTel Indemnitee, and the Stockholder Representative shall be entitled to reimbursement out of the Escrow Funds for such defense. The PictureTel Indemnitee may participate in the defense, at its sole expense, of any such claim for which the Stockholder Representative shall have assumed the defense; provided, however, that counsel for the Stockholder Representative shall act as lead counsel in all matters pertaining to the defense or settlement of such claims, suits or proceedings, except that the PictureTel Indemnitee shall control the defense of any claim or proceeding that in the PictureTel Indemnitee's reasonable judgment could have a material and adverse effect on the PictureTel Indemnitee's business apart from the payment of money damages. The PictureTel Indemnitee shall be entitled to indemnification for the reasonable fees and expenses of its counsel for any period during which the Stockholder Representative has not assumed the defense of any 37 47 claim. Whether or not the Stockholder Representative shall have assumed the defense of any claim, neither the PictureTel Indemnitee nor the Stockholder Representative shall make any settlement with respect to any such claim, suit or proceeding without the prior consent of the other, which consent shall not be unreasonably withheld or delayed. It is understood and agreed that in situations where failure to settle a claim expeditiously could have an adverse effect on the party wishing to settle, the failure of the party controlling the defense to act upon a request for consent to such settlement within five business days of receipt of notice thereof shall be deemed to constitute consent to such settlement for purposes of these indemnification provisions, but shall not be dispositive of the amount of Damages as between the holders of the Starlight Preferred Stock and the PictureTel Indemnitee. Except as discussed below, after the Effective Time, all claims for indemnification by a PictureTel Indemnitee shall be paid solely from the Escrow Funds. To the extent that PictureTel, PTC, Merger Sub or the Surviving Corporation or another PictureTel Indemnitee makes a claim against the Escrow Funds pursuant to the Escrow Agreement, and such claim is paid in shares of PictureTel Common Stock, then for purposes of such payment, the shares of PictureTel Common Stock shall be valued at $9.00 The indemnification and accompanying limitations described above shall be the sole and exclusive remedy of the parties with respect to any and all matters, including Damages, arising out of, or relating to, the Plan of Merger or any certificate or other document delivered in connection with the Plan of Merger, except that such indemnification and accompanying limitations shall not be the sole and exclusive remedy of the parties with respect to (i) any claim based on fraud or intentional misrepresentation, (ii) any claim based on a breach by Starlight of the representation and warranty relating to its capitalization, (iii) any claim by the Starlight Indemnitees based on (A) either PictureTel's, PTC's or Merger Sub's termination of the Plan of Merger other than in accordance with the termination provisions of the Plan of Merger or (B) either PictureTel's, PTC's or Merger Sub's failure to consummate the Merger by November 30, 1998; provided, however, that all of the conditions to the requisite obligations of Starlight to consummate the Merger have been met as of such date, and (iv) any claim by a PictureTel Indemnitee based on (A) Starlight's termination of the Plan of Merger other than in accordance with the termination provisions of the Plan of Merger or (B)Starlight's failure to consummate the Merger by November 30, 1998, provided, however, that all of the conditions to the requisite obligations of PictureTel to consummate the Merger have been met as of such date. In addition to the foregoing, the Escrow Agreement provides that the Stockholder Representative is entitled to indemnification from the holders of Starlight Preferred Stock. ESCROW Immediately prior to the Effective Time, PictureTel, the Stockholder Representative and the Escrow Agent will enter into the Escrow Agreement. In order to secure the indemnification obligations of the holders of the Starlight Preferred Stock under the Plan of Merger, 158,293 of the shares of PictureTel Common Stock which the holders of Starlight Preferred Stock are entitled to receive in the Merger will be withheld and deposited in escrow for twelve months in accordance with the terms of such Escrow Agreement. While the Escrow Shares remain in the Escrow Agent's possession pursuant to the Escrow Agreement, the holders of the Starlight Preferred Stock will retain and will be able to exercise all other incidents of ownership, including voting rights, of said Escrow Shares which are not inconsistent with the terms and conditions of the Escrow Agreement and PictureTel will take all reasonable steps necessary to allow the exercise of such rights. Under the terms of the Escrow Agreement, the holders of Starlight Preferred Stock will indemnify, defend and hold the Stockholder Representative from and against any loss, damage, tax, liability and expense that may be incurred by the Stockholder Representative arising out of or in connection with his or her acceptance of the appointment and/or the performance of his or her obligations as Stockholder Representative pursuant to the Escrow Agreement or the Plan of Merger, including the legal costs and expenses of defending against any claim or liability in connection with his performance pursuant to the Escrow Agreement or the Plan of Merger, except as caused by the willful misconduct of the Stockholder Representative. The foregoing indemnification obligation will be several and not joint and will be pro rata among the holders of Starlight Preferred Stock, and to the extent permitted by the indemnification provisions of the Escrow Agreement, the 38 48 Stockholder Representative will be entitled to offset any such indemnification amount by directing the Escrow Agent to transfer Escrow Shares from the account of the holders of Starlight Preferred Stock to the account of the Stockholder Representative. The holders of Starlight Preferred Stock will have the right to remove the Stockholder Representative and, upon such removal or, in the event of the Stockholder Representative's death or resignation, to appoint a new Stockholder Representative at any time and from time to time during the period when any shares are held in escrow, by a vote of holders of Starlight Preferred Stock holding a majority-in-interest in the Escrow Shares held in escrow at such time, evidenced in each case by a writing executed by such holders of Starlight Preferred Stock. The discussion in this Information Statement/Prospectus of the Escrow Agreement and the terms and conditions of the Escrow Agreement are subject to and qualified in their entirety by reference to the form of Escrow Agreement, a copy of which is attached hereto as ANNEX C and is incorporated herein by reference. 39 49 BUSINESS OF PICTURETEL GENERAL PictureTel develops, manufactures, markets and services visual collaboration solutions. These solutions - systems and collaboration software that employ advanced video and audio compression and interactive data technologies -- allow users to conduct face-to-face meetings at a distance with cost and convenience similar to the telephone. Visual collaboration sessions may be held between two locations or, using a multi point bridge, among multiple locations. PictureTel's compression technology permits the transmission of "full-motion" color video with integrated, full-duplex and high-fidelity audio at data rates as low as 56 kbps. By operating over such low speed switched digital lines, PictureTel's systems reduce the cost and increase the flexibility of videoconferencing. In addition to providing visual collaboration solutions for use over switched digital lines, PictureTel also offers those solutions for use over Internet Protocol ("IP") networks. While high-speed (e.g., 2 to 6 Mbps) collaboration sessions can operate over dedicated (i.e. non-dialed) lines, the per-minute usage cost can range from 10 to 100 times higher than PictureTel solutions designed for use over switched digital lines or IP-based networks. PictureTel offers a range of visual collaboration solutions for group and personal use, as well as multipoint bridges for multi-location conferencing and a full suite of services. PictureTel sells its products through a number of telecommunication and personal computer distribution channels in the United States and internationally, as well as through a direct sales force. See ANNEX D of this Information Statement/Prospectus for definitions of technical terms used in the description of PictureTel's business. PictureTel was incorporated in Delaware in 1984. PictureTel's principal executive offices are located at 100 Minuteman Road, Andover, Massachusetts 01810 (Telephone: (978) 292-5000). INDUSTRY BACKGROUND The driving force behind the visual collaboration systems market is the customer's objective to achieve effective face-to-face collaboration at a distance, 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 among workers in geographically separate sites via telephone, facsimile or electronic mail. Less frequently, individuals travel to a common site to meet and exchange information that cannot be transferred effectively by other collaboration technologies. These common site meetings maximize the exchange of information as visual, written, verbal and non-verbal collaboration occur real time, face-to-face. Visual collaboration solutions can improve worker productivity and reduce costs by eliminating or reducing travel. In addition to cost savings, visual collaboration solutions collapses the cycle time of key business processes. For example, visual collaboration solutions can hasten the decision-making process by reducing the time needed to exchange information between geographically dispersed work groups. Visual collaboration also allows customers to leverage scarce personnel resources located at a distance from co-workers who need their expertise. Initial generations of visual collaboration systems 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 significant visual communications requirements between geographically separate locations. Despite broad market interest, 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 and consideration of visual collaboration systems. These factors include the rapid growth of world-wide switched digital telephone services, the development of high speed switched local area computer networks, the development of corporate intranets, the unprecedented growth of the worldwide Internet and decreasing costs of these network services. Technological improvements in both audio and video quality, interactive data collaboration and the availability of lower cost, easy to use turnkey visual collaboration systems, as well as the steady increase in personal computer processing power, have elevated the appeal of visual collaboration systems. 40 50 Global connectivity, which is the ability to call any location without special equipment or arrangements, is a key reason for the popularity and wide use of the common telephone. 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 kbps 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 112kbps or 128 kbps, i.e., two multiplexed 56 kbps 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, i.e. two multiplexed 64 kbps lines. PictureTel's videoconferencing systems are fully compatible with one another whether used within the United States or internationally. PictureTel's products support common standards - for example, H.320 for switched digital networks and H.323 for IP networks -- and are interoperable with other standards -- 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 a U.S. ISDN dial-up network typically costs less than a local cellular phone call, while calls at 384 kbps cost less than twice as much as a cellular call. 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 or "encode" 90 Mbps of information contained in a television video signal down to as little as 20 kbps (an approximate 4,000- to-1 compression ratio) for transmission over various telephony and computer networks. Algorithms also decompress or "decode" the same signal for display at the receiving end. The compression algorithms help to achieve acceptable picture quality, as well as full duplex audio and data interactivity. 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 VLSI chip technology, videoconferencing systems have steadily declined in price as components have become smaller and systems more integrated, while simultaneously offering greater functionality to the user. Since the introduction of turnkey systems, videoconferencing products have become more convenient to purchase and utilize. 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 many cases, the need for trained specialists to operate the equipment. New networks expand the possibilities and reach of visual collaboration. The H.324 standard, for example, supports videoconferencing over POTS networks. This approach reduces the cost of a video call to that 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 visual collaboration is below that 41 51 required for normal business usage, but it is adequate for home use and for business travel (e.g. placing a video call from a hotel room). 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. PictureTel has several interoperable products for visual collaboration over LANs using the H.323 standard. The main advantage of LAN visual collaboration is that it removes the need to bring ISDN connections to every desktop by leveraging the network cable that is already connected to each PC. With H.323-to-H.320 gateways, visual collaboration systems in a LAN can communicate with any ISDN system. The Internet has also been emerging as a network for visual collaboration in two forms: first, as a way to interconnect geographically dispersed LANs within the same corporation, i.e. via intranets, which usually involves high-speed portions of the Internet being used to maintain an adequate bandwidth and quality of service; second, as a direct connection among computers or videoconferencing terminals connected to the Internet, although users generally experience low quality and with frequent dropouts in video and audio. Nonetheless, Internet visual collaboration allows for the lowest possible connection cost. For example, for the price of a local phone call long-distance, including international, video calls can be placed. Several products for Internet visual collaboration have been introduced in recent years, including Microsoft's NetMeeting(TM), which incorporates PictureTel application sharing technology. TECHNOLOGY Proprietary PictureTel'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. A standard broadcast video signal, when digitized, is comprised of roughly ninety million bits of information per second. Transmission of this amount of data is costly and, in many applications, it is not necessary to send one hundred percent of the bits in order to recreate an acceptable representation of the original video signal. The purpose of a video compression algorithm is to reduce the amount of information required to describe a sequence of digitized images, including the movements of objects within each frame, 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 how smoothly objects move and the types of visual distortions or artifacts introduced by the compression algorithm. Since its inception, PictureTel 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(TM), which was the first commercially available product using motion-compensated discrete cosine transform video compression technology. In 1988, PictureTel introduced HVQ(TM), hierarchical vector quantization, a more advanced compression technique which, among other improvements, replaced the discrete cosine transform in MCT with a multi-resolution pyramid and a vector quantizer. PictureTel's third generation algorithm, SG3(TM), which PictureTel first shipped in 1991, further advanced low bandwidth video compression technology. SG3 replaced the vector quantizer in HVQ with a more efficient version. SG3 was also the first commercial product to incorporate background estimation, which dramatically improves picture quality in scenes where objects frequently include complex backgrounds. The SG3 background estimator permits SG3 to dedicate more bandwidth to coding moving objects by storing views of non-moving objects at the receiving end that need not be retransmitted. PictureTel 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 in 1985. SG3 uses the additional bandwidth beyond 80 kbps available on a 112 kbps or higher data rate network to provide higher quality video and audio transmission. 42 52 PictureTel's latest video compression algorithm, SG4(TM), introduced in 1995 in the Concorde(TM) 4500 platform, incorporates several improvements over SG3. The most important advancements are improved encoding of the motion vectors, resulting in smoother motion rendition, and the PicturePlus(TM) video enhancement system, which compensates for variations in the video quality caused by poor lighting conditions and camera noise. Furthermore, SG4 transmits compressed data using the ITU H.221 protocol standard which allows multi point conferencing with SG4 video quality through standard H.320 MCUs. PictureTel has invested significant resources to develop state of the art audio compression and echo cancellation technologies in order to produce a more "natural" sound in its videoconferencing systems. PictureTel 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 fidelity improved to 3.5 KHz, comparable to regular telephone audio quality. PictureTel's 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 7.0 KHz audio fidelity is similar to the difference between sound on AM and FM radios. Today, nearly all of PictureTel's products use an improved audio compression technology, the patented PT724(TM), which delivers wideband 7.0 KHz audio in only 24 kbps bandwidth. PT724 compatible products automatically select PT724, freeing up as much as 39% more bandwidth in a 112 kbps call for the compressed video stream, which substantially improves video quality. An effective face-to-face meeting requires full-duplex audio capability. Unfortunately, videoconferencing system speakerphones pick up sounds from people at the remote site as well as sounds from the far end reproduced by the videoconferencing system's loudspeaker. If nothing were done, these combined sounds would be transmitted back to the remote site, where participants would hear an echo of their voices. Acoustic echo cancellation technology attempts to remove from the microphone signal all vestiges of sounds originating from the remote loudspeaker, while passing through to the far end all other sounds in the room, thus eliminating the acoustic echo. 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 per round trip over low speed channels, i.e. 128 kbps or less. Commercially available echo cancelers historically operated at telephone bandwidths, i.e. 3.5 KHz. Therefore, PictureTel developed IDEC(TM), its patented echo cancellation technology, which substantially eliminates all echo feedback and is standard in all of PictureTel's group and personal videoconferencing system products. IDEC has been steadily refined and improved since its introduction. Introduced by PictureTel in 1996, LimeLight(TM) microphone array, which is integrated with PictureTel's PowerCam(TM) camera and placed on top of the videoconferencing system's video monitor, brings a new level of sophistication and comfort to videoconferencing. Using just four microphones, LimeLight's proprietary signal processing algorithms locate, in three dimensions, the person who is currently speaking. The localization information is used to automatically control the pan, tilt, and zoom of PowerCam to optimally frame a "head and shoulders" view of such person. LimeLight also employs intelligent decision-making algorithms in order to frame multiple persons who engage in a conversation. In 1994, PictureTel introduced its LiveLAN(TM) product for LAN visual collaboration. Besides audio and video compression technologies, LiveLAN introduced additional components to accommodate 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 loss. Appropriate management protocols were also introduced to allow network managers to control and limit video traffic within any segment of their networks. In 1997, the LiveLAN and LiveGateway(TM) products were modified to support the ITU-T 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 multi point control units 43 53 ("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 such signals, 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 on 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 collaboration 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 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, i.e. 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 defined the initial proposals for a new standard, T.120, which was subsequently approved in 1995. PictureTel actively participated in the ITU-T discussions developing the T.120 standard. 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. PictureTel is currently incorporating this standard in its group, personal and network products. The application sharing technology for computer application sharing, jointly owned by PictureTel and Microsoft Corporation, has also been added to the ITU-T T.120 suite of products. As technological evolution enables other networks besides ISDN to effectively handle videoconferencing signals, new standards are emerging to define the protocols for such networks. PictureTel maintains a strong level of participation in the ITU-T, and has been a leader in many recent standardization efforts. In particular, an employee of PictureTel recently participated in the editing of the H.324 standard for POTS multimedia conferencing, which was initially approved by the ITU-T in November of 1995, and is a major technical contributor of the H.323 standard for LAN videoconferencing, the first version of which was determined by the ITU-T in 1997. PictureTel employees also hold key leadership positions within the videoconferencing industry's most prominent standard bodies, such as the ITU-T, ANSI (American National Standards Institute), and the IMTC (International Multimedia Telecommunication Consortium). The H.320, H.323 and H.324 standards incorporate technologies that have been developed and patented by codec manufacturers, including PictureTel and certain of its competitors. These codec manufacturers have agreed with the ITU-T to grant licenses, on a non-exclusive non-discriminatory basis and on fair and reasonable terms, to all manufacturers who agree to comply with these standards. PictureTel has already obtained several of these licenses upon reasonable terms and believes that it will obtain all other necessary licenses at reasonably low royalty rates. PRODUCTS PictureTel develops and manufactures the products listed below for the visual collaboration market. They range from high-end group systems for multiple locations to personal systems for one-on-one visual collaboration. PictureTel also offers products that complement these systems, such as multipoint bridges and various software options and peripherals. 44 54 Group Systems PictureTel 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 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 speakerphone, speakers, and associated audio electronics which facilitate echo cancellation, noise suppression, and gain control. The user interface is comprised of a keypad and on-screen menus that assist in placing a call and managing the videoconferencing event 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 at data rates ranging from 56 Kbps up to T1, or 1.544 Mbps, and E1, or 2.048 Mbps, as well as direct connect BRI or PRI interfaces for ISDN networks. PictureTel's Performance, Value, and Compact Group Systems are interoperable and, collectively, range in U.S. list price from $6,995 to in excess of $40,000, thereby 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. The current U.S. list prices range from $35,000 to in excess of $50,000 on a fully configured basis. The Concorde 4500ZX, introduced in April, 1995, is PictureTel's flagship product. The standard Concorde 4500ZX system includes an infrared-based keypad, camera and Look-At-Me-Button(TM) (LAMB), which is a unique device to facilitate distributed control during a videoconference call. The Concorde 4500ZX also comes standard with a WorldCart(TM) supporting color NTSC or PAL display up to 32" in size and an integrated speaker system, optimized for voice and developed exclusively for PictureTel by BOSE Corporation. Each of the 4200ZX and the Concorde 4500ZX systems offers 30 frames per second performance. This feature provides "30 frames per second quality" video at bandwidths starting as low as 256 Kbps and as high as 768 Kbps. In July 1996, PictureTel introduced a new feature, LimeLight(TM), on the System 4000 Family. Limelight, which is now standard on all Performance Group Systems is an automatic audio sensing intelligent camera positioning system. PictureTel continues to enhance the Performance Family with new user features. Value Group Systems. The Value Family is PictureTel's solution 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 Family is represented by the Venue(TM) 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, i.e. T1 or E1 speeds, and higher frame rates. The Venue Model products range in U.S. list price from $15,000 to approximately $30,000 for a fully loaded Venue Model. Compact Systems. In October, 1996, PictureTel introduced SwiftSite(TM), the industry's first Compact conferencing system. SwiftSite is a self-contained, optimized-for-simplicity system with a U.S. list price of $6,995. SwiftSite features ITU-T H.320 algorithms, as well as PictureTel proprietary enhancements. In addition, SwiftSite integrates a pan tilt zoom camera and a superdirective speakerphone into the self-contained unit, and includes the capability to download software over an ISDN link from PictureTel's Software Upgrade Server. SwiftSite heralds a new category of compact, group conferencing systems that offer simple, portable and affordable solutions to PictureTel customers. Systems for Desktop or Personal Meetings and Collaboration In 1993, PictureTel introduced the Live100(TM), a personal videoconferencing system designed for use with a personal computer or desktop product. The Live100 consists of a video board, audio board, camera, speakerphone and software. Utilizing the H.320 standard, the Live100 is interoperable with PictureTel's visual 45 55 collaboration and bridging products. Live100 also provides information sharing capabilities which allow users to simultaneously share files and applications while conducting a videoconference. The Live100 is designed to operate in ISA-bus or EISA-bus personal computer running Microsoft Windows 3.1(R) or Windows 95(R). The Live100 U.S. list price ranges from $4,995 to $5,495. In 1994, PictureTel shipped its LiveShare(TM) collaboration software with application sharing functionality that allows users to share files and interact on an application during a videoconference. In September 1994, PictureTel entered into the Local Area Network market with its LiveLAN family of products, which enable videoconferencing across a corporate LAN. The U.S. list price for these products ranges from $1,195 to $2,145. In 1995, PictureTel announced the Live50(TM) which complements the Live100. The product consists of a single audio/video board, a fixed focus camera, a speakerphone or headset and associated software. As with the Live100, the ITU-T H.320 compression standard is used, which provides interoperability with 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 Live100 which allows users to simultaneously share files while conducting a videoconference. The Live50 is designed to operate on an ISA-bus or EISA-bus personal computer running Microsoft Windows 3.1(R) or Windows 95(R). The Live50 U.S. list price ranges from $2,495 to $4,195. While the Live100 remains the high end member of the "Live" suite of products, offering greater flexibility in terms of network support and expansion options, the Live50 product line offers a more affordable solution for ISDN networks. In May, 1996, PictureTel shipped the Live200(TM). Unlike previous PictureTel desktop video products, the Live200 is a single board solution that utilizes the host computer's onboard or integrated graphics. The Live200 operates in PCI bus personal computers running Microsoft Windows 95(R). The Live200 consists of an audio/video board, camera, headset, speakers, speakerphone, and software. The Live200 U.S. list prices range from $1,195 to $2,535. In September, 1996, PictureTel began shipping its LAN family of products. The LiveGateway(TM) 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 and is an ISA bus board designed to run on a 486/66 or faster personal computer. The LiveGateway U.S. list price is $2,395. LiveLAN(TM), based on technology used in the Live200, enables a user to videoconference across an IP network using the H.323 standard. LiveLAN is sold as a plug-in kit with the same components as the Live200. LiveManager(TM) is a software application product 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 customer with both H.320 and H.323 systems. PictureTel has also launched follow-on releases which provide performance enhancements, such as full H.323 standards compliance, full CIF and full-screen video, wideband audio with echo cancellation, and support for the T.120 standard for multipoint data conferencing. In June, 1998, PictureTel entered into an agreement with Zydacron, Inc., for the design, engineering and manufacturing of PictureTel's next-generation PC-based visual collaboration products. PictureTel believes that this partnership will enable both Zydacron and PictureTel to expand the use of visual collaboration solutions worldwide. Under terms of the agreement, Zydacron will develop desktop videoconferencing products to PictureTel's specifications. These products, which will carry the PictureTel brand name, will be sold exclusively worldwide through PictureTel's direct and indirect sales channels. In addition, pursuant to the agreement, PictureTel became the exclusive distributor for the Zydacron OnWAN(R) desktop videoconferencing system. PictureTel expects that the addition of current and future Zydacron products to the PictureTel product line, along with the continuation of key PictureTel desktop products, will enable it to enhance its position in the desktop segment of the visual collaboration market by offering a greater variety of products with features and prices designed to appeal to a broader international customer base. 46 56 Server Based Products A number of hardware and software based products could be described as the "glue" that joins its visual collaboration systems products into a corporate-wide solution, commonly known as an "enterprise solution." Multi-location bridges and reservation and management systems software are the major components and expense attributed to enterprise solutions. These products deliver functionality that is "shared" among distributed visual collaboration systems throughout a network. Multi-location bridges enable videoconferences with more than two locations. Reservation and management systems allow conference rooms, bridging resources and network facilities to be scheduled and managed in advance of upcoming meetings directly from the PC. The Montage(TM) and Prism(TM) Conferencing Server product lines take advantage of "off-the-shelf" bridging hardware and incorporate differentiating software features unique to PictureTel, including PictureTel's proprietary compression algorithms SG4 and PT724. The base Montage Conferencing Server supports four sites in a multipoint conference and has a U.S. list price of $49,000. 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 participate in a single conference using a capability called cascading, which links multiple Montage servers together. A fully loaded Montage Model 570 has a U.S. list price of over $300,000. The Prism Conferencing Server is targeted at smaller conferencing groups and U.S. list prices range from $20,000 to $70,000. LiveScheduler(TM) 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, personnel and equipment, as well as videoconferencing network resources. Availability of sites, rooms, equipment, and even personnel, are depicted graphically to users through a GUI application based on the Windows operating system, while the LiveScheduler server analyzes the availability of required supporting resources, such as network equipment, multipoint bridge ports, and network bandwidth. The server can communicate simultaneously with many globally dispersed clients, whether connected over a LAN or by dial-up modem, and process all requests for meetings and schedules. Used in conjunction with PictureTel's Montage and Prism multipoint bridges, LiveScheduler can automatically arrange and end a video conference by provisioning the required network and instructing the bridge to dial directly to the sites to be connected. LiveScheduler U.S. list prices range from $18,000 to $40,000. In April 1998, PictureTel introduced the PictureTel 330 NetConference(TM) multipoint server software, which permits multiple users to meet in virtual conference rooms and perform business-quality audio, video and data sharing over their existing corporate IP infrastructure or other IP network. PictureTel 330 NetConference, which is based on the H.323 international standard for IP-based videoconferencing, allows up to 24 clients, consisting of individuals or teams, to meet in virtual conference rooms to perform visual collaboration, as well as audio-only conferencing and data collaboration using T.120, the international standard for data conferencing. PictureTel 330 NetConference can be deployed over any IP-based network including LANs, intranets, extranets, Virtual Private Data Networks and the Internet. PictureTel 330 NetConference also features the NetConference Web-center, a pure Java(TM)-enabled Web page used to manage the conference rooms. PictureTel 330 NetConference is a key component of PictureTel's full suite of H.323 conferencing products, which includes LiveLAN, LiveManager, and LiveGateway. PictureTel believes that these products together comprise a comprehensive, practical, high-quality and affordable multimedia visual collaboration enterprise solution. The U.S. list price for PictureTel 330 NetConference multipoint server software starts at $12,995 for eight-seat configurations and $23,995 for 24-seat configurations. Software PictureTel's group and personal visual collaboration systems are software based and can be upgraded by the customer using standard floppy diskettes or a removable memory cartridge, or remotely via server and modem. PictureTel also sells a developer toolkit, DTK(TM), which contains a set of software components 47 57 designed to give programmers an interface to major functions for set up and control of video, audio, windowing, data transfer, configuration and network communication. Options and Peripherals All 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 for the conference rooms and video cassette recorders. RESEARCH AND DEVELOPMENT PictureTel expects visual collaboration applications to become increasingly common in today's conference rooms, on desktop PCs, and as personal videophones, helping to fill the gap between voice telephony and in-person conversation. PictureTel believes that decreased size, lower cost and increased functionality will characterize future product generations. PictureTel also believes that as videoconferencing and collaboration expand beyond group meetings into the personal communications segment of the market, success will be dependent on the further development of compatible, interworking end-to-end components. Today, the vast majority of business class videoconferences are conducted using synchronous switched digital circuit networks, with the majority of the balance employing asynchronous packet switched Internet Protocol (IP) networks such as corporate LANs, intranets, Internet Service Provider networks and the Internet. PictureTel anticipates that the mix between switched and packet networks will steadily shift to IP over the next few years. PictureTel continues to invest to expand the interfacing and interconnecting capabilities of its product lines to take advantage of both switched and packet networks during this transition period. While it is difficult to foresee the rate at which the market will make this transition, PictureTel believes the shift will be evolutionary, resulting in a "hybrid" networking environment where multi-protocol capable products will provide value to the customer. Just as it is desirable for users to perceive wireless and wired telephones as being attached to the same network, PictureTel believes its customers will value products which make possible videoconferences over hybrid networks. PictureTel sees value in delivering to the market directly and through its channel partners a comprehensive portfolio of "front end" conference room and desktop products, together with "back end" MCU server products which have been integrated and tested worldwide over hybrid networks. Research and development investments continue to focus on designing, integrating and testing these products to deliver an end-to-end videoconferencing system that is reliable and easy to operate. For the six months ended June 28, 1998 and for the years ended December 31, 1997, 1996 and 1995, PictureTel spent $34,914,000, $86,775,000, $72,900,000 and $54,009,000, respectively, on research and development, including capitalized software costs. PictureTel had 427 full-time employees in research and development at September 1, 1998. PictureTel has entered into joint development agreements with Microsoft, NTT and others for product and software development that will further expand the market for desktop videoconferencing products. These partners retain non-exclusive rights under license from PictureTel to distribute the products that result from the joint development work. SALES PictureTel currently distributes its products worldwide via a direct sales force and indirect channels of distribution. As the market for videoconferencing systems expands, PictureTel expects to increase its reliance on joint selling and distribution through a combination of transmission carriers, telecommunication equipment distributors, personal computer distributors and resellers, value-added resellers, and has currently developed relationships with corporations in each of these indirect channels. In 1997, PictureTel derived approximately 26% of its worldwide product revenues from direct selling activities, and 74% from indirect channels. At 48 58 June 28, 1998 and December 31, 1997 and 1996, PictureTel had a product backlog of approximately $6,384,000, $15,700,000 and $12,481,000, respectively. Backlog consists of purchase orders for which a delivery schedule within six months of order 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 500(R), which is the largest product and service businesses in the United States as published annually by Fortune magazine, and expand PictureTel's presence in the Fortune 500 market, PictureTel has historically increased the number of telecommunication equipment distributors, regional Bell Operating Companies ("RBOCs"), value-added resellers ("VARs") and dedicated dealers who distribute PictureTel's products. Telecommunications distributors, or interconnects, act as dealers for PictureTel 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 corporations. 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 500 corporations, PictureTel has entered into distribution agreements with Lucent Technologies, Inc., CompuCom, MCI, GTE, Southwestern Bell, Ameritech, Pacific Bell, and Ingram Micro. Recently, PictureTel has created a second tier of distribution, consolidating a number of its smaller resellers and partners under one larger distributor. PictureTel believes that as system prices decrease additional applications for sales to vertical markets, such as distance learning, telemedicine and remote interviewing, may develop. VARs typically have expertise in a particular market which PictureTel would plan to utilize to stimulate its Applications Developers Program. Under this program, PictureTel sells to developers, VARs, original equipment manufacturers and systems integrators its Video Modem(TM) products and the DTK. These products together 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 Live100, Live50 and Live200 products, PictureTel continued to develop relationships with established personal computer distributors and VARs. Direct Sales Organization. PictureTel directly markets its videoconferencing systems principally to Fortune 500 corporations. These large corporation typically have multiple locations in the United States and internationally, and typically specify a single vendor to supply equipment on a world-wide basis. PictureTel 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. PictureTel 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. International Distribution Outside of the United States PictureTel relies on a network of foreign market distributors and its international subsidiaries. Agreements with PictureTel's foreign market distributors generally provide for pricing, volume discounts, order lead times, 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. PictureTel has operating subsidiaries in 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 Telegraph & Telephone (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 accounted for in U.S. dollars in order to minimize the risks associated with fluctuating foreign currency rates. Sales by PictureTel's operating subsidiaries to customers are generally made in the subsidiary's local currency. 49 59 PictureTel's revenues from sales to foreign markets represented approximately 45%, 43%, 44%, and 42% of PictureTel's total revenues for the six months ended June 28, 1998 and for the years ended December 31, 1997, 1996, and 1995, respectively. Additional information with respect to PictureTel's international business is included in Note 11 to the Consolidated Financial Statements included elsewhere in this Information Statement/Prospectus. ENTERPRISE SERVICES DIVISION PictureTel believes that the quality and reliability of its systems and services is important to customer satisfaction. Accordingly, PictureTel's Enterprise Services Division is ISO9002 registered and expects to continues to maintain its certification. PictureTel also regularly measures customer satisfaction and strives to implement corrective actions to improve the quality of its service. The delivery of service is backed by PictureTel's certification program, which tests and certifies the technical abilities of all support personnel dealing with videoconferencing products. PictureTel provides warranty support for parts and software media on the majority of its products. The warranty period is generally one year for hardware, ninety days for software media, and ninety days for repaired parts. The estimated expenses related to warranty services are accrued at the time of revenue recognition. PictureTel assists customers in implementing and managing their technology on a global basis through a comprehensive portfolio of maintenance, professional and conference services, which together address each phase of the product life cycle. Professional services include consulting, design and project management services. Consulting services provide planning and needs analysis to customers. Design services, such as room design and custom solutions, provide customized videoconferencing solutions to meet each customer's unique requirements. Project management, installation and training provide customers with effective implementation of videoconferencing systems. For the on-going operation of customers' videoconferencing environment, PictureTel provides conference services and maintenance services. Conference services facilitate the customer's use of the videoconferencing technology by providing conference room scheduling, call launching, bridging and end-to-end problem resolution during conferences. These services are delivered for point-to point, as well as multipoint conferences on a global basis. All services are sold both directly to customers and through PictureTel's distributors. Service programs for local and international distributors range from reselling PictureTel's service offerings to providing back-end support for servicing end-users. All maintenance services are delivered on a world-wide basis from several integrated global support centers located in the United States, United Kingdom, Singapore, and Japan. Spare parts are stocked around the world to meet response time commitments to customers and distributors. PictureTel utilizes direct field service staff as well as distributors and third party service providers to perform installation and on-site repairs. Conference services are delivered from geographically distributed Network Operations Centers located in the United States, United Kingdom, and Singapore. PictureTel delivers professional services and training through consultants, project managers and instructors. In addition, PictureTel offers electronic support via the World Wide Web. PictureTel's revenues from services represent approximately 11% of the total revenues for the year ended December 31, 1997. COMPETITION The visual collaboration industry is intensely competitive and is characterized by extensive research and development efforts that continue to introduce technologically advanced products on an accelerated basis. In order for PictureTel to maintain its market leadership in the visual collaboration industry, it must continue to develop, market and sell innovative, technologically advanced and cost-competitive products through internal development or by acquisition. For example, PictureTel and its competitors have recently begun exploring new technologies and networks, such as the Internet and corporate intranets or LANs, for delivering visual collaboration products and services. There can be no assurance that PictureTel will be successful in selecting, developing, manufacturing and marketing new products with attractive margins for these new technologies and networks or enhancing its existing products for these and other applications. Further there can be no assurance that PictureTel will be able to respond effectively, if at all, to technological changes, new standards or product announcements by competitors. The failure to do any of the foregoing may have a material adverse effect on PictureTel's business financial condition and results of operations. Moreover, unforeseen technical or other 50 60 difficulties may interfere with the development or production of new or enhanced products, or prevent or create delays in marketing such products. In its established businesses of group systems and desktop systems, PictureTel competes with a number of larger corporations, such as Sony and Intel Corporation. In the developing businesses of network-based visual collaboration systems and compact systems, a number of new corporations have begun to offer competitive products. In addition, a number of PictureTel's competitors have pursued and are continuing to pursue a strategy of partnering with or acquiring corporations which develop and market network-based visual collaboration products. The partnering with or acquisition of such corporations allows PictureTel's competitors to offer new products without the lengthy time delays associated with internal product development. As a consequence, competitors are able to more quickly meet the demand for advanced network-based visual collaboration products. The greater resources of the competitors engaged in these partnerships and acquisitions may permit them to accelerate the development and commercialization of new competitive products and the marketing of existing competitive products to their larger installed bases. There is significant competition among PictureTel and its competitors for the partnering and/or acquisition of corporations possessing such advanced technologies. The greater resources of PictureTel's current and potential competitors will enable them to compete more effectively for the partnering and/or acquisition of such corporations. Further, the industry standards for such network-based technology are still in the early stages of development, which PictureTel believes has led to customer uncertainty and, accordingly, a slowdown in the growth of the general market for visual collaboration products. This increased competition resulting from such partnerships and acquisitions, together with mergers among competitors and a slowdown in the growth of the general market for visual collaboration products, has led and may continue to lead to increases in the defection or dilution of PictureTel's distribution channel partners to competitors, decreases in average selling prices and margins in both group and desktop visual collaboration systems, and a lower segment market share by PictureTel for products and services in the emerging area of network-based visual collaboration. In some cases, PictureTel competes with its channel partners for various services, which increases the complexity of channel management. In addition, corporations such as Microsoft Corporation or Intel Corporation, respectively, may offer network-based visual collaboration software solutions or incorporate standard algorithms into processor chips free of additional charge, which may reduce the value PictureTel technology provides to the market, especially in its lower end visual collaboration products. In addition, the prices which PictureTel is able to charge for its visual collaboration products and services may further decrease from historical levels as a result of new product introductions by competitors, price competition, technological advances, or otherwise. Any of these factors could have a material adverse effect on PictureTel's business, financial condition and results of operations. Some of the corporations which now offer competing products, such as Intel Corporation, Philips Corporation and Sony Corporation, have significantly greater financial and other resources than PictureTel. PictureTel, however, competes primarily on the basis of video and audio quality and data collaboration, as well as on favorable features, support services and the pricing of those systems and services. PictureTel believes that its products are competitive in each of these areas. MANUFACTURING PictureTel has developed a supply chain management system that encompasses PictureTel's subassemblies and products supplied by vendors to the delivery of finished goods to the customer. This system has resulted in cost effective and timely delivery of products to PictureTel's customers. This system also allows PictureTel to reduce costly investment in manufacturing capital and to leverage the expertise of its vendors. PictureTel's manufacturing operations consist 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 all functional requirements are met. 51 61 Desktop hardware products are purchased in final form from various vendors. The products are subjected to PictureTel's quality testing at the vendor site and are placed into inventory and shipped according to demand. Certain components and parts used in PictureTel's products are procured from a single source. PictureTel decided in these limited circumstances to 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 PictureTel's delivery of products, which could materially adversely affect PictureTel's business, financial condition or results of operations. In 1996, PictureTel opened a European Distribution Center (EDC) in Holland to centralize shipments to its customer base in Europe. PictureTel has sourced components from local vendors in Europe to support proper stocking levels at the European Distribution Center and to maintain timely customer shipments. The EDC incorporates the same working relationships and policies with vendors in Europe as PictureTel currently employs in the United States. PATENTS AND COPYRIGHTS PictureTel's proprietary 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. This proprietary technology is incorporated in software and hardware configurations for use in PictureTel products and unique product designs. PictureTel has been issued a number of United States patents relating its proprietary technology which expire at various dates from 2004 to 2018. PictureTel 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 as necessary. There can be no assurance that its current patents or any additional patents that may be issued in the future will protect against misappropriation or provide broad protection against the development of similar product technology by competitors. In the absence of broad patent protection, and despite the PictureTel's reliance upon its proprietary confidential information, competitors of PictureTel may be able to develop and implement algorithms similar to those used by PictureTel to design and manufacture products that are directly competitive with PictureTel's products. In addition, the laws of some foreign countries do not protect PictureTel's proprietary rights to the same extent as do the laws of the United States. No assurance can be given that any patents issued to PictureTel will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages. PictureTel also protects its copyrightable software and related technology under U.S. and foreign copyright laws by placing appropriate copyright notices that comply with provisions of the U.S. copyright treaties and by entering into written agreements with its licensees. EMPLOYEES At September 1, 1998, PictureTel had 1,401 full-time employees, of whom 402 were employed in sales, marketing and customer support, 427 in product development and engineering, 141 in manufacturing, 123 in administration and finance and 34 in human resources and facilities. PictureTel had 274 employees in foreign countries at September 1, 1998. PictureTel'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 PictureTel's employees are represented by a labor union. PictureTel believes its relations with its employees are good. PROPERTIES PictureTel's corporate offices and research, development and manufacturing facilities are located in five leased facilities in Andover, Massachusetts, aggregating approximately 903,200 square feet, and one facility in Chelmsford, Massachusetts, aggregating approximately 51,200 square feet. The lease at 100 Brickstone in Andover, Massachusetts expires in June, 1999. The lease at 6 Riverside Drive in Andover, Massachusetts 52 62 expires in July, 2007. The lease at 100 Minuteman Road in Andover, Massachusetts expires in July, 2014. The lease at 50 Minuteman Road in Andover, Massachusetts expires in October, 2015. In June, 1998, the property at 50 Minuteman Road was subleased for a period of ten years. In March 1997, PictureTel entered into an agreement to lease an additional facility at 200 Minuteman Road in Andover, Massachusetts. The lease at 200 Minuteman Road in Andover, Massachusetts, commences on October 2, 1998 and will continue for a period of eighteen years. The lease will be accounted for as a capital lease. PictureTel is considering alternatives other than occupancy for the property at 200 Minuteman Road, since current staffing levels do not support the requirement for this facility. The lease in Chelmsford, Massachusetts expires in December, 2002. PictureTel also leases office space for its nineteen regional and branch sales and support offices in the United States and for similar offices of its subsidiary and branch operations worldwide. LEGAL PROCEEDINGS Datapoint Litigation In December 1993, PictureTel was sued by Datapoint Corporation in the United States District Court for the Northern District of Texas. Datapoint alleged that certain of PictureTel's products infringed patent rights allegedly owned by Datapoint. Datapoint has been joined as plaintiff by John Frassanito and David Monroe, two individuals who claim to have rights to Datapoint's patents. The matter went to trial on March 16, 1998. On April 9, 1998 a jury returned a verdict in favor of PictureTel finding that PictureTel did not infringe the Datapoint patents and that the Datapoint patent claims raised against PictureTel were invalid. Datapoint has appealed these findings and there can be no assurance that the outcome of the appeal will be in favor of PictureTel. PictureTel believes that it has meritorious defenses to the appeal. Shareholder Litigation Since September 23, 1997, seven class action shareholders' complaints have been filed against PictureTel, Norman E. Gaut, the former Chairman of the Board and Chief Executive Officer, and Les Strauss, the former Vice President and Chief Financial Officer, in the United States District Court for the District of Massachusetts. The plaintiffs, 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. These plaintiffs have consolidated their complaints into one lawsuit and filed a consolidated complaint on February 11, 1998, encaptioned In re PictureTel Corporation Securities Litigation, Civil Action No. 97-12135-DPW. The original complaints were filed following PictureTel's announcement on September 19, 1997 that it would restate its financial results for the first quarter of the fiscal year ended December 31, 1997 and the last two quarters of fiscal year ended December 31, 1996, and were amended when PictureTel announced on November 13, 1997 that it would also restate the second quarter of the fiscal year ended December 31, 1997. The consolidated complaint alleges that PictureTel and Messrs. Gaut and Strauss violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder, during the period from October 17, 1996 through November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the price of the PictureTel Common Stock. The consolidated complaint seeks to recover an unspecified amount of damages, including attorneys' and experts' fees and expenses. On April 7, 1998, PictureTel filed a motion to dismiss the complaint. The Plaintiffs filed an amended complaint in response to PictureTel's motion to dismiss. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. 53 63 NV Holdings, Inc. On February 13, 1998, NV Holdings, Inc., filed a complaint in the State District Court for Dallas County, Texas, NV Holdings, Inc. v. PictureTel Corporation, Cause No. DF 98-01404, alleging against PictureTel tortious interference with both business advantage and existing contracts as well as business disparagement and slander. While the plaintiff has listed no specific damages, it is seeking an injunction and $20,000,000 in punitive damages. PictureTel believes that it has meritorious defenses to the allegations of the complaint filed against it and is vigorously defending against the lawsuit and pursuing recovery under the following actions filed by PictureTel. PictureTel has filed three separate actions against parties that are believed, by PictureTel, to be related to NV Holdings, Inc.: (1) PictureTel Corporation v. NV Technologies, Inc. d/b/a NuVision Technologies, Inc., et al, Civil Action No. 98-337A, filed February 17, 1998 in the Superior Court for Essex County, Massachusetts, for False Advertising and Unfair Business Practices. On February 23, 1998, the court issued a preliminary injunction against NuVision Technologies, Inc. and all persons acting in concert, participation or combination with NuVision Technologies, prohibiting such parties from continuing to publish a certain advertisement that PictureTel alleges is false and misleading. On July 14, 1998, PictureTel sought leave of court to amend this complaint to include NV Holdings, Inc., and its subsidiary NuVision Technologies, Inc., of Nevada; (2) PictureTel Corporation v. NV Technologies d/b/a NuVision Technologies. Inc., Civil action No. 98-166-C, filed January 23, 1998, in the Superior Court for Essex County, Massachusetts, for Breach of Contract, seeking the repayment of approximately $4,000,000 from NuVision Technologies, Inc.; and (3) PictureTel Corporation v. Tandberg, ASA, NV Holdings, Inc., et al, Civil Action No. 3-98CV1449-R, filed June 7, 1998, in the United States District Court for the Northern District of Texas, for fraud, fraudulent conveyance and breach of contract and seeking repayment of $4,000,000 and unspecified punitive damages. Although discovery has begun with regard to these actions, PictureTel expresses no opinion as to the likely outcome of any of these matters. Revnet, Inc. On June 2, 1998, PictureTel was served with a complaint from a former distribution channel customer, Revnet, Inc., which has ceased operations. (Revnet, Inc. v. PictureTel Corporation. Civil Action 98092039, filed April 2, 1998, in the Circuit Court for Baltimore City, Maryland.) The complaint alleges that PictureTel breached an oral contract. Revnet is seeking $200,000,000 in damages. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. In addition to the above, PictureTel has also been and is from time to time subject to claims and suits incidental to the conduct of its business. There can be no assurance that PictureTel's insurance will be adequate to cover all liabilities that may arise out of such claims. Further, although PictureTel intends to defend itself vigorously against all such claims, the ultimate outcome of the claims cannot be accurately predicted. PictureTel does not believe that any claim of which it is aware, other than the claims listed above, could result in an outcome that will have a material adverse effect to its business, financial condition, results of operations or cash flows. 54 64 PICTURETEL -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion provides an analysis of PictureTel's financial condition and results of operations and should be read in conjunction with the "Selected Historical Financial Data" of PictureTel and the Notes thereto and the Consolidated Financial Statements and Notes thereto included elsewhere in this Information Statement/Prospectus. The discussion below contains certain forward-looking statements relating to, among other things, estimates of economic and industry conditions, sales trends, expense levels and capital expenditures. Actual results may vary from those contained in such forward-looking statements. See "Risk Factors." INTRODUCTION PictureTel develops, manufactures, markets and services visual collaboration solutions. These solutions -- systems and collaboration software that employ advanced video and audio compression and interactive data technologies -- allow users to conduct face-to-face meetings at a distance with cost and convenience similar to the telephone. Visual collaboration sessions may be held between two locations or, using a multipoint bridge, among multiple locations. Six Months Ended June 28, 1998 Compared to Six Months Ended June 29, 1997 Revenues. PictureTel's revenues decreased $34,273,000, or 14%, in the six month period ended June 28, 1998 compared to the six month period ended June 29, 1997. The decrease was primarily a result of decreased videoconferencing system unit shipments and a reduction in the average selling price of videoconferencing systems. Sales of group and desktop videoconferencing products accounted for 68% and 7%, respectively, of revenues for the six month period ended June 28, 1998 compared with 69% and 10%, respectively, for the six month period ended June 29, 1997. Desktop product revenue declined during the six month period ended June 28, 1998 due to lower average selling prices. In addition, sales of bridge products accounted for approximately 11% of PictureTel's revenues for the six month period ended June 28, 1998 and 12% for the six month period ended June 29, 1997. Revenues from service and maintenance agreements increased $5,806,000, or 25%, for the six month period ended June 28, 1998 compared with the six month period ended June 29, 1997. This increase was due to increased focus on the professional services business which began in the second half of the fiscal year ended December 31, 1997. Service revenues totaled 14% and 10% of total revenues for the six month period ended June 28, 1998 and the six month period ended June 29, 1997, respectively. PictureTel's revenues from sales to foreign markets totaled approximately $92,533,000 for the six month period ended June 28, 1998 compared with approximately $109,578,000 for the six month period ended June 29, 1997, representing 45% and 46%, respectively, of total revenues. Asian markets were primarily responsible for the decline. Fluctuations in the Asian currencies and general weakness in the Asian economies may continue to impact future international revenues. Gross Margin. PictureTel's gross margin declined $24,272,000, or 22%, in the six month period ended June 28, 1998 compared to the six month period ended June 29, 1997. Gross margin as a percentage of revenues was 42% for the six month period ended June 28, 1998 compared to 46% for the six month period ended June 29, 1997. Gross margin as a percentage of revenues decreased as a result of charges, totaling $6,808,000, recorded in the second quarter ended June 28, 1998, and a reduction in the average selling price of videoconferencing systems. Of these charges recorded in the second quarter ended June 28, 1998, $5,457,000 related to the write down of inventory and capitalized software to their net realizable value and other costs associated with the discontinuation of one of PictureTel's video network server product lines. In addition, inventory provisions of $1,351,000 were recorded to write down certain inventories to their net realizable value. The average selling prices of PictureTel's videoconferencing systems are expected to continue to decline and, accordingly, may have an adverse effect on future gross margins. Selling, General and Administrative. Selling, general and administrative expenses the six month period ended June 28, 1998 decreased $5,921,000, or 8%, from the six month period ended June 29, 1997, but increased as a percentage of revenues to 34% from 31%. The dollar decrease resulted primarily from efforts to 55 65 reduce PictureTel's cost structure which began during the last two quarters of the year ended December 31, 1997. Selling, general and administrative expenses as a percentage of revenues increased as a result of a $4,210,000 charge recorded in the second quarter of the fiscal year ending December 31, 1998, for unrecoverable leasehold improvements and furniture and fixtures related to the facility at 50 Minuteman Road in Andover, Massachusetts. PictureTel subleased this facility in June, 1998 for a ten-year term. Excluding this charge, selling, general and administrative expenses as a percentage of revenues would have been 31%. Research and Development. Research and development expenses decreased $9,841,000, or 24%, for the six month period ended June 28, 1998 compared with the six month period ended June 29, 1997, and were 15% and 17%, respectively, of revenues for the six month period ended June 28, 1998 and the six month period ended June 29, 1997. Research and development expenditures, prior to the capitalization of software costs, were $34,914,000 for the six month period ended June 28, 1998 and $45,101,000 for the six month period ended June 29, 1997, or 17% and 19% of revenues, respectively. PictureTel capitalized software costs of $3,397,000 for the six month period ended June 28, 1998 and $3,743,000 for the six month period ended June 29, 1997. PictureTel reduced the level of research and development investment during the six month period ended June 28, 1998 from the six month period ended June 29, 1997. PictureTel continues to evaluate the scope and direction of various programs and expects that the level of research and development for the remainder of 1998 will be comparable to or below that experienced during the six months ended June 30, 1998. There can be no assurance however, that management's initiatives to focus its research and development efforts will be successful or that any technologies will ultimately be successfully commercialized. Operating Loss. PictureTel posted an operating loss of $14,351,000 for the six month period ended June 28, 1998, compared with an operating loss of $5,841,000 for the six month period ended June 29, 1997. The operating loss results primarily from the lower revenues and the charges recorded in the second quarter of the fiscal year ending December 31, 1998. Excluding the charges, PictureTel generated an operating loss of approximately $3.3 million. Net Interest Income. Net interest income decreased to $1,001,000 for the six month period ended June 28, 1998 from $1,577,000 for the six month period ended June 29, 1997. The decrease was primarily the result of higher interest expense resulting from capital lease obligations. Other Income, Net. Other income, net of $329,000 for the six month period ended June 28, 1998, consists primarily of net gains on foreign currency transactions. Other income, net of $194,000 for the six month period ended June 29, 1997, consists primarily of net gains on foreign currency transactions and net gains on sales of securities. Income Taxes. PictureTel's effective tax rate for the six month period ended June 28, 1998 was 32% compared with 29% for the six month period ended June 29, 1997. The effective tax rate for the six month period ended June 28, 1998 differs from the federal statutory rate due primarily to state taxes offset by foreign taxes and research and development tax credits. The effective tax rate for the six month period ended June 29, 1997 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. At June 28, 1998, management believes it is more likely than not that the deferred tax asset will be realized. However, the realization of the net deferred tax asset is dependent on generating sufficient taxable income in future periods. The amount of the net deferred tax assets considered realizable could be significantly or completely reduced if taxable income is not generated in the near term. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Revenues. PictureTel's revenues for the year ended December 31, 1997 decreased $23,800,000, or 5%, from the year ended December 31, 1996. The decrease in revenue was primarily a result of decreased average selling prices in all product lines, particularly in the Group Systems products as a result of increased competition. This decrease was partially offset by increased shipments of the Group Systems videoconferencing systems. Videoconferencing system sales accounted for approximately 78% and 80% of PictureTel's revenues for the fiscal years ended December 31, 1997 and December 31, 1996, respectively. Sales of group and desktop videoconferencing products accounted for 69% and 9%, respectively, of revenues for the year 56 66 ended December 31, 1997, compared with 65% and 15%, respectively, for the year ended December 31, 1996. In addition, sales of bridge products accounted for approximately 11% of PictureTel's revenues for the year ended December 31, 1997 compared to approximately 13% for the year ended December 31, 1996. For the year ended December 31, 1997, revenues from service and maintenance agreements increased $10,204,000, or 26%, from the year ended December 31, 1996. Service revenues totaled 11% and 8% of total revenues for the fiscal years ended December 31, 1997 and December 31, 1996, respectively. The balance of the revenues for the fiscal years ended December 31, 1997 and December 31, 1996 were primarily from licensing/development agreements and the sales of stand-alone codecs and video modems. PictureTel's revenues from sales to foreign markets were approximately 43% and 44% of total revenues, for the fiscal years ended December 31, 1997 and December 31, 1996, respectively. PictureTel expects that international revenues will continue to account for a significant portion of total revenues. Gross Margin. PictureTel's gross margin decreased $48,662,000 or 20%, for the year ended December 31, 1997 compared to for the year ended December 31, 1996. Gross margin as a percentage of revenues was 41% for the year ended December 31, 1997 compared to 49% for the year ended December 31, 1996. Gross margin as a percentage of revenues decreased as a result of the significant charges discussed below and the reduction in the average selling price of videoconferencing systems. In addition, during the year PictureTel recorded other charges totaling $16,096,000 as a part of cost of revenues. These charges included $4,940,000 for various write-downs of excess and obsolete inventory to their net realizable values as a result of lower than forecasted demand, $9,881,000 to record impairment charges associated with software development projects canceled as a result of a realignment in PictureTel's planned product offerings, $1,122,000 for product retrofit accruals, and $153,000 related to work-force reductions and organizational realignment as a result of activities undertaken to reduce PictureTel's cost structure to bring it in line with lower-than-expected revenues. Selling, General, and Administrative. Selling, general and administrative expenses increased $34,813,000 or 26%, for the year ended December 31, 1997 from the year ended December 31, 1996, and increased as a percentage of revenues to 36% from 27%. The dollar increase in spending resulted primarily from charges of $20,637,000 recorded as part of selling, general and administrative expenses, including $2,561,000 for investment banking, accounting and legal advisory fees recorded in connection with the acquisition of MultiLink, $4,227,000 related to severance expense and sales office closings associated with the acquisition of MultiLink and work-force reductions as a result of activities undertaken to reduce PictureTel's cost structure to bring it in line with lower-than-expected revenues, $6,475,000 in specific accounts and notes receivable write-offs and provisions for allowances for doubtful accounts, $3,900,000 in provisions for sales taxes primarily related to MultiLink, $1,880,000 in advances to vertical partners written-off to reflect current business conditions and shifts in distribution channels, and $1,594,000 in charges related to other miscellaneous matters. The remaining increase in spending was primarily caused by increased personnel and facilities costs. Research and Development. Research and development expenses increased $14,389,000, or 22%, for the year ended December 31, 1997 from the year ended December 31, 1996, and were 17% and 13% of revenues for the fiscal years ended December 31, 1997 and December 31, 1996, respectively. Research and development expenditures, prior to the capitalization of software costs, were $86,775,000 for the year ended December 31, 1997 and $72,900,000 for the year ended December 31, 1996, or 19% and 15% of revenues, respectively. The dollar increase in expenditures primarily reflects PictureTel's continuing investment in new product and software development for existing and future videoconferencing products. In addition, during the year ended December 31, 1997, PictureTel recorded other charges totaling $931,000 for severance and equipment write-offs associated with canceled research and development projects and efforts to reduce PictureTel's cost structure. PictureTel capitalized software costs of $7,252,000 for the year ended December 31, 1997 and $6,887,000 for the year ended December 31, 1996, representing 8% and 9% of aggregate research and development expenditures for the fiscal years ended December 31, 1997 and December 31, 1996, respectively. Operating Income (Loss). Operating income (loss), as a percentage of revenues, decreased from income of 8% of revenues for the year ended December 31, 1996 to a loss of 12% of revenues for the year 57 67 ended December 31, 1997. This decrease was primary attributable to the various charges recorded for the year ended December 31, 1997, which totaled $39,164,000. In addition, the operating loss was significantly impacted by the lower average selling prices and increased operating expenses, without regard to the various charges recorded for the year ended December 31, 1997. Net Interest Income. Net interest income decreased to $2,518,000 for the year ended December 31, 1997 from $4,287,000 for the year ended December 31, 1996. The decrease was primarily the result of lower marketable securities portfolio balances and higher interest expense. Other Income (Expense). Other expense of $1,158,000 for the year ended December 31, 1997 consists primarily of other charges totaling $3,500,000 for write-offs of an equity investment. These other charges were partially offset by net gains on sales of securities. Other income of $2,794,000 for the year ended December 31, 1996 consists primarily of net gains on sales of securities. Income Taxes. PictureTel's effective tax rates for the fiscal years ended December 31, 1997 and December 31, 1996 were 29% and 33%, respectively. The tax rate for the year ended December 31, 1997 differs from the federal statutory rate due to state and foreign taxes offset by research and development tax credits and an increase to the valuation allowance related to certain current year tax credits and net operating losses whose benefits are uncertain. The tax rate for the year ended December 31, 1996 was lower than the federal statutory rate primarily due to the benefits of the research and development credits, the foreign sales corporation, and an decrease in the valuation allowance. The amount of the deferred tax asset considered realizable could be significantly or completely reduced. Although realization is not assured, management believes it is more likely than not that the net deferred asset will be realized. The valuation allowance primarily offsets the deferred benefit of certain federal and state tax credit carry forwards whose benefit is uncertain. PictureTel will continue to assess the valuation of the deferred tax asset each quarter. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 Revenues. PictureTel's revenues for the year ended December 31, 1996 increased $126,426,000, or 35%, from the year ended December 31, 1995. The increase in revenue was primarily attributable to 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 73% of product revenue coming from the indirect channels compared with 63% for the year ended December 31, 1995. Videoconferencing system sales accounted for approximately 80% of PictureTel's revenues for each of the years ended December 31, 1996 and December 31, 1995. Sales of group and desktop videoconferencing products accounted for 65% and 15%, respectively, of revenues for the year ended December 31, 1996, compared with 66% and 14%, respectively, for the year ended December 31, 1995. In addition, sales of bridge products accounted for approximately 13% of PictureTel's revenues for the year ended December 31, 1996 compared to approximately 10% for the year ended December 31, 1995. The balance of the revenues for the fiscal years ended December 31, 1996 and December 31, 1995 were primarily from maintenance services, licensing/development agreements and the sales of stand-alone codecs and video modems. PictureTel's revenues from sales to foreign markets were approximately 44% and 42% of total revenues for the fiscal years ended December 31, 1996 and December 31, 1995, respectively. Gross Margin. PictureTel's gross margin increased $54,159,000, or 29%, for the year ended December 31, 1996 compared to the year ended December 31, 1995. Gross margin as a percentage of revenues was 49% for the year ended December 31, 1996 compared to 51% for the year ended December 31, 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. Selling, General, and Administrative. Selling, general and administrative expenses for the year ended December 31, 1996 increased $24,681,000, or 23%, from the year ended December 31, 1995, and decreased as a percentage of revenues to 27% from 30%. The dollar increase in spending resulted primarily from the worldwide marketing focus associated with expanding indirect channels and from new product launches, as 58 68 well as increased commission expense. In addition, PictureTel has provided additional sales, general and administrative personnel in order to support PictureTel's overall growth. Research and Development. Research and development expenses for the year ended December 31, 1996 increased $16,418,000, or 34%, from the year ended December 31, 1995, and were 13% of revenues for each of the fiscal years ended December 31, 1996 and December 31, 1995. Research and development expenditures, prior to the capitalization of software costs, were $72,900,000 for the year ended December 31, 1996 and $54,009,000 for the year ended December 31, 1995, or 15% of revenues for each year. The dollar increase in expenditures primarily reflects PictureTel's continuing investment in new product and software development for existing and future videoconferencing products. PictureTel capitalized software costs of $6,887,000 for the year ended December 31, 1996 and $5,293,000 for the year ended December 31, 1995, representing 9% and 10% of aggregate research and development expenditures, respectively. Operating Income. Although gross margin as a percentage of revenues decreased from the year ended December 31, 1995, operating income as a percentage of revenues remained the same at 8% for both years due to a decline in operating expenses as a percentage of revenues for the year ended December 31, 1996. Net Interest Income. Net interest income increased to $4,287,000 for the year ended December 31, 1996 from $3,060,000 for the year ended December 31, 1995. The increase was primarily the result of higher marketable securities portfolio balances and lower interest expense. Other Income (Expense). Other income (expense) of $2,794,000 for the year ended December 31, 1996 consists primarily of net gains on sales of securities. Other income (expense) of $87,000 for the year ended December 31, 1995 consists primarily of net gains on foreign currency transactions. Income Taxes. PictureTel's effective tax rates for the years ended December 31, 1996 and December 31, 1995 were 33% and 29%, respectively. The tax rate for the year ended December 31, 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 carry forwards whose benefit is uncertain. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1997, PictureTel had $49,859,000 in cash and cash equivalents and $32,152,000 in short-term marketable securities. The primary uses of cash during the year ended December 31, 1997 were the pay down of trade accounts payable by $24,124,000, the repayment of debt (including obligations under capital leases) by $13,470,000, the purchase of property and equipment, and the internal development of software and other assets of $34,247,000. The principal sources of cash were the decrease in trade receivables of $34,508,000, the increase in accrued expenses at year end of $18,314,000 and the net proceeds from the sales of marketable securities of $15,884,000. At June 28, 1998 PictureTel had $33,638,000 in cash and cash equivalents and $52,545,000 in short-term marketable securities. During the six month period ended June 28, 1998, PictureTel generated $14,973,000 in cash from operating activities. The primary source of cash during the six month period ended June 28, 1998 was the collection of accounts receivable and the reduction of inventory. Cash used for investing activities increased as a result of excess cash being invested in marketable securities. PictureTel's secured revolving credit agreement was amended and restated in August 1998. The secured revolving credit agreement contains certain financial covenants, including the maintenance of certain financial ratios and minimum net income (loss) requirements. In addition, PictureTel is required at all times to maintain a cash collateral account with the lending institutions party to the credit agreement of not less than $47,000,000 of unencumbered cash and cash equivalents. Although PictureTel currently is in compliance with all covenants contained in the secured revolving credit agreement, certain anticipated transactions would require PictureTel to seek additional waivers of these covenants. PictureTel has available for borrowing up to $40,000,000 under its secured revolving credit agreement and approximately $4,400,000 available under local foreign guaranteed lines of credit to certain of its foreign subsidiaries. At June 28, 1998, there were no borrowed amounts outstanding under the revolving credit 59 69 agreement and $29,100,000 in standby letters of credit outstanding under the revolving credit agreement. There were no borrowed amounts outstanding under the foreign lines of credit. At June 28, 1998, PictureTel had $24,035,000 outstanding under various leasing lines, including the obligation for the lease of the facility at 50 Minuteman Road in Andover, Massachusetts, which totaled $20,534,000 at June 28, 1998. The facility at 50 Minuteman Road in Andover, Massachusetts was subleased in June, 1998 for a ten-year term. The Merger is expected to be completed in the fourth quarter of the year ending December 31, 1998, subject to satisfaction or waiver of certain conditions. PictureTel expects that cash expenditures of approximately $10.0 million to $15.0 million will be required in the first nine months after completion of the Merger. These expenditures relate to PictureTel's funding of the operations of Starlight until such time as revenues are generated from new products. Prior to the consummation of the Merger, PictureTel is obligated to fund Starlight's operations through November 30, 1998, and as of September 15, 1998 has loaned Starlight an aggregate of approximately $1.5 million evidenced by certain promissory notes in favor of PictureTel. In March 1997, PictureTel entered into an agreement to lease an additional facility at 200 Minuteman Road in Andover, Massachusetts. The lease commences October 2, 1998 and will continue for a period of eighteen years. The lease will be accounted for as a capital lease when construction is completed. PictureTel is considering alternatives other than occupancy, since current staffing levels do not support the requirement for this facility. PictureTel 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 PictureTel's near term operating, capital and projected acquisition requirements. YEAR 2000 COMPLIANCE The Year 2000 issue has gained considerable media coverage recently. There is widespread concern that computer programs and hardware systems may not operate correctly in connection with the change in the calendar year from 1999 to 2000. Though computers are at the center of the concern, virtually any electronic equipment that processes date information has the potential to exhibit this problem. During 1997, PictureTel developed and implemented a Year 2000 readiness program for its product lines. PictureTel uses a definition for Year 2000 compliance provided by the British Standards Institution (BSI). The definition requires Year 2000 compliant systems to operate correctly, consistently and unambiguously with regard to the import, export, and processing of date information, including correct handling of leap years. PictureTel has also tested its products for Year 2000 compliance and has determined that all PictureTel products currently available for sale have either successfully passed Year 2000 compliance testing or are not subject to Year 2000 compliance because such products do not import, export or process date information in any manner. A small number of installed base products do not pass Year 2000 compliance testing. For these older, non-compliant versions of products, PictureTel has, with one exception, developed adequate workarounds that will be made available to customers and that will permit the products to continue to operate with full functionality. Year 2000 Compliance. PictureTel has formed an internal compliance team to evaluate its internal information technology infrastructure and application systems ("IT Systems") and other non-IT infrastructure systems ("Non-IT Systems") to determine whether such systems will operate correctly with regard to the import, export, and processing of date information, including correct handling of leap years, in connection with the change in the calendar year from 1999 to 2000 (the "Year 2000 Issue"), and to evaluate the Year 2000 Issue with respect to the systems of third party partners and suppliers with which PictureTel has a material relationship ("Third Party Systems"). PictureTel expects to complete an IT Systems inventory analysis and risk assessment by December 31, 1998. As previously planned and budgeted, PictureTel is actively upgrading its core IT Systems to incorporate additional desired features and functionality. PictureTel expects to complete these upgrades by June 30, 1999. In connection with such upgrades, PictureTel expects its core IT Systems will be Year 2000 compliant. PictureTel expects to complete the IT Systems initiative as planned and, accordingly, does not 60 70 expect that any additional costs of addressing the Year 2000 Issue for its IT Systems will have a material adverse impact on PictureTel's financial position, results of operations or cash flows. PictureTel also expects to complete a Non-IT Systems inventory analysis and risk assessment by December 31, 1998. Any remediation actions required in order to be Year 2000 compliant have not been budgeted to date. As PictureTel believes the number of Non-IT Systems is relatively small, PictureTel does not expect that any additional costs of addressing the Year 2000 Issue for Non-IT Systems will have a material adverse impact on its operations or its financial position, results of operations or cash flows. With the assistance of an independent Year 2000 solution provider, PictureTel is in the process of creating a plan to complete a Third Party Systems inventory and risk assessment. PictureTel expects to verify Year 2000 compliance of Third Party Systems using this independent Year 2000 solution provider. As PictureTel believes the number of material Third Party Systems is relatively small, PictureTel expects to be in a position to evaluate the risks in a timely manner. Until Year 2000 compliance of all Third Party Systems is ascertained and written assurances are received, the risk to PictureTel's operations and any additional costs relating to such Third Party Systems is unknown. For the year ending December 31, 1998, PictureTel estimates it will spend a total of $320,000 on inventory analysis and risk assessment. To date, PictureTel has incurred $68,000 of expense relating to inventory analysis and risk assessment. These Year 2000 expenditures are within PictureTel's planned organizational budgets and include the cost of independent Year 2000 solution providers. Year 2000 expenditures for IT Systems, Non-IT Systems and Third Party Systems do not reflect the cost to PictureTel of internal resources working on the Year 2000 Issue and do not reflect planned upgrades or planned replacement systems which may have a positive impact on resolving the Year 2000 Issue. PictureTel expects to complete its risk assessment and cost estimate relating to the Year 2000 Issue no later than December 31, 1998 and to establish a contingency plan relating to the remediation and prioritization of its IT Systems, Non-IT Systems and Third Party Systems shortly thereafter. As of September 21, 1998, no IT Systems projects have been deferred due to problems associated with the Year 2000 Issue. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 131 (SFAS 131), "Disclosure about Segments of an Enterprise and Related Information," which changes the way public companies report information about their operating segments. SFAS 131, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers, and material geographic locations in which the entity holds assets and reports revenues. PictureTel will adopt SFAS 131 for its fiscal year ending December 31, 1998. PictureTel is currently evaluating the effects of this change on its reporting of segment and geographic information but does not expect the statement to have a material impact on its financial position or results of operations as the statement requires only additional disclosure. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. PictureTel is currently evaluating the effects of this change but anticipates that the adoption of SFAS 133 will not have a significant effect on PictureTel's results of operations or its financial position. In January 1997, the Commission issued Financial Reporting Release No. 48, which expands the disclosure requirements for certain derivative and other financial instruments. PictureTel adopted the enhanced accounting policy disclosure requirements in the fourth quarter of the fiscal year ending Decem- 61 71 ber 31, 1997. PictureTel will begin furnishing the qualitative and quantitative disclosures of market risk in PictureTel's Annual Report on Form 10-K for the year ending December 31, 1998. 62 72 QUARTERLY RESULTS AND SEASONALITY The following table sets forth certain unaudited quarterly statements of operations data of PictureTel for each of the fiscal quarters in each of the years ended December 31, 1997, and December 31, 1996, and for each of the fiscal quarters in the six months ended June 28, 1998. This information should be read in conjunction with the audited and unaudited consolidated financial statements of PictureTel and notes thereto included elsewhere in this Information Statement/Prospectus. In the opinion of management of PictureTel, the quarterly statements of operations data contain all adjustments, consisting of only normal, recurring adjustments, except as discussed in Note 2 of the notes to the audited consolidated financial statements included elsewhere in this Information Statement/Prospectus, necessary to present fairly the selected quarterly statements of operations data. The statements of operations data for any quarter are not necessarily indicative of the results for any future period.
THREE MONTHS ENDED ------------------------------------------------------ MAR. 30, JUN. 29, SEP. 28, DEC. 31, 1996 1996 1996 1996 -------- -------- ------------- ------------- (RESTATED)(2) (RESTATED)(2) (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues........................................ $108,055 $122,690 $120,785 $138,695 Gross margin.................................... 52,971 61,026 59,223 77,829 Net income (loss)............................... 6,943 9,864 6,884 8,680 Net income per share -- basic................... $ 0.20 $ 0.27 $ 0.19 $ 0.24 Net income per share -- diluted................. $ 0.17 $ 0.24 $ 0.17 $ 0.22
THREE MONTHS ENDED -------------------------------------------------- MAR. 29, JUN. 29, SEP. 28, DEC. 31, 1997 1997 1997 1997 ----------- ----------- -------- -------- RESTATED(2) RESTATED(2) (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues...................................... $121,935 $117,966 $109,689 $116,835 Gross margin.................................. 58,737 51,695 42,816 37,266 Net income (loss)(1).......................... 2,011 (4,900) (16,715) (19,994) Net income (loss) per share -- basic.......... $ 0.05 $ (0.13) $ (0.44) $ (0.52) Net income (loss) per share -- diluted........ $ 0.05 $ (0.13) $ (0.44) $ (0.52)
THREE MONTHS ENDED ---------------------- MAR. 29, JUN. 28, 1998 1998 --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues.................................................... $101,045 $104,582 Gross margin................................................ 45,887 40,273 Net loss(3)................................................. (2,165) (6,688) Net loss per share -- basic................................. $ (0.06) $ (0.23) Net loss per share -- diluted............................... $ (0.06) $ (0.23)
- --------------- (1) Includes other charges of $17,834,000 and $24,830,000 for the three month periods ended September 28, 1997 and December 31, 1997, respectively. See Note 14 of the notes to the audited consolidated financial statements included elsewhere in this Information Statement/Prospectus. (2) See Note 1 of the notes to the audited consolidated financial statements included elsewhere in this Information Statement/Prospectus. (3) Includes other charges totaling $11,018,000 before income tax benefit for the three months ended June 28, 1998. See "PictureTel -- Management's Discussion and Analysis of Financial Condition and Results of Operations." 62 73 BUSINESS OF STARLIGHT GENERAL Starlight develops, installs and customizes streaming media applications for large enterprises. Starlight's current products provide corporate communications solutions which include Starlight's and other firms' streaming video engines, business communications applications and streaming applications management. Products in development are expected to provide more fully integrated streaming video and streaming applications management for a variety of corporate applications, including business briefings and event management, distance learning, business television, advertising/electronic commerce. Starlight was incorporated in California in 1990. Starlight's principal executive offices are located at 205 Ravendale Drive, Mountain View, CA 94043 (Telephone: (650) 967-2774). PRODUCTS AND SERVICES Starlight has four principal offerings of products and/or services: StarCast(R), StarWorks(R), StarCenter(TM) and StarLive!(TM). StarCast is a streaming media application permitting live and delayed broadcasting across business networks, and includes the application software for the host server, client software for the desktop clients, and multicast software for the host server. StarWorks permits individuals to view video sequences at their convenience (i.e., video-on-demand) across a network. Both StarCast and StarWorks enable MPEG full motion video. StarCenter provides streaming media applications management. Starlight's StarLive! works with several streaming media platforms -- including both Starlight and third party streaming media applications such as Microsoft Corporation's NetShow and RealNetworks' Real Video -- streaming media management applications and installation and customization services. Enhanced services include event hosting, involving camera and audio setups, and recording, editing and multimedia enhancement of corporate events for subsequent video-on-demand. Backchannel data communication in StarLive! allows for two-way data delivery for a wide range of business applications, including e-commerce and delivery of questions and feedback in the business briefing setting. THE STARLIGHT SOLUTIONS Starlight provides corporate communications solutions consisting of basic proprietary software for high speed streaming of audio and video, third party streaming media products and other third party hardware, networking devices and communications equipment, as well as software services for the installation and customization of streaming media applications. Starlight believes that its products provide an integrated corporate communications solution with streaming media management, high bandwidth streaming media applications, and a service capacity necessary to install, customize and support a corporate communications system, including LAN and WAN and satellite communications support. The Starlight solution smooths data flows to match data traffic on each corporate network, and includes memory management to enhance performance of communications on the corporate network. Starlight believes that the majority of its revenues will ultimately be derived from the sale of integrated packages of software products and services, including application development and customization, installation and training, and corporate communications event management/hosting services. PRODUCTS UNDER DEVELOPMENT Starlight is currently developing an integrated streaming media application that is intended to include both StarLive! and StarCenter and which Starlight expects will become available for delivery by July, 1999. In addition, pursuant to a contract with a systems integrator servicing the retail petroleum industry, Starlight is currently developing advertising/e-commerce kiosks based upon its corporate communications products. However, there can be no assurance that Starlight will be able to successfully complete the development of its integrated streaming media application, or that such product or its advertising and electronic commerce 63 74 product will gain market acceptance, or that Starlight will be able to develop other new products or respond to competition, technological changes or new industry standards. MARKETING AND SALES Starlight's marketing strategy consists primarily of seminars, Starlight's Web site, reliance on vendors of complementary communications products, trade shows and some telemarketing and direct mail. The sales effort relies on a mix of sales personnel and service and engineering support personnel. Starlight relies principally on direct sales in North America and indirect sales channels for international sales. COMPETITION There are many corporations competing in various segments of the streaming media market, including its principal competitors, Microsoft Corporation, RealNetworks, Oracle Corporation, Silicon Graphics, Inc. and Cisco Systems. Microsoft Corporation and RealNetworks provide substantial competition in streaming media applications in the most popular operating system environments -- Windows NT and Solaris -- and are now offering high bandwidth MPEG products. Starlight believes, however, that neither corporation offers integrated or customized corporate communications solutions or streaming media management. Oracle Corporation provides a streaming media application focused on cable modem transmission but does not provide corporate communications solutions. Silicon Graphics provides a comprehensive corporate streaming media applications and management solution, but only for its proprietary hardware, which has a substantially smaller user base than the Windows NT and Solaris operating systems. Cisco Systems provides the broadest range of streaming media with both multicasting and video-on-demand, but does not offer streaming media management or comprehensive corporate solutions. Other, less significant competitors, provide limited streaming media capabilities, most often restricted to video-on-demand. Although competition in the streaming media market is currently limited, there can be no assurance that such competition will not intensify. Many of Starlight's competitors, including all of its principal competitors, are larger corporations with substantially greater financial and other resources. Key factors for success in this market include continued product development and attracting and retaining skilled sales, service and engineering personnel. There can be no assurance that Starlight will be able to attract and retain the personnel necessary to expand its business and compete successfully. EMPLOYEES As of September 1, 1998, Starlight had 44 full-time employees, of which 15 were involved in engineering and research and development activities, 12 were involved in sales and support, five in consulting services, five in marketing, and seven in administration. The continued success of Starlight will depend in part upon its ability to attract and retain highly qualified personnel. Starlight believes it has a good relationship with its employees. PROPERTIES Starlight currently leases approximately 30,000 square feet at its headquarters in Mountain View, California, under a lease term through May 31, 2003. 64 75 STARLIGHT -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides an analysis of Starlight's financial condition and results of operations and should be read in conjunction with the "Selected Historical Financial Data" of Starlight and the Notes thereto and the Financial Statements and Notes thereto included elsewhere in this Information Statement/ Prospectus. The discussion below contains certain forward-looking statements relating to, among other things, estimates of economic and industry conditions, sales trends, expense levels and capital expenditures. Actual results may vary from those contained in such forward-looking statements. See "Risk Factors." GENERAL Starlight is a provider of fully integrated streaming media solutions for corporate communications. Starlight develops, markets and sells a full suite of software products and professional services, the combination of which provides integrated applications that include streaming media management, live interactive multicast and video-on-demand capabilities. Starlight's historical operations reflect its significant investment in developing its technology and the emerging markets for its products and services which has been impacted by the development and adoption rates of streaming media enabled networks and hardware not provided by Starlight. Starlight's has experienced significant operating losses since inception. As of June 30, 1998, Starlight had an accumulated deficit of $28,367,000. Six Months ended June 30, 1998 Compared to Six Months Ended June 30, 1997 Revenues. Starlight's net revenues for the six month period ended June 30, 1998 were $1,527,000, a 52% decrease from net revenues of $3,206,000 for the six month period ended June 30, 1997. This decrease was attributable to the expiration of a value added reseller agreement with a major customer (which accounted for approximately 31% of revenues for the six month period ended June 30, 1997), economic conditions in Japan and the Pacific Rim which resulted in lower product shipments, the decision in the fourth quarter of the year ended December 31, 1997 to begin transitioning its sales focus from selling streaming media products to selling corporate communications solutions and the redirection of key resources to concentrate on Starlight's financing requirements. Gross Margin. Gross margins for the six months ended June 30, 1998 were 47% compared to 76% for the six month period ended June 30, 1997. The decrease is attributable to the combination of a higher professional services component in net revenues, which contributed to higher cost of revenues, and the absence of revenue from the expiration of the value added reseller agreement, which did not have any associated cost of goods sold for the six month period ended June 30, 1997. Research and Development. Research and development expenses for the six month period ended June 30, 1998 totaled $1,340,000, a decrease of $731,000, or 35%, from $2,071,000 of research and development expenses for the six month period ended June 30, 1997. The reduction in expenses reflects a decrease in the number of on-going development projects and an associated reduction in engineering and quality assurance headcount and outside engineering consulting expenses. Selling, General and Administrative. Selling, general and administrative expenses for the six month period ended June 30, 1998 were $2,798,000 compared to $3,207,000 for the six month period ended June 30, 1997, representing a 13% reduction. The decrease represents a reduction in headcount in sales, marketing and general and administrative, as well as lower expenditures for marketing and promotion activities to bring the cost structure more in line with revenues. Net Interest Expense. Net interest expense for the six month period ended June 30, 1998 was $241,000 compared to $291,000 for the six month period ended June 30, 1997. The reduction reflects lower interest expense resulting from the normal reduction of principal of the $3,000,000 promissory note issued by Starlight on August 30, 1996 and the capital equipment lease drawdowns in 1995 and 1996 and reduced interest income from lower average invested cash balances. Net Loss. Net loss for the six month period ended June 30, 1998 was $3,659,000 compared to $3,151,000 for the six month period ended June 30, 1997. The increase in the loss was due primarily to the lower revenues and gross margins. 65 76 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Revenues. Net revenues for the year ended December 31, 1997 were $8,074,000, or 22% higher than net revenues of $6,607,000 for the year ended December 31, 1996. The increase in net revenues reflects the general acceptance of Starlight's products and services worldwide. Domestic and international revenues increased 24% and 18%, respectively. International revenues as a percentage of total revenues were 26% for the year ended December 31, 1997 and 27% for the year ended December 31, 1996. Gross Margin. Gross margin for the year ended December 31, 1997 was 77% compared to 70% for the year ended December 31, 1996. The higher margin primarily reflects an improved revenue mix, with an increase in higher margin product sales and a reduction in lower margin revenues from development contracts. Research and Development. Research and development expenses for the year ended December 31, 1997 totaled $3,583,000, or a 27% decrease from the $4,888,000 of research and development expenses for the year ended December 31, 1996. The reduction in expenses reflects a decrease in the number of development projects and an associated reduction in engineering and quality assurance headcount and outside engineering consulting expenses as a result of the completion of the planned projects for the year ended December 31, 1996. Selling, General and Administrative. Selling, general and administrative expenses for the year ended December 31, 1997 were $6,121,000 compared to $7,055,000 for the year ended December 31, 1996, representing a 13% reduction. The decrease represents a reduction in sales related expenses and marketing and promotion activities. Net Interest Expense. Net interest expense for the year ended December 31, 1997 was $529,000 compared to $43,000 for the year ended December 31, 1996. The higher net interest expense for the year ended December 31, 1997 represents the combination of reduced interest income from lower average invested cash balances, higher interest expense resulting from additional capital equipment leases during the year ended December 31, 1997 and a full year of interest expense on the $3,000,000 promissory note issued by Starlight on August 30, 1996. Net Loss. Net loss for the year ended December 31, 1997 was $4,019,000 compared to $7,387,000 for the year ended December 31, 1996. The reduced loss reflects the higher revenues and gross margins and lower operating expenses. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 Revenues. Net revenues for the year ended December 31, 1996 were $6,607,000, or 15% lower than net revenues of $7,802,000 for the year ended December 31, 1995. The decrease in net revenues primarily reflects the combination of a significant reduction in product sales to Japan as a result of the general economic downturn in that country and the phase out of hardware component sales. International sales decreased from 40% of total revenues for the year ended December 31, 1995 to 27% for the year ended December 31, 1996. Gross Margin. Gross margin for the year ended December 31, 1996 was 70% compared to 66% for the year ended December 31, 1995. The higher margin primarily reflects an improved revenue mix, with an increase in higher margin product sales and a reduction in lower margin revenues from hardware component shipments. Research and Development. Research and development expenses for the year ended December 31, 1996 totaled $4,888,000, a 65% increase from the $2,968,000 of research and development expenses for the year ended December 31, 1995. The increased research and development expenses reflect additions in engineering and quality assurance staffing as well as increased outside engineering consulting expenses which were required as a result of Starlight's planned new development projects and product release schedules for 1996 and 1997. Selling, General and Administrative. Selling, general and administrative expenses for the year ended December 31, 1996 were $7,055,000 compared to $5,280,000 for the year ended December 31, 1995, representing a 34% increase. The increase primarily represents higher staffing levels in all areas related to increased sales, marketing, promotion and support activities. 66 77 Net Interest Income (Expense). Net interest expense for the year ended December 31, 1996 was $43,000 compared to net interest income of $157,000 for the year ended December 31, 1995. This $200,000 reduction in net interest income year-to-year reflects additional interest expense from capital equipment leases entered into during the year ended December 31, 1996 and four months of interest expense on the $3,000,000 promissory note issued by Starlight on August 30, 1996. Net Loss. Net loss for the year ended December 31, 1996 was $7,387,000 compared to $2,991,000 for the year ended December 31, 1995. The increased loss reflects the lower revenues, higher operating expenses and increased interest expense. LIQUIDITY AND CAPITAL RESOURCES From inception through June 30, 1998, Starlight has financed its operations through the combination of private placement of equity securities totaling approximately $22,399,000, revenues from sales of its products and services of approximately $30,643,000, proceeds of capital equipment lease financings of approximately $3,084,000, proceeds from the issuance of a $3,000,000 secured promissory note in August 1996, the issuance of convertible promissory notes in April, 1998 and May, 1998 in the aggregate amount of $1,184,000, and the issuance of a $600,000 promissory note to PictureTel Corporation on June 29, 1998. Cash and cash equivalents totaled $990,000 as of June 30, 1998. Net cash used in operations totaled $2,943,000, $3,639,000 and $7,684,000 for the periods ended June 30, 1998, December 31, 1997 and December 31, 1996, respectively. Net cash consumed in operations was used primarily for development, sales, marketing and general administrative expenses. Starlight's principal sources of liquidity at June 30, 1998 consisted of cash and cash equivalents of $990,000 and net accounts receivables of $394,000. At June 30, 1998, Starlight had short term debt of $4,628,000 and long term debt of $873,000. In the absence of the acquisition of Starlight by PictureTel, Starlight would not have sufficient capital to support its operations and would have to raise additional capital through equity or debt financing or pursue alternative transactions. There is no assurance that Starlight would be able to successfully raise additional capital or that such capital would be available on favorable terms. Similarly, there can be no assurance that Starlight would be able to achieve and maintain sufficient revenues to support its operations. Currently, PictureTel is funding Starlight's capital needs through the issuance of promissory notes and it is anticipated that PictureTel will continue to make such funding available to Starlight until such time as the Merger is completed. IMPACT OF YEAR 2000 Many currently installed computer systems and software products, as well as semiconductors embedded in other equipment, are coded to accept only two digit entries in date code fields. These date code fields will need to accept four digit entries to distinguish twenty-first century dates from twentieth century dates. As a result, the software and computer systems of many corporations may need to be upgraded or replaced in order to comply with such "Year 2000" requirements. Starlight has not yet modified its current products for Year 2000 compliance, but has included in its product engineering plans the modifications necessary for Year 2000 compliance. However, the failure of Starlight's products to operate properly with regard to the Year 2000 requirements could cause Starlight to incur unanticipated expenses to remedy any problems and could cause a reduction in sales, each of which could have a material adverse effect on Starlight's business, operating results and financial condition. Starlight utilizes third party equipment and software that may not be Year 2000 compliant. Starlight has not made inquiries of its material equipment and software suppliers as to the Year 2000 compliance of their products, and has not established a formal contingency plan for any potential failure of any of Starlight's or any third party's equipment or software. Starlight also has material relationships with third parties who may utilize equipment or software that may not be Year 2000 compliant, such as public utilities (each a "Material Party"). Starlight has not inquired 67 78 of any Material Party as to their Year 2000 status. Starlight believes that it could continue to operate despite any failure of a Material Party to be Year 2000 compliant, but such a failure could cause Starlight to incur unanticipated expenses, including expenses to remedy any problems, and could cause a reduction in sales, each of which have a material adverse effect on on Starlight's business, operating results and financial condition. The business, operating results and financial condition of Starlight's customers could also be adversely affected to the extent that they utilize equipment or software that is not Year 2000 compliant. Furthermore, the purchasing patterns of customers or potential customers may be affected by Year 2000 compliance issues as corporations expend significant resources to correct their equipment or software for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by Starlight, which could have a material adverse effect on Starlight's business, operating results and financial condition. Starlight expects that it will, either pursuant to its integration with PictureTel following the Merger or otherwise, make certain investments in its equipment, software systems and applications to ensure that Starlight is Year 2000 compliant. The financial impact to Starlight for Year 2000 compliance has not been and is not anticipated to be material to its financial position, results of operations or cash flows in any given year. However, failure to adequately resolve Year 2000 compliance issues respecting third party equipment, software systems and applications would likely have a material adverse effect on Starlight's business, operating results and financial condition. 68 79 SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF PICTURETEL The following table sets forth certain information with respect to the beneficial ownership of PictureTel Common Stock as of August 1, 1998, by (i) each person known by PictureTel to beneficially own more than five percent (5%) of the outstanding shares of PictureTel Common Stock, (ii) each director of PictureTel, (iii) each named executive officer of PictureTel, and (iv) all directors and named executive officers of PictureTel as a group. Unless otherwise indicated, the address of the stockholder is c/o PictureTel Corporation, 100 Minuteman Road, Andover, Massachusetts 01810.
PERCENTAGE OF NUMBER OF COMMON STOCK NAME OF BENEFICIAL OWNER SHARES(1)(2) OUTSTANDING(1) - ------------------------ ------------ -------------- Norman E. Gaut+........................................... 879,692(3) 2.3% Robert T. Knight+......................................... 37,000(4) * David B. Levi+............................................ 69,300(5) * Enzo Torresi+............................................. 25,000(6) * Bruce R. Bond+ ++......................................... -- -- David W. Grainger++....................................... 105,000(7) * Lawrence M. Bornstein++................................... 77,398(8) * The Crabbe Huson Group, Inc. ............................. 3,671,300(9) 9.6% 121 S.W. Morrison Suite 1400 Portland, OR 97204 State of Wisconsin Investment Board....................... 2,486,900(10) 6.5% P.O. Box 7842 Madison, WI 53707 Gilder, Gagnon & Howe & Co. .............................. 2,350,925(11) 6.1% 1775 Broadway, 26th floor New York, NY 10019 Directors and Executive Officers as a Group (7 Persons)... 1,193,390 3.2%
- --------------- + Director ++ Executive Officer * Less than One Percent. (1) Unless otherwise indicated, the persons named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. (2) For purposes of determining beneficial ownership of PictureTel Common Stock, owners of options exercisable within sixty (60) days are considered to be the beneficial owners of the shares of PictureTel Common Stock for which such securities are exercisable. The percentage ownership of the outstanding PictureTel Common Stock reported herein is based on the assumption (expressly required by the applicable rules of the Securities and Exchange Commission) that only the person whose ownership is being reported has converted his options into shares of PictureTel Common Stock. (3) Includes 675,000 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998 and 28,000 shares of PictureTel Common Stock owned by Marvin G. Gaut Trust which Mr. Gaut may be deemed to beneficially own. (4) Includes 30,000 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998. (5) Includes 39,000 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998. (6) Includes 15,000 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998. 69 80 (7) Includes 105,000 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998. (8) Includes 76,563 shares issuable upon exercise of options which are exercisable within sixty (60) days after August 1, 1998. (9) The Crabbe Huson Group, Inc. holds these shares as investment adviser for its investment management clients. This information is based on a Schedule 13G filed with the Securities and Exchange Commission on February 2, 1998. (10) The State of Wisconsin Investment Board is a government agency which manages public pension funds. This information is based on a Schedule 13G filed with the Securities and Exchange Commission on January 20, 1998. (11) Gilder, Gagnon & Howe & Co. holds these shares as a broker or dealer and the information provided herein is based solely on a Schedule 13G filed with the Securities and Exchange Commission on August 12, 1998. 70 81 SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF STARLIGHT The following table sets forth certain information with respect to the beneficial ownership of Starlight Common Stock and Starlight Preferred Stock as of August 1, 1998, giving effect to the conversion of the Subordinated Convertible Promissory Notes due August 15, 1998 into 8,106,983 shares of Starlight Series G Preferred Stock on August 15, 1998, by (i) each person known by Starlight to beneficially own more than five percent (5%) of the outstanding shares of Starlight Common Stock or Starlight Preferred Stock, (ii) each director of Starlight, (iii) all executive officers of Starlight, and (iv) all directors and executive officers of Starlight as a group. Except as otherwise indicated in the footnotes to the table, the persons named in the table have sole voting and investment power with respect to all shares beneficially owned, subject to community property laws where applicable. Unless otherwise indicated, the address of the shareholder is c/o Starlight Networks Incorporated, 205 Ravendale Drive, Mountain View, California 94043. The percentage ownership of outstanding Starlight Preferred Stock reported herein includes 73,992 shares of Starlight Preferred Stock issuable upon conversion of warrants held by the persons listed in the table below, each of which persons has agreed that all of his or its respective warrants shall not be exercised and shall be canceled immediately prior to the Effective Time.
PERCENTAGE OF AMOUNT AND AMOUNT AND NATURE COMMON NATURE OF PERCENTAGE OF OF COMMON STOCK STOCK PREFERRED STOCK PREFERRED STOCK NAME OF BENEFICIAL OWNER OWNERSHIP(1) OUTSTANDING OWNERSHIP(2) OUTSTANDING - ------------------------ ----------------- ------------- --------------- --------------- Interwest Partners IV............ -- -- 3,612,441(3) 20.3% 3000 Sand Hill Road Building 3, Suite 255 Menlo Park, CA 94025 Accel Partners................... -- -- 3,611,997(4) 20.3% 428 University Avenue Palo Alto, CA 94301 SVM Star Ventures................ -- -- 2,595,453(5) 14.6% Possartstr. 9, D-81679 Munchen, Germany Bass Associates/The Bass Trust... 233,267(6) 10.1% 1,503,889(7) 8.5% P.O. Box 1524 Palo Alto, CA 94302 Sequoia Capital.................. -- -- 1,091,813(8) 6.1% 3000 Sand Hill Road Building 4, Suite 280 Menlo Park, CA 94025 TVM Techno Venture Management.... -- -- 1,018,295(9) 5.7% 101 Arch Street Suite 1950 Boston, MA 02110 Charles J. Bedard................ 127,999 5.6% -- -- Joseph M. Gang, Jr............... 384,055(10) 16.5% 5,000 * Fouad Tobagi..................... 182,667(11) 7.9% 5,000 * Dr. Meir Barel +................. 15,767(12) * 2,595,453(13) 14.6% Charlie Bass +................... 233,267(14) 10.1% 1,503,889(15) 8.5% Robert Brannon +................. 95,142(16) 4.1% -- -- Dixon Doll +..................... 15,767(17) * 206,195(18) 1.2% Robert Frankenberg +............. 15,767(19) * -- -- Philip Gianos +.................. 15,767(20) * 3,612,441(21) 20.3% James E. Long ++................. 657,735(22) 27.5% -- -- Steve Lorenzen ++................ 51,875(23) 2.2% -- -- John B. Goodrich +............... -- -- 5,555(24) *
71 82
PERCENTAGE OF AMOUNT AND AMOUNT AND NATURE COMMON NATURE OF PERCENTAGE OF OF COMMON STOCK STOCK PREFERRED STOCK PREFERRED STOCK NAME OF BENEFICIAL OWNER OWNERSHIP(1) OUTSTANDING OWNERSHIP(2) OUTSTANDING - ------------------------ ----------------- ------------- --------------- --------------- Russell J. Knittel +............. 156,526(25) 6.4% -- -- Directors and Executive Officers as a Group (10 Persons)........ 1,257,613(26) 45.6% 7,923,533(27) 44.4%
- --------------- + Director + Executive Officer * Less Than One Percent (1) For purposes of determining beneficial ownership of Starlight Common Stock, owners of options exercisable within sixty (60) days of August 1, 1998 are considered to be beneficial owners of shares of Starlight Common Stock for which such options are exercisable. The percentage ownership of the outstanding Starlight Common Stock reported herein is based on the assumption (expressly required by the applicable rules of the Commission) that only the person whose ownership is being reported has converted his, her or its options into shares of Starlight Common Stock. (2) For purposes of determining beneficial ownership of Starlight Preferred Stock, owners of warrants exercisable within sixty (60) days of August 1, 1998 are considered to be beneficial owners of shares of Starlight Preferred Stock for which such warrants are exercisable. The percentage ownership of the outstanding Starlight Preferred Stock reported herein is based on the assumption (expressly required by the applicable rules of the Commission) that only the person whose ownership is being reported has converted his, her or its warrants into shares of Starlight Preferred Stock. (3) Includes 16,929 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Interwest Partners IV. (4) Includes 3,175,163 shares of Starlight Preferred Stock owned by Accel III L.P., 276,100 shares of Starlight Preferred Stock owned by Accel Japan L.P., 143,805 shares of Starlight Preferred Stock owned by Accel Investors '91 L.P., 14,952 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Accel III L.P., 1,300 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Accel Japan L.P. and 677 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Accel Investors '91 L.P. Accel III L.P., Accel Japan L.P., and Accel Investors '91 L.P. are all under the management of general partnerships which have common general partners. (5) Includes 431,324 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. I, 862,646 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. II, 839,087 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. III, 70,200 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. IIIa, 369,241 shares of Starlight Preferred Stock owned by SVM Star Ventures Managementgesellschaft mbH Nr. 3 & Co. Beteligungs KG, and 22,955 shares of Starlight Preferred Stock issuable upon conversion of warrants held by funds under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3. SVE Star Ventures Enterprises No. I, SVE Star Ventures Enterprises No. II, SVE Star Ventures Enterprises No. III, SVE Star Ventures Enterprises No. IIIa, and SVM Star Ventures Managementgesellschaft mbH Nr. 3 & Co. Beteligungs KG are all under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3. (6) Includes 200,000 shares of Starlight Common Stock owned by Bass Associates and 33,267 shares of Starlight Common Stock issuable upon the exercise of options held by Bass Associates, which options are exercisable within sixty (60) days of August 1, 1998. (7) Includes 1,067,351 shares of Starlight Preferred Stock owned by Bass Associates and 7,048 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Bass Associates. Also includes 429,490 shares of Starlight Preferred Stock owned by The Bass Trust. (8) Includes 988,898 shares of Starlight Preferred Stock owned by Sequoia Capital VI, 54,337 shares of Starlight Preferred Stock owned by Sequoia Technology Partners VI, 43,463 shares of Starlight Preferred Stock owned by Sequoia XXIV, and 5,115 shares of Starlight Preferred Stock issuable upon 72 83 the conversion of warrants held by the above named funds. Sequoia Capital VI, Sequoia Technology Partners VI and Sequoia XXIV are under the management of Sequoia Partners(O). (9) Includes 202,727 shares of Starlight Preferred Stock owned by TVM Intertech Limited Partners, 304,098 shares of Starlight Preferred Stock owned by TVM Techno Venture Enterprises No. II, 202,554 shares of Starlight Preferred Stock owned by TVM Eurotech Ltd. Partnership, 303,900 shares of Starlight Preferred Stock owned by TVM Zweite Beteiligung-U.S. Ltd., 1,003 shares of Starlight Preferred Stock issuable upon conversion of warrants held by TVM Intertech Limited Partners, 1,003 shares of Starlight Preferred Stock issuable upon conversion of warrants held by TVM Eurotech Ltd. Partnership, 1,505 shares of Starlight Preferred Stock issuable upon conversion of warrants held by TVM Techno Venture Enterprises No. II, and 1,505 shares of Starlight Preferred Stock issuable upon conversion of warrants held by TVM Zweite Beteiligung-U.S. Ltd. (10) Includes 54,055 shares of Starlight Common Stock issuable upon exercise of options held by Mr. Gang, which options are exercisable within sixty (60) days of August 1, 1998. (11) Includes 12,667 shares of Starlight Common Stock issuable upon exercise of options held by Mr. Tobagi, which options are exercisable within sixty (60) days of August 1, 1998. (12) Represents 15,767 shares of Starlight Common Stock issuable upon exercise of options held by Dr. Barel, which options are exercisable within sixty (60) days of August 1, 1998. (13) Includes 431,324 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. I, 862,646 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. II, 839,087 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. III, 70,200 shares of Starlight Preferred Stock owned by SVE Star Ventures Enterprises No. IIIa, 369,241 shares of Starlight Preferred Stock owned by SVM Star Ventures Managementgesellschaft mbH Nr. 3 & Co. Beteligungs KG, and 22,955 shares of Starlight Preferred Stock issuable upon conversion of warrants held by funds under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3. SVE Star Ventures Enterprises No. I, SVE Star Ventures Enterprises No. II, SVE Star Ventures Enterprises No. III, SVE Star Ventures Enterprises No. IIIa, and SVM Star Ventures Managementgesellschaft mbH Nr. 3 & Co. Beteligungs KG, are all under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3 of which Dr. Barel is managing director. Dr. Barel disclaims beneficial ownership of the shares held in the name of funds under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3 as managing partner, except to the extent of any individual interest in such funds. (14) Includes 200,000 shares of Starlight Common Stock owned by Bass Associates and 33,267 shares of Starlight Common Stock issuable upon the exercise of options held by Bass Associates, which options are exercisable within 60 days of August 1, 1998. Mr. Bass is the general partner of Bass Associates. Mr. Bass disclaims beneficial ownership of shares held in the name of Bass Associates, except to the extent of any individual interest in such entity. (15) Includes 1,067,351 shares of Starlight Preferred Stock owned by Bass Associates, 7,048 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Bass Associates, and 429,490 shares of Preferred Stock owned by The Bass Trust. Mr. Bass is the general partner of Bass Associates and sole trustee of The Bass Trust. Mr. Bass disclaims beneficial ownership of these shares, except to the extent of any individual interest in such entities. (16) Includes 65,142 shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Brannon, which options are exercisable within sixty (60) days of August 1, 1998. (17) Represents shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Doll which options are exercisable within sixty (60) days of August 1, 1998. (18) Includes 206,195 shares of Starlight Preferred Stock owned by certain funds under the management of Doll Technology Investment Management, L.L.C. of which Mr. Doll is the general partner. Mr. Doll disclaims beneficial ownership of shares held in the name of certain funds under the management of Doll Technology Investment Management, L.L.C., except to the extent of any individual interest in such funds. 73 84 (19) Represents shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Frankenberg, which options are exercisable within sixty (60) days of August 1, 1998. (20) Represents shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Gianos, which options are exercisable within sixty (60) days of August 1, 1998. (21) Includes 3,595,512 shares of Starlight Preferred Stock owned by Interwest Partners IV, and 16,929 shares of Starlight Preferred Stock issuable upon conversion of warrants held by Interwest Partners IV. Mr. Gianos is a general partner of Interwest Management Partners IV, L.P., the managing entity of Interwest Partners IV. Mr. Gianos disclaims beneficial ownership of shares held in the name of Interwest Partners IV, except to the extent of any individual interest in such fund. (22) Includes 112,735 shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Long, which options are exercisable within sixty (60) days of August 1, 1998. (23) Represents shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Lorenzen, which options are exercisable within sixty (60) days of August 1, 1998. (24) Includes 556 shares of Starlight Preferred Stock owned by Mr. Goodrich and 4,999 shares of Starlight Preferred Stock owned by WS Investment Company 91C. Mr. Goodrich is a member of Wilson Sonsini Goodrich & Rosati and a general partner of its affiliate WS Investment Company 91C. Mr. Goodrich disclaims beneficial ownership of the shares held by WS Investment Company 91C, except to the extent of any individual interest in such entity. (25) Represents shares of Starlight Common Stock issuable upon the exercise of options held by Mr. Knittel, which options are exercisable within sixty (60) days of August 1, 1998. (26) Includes shares of Starlight Common Stock held by Bass Associates, and shares of Starlight Common Stock issuable upon the exercise of options held by Bass Associates. Messrs. Barel, Bass, Doll, Gianos and Goodrich disclaim beneficial ownership of the shares held by entities or funds with which they are affiliated, except to the extent of any individual interest in such entities or funds. Also includes shares of Starlight Common Stock issuable upon the exercise of options held by Messrs. Barel, Brannon, Doll, Frankenberg, Gianos, Long, Lorentzen, and Knittel. (27) Includes shares of Starlight Preferred Stock held by, or issuable upon conversion of warrants held by, certain funds under the management of Interwest Management Partners IV, L.P., certains funds under the management of SVM Star Ventures Managementgesellschaft mbH Nr. 3, certain funds under the management of Sequoia Capital Management, certain funds under the management of Doll Capital Management, Bass Associates, The Bass Trust and WS Investment Company 91C. Messrs. Barel, Bass, Doll, Gianos and Goodrich disclaim beneficial ownership of the shares held by entities or funds with which they are affiliated, except to the extent of any individual interest in such entities or funds. 74 85 MANAGEMENT -- PICTURETEL DIRECTORS AND EXECUTIVE OFFICERS OF PICTURETEL The directors and executive officers of PictureTel are as follows:
NAME AGE POSITION ---- --- -------- Bruce R. Bond........... 51 Chairman of the Board, President and Chief Executive Officer Lawrence M. Bornstein... 55 Vice President of Human Resources David W. Grainger....... 55 Group Vice President Field Operations Norman E. Gaut.......... 60 Director David B. Levi........... 65 Director Robert T. Knight........ 60 Director Enzo Torresi............ 53 Director
Bruce R. Bond became President and Chief Executive Officer and was elected a Director in February, 1998. Mr. Bond is also currently Chairman of the Board. Mr. Bond came to PictureTel from ANS Communications, the networking subsidiary of America Online, Inc., where he served as Chief Executive Officer from July, 1996 to February, 1998. Prior to ANS, Mr. Bond spent seven years with British Telecom, where he ran British Telecom's largest business division. Mr. Bond is also a Director of WITCO Corporation, a public specialty chemical company, and Ceridian Corporation, a human resources information systems outsourcing company. Lawrence M. Bornstein joined PictureTel in January, 1994 as Vice President of Human Resources. From June, 1993 to January, 1994, Mr. Bornstein served as an executive recruiter for Heidrick and Struggles, an executive search firm. Mr. Bornstein also served as the Human Resources Officer for Computervision Corporation, the surviving entity of an acquisition and merger with Prime Computer, Inc. Prior to that time, Mr. Bornstein held similar positions with Fidelity Investments and Digital Equipment Corporation. David W. Grainger became Group Vice President Field Operations of PictureTel in November 1997. Mr. Grainger joined PictureTel in September, 1994 as Vice President, Worldwide Customer Services, which as of 1996 became the Enterprise Services Division. From September, 1991 to September, 1994, Mr. Grainger held the position of Senior Vice President and Officer, Worldwide Customer Services for Xerox Corporation. Prior to that time, Mr. Grainger held a number of positions of increasing responsibility in domestic and international operations for Digital Equipment Corporation. Norman E. Gaut has been a Director since September 1984 and was Chairman of the Board from April, 1987 until June, 1998. Dr. Gaut was President and Chief Executive Officer of PictureTel from January, 1986 to February, 1998. David B. Levi has been a Director of PictureTel since September, 1986 and is a member of the Audit Committee. Mr. Levi was the Chief Operating Officer of Voice Control Systems, a speech recognition company, until he retired in 1997. Previously, Mr. Levi was President of Voice Processing Corporation, a speech recognition technology company for telephony markets, from November, 1995 to November, 1996. From July, 1991 to April, 1995, Mr. Levi was President of Natural Microsystems Corporation, a manufacturer of voice processing systems. Mr. Levi is also a Director of Voxware, a public company in the speech compression business, and Microlog, a public company in the interactive voice response business. Mr. Levi is also a Director of several private companies. Robert T. Knight was elected a Director in December, 1992 and is a member of the Compensation Committee and Audit Committee. Mr. Knight became President of Technology Venture Services in January, 1996. Mr. Knight was Chairman of Digital Sound Corporation, a voice processing company, from December, 1994 to December, 1995. Previously, Mr. Knight was President and Chief Executive Officer of Digital Sound Corporation. Prior to 1991, Mr. Knight was a Corporate Vice President of Xerox Corporation. Mr. Knight is also a Director of Cottage Health Systems, a California Health Care provider, and Data Dimensions, Inc., a consulting company specializing in Year 2000 software compliance issues. 75 86 Enzo Torresi was elected a Director of PictureTel in August, 1996 and is a member of the Compensation Committee. He is currently Chairman, Cofounder, and Chief Executive Officer of ICAST Corporation, a privately held Internet software company that specializes in IP Broadcast and multimedia networking technology. Mr. Torresi is also Vice Chairman and a Cofounder of Power Computing Corporation. From January, 1989 to October, 1994, Mr. Torresi was President, Chief Executive Officer, and Cofounder of NetFRAME Systems Incorporated, a public company in the network server business. Mr. Torresi is also a director of FVC.COM, a public company in the business of internet video applications. EXECUTIVE COMPENSATION The following table below discloses the compensation received by PictureTel's Chief Executive Officer and PictureTel's four other executive officers for the fiscal years ended December 31, 1997, December 31, 1996 and December 31, 1995. SUMMARY COMPENSATION TABLE
ANNUAL LONG-TERM COMPENSATION COMPENSATION --------------------------- -------------------------------------- RESTRICTED OTHER ANNUAL STOCK OPTIONS ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARD(S) SHARES COMPENSATION(1) - --------------------------- ---- -------- -------- ------------ ---------- ------- --------------- Dr. Norman E. Gaut.......... 1997(2) $349,474 -- -- -- 150,000 $ 2,400 Chairman and Chief 1996 280,000 $ 50,000 -- -- 50,000 2,250 Executive Officer 1995 280,000 150,000 -- -- -- 2,250 Richard B. Goldman.......... 1997(3) 95,000 $ 48,000(4) -- -- 105,000 $ 1,575 Vice President Chief Financial Officer, Chief Administrative Officer, Treasurer, Secretary Domenic J. LaCava........... 1997(5) $232,040 -- -- -- -- $54,736(6) President, Chief 1996 190,000 $ 50,000 -- -- 19,800 2,250 Operating Officer 1995 190,000 75,000 -- -- -- 2,250 David W. Grainger........... 1997 $194,481 -- -- -- 180,000 $ 2,400 Vice President, Field 1996 160,000 $ 40,000 -- -- 20,000 2,250 Operations 1995 160,000 90,000(7) -- -- -- 2,250 Lawrence M. Bornstein....... 1997 $174,846 -- -- -- 50,000 $ 2,400 Vice President, Human 1996 155,000 $ 40,000 -- -- 17,500 2,250 Resources 1995 155,000 65,000 -- -- -- 2,250
- --------------- (1) Unless otherwise indicated, represents PictureTel's contributions to 401(k) plan. (2) Dr. Gaut resigned as Chairman of the Board in June, 1998 and remains a Director. Dr. Gaut resigned as Chief Executive Officer in February, 1998. (3) Mr. Goldman joined PictureTel in June, 1997. In July, 1998 Mr. Goldman resigned as Vice President and Chief Financial Officer of PictureTel. Mr. Goldman's employment terminated on September 11, 1998. (4) Represents sign-on bonus of $10,000 for Mr. Goldman and $38,000 bonus paid pursuant to PictureTel's employment agreement with Mr. Goldman. (5) Mr. LaCava resigned from PictureTel on October 31, 1997. (6) Represents payment for vacation time accrued of $12,428 as of the termination date and severance of $42,308 pursuant to Mr. LaCava's separation agreement. (7) Includes sign-on bonus installment of $20,000. 76 87 OPTION TABLES The following table below sets forth, for applicable executive officers in the Summary Compensation Table, information regarding individual grants of options made in the last fiscal year, and their potential realizable values. OPTION GRANTS IN THE FISCAL YEAR ENDED DECEMBER 31, 1997
POTENTIAL REALIZABLE VALUE AT ASSUMED NUMBER OF ANNUAL SHARES PERCENT OF RATES OF STOCK UNDERLYING TOTAL OPTIONS EXERCISE PRICE APPRECIATION OPTIONS GRANTED TO PRICE FOR OPTION TERM(2) GRANTED EMPLOYEES IN PER EXPIRATION ----------------------- NAME (#)(1) FISCAL YEAR SHARE DATE 5% 10% ---- ---------- ------------- -------- ---------- ---------- ---------- Norman E. Gaut................ 150,000 3.46% $16.875 2/18/07 $1,591,890 $4,034,161 Richard B. Goldman(3)......... 80,000 1.85% $ 9.190 7/18/07 462,103 1,171,304 25,000 0.58% $ 6.875 12/12/07 108,091 273,924 Domenic J. LaCava(4).......... -- -- -- -- -- David W. Grainger............. 100,000 2.31% $16.875 2/18/07 1,061,260 2,689,440 80,000 1.85% $10.440 11/10/07 524,601 1,330,056 Lawrence M. Bornstein......... 50,000 1.15% $16.875 2/18/07 530,630 1,344,720
- --------------- (1) Options granted for the year ended December 31, 1997 have a ten year term and are exercisable commencing twelve months after the grant date, with 25% of the option shares covered thereby becoming exercisable at that time and with an additional 6.25% of the option shares becoming exercisable quarterly thereafter, with all options being fully exercisable on the fourth anniversary of the grant date. (2) The potential realizable value is calculated based upon the term of the option at its time of grant and is calculated by assuming that the stock price on the date of grant appreciates at the indicated annual rate compounded annually for the entire term of the option and that the option is exercised and sold on the last day of its term for the appreciated price. The 5% and 10% assumed rates of appreciation are derived from the rules of the Securities and Exchange Commission and do not represent PictureTel's estimates or projection of the future price of PictureTel Common Stock. There can be no assurance that the Common Stock will appreciate at any particular rate or at all in future years. (3) In July, 1998, Mr. Goldman resigned as Vice President and Chief Financial Officer of PictureTel. Mr. Goldman's employment terminated on September 11, 1998. Mr. Goldman's options terminate on October 11, 1998. (4) Options granted to Mr. LaCava have since expired due to his resignation dated October 31, 1997. 77 88 The following table below depicts option exercise activity in the last fiscal year and fiscal year-end option values with respect to applicable executive officers named in the Summary Compensation Table. The fair market value of PictureTel's Common Stock on the Nasdaq National Market at December 31, 1997 was $6.50 per share. AGGREGATE OPTION EXERCISES IN THE FISCAL YEAR ENDED DECEMBER 31, 1997
VALUE OF UNEXERCISED NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS SHARES OPTIONS/SARS AT 12/31/97 AT 12/31/97(1)(2) ACQUIRED ON VALUE --------------------------- --------------------------- EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------- ----------- ----------- ------------- ----------- ------------- Norman E. Gaut.............. -- -- 483,047 228,125 $194,425 -- Richard B. Goldman.......... -- -- -- 105,000 -- -- Domenic J. LaCava........... -- -- 147,413(2) -- -- -- David W. Grainger........... -- -- 48,750 211,250 -- -- Lawrence M. Bornstein....... -- -- 40,156 77,344 -- --
- --------------- (1) This column reflects the market value of the shares at December 31, 1997 less the exercise price. The actual value of unexercised options fluctuates with stock market activity. (2) Mr. LaCava's exercisable options outstanding at the end of the fiscal year ended December 31, 1997 expired in January, 1998, three months after his resignation on October 31, 1997. EMPLOYMENT, SEVERANCE AND OTHER AGREEMENTS Mr. Gaut's active employment with PictureTel ceased on June 17, 1998 (the "Gaut Departure Date"), but he remains a member of the Board of Directors. Mr. Gaut is entitled to continue to receive his base salary and benefits as in effect on the Gaut Departure Date for thirty (30) consecutive months following the Gaut Departure Date. PictureTel has employment/severance agreements with the other Named Executive Officers in the Summary Compensation Table. These provide for the executive to be an Executive Officer and report to the Chief Executive Officer for base salary at the specified rates, subject to increase at the discretion of the Board of Directors and specified levels. In the event that Messrs. Bornstein, Goldman, or Grainger's employment is (i) involuntarily terminated by PictureTel for any reason other than for cause (as defined), they shall receive their then-current base salary for a period of twelve (12) consecutive months following the date of such termination; or (ii) involuntarily terminated for any reason other than for cause within eighteen (18) months after the employ of a new Chief Executive Officer (which occurred in February, 1998), they shall continue to receive, after any such termination (a) their then-current base salary until the end of such eighteen (18) month period and (b) fifty percent (50%) of their then-current bonus target opportunity, paid monthly over the balance of such period, but in no case shall the total of all such payments be less than the equivalent of twelve (12) months of the then-current base salary; or (iii) involuntarily terminated by PictureTel for any reason other than for cause within thirty-six (36) months after a Change of Control of PictureTel (as defined), they shall be paid an amount equal to two times the sum of (a) the higher of their then-current base salary or the base salary in effect prior to the Change in Control and (b) the highest bonus paid in the three years preceding the year of termination or the three years preceding the year in which the Change in Control occurs, such payments to be made in installments over a twenty-four (24) consecutive month period following the date of such termination. In all cases, the Executive Officer's welfare benefits (health, life, disability) would continue during such time as the executive is receiving the specified severance payments. These agreements provide these Executive Officers with such severance in the event they voluntarily terminate their employment within the same time period stated above for Good Reason (as defined). The agreements also contain provisions requiring the executive to remain in the employ of PictureTel until the Change of Control (subject to the specified provisions for termination by PictureTel) and provisions relating to an adjustment of the severance in the event that such amount is subject to the federal excise tax on change of control payments 78 89 and benefits. Mr. Goldman terminated his employment with PictureTel for Good Reason (as defined). The termination is effective September 11, 1998 (the "Goldman Termination Date"), and under an amended agreement Mr. Goldman will receive the benefits provided in clause (ii) above for fifteen (15) consecutive months following the Goldman Termination Date. In February, 1998 Bruce R. Bond joined PictureTel as the President and Chief Executive Officer. Mr. Bond's employment agreement provides for an annual base salary of $500,000, participation in PictureTel's management incentive plan and an option grant to purchase 1,500,000 shares of PictureTel Common Stock at an exercise price equal to $6.937 per share. PictureTel also agreed to make two loans to Mr. Bond, the first for $750,000 to enable Mr. Bond to retire an obligation with his former employer, and the second for $500,000 as a bridge loan to enable Mr. Bond to purchase a residence in Massachusetts. The first loan matures on February 28, 2002 or earlier upon Mr. Bond's termination of employment and is to be forgiven ratably over a four year period so long as Mr. Bond is an employee of PictureTel. Interest accrues on this loan at the rate of 8.5% a year. The second loan was repaid in full in July, 1998. PictureTel also agreed to provide full relocation expense reimbursement from Mr. Bond's New York residence to the Andover, Massachusetts area. Mr. Bond's employment agreement also provides that, in the event his employment is involuntarily terminated for any reason other than for cause (as defined), Mr. Bond is entitled to severance payments equal to his then-current base salary for a period of twenty-four (24) months. The parties have also entered into a separate change in control agreement, whereby, in the event Mr. Bond's employment is involuntarily terminated (other than for cause) or is terminated for Good Reason (as defined) during the thirty-six (36) months following a Change in Control (as defined) of PictureTel, he would receive an amount equal to three times the sum of (a) the higher of his then-current base salary or the base salary in effect immediately prior to the Change in Control and (b) the higher of his highest annual bonus paid in the three years preceding the year of termination or in the three years preceding the year in which the Change in Control occurs. DIRECTOR COMPENSATION For the year ended December 31, 1997, each director who is not an officer, employee, or full-time consultant to PictureTel or any subsidiary (an "Outside Director") received an annual retainer of $20,000 and received $1,000 for each meeting of the Board of Directors, including Compensation and Audit Committee meetings, that such Outside Director attended. Outside Directors also received expense reimbursements for attending meetings of the Board of Directors and Committees. In addition, Robert T. Knight received $10,000 from PictureTel for general marketing consulting services provided to PictureTel between October 20, 1997 and December 20, 1997. Mr. Knight was not a member of the Compensation Committee during this period. Directors who are officers or employees of PictureTel do not receive any additional compensation for their services as a director. Outside Directors are also entitled to participate in the Amended 1992 Non-Employee Directors' Stock Option Plan (the "Director Plan"). The Director Plan provides that each Outside Director who had been a director for more than two years on August 1, 1996 and each other Outside Director first elected a Director after August 1, 1996 ("Eligible Directors") shall automatically be granted an option to purchase 20,000 shares of PictureTel Common Stock at an exercise price equal to the fair market value of the PictureTel Common Stock on the respective effective date of the grant. Each option is exercisable in installments, 25% one year after the effective date of the grant and 6.25% after the end of each quarter thereafter so that the options are 100% exercisable four years after the effective date of grant. The Director Plan also provides for the annual grant of stock options to purchase 5,000 shares of PictureTel Common Stock to each Eligible Director on August 1 of each year, commencing on August 1, 1997, provided, however, that no such annual option shall be granted to an Eligible Director who first became a director of PictureTel within six months prior to August 1 of the relevant year. These annual grants become fully vested and exercisable one year from the date of grant. In February, 1998, this plan was amended to allow for the non-automatic grant of stock options to Eligible Directors from time to time at the discretion of the Board of Directors. Each of the then Outside Directors received a grant of stock options to purchase 20,000 shares of PictureTel Common Stock effective February 27, 1998 at an exercise price of $7.188, the market price of the PictureTel Common Stock on that 79 90 date, which amounted to 60,000 shares in the aggregate of the 430,000 shares that are covered by the Director Plan. Each option is exercisable 100% on one year from the date of grant. All options remain exercisable until ten years after date of grant unless an Eligible Director ceases to be a director for any reason other than death or total and permanent disability. All options held by the Eligible Director that are not then exercisable shall then terminate. Options that are exercisable on the date of such termination shall continue to be exercisable until the earlier of (i) three months thereafter or (ii) the date on which the option would have terminated had the director remained an Eligible Director. 80 91 DESCRIPTION OF CAPITAL STOCK OF PICTURETEL The following description does not purport to be complete and is subject in all respects to the applicable provisions of PictureTel's Third Restated Certificate of Incorporation, as amended, and By-laws, copies of which are filed as exhibits to the Registration Statement, of which this Information Statement/Prospectus is a part. The authorized capital stock of PictureTel consists of 80,000,000 shares of PictureTel Common Stock, par value $0.01 per share, and 15,000,000 shares of preferred stock, par value $0.01 per share (the "PictureTel Preferred Stock"). COMMON STOCK Subject to the powers, preferences and rights of any PictureTel Preferred Stock, the holders of PictureTel Common Stock are entitled to all powers and voting and other rights pertaining to the capital stock of PictureTel and each share of PictureTel Common Stock is entitled to one vote. There is no cumulative voting. Holders of PictureTel Common Stock have no preemptive or other subscription rights, and there are no conversion, redemption or sinking fund provisions applicable thereto. Upon liquidation or dissolution of PictureTel, subject to preferences that may be applicable to any outstanding series of PictureTel Preferred Stock, the holders of PictureTel Common Stock are entitled to share ratably in all assets available for distribution to stockholders. The Board of Directors of PictureTel is authorized to issue from time to time all of the authorized and unissued shares of PictureTel Common Stock. PREFERRED STOCK PictureTel's Third Restated Certificate of Incorporation provides that the PictureTel Board of Directors is authorized to issue PictureTel Preferred Stock from time to time in one or more series, each of such series to have such voting powers, full or limited, or no voting powers, and such designations, preferences and special rights as shall be determined by the Board of Directors of PictureTel in a resolution or resolutions providing for the issue of such PictureTel Preferred Stock. Such provisions may discourage or preclude certain transactions, whether or not beneficial to stockholders, and could discourage certain types of tactics that involve an actual or threatened acquisition or change of control of PictureTel. The Board of Directors of PictureTel has designated 800,000 shares of PictureTel Preferred Stock as Junior Preferred Stock, none of which is outstanding as of the date of this Information Statement/Prospectus. The voting powers, preferences and special rights of the Junior Preferred Stock are set forth in the Third Restated Certificate of Incorporation of PictureTel. The Third Restated Certificate of Incorporation of PictureTel states that it may not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Junior Preferred Stock without the affirmative vote of two-thirds of the issued and outstanding shares of Junior Preferred Stock. PictureTel has no current intention to issue any of its unissued, authorized shares of PictureTel Preferred Stock. The issuance, however, of any shares of PictureTel Preferred Stock in the future could adversely affect the rights of the holders of PictureTel Common Stock. RIGHTS PLAN On March 25, 1992, the Board of Directors of PictureTel declared a dividend of one purchase right (a "Right") for every outstanding share of PictureTel Common Stock. Each Right entitles the holder to purchase from PictureTel one two-hundredths of a share of Junior Preferred Stock at a price of $90.00 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 between PictureTel and The First National Bank of Boston, as Rights Agent, as amended (the "Rights Agreement"), has acquired, or obtained the right to acquire, beneficial ownership of fifteen percent (15%) or more of the outstanding PictureTel 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 fifteen percent (15%) or more of the outstanding PictureTel Common Stock. 81 92 If PictureTel were acquired in a merger or other business combination, or more than twenty five percent (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 fifteen percent (15%) of the outstanding PictureTel Common Stock, each holder of a Right, other than the acquiring person, will be entitled to receive shares of PictureTel Common Stock having a market value of two times the exercise price of the Right. At any time PictureTel may redeem the Rights at a redemption price of $0.005 per Right. The Rights expire March 25, 2002. DELAWARE LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS PictureTel is subject to the provisions of Section 203 of the DGCL. Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. The Third Restated Certificate of Incorporation of PictureTel provides that so long as PictureTel has a class of capital stock registered under the Exchange Act, all stockholder action must be effected at a duly called meeting, and not by a consent in writing. The By-laws of PictureTel prohibit any stockholder from directly calling a special meeting of stockholders. The By-laws of PictureTel also provide that any action permitted to be taken by the stockholders of PictureTel at an annual meeting or special meeting of stockholders may only be taken if it is properly brought before such meeting. Under the By-laws of PictureTel, in order for any matter to be considered "properly brought" before a meeting, a stockholder must comply with certain requirements regarding advance notice to PictureTel. The foregoing provisions could have the effect of delaying until the next stockholders' meeting stockholder actions which are favored by the holders of a majority of the outstanding voting securities of PictureTel. These provisions may also discourage another person or entity from making a tender offer for the PictureTel Common Stock. For example, if a person or entity acquired a majority of the outstanding voting securities of PictureTel, such person or entity would be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders' meeting, and not by written consent. COMPARISON OF STOCKHOLDER RIGHTS The following is a summary of the material similarities and differences between the rights of holders of Starlight Stock and the rights of holders of PictureTel Common Stock. Starlight is organized under the California Corporations Code (the "CCC") and PictureTel is organized under the DGCL, and accordingly, these differences arise from differing state laws and provisions in the Restated Articles of Incorporation, as amended (the "Starlight Articles"), and By-laws, as amended (the "Starlight By-laws") of Starlight and the Third Restated Certificate of Incorporation, as amended, (the "PictureTel Certificate") and By-laws, as amended, (the "PictureTel By-laws") of PictureTel. Upon consummation of the Merger, Starlight Shareholders will become stockholders of PictureTel and their rights as stockholders will be governed by the DGCL, the PictureTel Certificate and the PictureTel By-laws. This summary does not purport to be a complete statement of such similarities and differences. The identification of specific similarities and differences is not meant to indicate that other equally or more significant similarities and differences do not exist. Such similarities and differences can be examined in full by reference to the DGCL, the CCC, the Starlight Articles, the Starlight By-laws, the PictureTel Certificate and the PictureTel By-laws. AMENDMENT OF STARLIGHT ARTICLES AND PICTURETEL CERTIFICATE The CCC provides that, unless otherwise specified in the articles of incorporation, an amendment to the articles of incorporation requires the approval of the board of directors and the affirmative vote of a majority of 82 93 the outstanding shares entitled to vote thereon, either before or after the board approval. The Starlight Articles also provide that the Starlight Articles may not be amended without approval of holders of a majority in interest of the outstanding shares of Starlight Preferred Stock, voting together as a single class. To amend a certificate of incorporation, the DGCL requires the affirmative recommendation of the board of directors and the approval of a majority of all outstanding shares entitled to vote therefor, unless a greater level of approval is required by the certificate of incorporation. Furthermore, under the DGCL, the holders of the outstanding shares of a class are entitled to vote as a class upon any proposed amendment to the certificate of incorporation if the amendment would increase or decrease the number of authorized shares of such class, increase or decrease the par value of the shares of such class, or alter or change the powers, preferences or special rights of the shares of such class so as to adversely affect the holders thereof. The PictureTel Certificate provides that the PictureTel Certificate may not be amended in any manner which would materially adversely alter or change the powers, preferences and special rights of Junior Preference Stock without the affirmative vote of two-thirds or more of the holders of outstanding shares of Junior Preference Stock, voting together as a single class. AMENDMENT OF STARLIGHT AND PICTURETEL BY-LAWS Under the CCC, by-laws may be adopted, amended or repealed either by the board of directors or by the holders of a majority in interest of the outstanding shares, except that a by-law specifying or changing the fixed number of directors or the maximum or minimum number or changing from a fixed to a variable board of directors or vice versa may only be adopted by holders of a majority in interest of the outstanding shares; provided, however, that an amendment to the by-laws reducing the fixed number or the minimum number of directors to less than five cannot be adopted if votes cast against its adoption are equal to or more than 16 2/3% of the outstanding shares entitled to vote thereon. Under the DGCL, the authority to adopt, amend or repeal the by-laws of a corporation is held exclusively by the stockholders entitled to vote unless such authority is conferred upon the board of directors in the corporation's certificate of incorporation. The fact that such power has been so conferred upon the directors does not divest the stockholders of their power to amend the by-laws. The PictureTel By-laws states that a majority of directors in office or the majority of the outstanding stock entitled to vote may amend the PictureTel By-laws. VOTING RIGHTS Holders of Starlight Common Stock are entitled to one vote per share on each matter submitted to a vote of the shareholders. The Starlight Common Stock is substantially identical to the PictureTel Common Stock in this respect. Each holder of each class of Starlight Preferred Stock is entitled to vote on all matters and is entitled to the number of votes equal to the number of shares of Starlight Common Stock into which such shares of Starlight Preferred Stock could be converted pursuant to the conversion provisions in the Starlight Articles. The conversion rate currently in effect for each series of Starlight Preferred Stock is one to one. Holders of PictureTel Junior Preference Stock are entitled to 100 votes per share on each matter submitted to a vote of the stockholders. The Starlight Articles currently provide that holders of Starlight Series A Preferred and Starlight Series C Preferred, each series voting separately as a class, are entitled to elect, respectively, two and one directors to the Board of Directors of Starlight. The Starlight Articles also provide that Starlight may not, without the approval of the holders of more than fifty percent (50%) of the outstanding shares of Starlight Preferred Stock, (i) amend, repeal or add any provision or portion of any provision to the Starlight Articles, (ii) authorize any additional capital stock with rights, preferences or privileges superior to the currently issued Starlight Preferred Stock, (iii) merge or consolidate with or into any other corporation, (iv) sell or convey all or substantially all of the assets of Starlight, (v) pay dividends or make any distributions in respect of the Starlight Common Stock, (vi) repurchase or redeem any of the Starlight Common Stock or Starlight Preferred Stock, except as provided in the Starlight Articles and except for repurchases of shares from certain individuals, (vii) purchase or otherwise acquire for value an equity interest in any other business entity for 83 94 more than $200,000, (viii) sell or transfer any of its technology other than under licenses in the ordinary course of business, (ix) issue securities of a subsidiary of the corporation to third parties, or (x) enter into any contract or agreement in which an officer, director or employee has a material interest. SPECIAL MEETINGS OF SHAREHOLDERS AND STOCKHOLDERS Under the CCC and the Starlight By-laws, a special meeting of shareholders may be called by the Board of Directors, the Chairman of the Board of Directors, the President, or by one or more holders of shares entitled to cast not less than ten percent (10%) of the votes at such meeting. Under the DGCL, a special meeting of stockholders may be called by the Board of Directors or by any other person authorized to do so in the certificate of incorporation or the by-laws. The PictureTel By-laws permit a special meeting of stockholders to be called by the Chairman of the Board, if any, the President, or the Board of Directors. ACTIONS BY WRITTEN CONSENT OF STOCKHOLDERS AND SHAREHOLDERS Under the DGCL, unless otherwise provided in the PictureTel Certificate, any action which may be taken at a meeting of stockholders may be taken without a meeting and without prior notice if written consents setting forth the action so taken are signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all stockholders entitled to vote thereon were present and voted. The PictureTel Certificate provides that if PictureTel has a class of stock held by more than three hundred stockholders or registered pursuant to the provisions of the Securities Exchange Act of 1934, any action by stockholders of such class must be taken at an annual or special meeting and may not be taken by written consent. Under the CCC, shareholders may execute an action by written consent in lieu of a shareholder meeting. The Starlight By-laws provide that an action may be executed by written consent if signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shareholders entitled to vote thereon were present and voted; provided, however, any action to fill a vacancy created by the removal of a director by the shareholders or by court order, if accomplished by written consent, would require the unanimous written consent of all shares entitled to vote thereon. SIZE OF THE BOARD OF DIRECTORS The CCC allows the number of persons constituting the board of directors to be fixed by the by-laws or the articles of incorporation, or permits the by-laws to provide that the number of directors may vary within a specified range, the exact number of which is to be determined by the board of directors. The CCC further provides that, in the case of a variable board of directors, the maximum number of directors may not exceed two times the minimum number minus one. The Starlight By-laws currently provide that the number of directors authorized shall be not less than five nor more than nine, with the exact number currently fixed at eight. The DGCL provides that the board of directors of a corporation shall consist of one or more members. The number of directors may be fixed by, or in the manner provided in, such corporation's by-laws unless the certificate of incorporation fixes the number of directors, in which case a change in the number of directors may be made only by amendment to the certificate of incorporation. The PictureTel By-laws state that the number of directors shall not be less than one nor more than fifteen, with the Board of Directors of PictureTel responsible for determining the exact number of the Board of Directors. The number of directors of PictureTel is currently fixed at five. CLASSIFICATION OF THE BOARD OF DIRECTORS The CCC generally requires that directors be elected annually but does permit a "classified" board of directors if the corporation is "listed." A listed corporation is defined under the CCC as one (i) which is listed 84 95 on the New York Stock Exchange or American Stock Exchange or (ii) with a class of securities designated as a national market system security on and by the National Association of Securities Dealers Automatic Quotation System if the corporation has at least eight hundred holders of its equity securities. If eligible, the CCC permits a corporation to provide for a board of directors divided into as many as three classes by adopting an amendment to its articles of incorporation or by-laws, which amendment must be approved by the shareholders. The size of the classes must be as even as possible, and any change in number of classes must be approved by the shareholders. Neither the Starlight Articles nor the Starlight By-laws provide for a classified board. The DGCL permits, but does not require, a classified board of directors, divided into as many as three classes with staggered terms under which one-half or one-third of the directors are elected for terms of two or three years, respectively. The PictureTel By-laws do not provide for a classified board of directors. CUMULATIVE VOTING Under the CCC, cumulative voting in the election of directors is mandatory upon notice given by a shareholder at a shareholders' meeting at which directors are to be elected. To cumulate votes, a shareholder must give notice at the meeting, prior to the voting, of the shareholder's intention to vote cumulatively. If any one shareholder gives such a notice, all shareholders may cumulate their votes. The Starlight By-laws permit any person entitled to vote at an election for directors to cumulate the votes to which such person is entitled; provided, however, that no shareholder shall be entitled to cumulate such shareholder's votes unless the candidates for which such shareholder is voting have been placed in nomination prior to the voting and a shareholder has given notice at the meeting, prior to the vote, of an intention to cumulate votes. Under the DGCL, cumulative voting in the election of directors is not available unless specifically provided for in the certificate of incorporation. The PictureTel Certificate does not provide for cumulative voting. REMOVAL OF DIRECTORS Under the CCC, any director or the entire board of directors may be removed with or without cause by the affirmative vote of a majority of the outstanding shares; provided, however, that no individual director may be removed (unless the entire board is removed) if the number of shares voting against removal would be sufficient to elect the director by cumulative voting. In addition, when, by the provisions of the articles of incorporation, the holders of shares of a class or series, voting separately as a class or series, are entitled to elect one or more directors, any director so elected may be removed only by the applicable vote of holders of shares of that class or series. Under the DGCL, any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors, except (i) unless the certificate of incorporation otherwise provides, in the case of a corporation with a classified board of directors, shareholders may effect removal only for cause or (ii) in the case of a corporation having cumulative voting, if less than the entire board of directors is to be removed, no director may be removed without cause if the votes cast against his removal would be sufficient to elect him if then cumulatively voted at an election of the entire board of directors, or, if there be classes of directors, at an election of the class of directors of which he is a part. The PictureTel By-laws provide that a director may be removed with or without cause by vote of holders of a majority of outstanding shares entitled to vote at an election of directors. FILLING VACANCIES IN THE BOARD OF DIRECTORS Under the CCC, any vacancy on the board of directors other than one created by removal of a director may be filled by the board of directors. If the number of directors in office is less than a quorum, a vacancy may be filled by the unanimous written consent of the directors then in office, by the affirmative vote of a majority of the directors at a properly noticed meeting or by a sole remaining director. A vacancy created by removal of a director may be filled by the board of directors only if so authorized by a corporation's articles of incorporation or by a by-law approved by a corporation's shareholders. Furthermore, if, after the filling of any 85 96 vacancy by the directors of a corporation, the directors then in office who have been elected by the corporation's shareholders constitute less than a majority of the directors then in office, then: (i) any holder of more than five percent (5%) of the corporation's voting stock may call a special meeting of shareholders, or (ii) the superior court of the appropriate county may order a special meeting of the shareholders to elect the entire board of directors of the corporation. The Starlight By-laws provide that the shareholders may elect a director at any time to fill any vacancy not filled by the board of directors. Any such election by written consent, other than to fill a vacancy created by removal, requires the consent of a majority of the outstanding shares entitled to vote. The unanimous written consent of holders of outstanding shares entitled to vote is required to fill a vacancy created by removal. Under the DGCL, vacancies may be filled by a majority of the directors then in office, even though less than a quorum, unless otherwise provided in the certificate of incorporation or by-laws, and unless the certificate of incorporation directs that a particular class is to elect such director, in which case any other directors elected by such class, or a sole remaining director, shall fill such vacancy. The DGCL further provides that if, at the time of filling any vacancy, the directors then in office constitute less than a majority of the board of directors, as constituted immediately prior of any such increase, the Delaware Court of Chancery may, upon application of any holder or holders of at least ten percent (10%) of the total number of the outstanding stock having the right to vote for directors, summarily order a special election be held to fill any such vacancy or to replace directors chosen by the board of directors to fill such vacancies. The PictureTel By-laws state that any vacancies shall be filled by a majority of the directors then in office, even if less than a quorum, or by a sole remaining director. DIVIDENDS AND REPURCHASES OF SHARES Under the CCC, a corporation may not make any distribution (including dividends, whether in cash or other property, and repurchases of its shares) unless either (i) the corporation's retained earnings immediately prior to the proposed distribution equal or exceed the amount of the proposed distribution or, (ii) immediately after giving effect to such distribution, the corporation's assets (exclusive of good will, capitalized research and development expenses and deferred charges) would be at least equal to 1 1/4 times its liabilities (not including deferred taxes, deferred income and other deferred credits) and the corporation's current assets, as defined, would be at least equal to its current liabilities, or 1 1/4 times its current liabilities if the average pre-tax and pre-interest earnings for the preceding two fiscal years were less than the average interest expenses for such years. Such tests are applied to California corporations on a consolidated basis. Under the CCC, there are certain exceptions to the foregoing rules for repurchases of shares in connection with certain rescission actions or pursuant to certain employee stock plans. The DGCL permits a corporation to declare and pay dividends out of statutory surplus or, if there is no surplus, out of net profits for the fiscal year in which the dividend is declared and/or for the preceding fiscal year; provided, however, that the amount of capital of the corporation following the declaration and payment of the dividend is not less than the aggregate amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets. In addition, the DGCL generally provides that a corporation may redeem or repurchase its shares only if such redemption or repurchase would not impair the capital of the corporation. APPRAISAL RIGHTS Under both the CCC and the DGCL, a shareholder of a corporation participating in certain major corporate transactions may, under varying circumstances, be entitled to appraisal rights pursuant to which such shareholder may receive cash in the amount of the fair market value of his or her shares in lieu of the consideration he or she would otherwise receive in the transaction. Under the DGCL, such fair market value is determined exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, and such appraisal rights are not available (a) with respect to the sale, lease or exchange of all or substantially all of the assets of a corporation, unless otherwise provided in the certificate of incorporation, (b) with respect to a merger or consolidation by a corporation, the shares of which are either listed on a national securities exchange or designated as a national market system security on an interdealer quotation 86 97 system by the National Association of Securities Dealers, Inc. or are held of record by more than two thousand holders; provided, however, that such stockholders receive only shares of the surviving corporation or shares of any other corporation which are either listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. or held of record by more than two thousand holders, plus cash in lieu of fractional shares, or (c) to stockholders of a corporation surviving a merger if no vote of the stockholders of the surviving corporation is required to approve the merger either because the merger agreement does not amend the existing certificate of incorporation, each share of the surviving corporation outstanding prior to the merger is an identical outstanding or treasury share after the merger, and the number of shares to be issued in the merger does not exceed twenty percent (20%) of the shares of the surviving corporation outstanding immediately prior to the merger and if certain other conditions are met. The limitations on the availability of appraisal rights under the CCC are different from those under the DGCL. Shareholders of a California corporation whose shares are listed on a national securities exchange or on a list of over-the-counter margin stocks issued by the Board of Governors of the Federal Reserve System generally do not have such appraisal rights unless the holders of at least five percent (5%) of the class of outstanding shares claim the right or the corporation or any law restricts the transfer of such shares. Appraisal rights are also unavailable if the shareholders of a corporation or the corporation itself, or both, immediately prior to the reorganization will own immediately after the reorganization equity securities constituting more than five-sixths of the voting power of the surviving or acquiring corporation or its parent entity. The CCC generally affords appraisal in sale of asset reorganizations. In connection with the Merger, holders of Starlight Common Stock and Starlight Preferred Stock may, by complying with Chapter 13 of the CCC, be entitled to appraisal rights as set forth therein, and the shares of such Starlight Common Stock and/or Starlight Preferred Stock held will be deemed to be dissenting shares. Chapter 13 of the CCC is attached as ANNEX B to this Information Statement/Prospectus. INSPECTION OF BOOKS AND RECORDS Both the CCC and the DGCL allow any shareholder to inspect the shareholder list for a purpose reasonably related to such person's interest as a shareholder. The CCC provides, in addition, an absolute right to inspect and copy the corporation's shareholders' list by a shareholder or shareholders holding at least five percent (5%) in aggregate of the outstanding voting shares of a corporation or who hold at least one percent (1%) of such voting shares and have filed a Schedule 14A with the Commission relating to the election of directors. LIMITATION OF LIABILITY OF DIRECTORS The laws of both Delaware and California permit corporations to adopt a provision in their certificate of incorporation or articles of incorporation, respectively, eliminating, with certain exceptions, the personal liability of a director to the corporation or its shareholders for monetary damages for breach of the director's fiduciary duty as a director. The CCC does not permit the elimination of monetary liability where such liability is based on: (a) intentional misconduct or knowing and culpable violation of law; (b) acts or omissions that a director believes to be contrary to the best interests of the corporation or its shareholders, or that involve the absence of good faith on the part of the director; (c) receipt of any improper personal benefit; (d) acts or omissions that show reckless disregard for the director's duty to the corporation or its shareholders, where the director in the ordinary course of performing a director's duties should have been aware of such risk of serious injury to the corporation or its shareholders; (e) acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the corporation and its shareholders; (f) interested transactions between the corporation and a director in which a director has a material financial interest; or (g) liability for improper distributions, loans or guarantees. The Starlight Certificate eliminates the liability of members of the Starlight Board of Directors to the fullest extent permissible under California law. 87 98 Under the DGCL, a corporation may not eliminate monetary liability for (a) breaches of the director's duty of loyalty to the corporation or its stockholders; (b) acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law; (c) unlawful dividends, stock repurchases or redemptions; or (d) transactions from which the director received an improper personal benefit. Such provision(s) for the limitation of liability may not limit a director's liability for violation of, or otherwise relieve directors from, the necessity of complying with federal or state securities laws, or affect the availability of nonmonetary remedies such as injunctive relief or rescission. The PictureTel Certificate eliminates the liability of the PictureTel Board to the fullest extent permissible under the DGCL. INDEMNIFICATION The DGCL provides that a corporation may indemnify a director, officer, employee or agent of the corporation and certain other persons serving at the request of the corporation in related capacities against amounts paid and expenses incurred in connection with an action or proceeding to which he is or is threatened to be made a party by reason of such position, if such person shall have acted in good faith and in a manner he reasonably believed to be in or (in contrast to the CCC) not opposed to the best interests of the corporation, and, in any criminal proceeding, if such person had no reasonable cause to believe his conduct was unlawful. No indemnification, however, shall be made with respect to any matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the adjudicating court determines that such indemnification is proper under the circumstances. The DGCL requires indemnification of expenses when the individual being indemnified has successfully defended the action on the merits or otherwise. The PictureTel Certificate provides that PictureTel will indemnify its directors and executive officers and may indemnify other offices to the fullest extent permitted by law. The PictureTel By-laws also require PictureTel to advance litigation expenses upon request to such persons. However, the PictureTel Certificate also provides that the corporation will not indemnify or advance litigation expenses to any person in connection with any action, suit, proceeding, claim or counterclaim initiated by or on behalf of such person. The CCC permits indemnification of expenses incurred in derivative or third-party actions, except that with respect to derivative actions (a) no indemnification may be made when a person is adjudged liable to the corporation in the performance of that person's duty to the corporation and its shareholders, unless a court determines such person is entitled to indemnity for expenses, and then such indemnification may be made only to the extent that such court shall determine, and (b) no indemnification may be made without court approval in respect of amounts paid in settling or otherwise disposing of an action or expenses incurred in defending an action which is settled or otherwise disposed of without court approval. Indemnification is permitted by the CCC only for acts taken by the person seeking indemnification in good faith and believed to be in the best interests of the corporation and its shareholders and, with respect to a criminal proceeding, which such person had no reasonable cause to believe his conduct was unlawful, as determined by either a majority vote of a quorum of disinterested directors, independent legal counsel if a quorum of disinterested directors is not obtainable, a majority vote of a quorum of the shareholders, excluding shares owned by the indemnified party, or the court handling the action. The CCC requires indemnification when the individual has successfully defended the action on the merits. California corporations may include in their articles of incorporation a provision which extends the scope of indemnification through agreements, by-laws or other corporate actions beyond that specifically authorized by law. The Starlight Articles include a provision authorizing Starlight to indemnify its agents in excess of the indemnification otherwise permitted by statute with respect to corporate agents, subject to statutory limits relating to actions for breach of duty to the corporation and its shareholders. STOCKHOLDER AND SHAREHOLDER APPROVAL OF CERTAIN BUSINESS COMBINATIONS Section 203 of the DGCL prohibits a corporation from engaging in a "business combination" with an "interested stockholder" for three years following the date that such person becomes an interested stockholder. With certain exceptions, an interested stockholder is a person or entity who or which owns fifteen percent (15%) or more of the corporation's outstanding voting stock (including any rights to acquire stock pursuant to an option, warrant, agreement, arrangement or understanding, or upon the exercise of conversion or exchange rights, and stock with respect to which the person has voting rights only), or is an affiliate or 88 99 associate of the corporation and was the owner of fifteen percent (15%) or more of such voting stock at any time within the previous three years. For purposes of Section 203, the term "business combination" is defined broadly to include mergers of the corporation or a subsidiary with or caused by the interested stockholder; sales or other dispositions to the interested stockholder, except proportionately with the corporation's other stockholders, of assets of the corporation or a subsidiary equal to ten percent (10%) or more of the aggregate market value of the corporation's consolidated assets or its outstanding stock; the issuance or transfer by the corporation or a subsidiary of stock of the corporation or such subsidiary to the interested stockholder, except for certain transfers in a conversion or exchange or a pro rata distribution or certain other transactions, none of which increase the interested stockholder's proportionate ownership of any class or series of the corporation's or such subsidiary's stock; or receipt by the interested stockholder, except proportionately as a stockholder, directly or indirectly, of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation or a subsidiary. The three-year moratorium imposed on business combinations by Section 203 does not apply if: (i) prior to the date at which such stockholder becomes an interested stockholder the board of directors approves either the business combination or the transaction which resulted in the person becoming an interested shareholder; (ii) the interested stockholder owns eighty-five percent (85%) of the corporation's voting stock upon consummation of the transaction which made him or her an interested stockholder, excluding from the number of shares outstanding those shares owned by directors who are also officers of the target corporation and shares held by employee stock plans which do not permit employees to decide confidentially whether to accept a tender or exchange offer; or (iii) on or after the date such person becomes an interested stockholder, the board of directors approves the business combination and such business combination is also approved at a stockholder meeting by 66 2/3% of the voting stock not owned by the interested stockholder. Under the CCC, there is no equivalent provision to Section 203 of the DGCL. Section 1203 of the CCC provides that, except where the fairness of the terms and conditions of the transaction has been approved by the California Commissioner of Corporations and except in a "short-form" merger, if the surviving corporation or its parent corporation owns, directly or indirectly, shares of the target corporation representing more than fifty percent (50%) of the voting power of the target corporation prior to the merger, the nonredeemable common stock of a target corporation may be converted only into nonredeemable common stock of the surviving corporation or its parent corporation, unless all of the shareholders of the class consent. The effect of this provision is to prohibit a cash-out merger of minority shareholders, except where the majority shareholders already own ninety percent (90%) or more of the voting power of the target corporation and could, therefore, effect a short-form merger to accomplish such a cash-out of minority shareholders. STOCKHOLDER AND SHAREHOLDER VOTING ON MERGERS AND SIMILAR TRANSACTIONS The laws of both California and Delaware generally require that a majority of the stockholders of both acquiring and target corporations approve statutory mergers. The DGCL does not require a stockholder vote of the surviving corporation in a merger, unless the corporation provides otherwise in its certificate of incorporation, if (a) the merger agreement does not amend the existing certificate of incorporation, (b) each share of stock of the surviving corporation outstanding before the merger is an identical outstanding or treasury share of stock after the merger, and (c) the number of shares to be issued by the surviving corporation in the merger does not exceed twenty percent (20%) of the shares outstanding immediately prior to the merger. The CCC contains a similar exception to its voting requirements for reorganization where shareholders or the corporation itself, or both, immediately prior to the reorganization will own immediately after the reorganization equity securities constituting of more than five-sixths of the voting power, assuming the conversion of convertible equity securities, of the surviving or acquiring corporation or its parent entity. The laws of both California and Delaware also generally require that a sale of all or substantially all of the assets of a corporation be approved by a majority of the outstanding voting shares of the corporation transferring such assets. With certain exceptions, the CCC also requires that mergers, reorganizations, and similar transactions be approved by a majority vote of each class of shares outstanding. In contrast, the DGCL generally does not 89 100 require class voting, except for amendments to the certificate of incorporation that change the number of authorized shares or the par value of shares of a specific class or that adversely affect such class of shares. LOANS TO DIRECTORS, OFFICERS AND EMPLOYEES Under the CCC, any loan to or guaranty for the benefit of a director or officer, including pursuant to an employee benefit plan, of the corporation requires approval of holders of a majority of the outstanding shares of the corporation. The CCC, however, also provides that if a corporation has one hundred or more shareholders of record and has adopted a by-law proviso allowing the board of directors to do so, the board of directors alone may approve loans to or guaranties on behalf of an officer (whether or not such officer is a director) or adopt an employee benefit plan authorizing such loans or guarantees by a vote sufficient without counting the vote of any interested director or directors, if the board of directors determines that any such loan, guaranty or plan may reasonably be expected to benefit the corporation. The DGCL permits a corporation to make loans to, guarantee the obligations of, or otherwise assists its officers or other employees when such action, in the judgment of the board of directors, may reasonably be expected to benefit the corporation. INTERESTED DIRECTOR TRANSACTIONS Under the laws of both California and Delaware, contracts or transactions between a corporation and one or more of its directors or between a corporation and any other entity in which one or more of its directors are directors or have a financial interest, are not void or voidable because of such interest or because such director is present at a meeting of the board of directors which authorizes or approves the contract or transaction, provided, however, that certain conditions, such as obtaining the required approval and fulfilling the requirements of good faith and full disclosure, are met. With certain exceptions, the conditions are similar under the CCC and the DGCL. Under the CCC and the DGCL, either (a) the shareholders or the board of directors must approve any such contract or transaction in good faith after full disclosure of the material facts (and, in the case of approval by the board of directors other than for a common directorship, the CCC requires that the contract or transaction must also be "just and reasonable" to the corporation), or (b) the contract or transaction must have been "fair", according to the DGCL, or, in the case of a common directorship according to the CCC, "just and reasonable" as to the corporation at the time it was approved. The CCC explicitly places the burden of proof of the just and reasonable nature of the contract or transaction on the interested director. Under the CCC, if shareholder approval is sought, the interested director is not entitled to vote his or her shares at a shareholder meeting with respect to any action regarding such contract or transaction. If board approval is sought, the contract or transaction must be approved by a majority vote of a quorum of the directors, without counting the vote of any interested directors (except that interested directors may be counted for purposes of establishing a quorum). Under the DGCL, if board approval is sought, the contract or transaction must be approved by a majority of the disinterested directors (even though less than a majority of a quorum). STOCKHOLDER AND SHAREHOLDER DERIVATIVE SUIT The CCC provides that a shareholder bringing a derivative action on behalf of a corporation need not have been a shareholder at the time of the transaction in question, provided that certain criteria are met. The CCC also provides that the corporation or the defendant in a derivative suit may, under certain circumstances, make a motion to the court for an order requiring the plaintiff shareholder to furnish a security bond. The DGCL does not have a similar bonding requirement. Under the DGCL, a stockholder may only bring a derivative action on behalf of the corporation if the stockholder was a stockholder of the corporation at the time of the transaction in question or his or her stock thereafter devolved upon him or her by operation of law. A stockholder must also first make demand on the corporation that it bring suit and have such demand be refused unless it is shown such demand would have been futile. 90 101 STARLIGHT 1998 BONUS RETENTION PLAN GENERAL DESCRIPTION On May 7, 1997, the Board of Directors of Starlight approved the grant of a bonus to its employees equal to 15% of the gross proceeds (the "Bonus Pool") offered to shareholders in consideration for their shares of the capital stock of Starlight in a merger or acquisition of Starlight or the sale of all or substantially all of the assets of Starlight (an "Acquisition Transaction"). On July 17, 1998, the Board of Directors of Starlight approved the Starlight 1998 Bonus Retention Plan upon substantially the same terms set forth in the May 7, 1997 resolutions of the Board of Directors. The Bonus Retention Plan, however, increased the size of the Bonus Pool to 15.86% of the gross proceeds offered to shareholders in consideration for their shares of the capital stock of Starlight in an Acquisition Transaction, and authorized the participation of consultants and members of the Board of Directors. The bonuses granted under the Bonus Retention Plan will be payable in cash, or, upon the determination of the Board of Directors or Compensation Committee, in the shares of the unrelated issuer in the Acquisition Transaction. The Board of Directors adopted the Bonus Retention Plan in order to induce employees, directors and consultants of Starlight (each, a "Participant") to continue to serve at Starlight during difficult periods when neither stock options nor stock ownership were likely to provide adequate incentives to remain with Starlight. The Bonus Retention Plan provides for the Bonus Pool to be allocated among Starlight's employees, consultants and directors in such amounts as determined by the Board of Directors or the Compensation Committee of the Board of Directors. Contemporaneously with the adoption of the Bonus Retention Plan on July 17, 1998, the Board of Directors approved an allocation schedule that set forth the division of the Bonus Pool among Starlight employees, directors and consultants. If a Participant voluntarily terminates employment or service as a director or consultant with Starlight, or is terminated for "cause" (as defined in the Bonus Retention Plan) by Starlight prior to the Merger, then such Participant will not be eligible to receive any bonus payment, and such Participant's bonus will revert back to the Bonus Pool and will be reallocated among the remaining Participants in such amounts as determined in the discretion of the Compensation Committee of the Board of Directors. Pursuant to the Bonus Retention Plan, the Merger constitutes an Acquisition Transaction, and thus entitles the Participants to receive 15.86% of the gross proceeds of the Merger, or a maximum of 251,082 shares of PictureTel Common Stock at the Merger Price. Giving effect to the purchase by PTC of 5,000 shares of Series B Preferred Stock from David A. Edwards immediately prior to the Merger, the initial number of shares of Parent Common Stock that would have been issued to the holders of Starlight Preferred Stock in the Merger was 1,582,996. Pursuant to the Bonus Retention Plan, 251,082 of such shares of _Parent Common Stock have been allocated for issuance under the Bonus Retention Plan, although Parent may issue cash in lieu of shares of Parent Common Stock to satisfy its obligations under the Bonus Retention Plan. According to the existing allocation schedule, all but nine of the Participants will receive cash upon consummation of the Merger, and the remaining nine Participants will receive shares of PictureTel Common Stock. Section 310 of the CCC provides that a transaction between a corporation and its directors shall not be void or voidable if (a) the material facts as to the transaction and as to each director's interest is fully disclosed or known to the shareholders and is approved in good faith by the majority of the shares entitled to vote thereon, excluding shares owned by the interested directors, or (b) the material facts as to the transaction and as to each director's interest is fully disclosed or known to the board of directors or a committee thereof, and the board of directors or committee approves or ratifies the contract or transaction in good faith by a vote sufficient without counting the vote of the interested director or directors and the contract or transaction is just and reasonable to the corporation at the time it is authorized, approved or ratified, or (c) as to contracts or transactions not approved as provided in (a) or (b), the person asserting the validity of the contract or transaction sustains the burden of proving that the contract or transaction was just and reasonable as to the corporation at the time authorized, approved or ratified. Four of the members of the Starlight Board of Directors have an interest in the Bonus Retention Plan, and, because their rights under the Bonus Retention Plan are dependent upon the consummation of the Merger, in the Merger itself. Specifically, Messrs. Long, Lorentzen, Bass and Brannon are entitled to receive, 91 102 upon the consummation of the Merger, bonuses of 56,700, 23,750, 19,250 and 6,450 shares of the PictureTel Common Stock, respectively. As a consequence, the Merger will be subject to challenge unless consented to by a majority of the outstanding shares of Starlight Common Stock and Starlight Preferred Stock, but excluding shares owned by the interested directors. See "Securities Ownership of Certain Beneficial Owners and Management of Starlight." APPROVAL OF CERTAIN PAYMENTS FOR PURPOSES OF SECTION 280G AND SECTION 4999 OF THE CODE The Starlight Shareholders are also being asked to approve the bonuses of 19,250 and 56,700 shares of PictureTel Common Stock to be paid under the Bonus Retention Plan to Messrs. Bass and Long, respectively, to the extent such bonuses would otherwise be subject to Section 280G and Section 4999 of the Code. The approval of the bonus payments requires the written consent of the holders of seventy-five percent (75%) of the outstanding shares of Starlight Stock, excluding shares held by those individuals who are receiving the payments for which shareholder approval is being sought for purposes of Section 280G and Section 4999 of the Code (the "Required Section 280G Consent"). Under Section 280G and Section 4999 of the Code, payments to certain officers and directors of a corporation contingent on a change of control of the corporation (so called "parachute payments") are not deductible by the corporation and are subject to a twenty percent (20%) excise tax in the hands of recipients to the extent they exceed the recipient's average annual taxable compensation paid by the corporation for the five most recent calendar years (the "Base Amount"), but only if such payments in the aggregate equal or exceed three times the Base Amount (the "Trigger Amount"). Payments for services following a change of control are not parachute payments to the extent they are reasonable. Payments to an executive of an acquired corporation contingent on a change of control which are reasonable compensation for past services are parachute payments taken into account in determining whether parachute payments equal or exceed the Trigger Amount, but are not taken into account in determining the extent to which parachute payments exceed the Base Amount and are subject to Section 280G and Section 4999. A payment to an executive of a non-publicly-traded corporation is not a parachute payment if it is approved after adequate disclosure by a vote of the corporation's shareholders owning more than seventy-five percent (75%) of all outstanding stock of the corporation immediately prior to the time of the change of control, excluding the stock of the executive and other persons entitled to payments that would be subject to Section 4999 of the Code. The payment of the bonuses under the Bonus Retention Plan to Messrs. Bass and Long are contingent on a change of control of Starlight and are, therefore, parachute payments. While Mr. Long has entered into an employment agreement with PictureTel that takes effect at the Effective Time, the terms of that agreement, including the options for PictureTel Common Stock to be granted thereunder, are comparable to terms offered to similarly situated PictureTel employees. Starlight therefore believes that payments under that agreement are reasonable compensation for future services and are not parachute payments. Mr. Bass is a member of the Board of Directors of Starlight who has received no compensation for his services. The Base Amount and Trigger Amount for Mr. Bass are each $0. Consequently, the bonus paid to Mr. Bass will be subject to Section 280G and Section 4999 except to the extent such bonus includes reasonable compensation for past services. Mr. Long is the Chairman of the Board of Directors and member of the Board of Directors of Starlight. Mr. Long's Base Amount is believed to be approximately $145,000 and his Trigger Amount approximately $435,000. Mr. Long's bonus will be subject to Section 280G and Section 4999 of the Code if it equals or exceeds his Trigger Amount, in which case the excess over his Base Amount would be subject to Section 280G and Section 4999 except to the extent such bonus includes reasonable compensation for past services. The value of each bonus will equal the fair market value of the shares of PictureTel Common Stock on receipt. While the value that the shares of PictureTel Common Stock allocated to Mr. Long will have on receipt is not known, the value of those shares of PictureTel Common Stock on September 16, 1998, did not equal or exceed his Trigger Amount. In order to avoid the application of Section 280G and Section 4999, Mr. Bass has agreed that he will forego receipt of his entire bonus unless the bonus is approved by the Required Section 280G Consent and Mr. Long has agreed that he will forego receipt of (i) that portion of his bonus in excess of his Trigger 92 103 Amount, as finally determined by PictureTel after consultation with Mr. Long, plus (ii) one dollar, unless such excess payment is approved by the Required Section 280G Consent (each such foregone amount a "Section 280G Amount"). If the Required Section 280G Consent is not obtained, the Section 280G Amounts will be returned to the Bonus Retention Plan to be redistributed in the discretion of the Compensation Committee of the Starlight Board of Directors. LEGAL MATTERS Certain legal matters with respect to the validity of the securities offered hereby will be passed upon for PictureTel by Ropes & Gray, Boston, Massachusetts. Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California has rendered an opinion regarding certain United States Federal income tax matters. EXPERTS The consolidated balance sheets as of December 31, 1997 and 1996 and the consolidated statements of operations, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1997 of PictureTel Corporation included elsewhere in this Information Statement/Prospectus have been included herein in reliance on the report, which includes an explanatory paragraph regarding the restatement of the financial statements for the year ended December 31, 1996, of PricewaterhouseCoopers LLP, independent accountants, given on the authority of the firm as experts in accounting and auditing. The financial statements of Starlight Networks Incorporated at December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997, included in the Registration Statement, of which this Information Statement/Prospectus is a part, have been audited by Ernst & Young LLP, independent auditors, as set forth in their reports appearing elsewhere herein which contain an explanatory paragraph describing conditions that raise substantial doubt about Starlight Networks Incorporated's ability to continue as a going concern as described in Note 1 to the financial statements, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. 93 104 INDEX TO FINANCIAL STATEMENTS CONTENTS
PAGE ---- PICTURETEL CORPORATION Report of Independent Accountants......................... F-2 Consolidated Balance Sheets............................... F-3 Consolidated Statements of Operations..................... F-4 Consolidated Statements of Stockholders' Equity........... F-5 Consolidated Statements of Cash Flows..................... F-6 Notes to Consolidated Financial Statements................ F-7 Consolidated Balance Sheet as of June 28, 1998 (Unaudited)............................................ F-25 Consolidated Statements of Operations for six months ended June 28, 1998 and June 29, 1997 (Unaudited)............ F-26 Consolidated Statements of Cash Flows for six months ended June 28, 1998 and June 29, 1997 (Unaudited)............ F-27 Notes to Consolidated Financial Statements (Unaudited).... F-28 STARLIGHT NETWORKS INCORPORATED Report of Independent Auditors............................ F-33 Balance Sheets............................................ F-34 Statements of Operations.................................. F-35 Statements of Redeemable Convertible Preferred Stock and Changes in Shareholders' Equity (Net Capital Deficiency)............................................ F-36 Statements of Cash Flows.................................. F-37 Notes to Financial Statements............................. F-38
F-1 105 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, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 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 February 25, 1998 F-2 106 PICTURETEL CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
DECEMBER 31, ---------------------- 1997 1996 -------- ---------- (RESTATED) ASSETS Current assets: Cash and cash equivalents................................... $ 49,859 $ 63,333 Marketable securities....................................... 32,152 38,918 Accounts receivable less allowance for doubtful accounts of $6,315 and $3,336 at December 31, 1997 and 1996, respectively.............................................. 108,729 143,237 Inventories, net............................................ 44,901 51,538 Deferred taxes, net......................................... 15,615 6,462 Other current assets........................................ 6,803 5,781 -------- -------- Total current assets...................................... 258,059 309,269 Marketable securities....................................... -- 9,118 Deferred taxes, net......................................... 16,106 3,945 Property and equipment, net................................. 69,103 47,747 Capitalized software costs, net............................. 2,368 9,110 Other assets................................................ 9,415 7,065 -------- -------- Total assets.............................................. $355,051 $386,254 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings....................................... $ 186 $ 519 Accounts payable............................................ 30,169 54,293 Accrued compensation and benefits........................... 10,551 8,906 Accrued expenses............................................ 37,207 20,538 Current portion of capital lease obligations................ 3,426 3,423 Deferred revenue............................................ 23,547 19,527 -------- -------- Total current liabilities................................. 105,086 107,206 Long-term borrowings........................................ -- 9,242 Capital lease obligations, net of current portion........... 22,000 4,960 Commitments and contingencies (Notes 6, 7 and 15) Stockholders' equity: Preference stock, $.01 par value; 15,000,000 shares authorized; none issued............................................ -- -- Common stock, $.01 par value; 80,000,000 shares authorized; 38,040,363 and 37,499,111 shares issued and outstanding at December 31, 1997 and 1996................................ 380 376 Additional paid-in capital.................................. 204,242 199,755 Retained earnings........................................... 25,425 64,429 Cumulative translation adjustment........................... (2,077) (602) Unrealized gain (loss) on marketable securities, net........ (5) 888 -------- -------- Total stockholders' equity................................ 227,965 264,846 -------- -------- Total liabilities and stockholders' equity................ $355,051 $386,254 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-3 107 PICTURETEL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 -------- -------- -------- (RESTATED) Revenues: Product revenues......................................... $417,115 $451,119 $337,502 Service revenues......................................... 49,310 39,106 26,297 -------- -------- -------- Total revenues........................................ 466,425 490,225 363,799 Cost of revenues Product cost of revenues................................. 234,953 223,680 161,380 Service cost of revenues................................. 40,958 27,369 17,402 -------- -------- -------- Total cost of revenues................................ 275,911 251,049 178,782 Gross margin............................................... 190,514 239,176 185,017 Operating expenses: Selling, general and administrative...................... 167,841 133,028 108,347 Research and development................................. 79,523 65,134 48,716 -------- -------- -------- Total operating expenses.............................. 247,364 198,162 157,063 -------- -------- -------- Income (loss) from operations.............................. (56,850) 41,014 27,954 Interest income............................................ 4,339 5,337 4,123 Interest expense........................................... 1,821 1,050 1,063 Other income (expense), net................................ (1,158) 2,794 87 -------- -------- -------- Income (loss) before income tax expense (benefit).......... (55,490) 48,095 31,101 Income tax expense (benefit)............................... (16,092) 15,923 9,242 -------- -------- -------- Net income (loss).......................................... $(39,398) $ 32,172 $ 21,859 ======== ======== ======== Net income (loss) per common share -- basic................ $ (1.04) $ 0.89 $ 0.64 ======== ======== ======== Net income (loss) per common share -- diluted.............. $ (1.04) $ 0.81 $ 0.57 ======== ======== ======== Weighted average common shares outstanding -- basic........ 37,760 36,097 34,178 ======== ======== ======== Weighted average common shares outstanding -- diluted...... 37,760 39,598 38,428 ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-4 108 PICTURETEL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, 1995 (DOLLARS IN THOUSANDS)
UNREALIZED (LOSS) GAIN ON COMMON STOCK ADDITIONAL CUMULATIVE MARKETABLE TOTAL ---------------------- PAID-IN RETAINED TRANSLATION SECURITIES, STOCKHOLDERS' SHARES PAR VALUE CAPITAL EARNINGS ADJUSTMENT NET EQUITY ---------- --------- ---------- -------- ----------- -------------- ------------- Balance, December 31, 1994........ 32,591,848 $326 $146,508 $ 10,874 $ (452) $(414) $156,842 Exercise of employee stock options and related tax benefit......... 2,323,033 23 26,389 -- -- -- 26,412 Employee stock purchase plan shares.......................... 131,994 2 1,151 -- -- -- 1,153 Conversion of preferred stock to common stock.................... 469,254 5 1,955 -- -- -- 1,960 Exercise of stock purchase warrants........................ 84,000 1 74 -- -- -- 75 Foreign currency translation adjustment...................... -- -- -- -- (79) -- (79) Unrealized gain on marketable securities, net................. -- -- -- -- -- 638 638 Net income........................ -- -- -- 21,859 -- -- 21,859 Multilink paid dividends.......... -- -- -- (476) -- -- (476) ---------- ---- -------- -------- ------- ----- -------- Balance, December 31, 1995........ 35,600,129 357 176,077 32,257 (531) 224 208,384 Exercise of employee stock options and related tax benefit......... 1,300,155 13 21,061 -- -- -- 21,074 Employee stock purchase plan shares.......................... 73,827 1 1,878 -- -- -- 1,879 Conversion of subordinated debt to common stock.................... 525,000 5 739 -- -- -- 744 Foreign currency translation adjustment...................... -- -- -- -- (71) -- (71) Unrealized gain on marketable securities, net................. -- -- -- -- -- 664 664 Net income........................ -- -- -- 32,172 -- -- 32,172 ---------- ---- -------- -------- ------- ----- -------- Balance, December 31, 1996 (Restated)...................... 37,499,111 376 199,755 64,429 (602) 888 264,846 Exercise of employee stock options and related tax benefit......... 358,235 3 1,196 -- -- -- 1,199 Employee stock purchase plan shares.......................... 183,017 1 3,291 -- -- -- 3,292 Foreign currency translation adjustment...................... -- -- -- -- (1,475) -- (1,475) Unrealized loss on marketable securities, net................. -- -- -- -- -- (893) (893) Adjustment to conform Multilink's fiscal year..................... -- -- -- 394 -- -- 394 Net loss.......................... -- -- -- (39,398) -- -- (39,398) ---------- ---- -------- -------- ------- ----- -------- Balance, December 31, 1997........ 38,040,363 $380 $204,242 $ 25,425 $(2,077) $ (5) $227,965 ========== ==== ======== ======== ======= ===== ========
The accompanying notes are an integral part of the consolidated financial statements. F-5 109 PICTURETEL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 -------- -------- -------- (RESTATED) Cash flows from operating activities: Net income (loss)........................................ $(39,398) $ 32,172 $ 21,859 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................ 35,221 22,744 18,699 Deferred taxes, net...................................... (21,314) 1,955 (1,938) Other non-cash items..................................... 2,107 (225) (111) Changes in operating assets and liabilities: Accounts receivable...................................... 34,508 (40,085) (31,960) Inventories.............................................. 6,637 (5,954) (13,069) Other assets............................................. (1,022) (900) (2,493) Accounts payable......................................... (24,124) 27,906 7,405 Accrued compensation and benefits and accrued expenses... 18,314 11,714 16,964 Deferred revenue......................................... 4,020 (399) 5,786 -------- -------- -------- Net cash provided by operating activities.................. 14,949 48,928 21,142 Cash flows from investing activities: Purchase of marketable securities........................ (26,392) (20,115) (71,772) Proceeds from marketable securities...................... 42,276 25,987 70,902 Additions to property and equipment...................... (21,645) (39,877) (18,207) Proceeds from disposals of property and equipment........ -- 387 -- Capitalized software costs............................... (7,252) (6,887) (5,293) Purchase of other assets................................. (5,350) (565) -- Proceeds from sale of intangible asset................... -- 2,050 -- -------- -------- -------- Net cash used in investing activities...................... (18,363) (39,020) (24,370) Cash flows from financing activities: Change in short-term borrowings.......................... (333) 38 (6,412) Change in long-term borrowings........................... (9,242) (3,784) 13,026 Principal payments under capital lease obligations....... (3,895) (3,387) (3,504) Proceeds from capital leases............................. -- 8,492 -- Payment of Multilink dividends........................... -- -- (476) Redemption of preferred stock............................ -- -- (650) Proceeds from exercise of stock options.................. 954 10,676 14,025 Proceeds from employee stock purchase plan............... 3,537 1,948 1,153 -------- -------- -------- Net cash provided by (used in) financing activities........ (8,979) 13,983 17,162 Adjustment to conform fiscal year of Multilink............. 394 -- -- Effect of exchange rate changes on cash.................... (1,475) (151) 401 -------- -------- -------- Net increase (decrease) in cash and cash equivalents....... (13,474) 23,740 14,335 Cash and cash equivalents at beginning of year............. 63,333 39,593 25,258 -------- -------- -------- Cash and cash equivalents at end of year................... $ 49,859 $ 63,333 $ 39,593 ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-6 110 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 of visual collaboration products and services. 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 reflect all such restatements. A summary of the impact of such restatements for the year ended December 31, 1996 including the financial condition and results of operations from the Multilink acquisition on July 22, 1997, accounted for as a pooling-of-interests, is as follows (in thousands):
YEAR ENDED DECEMBER 31, 1996 ---------------------- PREVIOUSLY AS REPORTED RESTATED ---------- -------- Revenues.................................................... $504,952 $490,225 Gross margin................................................ 245,204 239,176 Income before taxes......................................... 54,123 48,095 Income tax expense.......................................... 17,894 15,923 Net income.................................................. 36,229 32,172 Net income per common share -- basic........................ $ 1.00 $ 0.89 Net income per common share -- diluted...................... $ 0.91 $ 0.81
DECEMBER 31, 1996 ---------------------- PREVIOUSLY AS REPORTED RESTATED ---------- -------- Total assets................................................ $389,522 386,254 Total liabilities........................................... $120,632 121,408 Total stockholders' equity.................................. $268,890 264,846
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ACQUISITION OF MULTILINK, INC. On July 22, 1997, the Company acquired all of the common stock of MultiLink, Inc. (MultiLink) in a transaction accounted for as a pooling of interests. MultiLink develops, manufactures and markets software and hardware that enable users at two or more sites to participate in face-to-face meetings. The Company issued 3,578,026 shares of common stock in exchange for 6,389,332 shares of MultiLink common stock at a ratio of one share of MultiLink common stock to 0.56 shares of the Company's common stock. The accompanying consolidated financial statements for all periods prior to the acquisition have been restated to include the results of operations, financial position and cash flows of MultiLink. F-7 111 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following information presents certain statement of operations data of the separate companies for the periods prior to the acquisition which for these purposes has been assumed to occur on June 29, 1997.
SIX MONTHS ENDED YEAR ENDED JUNE 29, DECEMBER 31, ------------------- ------------------- 1997 1996 1996 1995 -------- -------- -------- -------- Revenues PictureTel............................. $227,439 $221,083 $467,805 $346,758 MultiLink.............................. 12,462 9,662 22,420 17,041 Net income (loss) PictureTel............................. $ (1,513) $ 15,957 $ 30,598 $ 19,626 MultiLink.............................. (1,376) 651 1,574 2,233
In conjunction with the acquisition, MultiLink's fiscal year end has been changed from September 30 to December 31 to conform to the Company's fiscal year end. As a result, the financial statements for the years ended December 31, 1996 and 1997 include the results of operations and financial position of MultiLink for the year ended September 30, 1996 and the year ended December 31, 1997, respectively. Accordingly, MultiLink's results of operations and financial position for the quarter ended December 31, 1996 excluded from the financial statements are as follows (in thousands): Revenues.................................................... $6,613 ====== Total cost of sales and operating expenses.................. $5,918 ====== Net income.................................................. $ 394 ======
The net income of $394,000 for the quarter ended December 31, 1996 has been credited directly to retained earnings. Intercompany sales from MultiLink to the Company were insignificant and have been eliminated in consolidation. Costs associated with the acquisition of $2,561,000 were charged to operations for the year ended December 31, 1997. These costs principally relate to investment banking, accounting and legal advisory fees and severance expense. 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. 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. Transaction gains and losses are recognized in the statement of operations. F-8 112 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 criteria the Company uses for designating a forward contract as a hedge include the instrument's effectiveness in risk reduction and one-to-one matching of the forward contract to the underlying transaction. The Company's accounting for forward contracts used as a means of hedging exposure to foreign currency exchange risk is in accordance with the concepts established in SFAS No. 52, "Foreign Currency Translation" and various EITF pronouncements. The carrying amount of the forward contracts is the fair value which is determined by obtaining market prices. Gains and losses on forward contracts are deferred and recognized in the same period that the underlying transactions are settled. The contract premiums or discounts are amortized over the life of the foreign exchange contracts and are recognized in other income. At December 31, 1997 and 1996 the Company had contracts maturing through April 6, 1998 to purchase $24,627,000 and $18,534,000, 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 considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. 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. 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, 1997 and 1996 cash equivalents and marketable 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: Building under capital lease....................... 18 years 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
F-9 113 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, 1997, 1996, and 1995, the Company capitalized approximately $7,252,000, $6,887,000, and $5,293,000, respectively, of software costs. During the years ended December 31, 1997, 1996, and 1995, the Company amortized approximately $13,994,000, $5,694,000, and $4,389,000, respectively, of software costs. OTHER ASSETS Included in other assets are intangible assets which consist primarily of intellectual property rights and noncompete agreements which are amortized over their estimated useful life, which range from eighteen to thirty-six months. Accumulated amortization on intangible assets was $3,868,000 and $3,771,000 at December 31, 1997 and 1996, 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 recorded 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. F-10 114 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share." This statement replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share (EPS). Basic EPS excludes the effect of any dilutive options, warrants or convertible securities 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 by dividing income available to common stockholders by the sum of the weighted average number of common shares and common share equivalents computed using the average market price for the period under the treasury stock method. All earnings per share amounts have been restated to conform with the SFAS 128 requirements. The following table reconciles the numerator and the denominators of the basic and diluted EPS computations shown on the Consolidated Statements of Operations (in thousands, except per share data):
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 -------- ---------- ------- (RESTATED) BASIC EPS COMPUTATION: Numerator: Net income (loss)................................. ($39,398) $32,172 $21,859 ======== ======= ======= Denominator: Weighted average common shares outstanding........ 37,760 36,097 34,178 ======== ======= ======= Basic EPS........................................... $ (1.04) $ 0.89 $ 0.64 ======== ======= ======= DILUTED EPS COMPUTATION: Numerator: Net income (loss)................................. ($39,398) $32,172 $21,859 ======== ======= ======= Denominator: Weighted average common shares outstanding........ 37,760 36,097 34,178 Stock options..................................... -- 3,501 4,250 -------- ------- ------- Total Shares................................... 37,760 39,598 38,428 ======== ======= ======= Diluted EPS......................................... $ (1.04) $ 0.81 $ 0.57 ======== ======= =======
Options to purchase shares of the Company's common stock of 4,729,391 at December 31, 1997 were outstanding during the year but were not included in the computation of diluted EPS because they were antidilutive due to the net loss sustained in 1997. Options to purchase shares of the Company's common stock of 1,061,600 and 360,750 for the years ended December 31, 1996, and 1995, respectively, were outstanding during the respective periods but were not included in the computation of diluted EPS because the exercise price of the options, which range from $34.38 to $40.50 for 1996, and $24.44 to $35.13 for 1995, was greater than the average market price of the common stock for the reported period. 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 F-11 115 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. 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 June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." This statement requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. The statement will become effective for fiscal years beginning after December 15, 1997. The Company will adopt the new standard beginning in the first quarter of the fiscal year ending December 31, 1998 and does not expect that the statement will have a material impact on its financial position or results of operations as the statement requires only additional disclosure. The additional disclosure will include comprehensive income, which will differ from historical net income by the amount of the translation adjustments and unrealized gain (loss) on investments included as separate components of stockholders' equity. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," which changes the way public companies report information about their operating segments. SFAS No. 131, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers, and material geographic locations in which the entity holds assets and reports revenues. The Company will adopt SFAS No. 131 for its fiscal year ending December 31, 1998. The Company is currently evaluating the effects of this change on its reporting of segment and geographic information but does not expect the statement to have a material impact on its financial position or results of operations as the statement requires only additional disclosure. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, "Software Revenue Recognition," which provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions and supersedes SOP 91-1, "Software Revenue Recognition." The Company will adopt SOP 97-2 effective January 1, 1998. The Company does not expect the new pronouncement will have a material impact on its financial position or results of operations. In January 1997, the U.S. Securities and Exchange Commission issued Financial Reporting Release No. 48 which expands the disclosure requirements for certain derivative and other financial instruments. The Company adopted the enhanced accounting policy disclosure requirements in the fourth quarter of the fiscal year ending December 31, 1997. The Company will begin furnishing the qualitative and quantitative disclosures of market risk in the second quarter of the fiscal year ending December 31, 1998 and expects to adopt the tabular presentation. F-12 116 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 3. INVENTORIES: Inventories consist of the following (in thousands):
DECEMBER 31, --------------------- 1997 1996 ------- ---------- (RESTATED) Purchased parts......................................... $ 2,983 $ 7,088 Work in process......................................... 2,128 2,858 Finished goods.......................................... 39,790 41,592 ------- ------- $44,901 $51,538 ======= =======
4. MARKETABLE SECURITIES: At December 31, 1997 and 1996, marketable securities can be summarized as follows (in thousands):
AVAILABLE FOR SALE SECURITIES -------------------------------------------- 1997 1996 -------------------- -------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- ------- --------- ------- U. S. Government and its agencies.......... $16,296 $16,291 $42,992 $42,956 Municipal Issues........................... 15,863 15,861 3,352 3,353 ------- ------- ------- ------- Total Debt Securities.................... 32,159 32,152 46,344 46,309 Equity Securities.......................... -- -- 482 1,727 ------- ------- ------- ------- $32,159 $32,152 $46,826 $48,036 ======= ======= ======= =======
Unrealized holding losses of $7,000 for 1997 and gains of $1,210,000 for 1996 are included as a separate component of stockholders' equity, net of tax. Realized gains of approximately $1,500,000, $3,000,000 and $107,000 from the sales of available for sale securities are included in other income for the years ended December 31, 1997, 1996 and 1995, respectively. At December 31, 1997 all of the Company's marketable securities have stated maturity dates within one year of the balance sheet date. 5. PROPERTY AND EQUIPMENT: Property and equipment consist of the following (in thousands):
DECEMBER 31, -------------------- 1997 1996 -------- -------- Building under capital lease........................... $ 20,938 $ -- Equipment.............................................. 96,589 83,954 Equipment and furniture under capital leases........... 9,665 12,581 Furniture and fixtures................................. 10,831 7,588 Leasehold improvements................................. 11,442 5,489 -------- -------- 149,465 109,612 Less: Accumulated depreciation and amortization........ 80,362 61,865 -------- -------- $ 69,103 $ 47,747 ======== ========
At December 31, 1997 and 1996 accumulated amortization amounted to $4,865,000 and $4,385,000 on equipment and furniture under capital leases. At December 31, 1997, accumulated amortization amounted to F-13 117 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) $388,000 on the building under capital lease. Depreciation expense for the years ended December 31, 1997, 1996, and 1995 was $21,227,000, $17,741,000 and $13,684,000, 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 paid by the expiration date. Accordingly, the borrowings under the amended agreement are classified as long-term borrowings. In addition, the Company has $29,100,000 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 to one and one-half percent per annum of the face amount. 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. In addition, the Company is required to at all times maintain in a cash collateral account with the lending institutions not less than $45,000,000 of unencumbered cash and cash equivalents. At December 31, 1997 no borrowings were outstanding under this credit agreement. At December 31, 1996, $9,242,000 was outstanding under this credit agreement. The Company was in compliance with, or compliance was waived for, 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. No borrowings were outstanding against these local lines of credit at December 31, 1997. A total of $519,000 was borrowed against these local lines of credit at December 31, 1996. At December 31, 1997 and 1996, the weighted average interest rate on outstanding short-term borrowings was 4.8% and 4.6%, respectively. 7. COMMITMENTS: The Company has commitments under capital and non-cancelable 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 $11,600,000, $9,619,000 and $7,238,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The Company entered into an eighteen year lease agreement for an additional building at 50 Minuteman Road in Andover, Massachusetts. Beginning in August, 1997 the Company took possession of the building, accounting for it as a capital lease; The Company has since sublet this premises for ten years, beginning June, 1998. The Company is lessee under several capital lease and sale-leaseback agreements with third parties for certain leasehold improvements, equipment and furniture. F-14 118 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Future minimum lease payments under capital and operating leases with initial or remaining terms of one year or more are (in thousands):
CAPITAL OPERATING LEASES LEASES ------- --------- 1998.................................................... $ 5,534 $12,593 1999.................................................... 4,106 5,767 2000.................................................... 2,353 5,219 2001.................................................... 2,353 4,975 2002.................................................... 2,353 4,600 Thereafter.............................................. 29,802 38,772 ------- ------- Total future minimum lease payments..................... $46,501 $71,926 ======= ======= Less amount representing interest....................... 21,075 Present value of net future minimum lease payments...... 25,426 Less current portion.................................... 3,426 Long-term obligation under capital leases............... $22,000 =======
In addition to the above obligations, the Company has entered into an agreement to lease an additional facility, currently under construction at 200 Minuteman Road in Andover. The agreement calls for monthly payments of $312,500 for eighteen years with buyout options after five and ten years. Rental payments do not begin until November 1, 1998. The lease will be accounted for as a capital lease when construction is completed. Due to the unexpected slowdown in revenue growth, the Company is considering alternatives other than immediate occupancy. 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. F-15 119 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 1997, 1996, and 1995. Net income (loss) and net income (loss) 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):
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- ------- ------- (RESTATED) Net income (loss)...................... As reported $(39,398) $32,172 $21,859 Pro forma (46,554) 25,812 20,154 Net income (loss) per share -- Basic... As reported $ (1.04) $ 0.89 0.64 Pro forma (1.23) 0.72 0.59 Net income (loss) per share -- Diluted..................... As reported $ (1.04) $ 0.81 0.57 Pro forma (1.23) 0.65 0.52
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. The Plan was amended effective October 18, 1996 and approved at the Annual Meeting on June 12, 1997 so as to change the service eligibility for Plan participation to six months. Under the provisions of the Plan up to 1,000,000 shares are authorized after the Stock Split. Shares purchased under the Plan in 1997, 1996 and 1995 totaled 183,017, 73,827 and 131,994, respectively. The weighted average grant date fair value of the shares purchased was $7.62, $7.86 and $4.43 in 1997, 1996 and 1995, respectively. There are 611,162 shares available under the Plan at December 31, 1997. For the purpose of providing pro forma disclosures, the fair value of shares purchased were estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions used for purchases in 1997, 1996 and 1995, respectively: a risk-free interest rate of 6.07%, 5.23% and 5.89%, an expected life of 6 months, expected volatility of 56%, 50% and 50%, and no expected dividends. F-16 120 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) STOCK OPTION PLANS 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 5, 1997, the Compensation Committee of the Board of Directors granted replacement options at the rate of four replacement options for every five outstanding options (including replacement options granted in February, 1997) returned, at an exercise price of $9.187 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 $10.00 or more. The replacement options become exercisable (unless accelerated by the committee) over a four-year period, and to the extent the canceled options 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 November, 1998. On November 14, 1989, the Company's shareholders approved the PictureTel Equity Incentive Plan. As of December 31, 1997 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, 1997 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 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, 1997 there were 1,424,103 shares available for future grant under these plans. Effective upon the consummation of the Merger on July 22, 1997, the Board of Directors of PictureTel Corporation voted to assume the 1984, 1986, 1987 and 1996 Multilink, Inc. Stock Options Plans and renamed the 1984, 1986, 1987 and 1996 PictureTel (Multilink) Option Plans (the "Plans"), as appropriate, and providing for the issuance of shares of Common Stock of PictureTel in replacement for Multilink Common Stock upon the exercise thereof. The Compensation Committee of the Board of Directors administers the Multilink Option Plans assumed (and renamed) by PictureTel. There is reserved for issuance under the Plans F-17 121 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 655,419 shares of Common Stock of PictureTel Corporation to be issued upon exercise of the options outstanding under the Plans. No additional options will be issued under the Plans. The following table summarizes the Company's stock option plans at December 31, 1997, 1996, and 1995, and changes during the years then ended:
1997 1996 1995 ----------------------- ----------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ----------- --------- ----------- --------- ----------- --------- Outstanding at beginning of year.... 5,252,627 $17.82 5,296,989 $10.93 6,582,531 $ 7.19 Granted at fair market value................ 4,351,943 13.17 1,608,889 31.94 1,209,084 21.87 Exercised.............. (342,222) 4.95 (1,314,188) 8.18 (2,314,228) 6.02 Forfeited.............. (4,532,957) 21.22 (339,063) 14.50 (180,398) 10.79 ----------- ----------- ----------- Outstanding at end of year................. 4,729,391 $11.22 5,252,627 $17.82 5,296,989 $10.93 =========== =========== =========== Options exercisable at year-end............. 2,037,160 $10.06 2,067,035 $ 9.59 2,033,612 $ 6.93 Weighted-average grant- date fair value of options granted during the year at fair market value.... $ 7.62 $16.80 $11.48
The following table summarizes information about stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------- --------------------------- NUMBER WEIGHTED-AVERAGE NUMBER OUTSTANDING REMAINING WEIGHTED- EXERCISABLE WEIGHTED RANGE OF AT CONTRACTUAL LIFE AVERAGE AT AVERAGE EXERCISE PRICES 12/31/97 (IN YEARS) EXERCISE PRICE 12/31/97 EXERCISE PRICE - ------------------- ----------- ----------------- -------------- ----------- -------------- $0.268 - 8.500 614,060 5.06 $ 5.35 463,346 $ 4.91 8.625 - 8.875 695,721 6.78 8.87 503,676 8.87 8.929 - 9.000 274,646 7.36 8.95 186,239 8.96 9.187 - 9.187 862,183 9.84 9.18 0 0.00 9.188 - 9.625 1,042,264 7.31 9.40 504,614 9.61 9.750 - 16.875 997,627 8.18 14.64 266,608 12.22 18.440 - 40.500 242,890 8.17 36.24 112,676 35.24 --------- --------- $0.268 - 40.500 4,729,391 7.63 $11.22 2,037,159 $10.06 ========= =========
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 1997, 1996 and 1995, respectively: a risk-free interest rate of 6.06%, 5.95% and 6.13%, an expected life of 5.5, 4 and 4 years, expected volatility of 57%, 50% and 50% (No volatility assumption was used for Multilink options) and no expected dividends. F-18 122 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 9. INCOME TAXES: Significant items making up total net deferred tax assets are as follows (in thousands):
DECEMBER 31, ------------------ 1997 1996 ------- ------- Net operating loss and tax credit carryforwards............. $23,825 $10,125 Inventory reserves.......................................... 3,553 2,338 Other temporary differences................................. 12,623 2,711 Valuation allowance......................................... (8,280) (4,767) ------- ------- Total net deferred tax assets............................... $31,721 $10,407 ======= =======
Other temporary differences principally represent bad debt and warranty reserves, depreciation and vacation and other payroll related differences. 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 $7,230,000 reflecting the benefit of deductions from the exercise of stock options. This deferred tax asset is partially offset by a valuation allowance of $3,959,000 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. At December 31, 1997, the realization of the net deferred tax asset is dependent on generating sufficient taxable income in future periods. The amount of the net deferred tax asset considered realizable could be significantly or completely reduced. Although realization is not assured, management believes it is more likely than not that the net deferred tax asset will be realized. The provision (benefit) for income taxes consisted of the following (in thousands):
YEARS ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- ------- ------- (RESTATED) Federal income taxes: Currently payable.................................. $ 2,742 $ 8,509 $ 8,276 Deferred........................................... (18,161) 3,098 (1,693) State income taxes: Currently payable............................... -- 377 1,474 Deferred........................................ (3,134) 1,375 (77) Foreign taxes: Currently payable.................................. 2,002 3,368 1,430 Deferred........................................... 459 (804) (168) -------- ------- ------- Total................................................ $(16,092) $15,923 $ 9,242 ======== ======= =======
F-19 123 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The differences between the statutory federal income tax rate and the Company's effective income tax rate were as follows:
YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 1995 ------ ----- ----- Statutory federal income tax rate........................... (35.0%) 35.0% 35.0% State income tax, net of federal tax benefit................ (4.7) 3.0 4.9 Federal and state tax credits from research and development............................................... (0.9) (1.4) (2.0) Difference between foreign and US tax rates and the benefit of the foreign sales corporation.......................... 0.7 (2.1) (1.0) Change in deferred asset valuation allowance................ 5.0 (2.8) (7.8) Other....................................................... 5.9 1.4 0.6 ----- ---- ---- Effective tax rate.......................................... (29.0%) 33.1% 29.7% ----- ---- ----
At December 31, 1997, the Company had remaining net operating loss ("NOL") carryforwards available of approximately $37,959,000 to offset future federal and state taxable income. The Company also has unused federal research and development tax credits of approximately $2,857,000. The NOL and tax credit carryforwards expire at various dates through the year 2008 and 2009, 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, 1997, approximately $3,975,000 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. 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. The Plan document states that the Company will provide at least 33.3% matching contribution up to the first 3% of each participant's eligible compensation. For the years ended December 31, 1997, 1996 and 1995 the Company's matching contribution up to the first 3% of each participant's eligible compensation was 50%, 33.3% and 50% respectively or $929,000, $857,000 and $661,000, respectively. The Company assumed the Multilink, Inc. 401K Plan as a result of the acquisition in July 1997. However, the Company has filed a Plan termination with the Internal Revenue Service. The final termination of the Plan is pending. No Company contributions were made to the Multilink Plan in 1997, 1996 or 1995. F-20 124 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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):
UNITED STATES EUROPE ASIA/PACIFIC ELIMINATIONS CONSOLIDATED ------------- -------- ------------ ------------ ------------ YEAR ENDED DECEMBER 31, 1997: Total revenues Unaffiliated customers............... $286,387 $107,080 $72,958 -- $466,425 Inter-company transfers.............. 110,671 6 -- $(110,677) -- -------- -------- ------- --------- -------- Total............................. $397,058 $107,086 $72,958 $(110,677) $466,425 ======== ======== ======= ========= ======== Income (loss) from operations.......... $(63,159) $ (3,345) $ 9,152 $ 502 $(56,850) ======== ======== ======= ========= ======== Identifiable assets.................... $284,133 $ 54,500 $29,885 $ (87,500) $281,018 ======== ======== ======= ========= Corporate assets....................... 74,033 -------- Total assets...................... $355,051 ======== YEAR ENDED DECEMBER 31, 1996 (RESTATED): Total revenues Unaffiliated customers............... $321,418 $111,158 $57,649 -- $490,225 Inter-company transfers.............. 101,230 630 -- $(101,860) -- -------- -------- ------- --------- -------- Total............................. $422,648 $111,788 $57,649 $(101,860) $490,225 ======== ======== ======= ========= ======== Income from operations................. $ 28,984 $ 6,201 $ 3,383 $ 2,446 $ 41,014 ======== ======== ======= ========= ======== Identifiable assets.................... $262,184 $ 54,136 $25,691 $ (23,984) $318,027 ======== ======== ======= ========= Corporate assets....................... 68,227 -------- Total assets................. $386,254 ======== YEAR ENDED DECEMBER 31, 1995: Total revenues Unaffiliated customers............... $248,781 $ 79,010 $36,008 -- $363,799 Inter-company transfers.............. 80,300 701 -- $ (81,001) -- -------- -------- ------- --------- -------- Total............................. $329,081 $ 79,711 $36,008 $ (81,001) $363,799 Income (loss) from operations.......... $ 26,783 $ (1,515) $ 1,037 $ 1,649 $ 27,954 ======== ======== ======= ========= ======== Identifiable assets.................... $205,968 $ 42,196 $17,434 $ (26,254) $239,344 ======== ======== ======= ========= Corporate assets....................... 61,269 -------- Total assets................. $300,613 ========
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. F-21 125 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Export sales to unaffiliated customers from the Company's United States operations were as follows (in thousands):
YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ------- ---------- ------- (RESTATED) Europe............................................... $ 35 $ 3,391 $ 4,348 Canada............................................... 7,329 8,319 8,341 Asia/Pacific......................................... 20,769 19,332 13,220 Other................................................ 13,534 15,638 8,709 ------- ---------- ------- $41,667 $ 46,680 $34,618 ======= ========== =======
In 1997, 1996 and 1995 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):
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ------------- -------------- ------------- -------------- 1997 Revenues....................................... $121,935 $117,966 $109,689 $116,835 Gross margin................................... 58,737 51,695 42,816 37,266 Net income (loss).............................. 2,011 (4,900) (16,715) (19,794) Net income (loss) per common share -- basic.... $ 0.05 $ (0.13) $ (0.44) $ (0.52) Net income (loss) per common share -- diluted............................. $ 0.05 $ (0.13) $ (0.44) $ (0.52) 1996 Revenues....................................... $108,055 $122,690 $120,785 $138,695 Gross margin................................... 52,971 61,026 59,223 65,956 Net income..................................... 6,943 9,664 6,884 8,681 Net income per common share -- basic........... $ 0.20 $ 0.27 $ 0.19 $ 0.24 Net income per common share -- diluted......... $ 0.17 $ 0.24 $ 0.17 $ 0.22
The above schedules reflect the restatements to the third and fourth quarters of 1996 and the first and second quarters of 1997 as discussed in Note 1. 13. SUPPLEMENTAL CASH FLOW INFORMATION
1997 1996 1995 ------- ------- ------- Supplemental cash flow information: Interest paid....................................... $ 1,722 $ 1,036 $ 1,050 Income taxes paid................................... $ 4,237 $ 2,676 $ 4,274 Supplemental disclosure of non-cash investing activity: Building acquired under capital lease............... $20,938 $ -- $ --
14. OTHER CHARGES AND FOURTH QUARTER ADJUSTMENTS During the year ended December 31, 1997, the Company recorded other charges of $42,664,000. Other charges of $16,096,000 reported as part of cost of revenues include $4,940,000 for various write-downs of excess and obsolete inventory to their net realizable value as a result of lower than forecasted demand, $9,881,000 to record impairment charges associated with software development projects canceled as a result of F-22 126 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) a realignment in the Company's planned product offerings, $1,122,000 for product retrofit accruals, and $153,000 related to work-force reductions and organizational realignment as a result of activities undertaken to reduce the Company's cost structure to bring it in line with lower-than-expected revenues. Other charges of $21,568,000 reported as part of operating expenses include $2,561,000 recorded in connection with the acquisition of MultiLink, $4,373,000 related to severance expense and sales office closings associated with the acquisition of MultiLink and PictureTel related work-force reductions as a result of activities undertaken to reduce the Company's cost structure to bring it in line with lower-than-expected revenues, $6,475,000 in specific accounts and notes receivable write-offs and provisions for allowances for doubtful accounts, $3,900,000 in provisions for sales taxes primarily related to MultiLink, $1,880,000 in advances written-off to reflect current business conditions and shifts in distribution channels, and $2,379,000 in charges related to other miscellaneous matters. In addition the Company established a $1,500,000 provision recorded against revenue to accrue for estimated sales returns and allowances. Other charges of $3,500,000 included in other income/expense include the write-off of certain equity investments to reflect current business conditions. The Company recorded $24,830,000 of the charges referred to above during the fourth quarter of 1997. Other charges of $12,076,000 recorded during the fourth quarter reported as part of cost of revenues include $9,881,000 to record impairment charges associated with canceled software development projects, $1,073,000 for various write-downs of excess and obsolete inventory, and $1,122,000 for product retrofit accruals. Other charges of $12,254,000 recorded during the fourth quarter reported as part of operating expenses include $2,664,000 in severance expense and sales office closings, $3,900,000 in provisions for sales taxes, $3,975,000 in specific accounts receivable write-offs and provisions for allowances for doubtful accounts, $500,000 for an advance to a vertical partner written-off, and $1,715,000 in charges related to other miscellaneous matters. 15. LITIGATION Datapoint 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 $100-190 million in damages for alleged past infringement and an injunction against alleged future infringement. In the fall of 1995, the Court appointed a Special Master to consider the Company's motion for summary judgment of non-infringement. The Special Master recommended that the motion for summary judgment be denied. On September 16, 1996, the Court adopted the Special Master's claim construction of the Datapoint patents and denied PictureTel's summary judgment motion. The Company believes that it has meritorious defenses to the allegations of the complaint, and is vigorously defending against the lawsuit. On March 16, 1998, the case went to trial before a jury. Efforts at non-binding mediation were unsuccessful. 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 take 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 financial position, results of operations and cash flow of the Company. Shareholder Litigation Since September 23, 1997, seven class action shareholders' complaints were filed against the Company, Norman E. Gaut, Chairman of the Board and Chief Executive Officer, and Les Strauss, the former Vice F-23 127 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. These plaintiffs have consolidated their lawsuits onto one lawsuit and filed a consolidated complaint on February 11, 1998, encaptioned In re PictureTel Corporation Securities Litigation, Civil Action No. 97-12135-DPW. The original complaints were filed following the Company's announcement on September 19, 1997, that it would restate its financial results for the first quarter of fiscal 1997 and the last two quarters of fiscal 1996, and were amended when the Company announced that it would also restate the second fiscal quarter of 1997 on November 13, 1997. The consolidated Complaint alleges 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 November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the prices of PictureTel common stock. The consolidated 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 consolidated complaint and will respond to the allegations in a timely fashion when responses become due. No discovery has occurred and the Company expresses no opinion as to the likely outcome. NV Technologies, Inc. d/b/a NuVision Technologies, Inc. On January 23, 1998, the Company filed PictureTel Corporation v. NV Technologies d/b/a NuVision Technologies, Inc., Civil Action No. 98-166-C, for breach of contract in the Massachusetts Superior Court in Essex County, seeking the repayment of approximately $4,000,000 from NuVision Technologies, Inc. for products sold by the Company. On February 17, 1998, the Company filed PictureTel Corporation v. NV Technologies, Inc. d/b/a NuVision Technologies, Inc., et al., Civil Action No. 98-337A, in the Massachusetts Superior Court in Essex County for false advertising and unfair business practices. On February 23, 1998, the court issued a preliminary injunction against NuVision Technologies, Inc., and all persons acting in concert, participation or combination with them, prohibiting them from continuing to publish a certain advertisement that the company alleges is false and misleading and contains confidential and proprietary information of the Company. As of March 9, 1998, the advertisement in question had continued to be published and the Company is pursuing its legal remedies. Since both actions have recently started, the Company expresses no opinion about their likely outcomes. NV Holdings, Inc. On February 13, 1998, NV Holdings, Inc., which may be related to NuVision Technologies, Inc., filed a complaint in the State District Court for Dallas County, Texas, NV Holdings, Inc. v. PictureTel Corporation, Cause No. DF 98-01404 alleging against PictureTel tortious interference with business advantage and existing contracts as well as business disparagement and slander. While the plaintiff has listed no specific damages they are seeking an injunction and $20,000,000 in punitive damages. The Company believes that it has meritorious defenses to the allegations of the complaint filed against it, and is vigorously defending against the lawsuit. Since this action has recently started, the Company expresses no opinion about its likely outcome. F-24 128 PICTURETEL CORPORATION CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) (UNAUDITED)
JUNE 28, 1998 -------- ASSETS Current assets: Cash and cash equivalents.............................. $ 33,638 Marketable securities.................................. 52,545 Accounts receivable less allowance for doubtful accounts of $5,956 in 1998 and $6,315 in 1997......... 95,954 Inventories, net (Note 3).............................. 36,651 Deferred taxes, net.................................... 15,615 Other current assets................................... 9,732 -------- Total current assets.............................. 244,135 Deferred taxes, net......................................... 20,273 Property and equipment, net................................. 58,724 Capitalized software costs, net............................. 4,176 Other assets................................................ 9,500 -------- Total assets...................................... $336,808 ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings (Note 7)......................... $ -- Accounts payable....................................... 26,096 Accrued compensation and benefits...................... 12,486 Accrued expenses....................................... 30,767 Current portion of capital lease obligations........... 3,304 Deferred revenue....................................... 21,965 -------- Total current liabilities......................... 94,618 Capital lease obligations................................... 20,731 Commitments and contingencies (Notes 6, 7 and 8) Stockholders' equity: Preference stock, $.01 par value; 15,000,000 shares authorized; none issued............................... -- Common stock, $.01 par value; 80,000,000 shares authorized; 38,338,225 and 38,040,363 shares issued and outstanding in 1998 and 1997, respectively........ 383 Additional paid-in capital............................. 206,182 Retained earnings...................................... 16,571 Cumulative translation adjustment...................... (1,676) Unrealized loss on marketable securities, net.......... (1) -------- Total stockholders' equity........................ 221,459 -------- Total liabilities and stockholders' equity........ $336,808 ========
F-25 129 PICTURETEL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
SIX MONTHS ENDED ---------------------- JUNE 28, JUNE 29, 1998 1997 -------- ---------- (RESTATED) Revenues: Product revenues....................................... $176,305 $216,384 Service revenues....................................... 29,323 23,517 -------- -------- Total revenues.................................... 205,628 239,901 Cost of revenues: Product cost of revenues............................... 96,110 110,941 Service cost of revenues............................... 23,358 18,528 -------- -------- Total cost of revenues............................ 119,468 129,469 -------- -------- Gross margin................................................ 86,160 110,432 Operating expenses: Selling, general and administrative.................... 68,994 74,915 Research and development............................... 31,517 41,358 -------- -------- Total operating expenses.......................... 100,511 116,273 -------- -------- Loss from operations........................................ (14,351) (5,841) Interest income, net........................................ 1,001 1,577 Other income (expense), net................................. 329 194 -------- -------- Loss before income tax benefit.............................. (13,021) (4,070) Income tax benefit.......................................... (4,167) (1,181) -------- -------- Net loss.......................................... $ (8,854) $ (2,889) ======== ======== Net loss per common share -- basic.......................... $ (0.23) $ (0.08) ======== ======== Net loss per common share -- diluted........................ $ (0.23) $ (0.08) ======== ======== Weighted average shares outstanding -- basic................ 38,200 37,589 ======== ======== Weighted average shares outstanding -- diluted.............. 38,200 37,589 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-26 130 PICTURETEL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED --------------------- JUNE 28, JUNE 29, 1998 1997 -------- ---------- (RESTATED) Cash flows from operating activities: Net loss.................................................. $(8,854) $(2,889) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 13,527 15,526 Provisions to write down inventory and capitalized software to net realizable value...................... 2,843 -- Write down of long-lived assets........................ 4,210 -- Bad debt provision..................................... 700 -- Deferred taxes, net.................................... (4,167) (689) Other non-cash items................................... 885 -- Changes in operating assets and liabilities: Accounts receivable.................................... 11,494 21,411 Inventories............................................ 4,943 (19,976) Other current assets................................... (3,178) (11,355) Accounts payable....................................... (3,739) (16,890) Accrued expenses....................................... (2,196) 1,948 Deferred revenue....................................... (1,495) (3) ------- ------- Net cash provided by (used in) operating activities......... 14,973 (12,917) Cash flows from investing activities: Purchase of marketable securities......................... (76,519) (16,011) Proceeds from marketable securities....................... 56,126 32,871 Additions to property and equipment....................... (7,783) (14,784) Capitalized software costs................................ (3,397) (3,743) Purchase of other assets.................................. (268) (758) ------- ------- Net cash used in investing activities....................... (31,841) (2,425) Cash flows from financing activities: Proceeds from (payment to) foreign lines of credit........ (186) 1,427 Payments on long-term borrowings.......................... -- (7,788) Principal payments under capital lease obligations........ (1,372) (1,781) Proceeds from exercise of stock options................... 1,044 1,206 Proceeds from stock purchase plan......................... 879 1,099 ------- ------- Net cash provided by (used in) financing activities......... 365 (5,837) Adjustment to conform fiscal year of MultiLink.............. -- 394 Effect of exchange rate changes on cash..................... 282 432 ------- ------- Net decrease in cash and cash equivalents................... (16,221) (20,353) Cash and cash equivalents at beginning of period............ 49,859 63,333 ------- ------- Cash and cash equivalents at end of period.................. $33,638 $42,980 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. F-27 131 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. MANAGEMENT'S REPRESENTATION As permitted by the rules of the Securities and Exchange Commission applicable to Quarterly Reports on Form 10-Q, these notes are condensed and do not contain all the disclosures required by generally accepted accounting principles. Reference should be made to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as filed with the Securities and Exchange Commission on March 31, 1998. In the opinion of the management of PictureTel Corporation, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal, recurring adjustments, except as discussed in Note 2 to Notes to Consolidated Financial Statements) necessary to present fairly the Company's financial position at June 28, 1998, the results of operations for the six months ended June 28, 1998 and changes in cash flows for the six months ended June 28, 1998. The results disclosed in the Consolidated Balance Sheets at June 28, 1998 and the Consolidated Statements of Operations and Consolidated Statements of Cash Flows for the six months ended June 28, 1998 are not necessarily indicative of the results to be expected for the full year. 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 also affect the reported amounts of revenues and expenses during the reporting period. The financial statements include significant estimates of the net realizable value of accounts receivable, inventory and capitalized software as well as the future tax benefit of deferred tax assets and the amount of certain contingent liabilities. Actual results could differ from those estimates. The financial statements and footnotes included in this Form 10-Q reflect the restatement of financial results described in Note 2 to Notes to Consolidated Financial Statements. 2. 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 also 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-Q reflect the restatements that were made on Form 10-Q/A for the three and six month periods ended June 29, 1997 as filed with the Securities and Exchange Commission on January 20, 1998. A summary of the impact of the restatements for the six months ended June 29, 1997 is as follows (in thousands except per share amounts): F-28 132 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
SIX MONTHS ENDED JUNE 29, 1997 --------------------- PREVIOUSLY AS REPORTED RESTATED ---------- -------- Revenues.................................................... $242,922 $239,901 Gross margin................................................ 111,847 110,432 Loss before income taxes.................................... (1,854) (4,070) Income tax benefit.......................................... (676) (1,181) Net loss.................................................... $ (1,178) $ (2,889) Net loss per common share -- basic.......................... $ (0.03) $ (0.08) Net loss per common share -- diluted........................ $ (0.03) $ (0.08)
AS OF JUNE 29, 1997 --------------------- PREVIOUSLY AS REPORTED RESTATED ---------- -------- Total assets................................................ $367,584 $363,035 Total liabilities........................................... $ 96,996 $ 98,321 Total stockholders' equity.................................. $270,588 $264,714
3. INVENTORIES Inventories (net) consist of the following (in thousands):
JUNE 28, 1998 -------- Purchased parts............................................. $ 3,732 Work in process............................................. 1,909 Finished goods.............................................. 31,010 ------- $36,651 =======
F-29 133 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) 4. EARNINGS PER SHARE The following table reconciles the numerator and the denominators of the basic and diluted EPS computations shown on the Consolidated Statements of Operations (in thousands, except per share data):
SIX MONTHS ENDED --------------------- JUNE 28, JUNE 29, 1998 1997 -------- ---------- (RESTATED) BASIC EPS COMPUTATION: Numerator: Net loss............................................... $(8,854) $(2,889) ======= ======= Denominator: Weighted average common shares outstanding............. 38,200 37,589 ======= ======= Basic EPS.............................................. $ (0.23) $ (0.08) ======= ======= DILUTED EPS COMPUTATION: Numerator: Net loss............................................... $(8,854) $(2,889) ======= ======= Denominator: Weighted average common shares outstanding............. 38,200 37,589 Stock options.......................................... -- -- ======= ======= Total shares........................................... 38,200 37,589 ======= ======= Diluted EPS............................................ $ (0.23) $ (0.08) ======= =======
5. COMPREHENSIVE INCOME (LOSS) In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 130 (SFAS 130), "Reporting Comprehensive Income." This statement requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. The statement is effective for fiscal years beginning after December 15, 1997. The Company adopted the interim reporting requirements in the first quarter of fiscal year 1998 and will adopt the annual reporting requirements in the fourth quarter of fiscal year 1998. Total comprehensive loss for the six month period ended June 28, 1998 was $8,449,000, and total comprehensive loss for the comparable period in 1997 was $2,832,000. The components of other comprehensive income are foreign currency translation adjustments and unrealized gains and losses on marketable securities. 6. 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 alleged that certain of PictureTel's products infringed 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 matter went to trial on March 16, 1998. On April 9, 1998 a jury returned a verdict in favor of PictureTel finding that PictureTel did not infringe the Datapoint patents and that the Datapoint patent claims raised against PictureTel were invalid. Datapoint has, as a matter of course, appealed these findings. The Company believes that it has meritorious defenses to the appeal. F-30 134 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) B. Shareholder Litigation Since September 23, 1997, seven class action shareholders' complaints have been filed against the Company, Norman E. Gaut, Director and former Chairman 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. These plaintiffs filed a consolidated complaint on February 11, 1998, encaptioned In re PictureTel Corporation Securities Litigation, Civil Action No. 97-12135-DPW. The original Complaints were filed following the Company's announcement on September 19, 1997 that it would restate its financial results for the first quarter of fiscal 1997 and the last two quarters of fiscal 1996 and were amended when the Company announced that it would also restate the second fiscal quarter of 1997 on November 13, 1997. The consolidated Complaint alleges 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 November 13, 1997, through the alleged preparation and dissemination of materially false and misleading financial statements which artificially inflated the prices of PictureTel common stock. The consolidated Complaint seeks to recover an unspecified amount of damages, including attorneys' and experts' fees and expenses. On April 7, 1998, the Company filed a motion to dismiss the complaint. The Plaintiffs filed an amended complaint in response to the Company's motion to dismiss. No discovery has occurred and the Company expresses no opinion as to the likely outcome. C. NV Holdings, Inc. On February 13, 1998, NV Holdings, Inc., filed a complaint in the State District Court for Dallas County, Texas, NV Holdings, Inc. v. PictureTel Corporation, Cause No. DF 98-01404, alleging against PictureTel tortious interference with both business advantage and existing contracts as well as business disparagement and slander. While the plaintiff has listed no specific damages they are seeking an injunction and $20,000,000 in punitive damages. The Company believes that it has meritorious defenses to the allegations of the complaint filed against it and is vigorously defending against the lawsuit and pursuing recovery under the following actions filed by it. The Company has filed three separate actions against parties that are believed, by the Company, to be related to NV Holdings, Inc.: (1) (PictureTel Corporation v. NV Technologies, Inc. d/b/a NuVision Technologies, Inc., et al, Civil Action No. 98-337A, filed February 17, 1998 in the Superior Court for Essex County, Massachusetts, for False Advertising and Unfair Business Practices). On February 23, 1998, the court issued a preliminary injunction against NuVision Technologies, Inc. and all persons acting in concert, participation or combination with them, prohibiting them from continuing to publish a certain advertisement that the Company alleges is false and misleading. On July 14, 1998, the Company sought leave of court to amend this complaint to include NV Holdings, Inc., and its subsidiary NuVision Technologies, Inc., of Nevada; (2) (PictureTel Corporation v. NV Technologies d/b/a NuVision Technologies. Inc. Civil action No.98-166-C, filed January 23, 1998, in the Superior Court for Essex County, Massachusetts, for Breach of Contract), seeking the repayment of approximately $4,000,000 from NuVision Technologies, Inc.; and (3) (PictureTel Corporation v. Tandberg, ASA, NV Holdings, Inc., et al, Civil Action No. 3-98CV1449-R, filed June 7, 1998, in the United States District Court for the Northern District of Texas, for fraud, fraudulent conveyance and breach of contract) seeking repayment of $4,000,000 and unspecified punitive damages. F-31 135 PICTURETEL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) Discovery has begun with regard to these actions; however, the Company expresses no opinion as to the likely outcome of any of these matters. D. Revnet, Inc. On June 2, 1998, the Company was served with a complaint from a former distribution channel customer, Revnet, Inc., which has ceased operations. (Revnet, Inc. v. PictureTel Corporation. Civil Action 98092039, filed April 2, 1998, in the Circuit Court for Baltimore City, Maryland.) The complaint alleges that the Company breached an oral contract. Revnet is seeking $200,000,000 in damages. No discovery has occurred and PictureTel expresses no opinion as to the likely outcome. 7. DEBT The Company has available 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 June 28, 1998, there were no borrowed amounts outstanding under the revolving credit agreement and $29,100,000 in standby letters of credit outstanding under the revolving credit agreement. There were no borrowed amounts outstanding under the foreign lines of credit. At June 28, 1998, the Company had $24,035,000 outstanding under various leasing lines including the obligation for the lease of the facility at 50 Minuteman Road in Andover which was $20,534,000 at June 28, 1998. This facility was subleased in June, 1998 for a ten-year term. The revolving credit agreement is secured by cash and marketable securities and contains certain financial covenants, including the maintenance of certain ratios including total liabilities to tangible net worth and minimum net income (loss) requirements. The Company was in compliance with, or compliance was waived for, all covenants for the quarter ending June 28, 1998. 8. COMMITMENTS In March 1997, the Company entered into an agreement to lease an additional facility currently under construction at 200 Minuteman Road in Andover. Rental payments are expected to begin early in the fourth quarter. The lease will be accounted for as a capital lease when construction is completed. The Company is considering alternatives other than occupancy, since current staffing levels do not support the requirement for this facility. 9. SUBSEQUENT EVENT On July 22, 1998, the Company announced it had signed a letter of intent to purchase Starlight Networks, Inc., a leading provider of streaming media solutions for enterprise communications. The Company intends to purchase Starlight Networks primarily with common stock and cash. The acquisition is expected to be completed in the fourth quarter, subject to completion of the Company's registration statement on Form S-4 to be filed with the Securities and Exchange Commission. When completed, the transaction is expected to be accounted for under the purchase method of accounting. F-32 136 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders of Starlight Networks Incorporated We have audited the accompanying balance sheets of Starlight Networks Incorporated as of December 31, 1996 and 1997, and the related statements of operations, redeemable convertible preferred stock and shareholders' equity (net capital deficiency), and cash flows for each of the three years in the period ended December 31, 1997. 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 financial position of Starlight Networks Incorporated at December 31, 1996 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that Starlight Networks Incorporated will continue as a going concern. As described in Note 1, the Company has incurred recurring operating losses and has working capital and net capital deficiencies. In addition, the Company is not in compliance with the covenants of its note payable. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. ERNST & YOUNG LLP San Jose, California March 19, 1998 F-33 137 STARLIGHT NETWORKS INCORPORATED BALANCE SHEETS
DECEMBER 31, SIX-MONTH PERIOD ---------------------------- ENDED JUNE 30, 1996 1997 1998 ------------ ------------ ---------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 1,773,479 $ 2,684,244 $ 989,565 Accounts receivable, net of allowance for doubtful accounts of $101,691 at December 31, 1996, $105,127 at December 31, 1997, and $113,572 at June 30, 1998 (unaudited)............................................. 1,322,880 1,254,854 393,578 Other current assets...................................... 554,085 364,958 303,929 ------------ ------------ ------------ Total current assets........................................ 3,650,444 4,304,056 1,687,072 Property and equipment, at cost: Computer equipment........................................ 3,390,258 3,558,746 3,672,796 Furniture and fixtures.................................... 205,535 212,448 212,448 Leasehold improvements.................................... 65,763 65,763 65,763 ------------ ------------ ------------ 3,661,556 3,836,957 3,951,007 Accumulated depreciation and amortization................. 1,823,525 2,719,562 3,114,382 ------------ ------------ ------------ Net property and equipment.................................. 1,838,031 1,117,395 836,625 Other assets................................................ 35,785 30,581 25,581 ------------ ------------ ------------ Total assets................................................ $ 5,524,260 $ 5,452,032 $ 2,549,278 ============ ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) Current liabilities: Accounts payable.......................................... $ 432,272 $ 442,096 $ 498,087 Deferred revenue.......................................... 423,189 420,066 271,459 Deferred revenue -- related parties....................... 2,156,825 1,631,236 1,441,116 Accrued liabilities....................................... 804,370 789,612 588,404 Current portion of capital lease obligations.............. 449,876 494,281 526,512 Note payable.............................................. 3,367,080 2,626,637 2,317,890 Notes payable -- related parties.......................... -- -- 1,784,057 ------------ ------------ ------------ Total current liabilities................................... 7,633,612 6,403,928 7,427,525 Long-term liabilities: Capital lease obligations................................. 1,387,496 1,026,101 873,184 Deferred revenue -- related party......................... 488,855 244,440 122,240 ------------ ------------ ------------ Total long-term liabilities................................. 1,876,351 1,270,541 995,424 Commitments and contingencies Redeemable convertible preferred stock, issuable in series, no par value: Authorized shares -- 12,129,187 Issued and outstanding shares -- 7,766,745 at December 31, 1996, 9,674,270 at December 31, 1997, and 9,676,475 at June 30, 1998 (unaudited) Aggregate liquidation value -- $16,656,122 at December 31, 1996, $22,543,830 at December 31, 1997, and $22,547,468 at June 30, 1998 (unaudited)............................ 16,625,035 22,395,037 22,398,675 Shareholders' equity (net capital deficiency): Common stock, no par value: Authorized shares -- 20,000,000 Issued and outstanding shares -- 2,229,328 at December 31, 1996, 2,261,011 at December 31, 1997, and 2,276,898 at June 30, 1998 (unaudited)............................... 78,104 90,657 94,651 Accumulated deficit....................................... (20,688,842) (24,708,131) (28,366,997) ------------ ------------ ------------ Total shareholders' equity (net capital deficiency)......... (20,610,738) (24,617,474) (28,272,346) ------------ ------------ ------------ Total liabilities and shareholders' equity (net capital deficiency)............................................... $ 5,524,260 $ 5,452,032 $ 2,549,278 ============ ============ ============
See accompanying notes. F-34 138 STARLIGHT NETWORKS INCORPORATED STATEMENTS OF OPERATIONS
SIX-MONTH PERIODS ENDED YEARS ENDED DECEMBER 31, JUNE 30, --------------------------------------- ------------------------- 1995 1996 1997 1997 1998 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) Revenues: Revenues....................... $ 4,723,741 $ 3,728,622 $ 5,659,842 $ 1,870,072 $ 1,061,926 Revenues -- related party...... 3,078,504 2,878,163 2,414,085 1,335,526 464,771 ----------- ----------- ----------- ----------- ----------- Total revenues................... 7,802,245 6,606,785 8,073,927 3,205,598 1,526,697 Costs and expenses: Cost of revenues............... 2,642,361 1,968,986 1,851,333 778,323 805,805 Research and development....... 2,967,729 4,888,200 3,582,846 2,071,380 1,340,068 Selling, general, and administrative.............. 5,279,636 7,055,076 6,120,991 3,206,843 2,798,265 ----------- ----------- ----------- ----------- ----------- Total costs and expenses......... 10,889,726 13,912,262 11,555,170 6,056,546 4,944,138 ----------- ----------- ----------- ----------- ----------- Loss from operations............. (3,087,481) (7,305,477) (3,481,243) (2,850,948) (3,417,441) Interest income.................. 250,310 240,482 102,209 48,597 25,530 Interest expense................. (93,662) (283,129) (631,537) (339,826) (266,155) ----------- ----------- ----------- ----------- ----------- Loss before income taxes......... (2,930,833) (7,348,124) (4,010,571) (3,142,177) (3,658,066) Provision for income taxes....... (60,412) (38,847) (8,718) (8,718) (800) ----------- ----------- ----------- ----------- ----------- Net loss......................... $(2,991,245) $(7,386,971) $(4,019,289) $(3,150,895) $(3,658,866) =========== =========== =========== =========== ===========
See accompanying notes. F-35 139 STARLIGHT NETWORKS INCORPORATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
REDEEMABLE CONVERTIBLE PREFERRED STOCK SHAREHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) ---------------------- ------------------------------------------------- TOTAL SHAREHOLDERS' COMMON STOCK EQUITY ------------------ ACCUMULATED (NET CAPITAL SHARES AMOUNT SHARES AMOUNT DEFICIT DEFICIENCY) --------- ----------- --------- ------- ------------ ------------- Balance at December 31, 1994....... 5,999,167 $ 9,645,900 2,194,991 $66,946 $(10,310,626) $(10,243,680) Issuance of Series D redeemable convertible preferred stock, net of issuance costs of $15,401........................ 1,743,134 6,957,135 -- -- -- -- Issuance of common stock through stock plan..................... -- -- 15,019 3,004 -- 3,004 Repayment of note receivable from employee....................... -- -- -- 1,016 -- 1,016 Repurchases of shares under stock plan........................... -- -- (23,583) (2,127) -- (2,127) Net loss......................... -- -- -- -- (2,991,245) (2,991,245) --------- ----------- --------- ------- ------------ ------------ Balance at December 31, 1995....... 7,742,301 16,603,035 2,186,427 68,839 (13,301,871) (13,233,032) Issuance of common stock through stock plan..................... -- -- 46,578 9,632 -- 9,632 Repurchases of shares issued through stock plan............. -- -- (3,677) (367) -- (367) Exercise of preferred stock warrants....................... 24,444 22,000 -- -- -- -- Net loss......................... -- -- -- -- (7,386,971) (7,386,971) --------- ----------- --------- ------- ------------ ------------ Balance at December 31, 1996....... 7,766,745 16,625,035 2,229,328 78,104 (20,688,842) (20,610,738) Issuance of common stock through stock plan..................... -- -- 46,663 12,583 -- 12,583 Repurchases of shares issued through stock plan............. -- -- (14,980) (30) -- (30) Exercise of preferred stock warrants....................... 13,217 21,807 -- -- -- -- Issuance of Series E preferred stock, net of issuance costs of $17,501........................ 692,428 3,444,639 -- -- -- -- Issuance of Series F preferred stock, net of issuance costs of $100,204....................... 1,201,880 2,303,556 -- -- -- -- Net loss......................... -- -- -- -- (4,019,289) (4,019,289) --------- ----------- --------- ------- ------------ ------------ Balance at December 31, 1997....... 9,674,270 22,395,037 2,261,011 90,657 (24,708,131) (24,617,474) Issuance of common stock through stock plan..................... -- -- 15,887 3,994 -- 3,994 Exercise of preferred stock warrants....................... 2,205 3,638 -- -- -- -- Net loss......................... -- -- -- -- (3,658,866) (3,658,866) --------- ----------- --------- ------- ------------ ------------ Balance at June 30, 1998........... 9,676,475 $22,398,675 2,276,898 $94,651 $(28,366,997) $(28,272,346) ========= =========== ========= ======= ============ ============
See accompanying notes. F-36 140 STARLIGHT NETWORKS INCORPORATED STATEMENTS OF CASH FLOWS
SIX-MONTH PERIODS ENDED YEARS ENDED DECEMBER 31, JUNE 30, --------------------------------------- ------------------------- 1995 1996 1997 1997 1998 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) OPERATING ACTIVITIES Net loss................................. $(2,991,245) $(7,386,971) $(4,019,289) $(3,150,895) $(3,658,866) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.......... 426,227 722,785 896,038 477,177 394,820 Changes in operating assets and liabilities: Accounts receivable................. (655,812) 656,661 68,026 94,304 861,276 Other assets........................ 198,408 (449,495) 194,331 113,642 66,029 Accounts payable and accrued liabilities....................... 699,753 (136,896) (4,934) (217,369) (145,217) Accrued interest expense............ -- 450,000 -- -- -- Deferred revenue.................... (1,293,493) (1,540,458) (773,127) 569,309 (460,927) ----------- ----------- ----------- ----------- ----------- Net cash used in operating activities.... (3,616,162) (7,684,374) (3,638,955) (2,113,832) (2,942,885) INVESTING ACTIVITIES Capital expenditures..................... (300,950) (122,651) (16,711) -- (114,050) Purchases of short-term investments...... (3,608,054) -- -- -- -- Maturity of short-term investments....... 1,374,479 2,233,575 -- -- -- ----------- ----------- ----------- ----------- ----------- Net cash provided by (used in) investing activities............................. (2,534,525) 2,110,924 (16,711) -- (114,050) FINANCING ACTIVITIES Proceeds from issuance of common stock, net of repurchases..................... 877 9,265 12,553 4,969 3,994 Proceeds from issuance of preferred stock.................................. 6,957,135 22,000 5,770,002 3,464,436 3,638 Repayment of note receivable from employee............................... 1,016 -- -- -- -- Principal payments on capital lease obligations............................ (261,660) (420,444) (475,681) (200,231) (120,686) Proceeds from issuance of note payable... -- 3,000,000 -- -- -- Proceeds from issuance of notes payable -- related parties............. -- -- -- -- 1,784,057 Principal payments on note payable....... -- (82,920) (740,443) (351,293) (308,747) ----------- ----------- ----------- ----------- ----------- Net cash provided by financing activities............................. 6,697,368 2,527,901 4,566,431 2,917,881 1,362,256 ----------- ----------- ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents............................ 546,681 (3,045,549) 910,765 804,049 (1,694,679) Cash and cash equivalents at beginning of year................................... 4,272,347 4,819,028 1,773,479 1,773,479 2,684,244 ----------- ----------- ----------- ----------- ----------- Cash and cash equivalents at end of year................................... $ 4,819,028 $ 1,773,479 $ 2,684,244 $ 2,577,528 $ 989,565 =========== =========== =========== =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid............................ $ 93,661 $ 283,129 $ 631,537 $ 339,826 $ 266,155 SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Additions to property and equipment under capital leases......................... $ 654,977 $ 1,274,647 $ 158,691 $ 130,472 $ --
See accompanying notes. F-37 141 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Basis of Presentation Starlight Networks Inc. (the Company) was incorporated in California on July 27, 1990 for the purpose of developing and selling software and hardware that enables the distribution of digitized multimedia across local area networks in mixed client/server environments. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As of December 31, 1997, the Company has a working capital deficiency of $2,100,000 and a net capital deficiency of $24,617,474. Cumulative net losses since inception amount to $24,708,000. The Company will need to obtain additional funds from existing or new investors to continue its research and development activities, fund operating expenses, and build production, sales, and marketing capabilities, as necessary. Management believes that it will be able to obtain additional funds through public or private equity or debt financings, collaborative or other arrangements with corporate partners, or from other sources. If adequate funds are not available, the Company may be required to reduce its level of spending, eliminate one or more of its research or development programs, and/or obtain funds through arrangements with corporate partners or others, all of which may require the Company to relinquish certain rights to its technologies. See Note 7 regarding the issuance of convertible debt and plan of merger. Interim Financial Statements The accompanying balance sheet as of June 30, 1998 and the statements of operations and cash flows for the six-month periods ended June 30, 1997 and 1998 are unaudited. In the opinion of management, the unaudited financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the financial position, results of operations, and cash flows for the interim periods. The results of operations for the six-month period ended June 30, 1998 are not necessarily indicative of operating results to be expected for the full fiscal year. Revenue Recognition Product license and hardware revenue, principally from sales to developers and users of multimedia applications, is recognized at the time of shipment, provided that no significant vendor obligations remain and collection of the resulting receivable is deemed probable. When the Company receives advance payments for products, such payments are recorded as deferred revenue and recognized as revenue when the products are actually shipped. Nonguaranteed per-copy sublicense fees from distributors, OEMs, and VARs are normally recognized as revenue when they are reported as sales by the distributors, OEMs, or VARs. Under the Company's major distributor agreement, significant vendor obligations remain on the Company's sales until the final sell-through to end users. Recognition of revenue under these agreements is deferred until distributor shipment of the product to the end user, which resulted in deferred revenue of approximately $472,000 and $1,387,000 as of December 31, 1996 and 1997, respectively. Maintenance revenues, including technical support and software update fees, are recognized ratably over the term of the contract. Other service revenues are generally recognized at the time the service is performed. The Company performs certain product development services under contractual arrangements. Development fees are recorded as revenue as earned, based on either work completed or the performance requirements of the arrangements. Revenue earned under product development arrangements for the years ended December 31, 1995, 1996, and 1997 amounted to approximately $1,105,000, $404,000, and $160,977, F-38 142 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) respectively, which exceeds costs incurred under such contracts. Such costs are primarily included in research and development expense. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity from the date of purchase of three months or less to be cash equivalents. The Company invests its excess cash primarily in deposits with banks, money market funds, and short-term, high-quality securities which mature or are redeemable within 90 days of issuance and therefore bear minimal risk. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. Geographic Information and Concentration of Credit and Other Risks The Company's foreign operations consist of sales and marketing activities primarily through distributors located throughout the world. The Company's revenue by geographic region, as a percentage of total revenue, was as follows:
YEARS ENDED DECEMBER 31, -------------------- 1995 1996 1997 ---- ---- ---- United States............................................ 60% 73% 74% Asia Pacific............................................. 40% 27% 21% Europe................................................... -- -- 5% --- --- --- 100% 100% 100% === === ===
For the year ended December 31, 1995, two customers accounted for 23% and 16% of total revenue. For the year ended December 31, 1996, two customers accounted for 34% and 16% of total revenue and three customers accounted for 19%, 14%, and 13% of accounts receivable at December 31, 1996. For the year ended December 31, 1997, two customers accounted for 21% and 14% of total revenue, and two customers accounted for 29% and 24% of accounts receivable at December 31, 1997. The Company generally does not require collateral or security when extending credit to customers. Management believes the concentration of credit risk with respect to accounts receivable is substantially mitigated by the Company's credit evaluation process and relatively short collection terms. The market for the Company's products is characterized by rapid technological developments, evolving industry standards, changes in customer requirements, frequent new product introductions and enhancements, and short product life cycles. The market for digitized multimedia access across local area networks is primarily dependent upon the market for such access from individual personal computers (PC). From time to time, the PC industry has experienced significant downturns, often in connection with, or in anticipation of, declines in general economic conditions. These downturns have been characterized by diminished product demand, production over capacity, and resultant accelerated erosion of average selling prices. The Company's business could be materially and adversely affected by industrywide fluctuations in the PC marketplace in the future. F-39 143 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, generally two to four years. Amortization of leasehold improvements is provided on a straight-line basis over the life of the related asset or the lease term, if shorter. Amortization of assets purchased under capital lease is included in depreciation expense. Software Development Costs Development costs include costs related to software products that are expensed as incurred until the technological feasibility of the product is established. After technological feasibility is established, any additional costs are capitalized in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." The establishment of technological feasibility and the ongoing assessment of the recoverability of capitalized software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological feasibility, anticipated future gross revenues, estimated economic life, and changes in software and hardware technologies. No software development costs have been capitalized in 1996 or 1997, as costs incurred subsequent to the establishment of technological feasibility have not been significant. Advertising Costs The Company's policy is to expense advertising costs as incurred. The Company's advertising and promotion expenses were not significant for the years ended December 31, 1995, 1996, and 1997. Stock-Based Compensation Effective January 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). In accordance with the provisions of FAS 123, the Company measures stock-based compensation expense using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25 and related interpretations and, accordingly, recognizes no compensation expense for stock option grants to employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS 130), which establishes standards for reporting and displaying comprehensive income and its components. The Company adopted FAS 130 during 1998. For the six month period ended June 30, 1998 Comprehensive income was not different from the presented net loss. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2), which supercedes SOP 91-1. The Company will be required to adopt this standard in fiscal 1998. SOP 97-2 addresses software revenue recognition matters primarily from a conceptual level, and implementation guidelines have not yet been issued. In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2" (SOP 98-4). SOP 98-4 is effective March 31, 1998 and defers for one year the implementation of the provision of SOP 97-2 that defines what constitutes vendor-specific objective evidence with regard to software revenue recognition. As of June 30, 1998, SOP 97-2 did not have a significant effect on the existing revenue recognition practices. F-40 144 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 2. LEASES Included in computer equipment at December 31, 1996 and 1997 are assets with a cost of approximately $2,133,000 and $2,292,000, respectively, acquired pursuant to capital lease obligations (accumulated amortization of approximately $767,000 and $1,475,000 at December 31, 1996 and 1997, respectively). Included in furniture and fixtures at December 31, 1996 and 1997 are assets with a cost of approximately $98,000, acquired pursuant to capital lease obligations (accumulated amortization of approximately $41,000 and $71,000 at December 31, 1996 and 1997, respectively). The leases provide that the Company pay taxes, insurance, and maintenance expense related to the leased assets. The leases are secured by their underlying equipment. Certain leases contain mandatory 10% to 15% residual buyouts at maturity, which have been included in the future minimum payments below. Future minimum payments in the aggregate under leases consisted of the following at December 31, 1997:
CAPITAL OPERATING LEASES LEASES ---------- ---------- Years ended December 31, 1998...................................................... $ 672,340 $ 486,290 1999...................................................... 697,977 640,500 2000...................................................... 482,496 658,500 2001...................................................... 28,190 676,500 2002...................................................... -- 694,500 2003 and thereafter....................................... -- 292,500 ---------- ---------- Total minimum lease payments................................ 1,881,003 $3,448,790 ========== Less amount representing interest........................... 360,621 ---------- Present value of minimum lease payments..................... 1,520,382 Less amount due within one year............................. 494,281 ---------- $1,026,101 ==========
Rent expense related primarily to facility leases was $264,000, $289,000, and $252,000 for the years ended December 31, 1995, 1996, and 1997, respectively. 3. NOTE PAYABLE In August 1996, the Company issued a promissory note for $3,000,000 that is due in forty-two equal monthly installments of $82,920 through May 1, 2000. Installment payments include interest at a fixed rate per annum of 9%. An additional interest payment of $450,000 is due on June 1, 2000 or upon default of the loan. Borrowings are subject to certain financial covenants, including the requirement to maintain a specific ratio of current assets to principal outstanding of at least 1.5:1, and are secured by the Company's tangible and intangible assets. In conjunction with the issuance of the note, the Company issued a warrant to the lender for the purchase of 75,000 common shares at an exercise price of $6.00 per share. This warrant was outstanding at December 31, 1996 and 1997. As of December 31, 1997, the Company was in compliance with all covenants. However, subsequent to December 31, 1997, the Company is not in compliance with the ratio covenant as described above. Accordingly, the $450,000 interest payment has been accrued, and all amounts payable under the note have been classified as a current liability in the accompanying balance sheet. F-41 145 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Future minimum payments in the aggregate under the note consisted of the following at December 31, 1997: Years ended December 31, 1998...................................................... $ 995,040 1999...................................................... 995,040 2000...................................................... 781,680 2001...................................................... -- ---------- Total minimum loan payments................................. 2,771,760 Less amount representing interest, excluding $450,000 interest accrued.......................................... 459,123 ---------- Present value of minimum loan payments...................... $2,312,637 ==========
4. RELATED PARTY TRANSACTIONS In 1995, the Company entered into an agreement with a preferred shareholder (owning 39% of the Series B and 3% of the Series C preferred stock of the Company) to sell and license the Company's video networking products. Under the terms of the agreement, the Company received $5,800,000 from the shareholder in advance payment of license and maintenance fees, which would be rendered through 1999. In 1995, 1996, and 1997, the Company recognized $1,272,000, $2,258,000, and $1,684,000, respectively, of revenue under this contract. As of December 31, 1997, total deferred revenue under this contract was $489,000, of which $244,000 is classified as long-term, as this revenue is expected to be recognized in 1998 and 1999 based on performance criteria in the revised agreement. As discussed in Note 1, the Company has entered into a distribution agreement with a preferred shareholder to distribute the Company's video networking products in Japan. The Company has received advanced payments of license fees and the Company's policy is to recognize the license revenue on a sell through basis. In the years ended December 31, 1995, 1996, and 1997, the Company recognized $1,806,000, $620,000, and $730,000, respectively, of revenue under the distribution agreement. The deferred revenue balance was $472,326 and $1,386,776 as of December 31, 1996 and 1997, respectively. F-42 146 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 5. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY Redeemable Convertible Preferred Stock The Company has designated four series of preferred stock. Preferred stock authorized and outstanding at December 31, 1996 and 1997 is as follows:
DECEMBER 31, LIQUIDATION ------------------------- PREFERENCE 1996 1997 PER SHARE(1) ----------- ----------- ------------ Series A, 2,529,999 shares authorized, issued and outstanding............................... $ 2,277,000 $ 2,277,000 $0.90 Series B, 1,594,188 shares authorized; 1,561,698 and 1,574,915 shares issued and outstanding in 1996 and 1997, respectively................... 2,575,377 2,597,184 $1.65 Series C, 2,025,000 shares authorized; 1,931,914 shares issued and outstanding................. 4,815,523 4,815,523 $2.50 Series D, 1,780,000 shares authorized; 1,743,134 shares issued and outstanding................. 6,957,135 6,957,135 $4.00 Series E, 2,500,000 shares authorized; 692,428 shares issued and outstanding................. -- 3,444,639 $5.00 Series F, 1,700,000 shares authorized; 1,201,880 shares issued and outstanding................. -- 2,303,556 $2.00 ----------- ----------- $16,625,035 $22,395,037 =========== ===========
- --------------- (1) Plus any declared but unpaid dividends Each share of Series A, B, C, D, E, and F preferred stock is convertible into one share of common stock at the option of the holder. Upon the approval of the holders of more than 50% of the outstanding shares of the Series A, B, C, D, E, or F preferred stock, the Series A, B, C, D, E, or F preferred shares are convertible into common stock on a one-for-one basis, subject to adjustment for antidilution. Additionally, the preferred shares automatically convert into common stock concurrent with the closing of an underwritten public offering of common stock under the Securities Act of 1933 in which the Company receives at least $10,000,000 in gross proceeds and the price per share is at least $4.50 (subject to adjustment for a recapitalization or stock dividends). Series A, B, C, D, E, and F preferred shareholders are entitled to noncumulative dividends at an annual rate of $0.063, $0.1155, $0.175, $0.28, $0.35, and $0.14 per share, respectively. Dividends will be paid only when declared by the Board of Directors out of legally available funds. No dividends have been declared as of December 31, 1997. If, on liquidation, the assets of the Company are insufficient to permit the payment of the preferred stock liquidation preferences in full, the preferred shareholders are entitled to receive a distribution in proportion to their full liquidation preferences. If the assets are more than sufficient to pay the full preferences, then following the payment of the full preferences, and until the total value of the assets to be distributed per share of common stock and Series A, B, and F preferred stock treated on an as-converted basis is equal or greater than $2.25, the remaining assets of the Company shall be distributed among the holders of common stock and Series A, B, and F preferred stock, following adjustments for the Series A, B, C, D, E, and F preferences previously allocated. However, if the common equivalent distribution per share is equal to or greater than $2.25, then the assets of the Company shall be distributed ratably among the holders of common stock and Series A, B, and F preferred stock on an as-converted basis. The Series A, B, C, D, E, and F preferred shares carry one vote per share on all matters submitted to a vote of shareholders. On May 7, 1997, the Board of Directors approved the grant of a bonus to employees equal to 15% of the gross proceeds to shareholders in F-43 147 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) consideration for their shares of stock of the Company in a merger or acquisition of the Company or the sale of or substantially all of the assets of the Company in the event that the proceeds do not exceed the aggregate liquidation value of the outstanding preferred stock. Beginning in June 2002, upon receipt of requests from the holders of at least a majority of the outstanding shares of preferred stock, the Company is required to redeem certain numbers of shares of Series A, B, C, D, E, and F preferred stock at $0.90, $1.65, $2.50, $4.00, $5.00, and $2.00 per share, respectively, plus all declared but unpaid dividends. Beginning in June 2005, the Company, at its option, may redeem all or any part of the outstanding shares of Series A, B, C, D, E, and F preferred stock at $0.90, $1.65, $2.50, $4.00, $5.00, and $2.00 per share, respectively, plus all declared but unpaid dividends. As of December 31, 1997, the Company has reserved 19,273 shares of Series B, 46,713 shares of Series C, and 320,000 shares of Series E preferred stock for issuance under warrants. Common Stock As of December 31, 1997, the Company has reserved 11,465,948 shares of its common stock for issuance upon conversion of its Series A, B, C, D, E, and F preferred stock, 3,120,499 shares for future issuance under the 1991 Stock Plan, and 128,571 shares for issuance under a warrant. 1991 Stock Plan The 1991 Stock Plan (the 1991 Plan) was adopted in June 1991 and provides for the issuance of stock options, stock purchase rights, and stock bonus awards. At December 31, 1997, 1,064,617 shares of common stock were available for the granting of future options, purchase rights, or bonus awards under the 1991 Plan. The 1991 Plan provides that (i) the exercise price of an incentive stock option will be no less than the fair market value of the Company's common stock, as determined by the Board of Directors, on the date of grant, (ii) the exercise price of a nonstatutory stock option will be no less than 85% of the fair market value of the common stock on the date of grant, (iii) the exercise price to an optionee who possesses more than 10% of the total combined voting power of all classes of stock will be no less than 110% of the fair market value of the common stock on the date of grant, and (iv) all unexercised options of an employee are canceled upon termination of employment. Options generally vest over a four-year period and expire ten years after the date of grant or earlier if employment is terminated. Stock purchase rights may not be issued at less than 50% of the fair market value of the common stock on the date of issue. Shares issued pursuant to stock purchase rights may be subject to repurchase by the Company. No purchase rights were granted in 1997. At December 31, 1996 and 1997, there were no outstanding stock purchase rights. F-44 148 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) A summary of activity under the option portion of the 1991 Plan is as follows:
OUTSTANDING OPTIONS ---------------------------- NUMBER WEIGHTED OF AVERAGE SHARES EXERCISE PRICE ---------- -------------- Balance at December 31, 1994............................... 808,733 $0.20 Options granted.......................................... 436,225 $0.28 Options exercised........................................ (15,019) $0.20 Options canceled or expired.............................. (76,127) $0.20 ---------- Balance at December 31, 1995............................... 1,153,812 $0.23 Options granted.......................................... 831,323 $0.61 Options exercised........................................ (46,578) $0.21 Options canceled or expired.............................. (422,091) $0.31 ---------- Balance at December 31, 1996............................... 1,516,466 $0.40 Options granted.......................................... 1,952,650 $0.43 Options exercised........................................ (46,663) $0.27 Options canceled or expired.............................. (1,366,571) $0.59 ---------- Balance at December 31, 1997............................... 2,055,882 $0.22 ==========
In May 1997, the Company approved a reduction in the exercise price of 890,600 outstanding options granted prior to May 1997 to $0.20 per share, the new fair value of the Company's common stock, determined by the Board of Directors. As a result of this repricing, the weighted average exercise price of the 890,600 options was reduced from $0.762 per share to $0.20 per share. The 890,600 options are included in options granted and canceled in the summary presented above. The following table summarizes information concerning outstanding and exercisable options as of December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ---------------------------------------------------------- ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - ------------------- ----------- ----------- -------- ----------- -------- $0.1000 - $0.1000.. 25,000 5.95 years $0.1000 25,000 $0.1000 $0.2000 - $0.2000.. 1,943,552 6.12 years $0.2000 637,068 $0.2000 $0.4000 - $0.4000.. 58,531 8.17 years $0.4000 31,425 $0.4000 $1.0000 - $1.0000.. 28,799 8.82 years $1.0000 19,173 $1.0000 --------- ------- $0.1000 - $1.0000.. 2,055,882 6.21 years $0.2156 712,666 $0.2268 ========= =======
F-45 149 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Pro forma information regarding net loss is required by FAS 123, computed as if the Company had accounted for its employee stock options granted or otherwise modified subsequent to December 31, 1994 under the fair value-based accounting method of that statement. The value for these options was estimated at the date of grant using the minimum value method with the following weighted average assumptions:
1995 1996 1997 ------------- ------------- --------- Expected dividend yield................... 0.00% 0.00% 0.00% Weighted average risk-free interest rate.................................... 5.44% - 7.60% 5.48% - 6.81% 5.19% Expected life............................. 7 years 7 years 5.3 years Expected volatility....................... 0.00% 0.00% 0.00%
The weighted average fair value of options granted in 1995, 1996, and 1997 was $0.10, $0.21, and $0.09, respectively.
1995 1996 1997 ----------- ----------- ----------- Pro forma net loss.......................... $(2,993,614) $(7,408,504) $(4,072,419)
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Because FAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 2002. Warrants At various times, the Company has issued warrants in connection with lease and debt arrangements. At December 31, 1997, warrants that entitle the holders to purchase 19,273 shares of Series B preferred stock with exercise prices of $1.65 to $2.27 per share, 48,676 shares of Series C preferred stock at exercise prices of $2.50 to $4.00 per share, 138,475 shares of Series E preferred stock at an exercise price of $5.00 per share, and 75,000 common shares at an exercise price of $6.00 per share were outstanding. These warrants expire on various dates through 2005. The warrants are subject to acceleration upon the occurrence of certain events. 6. INCOME TAXES The provision for income taxes consists of the following:
DECEMBER 31, ---------------------------- 1995 1996 1997 ------- ------- ------ Current: Federal.............................................. $20,000 $ -- $ -- State................................................ -- -- -- Foreign.............................................. 40,412 38,847 8,718 ------- ------- ------ Total provision........................................ $60,412 $38,847 $8,718 ======= ======= ======
The current income tax provision for 1997 is a result of foreign withholding tax. As of December 31, 1997, the Company had federal and state net operating loss carryforwards of approximately $23,600,000 and $6,500,000, respectively. The Company also had federal research and development tax credit carryforwards of approximately $600,000. The federal net operating loss and credit carryforwards will expire at various dates beginning in 2005 through 2012, if not utilized. The California net operating loss carryforward will expire beginning in 1999 through 2002, if not utilized. Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the ownership change provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilization. F-46 150 STARLIGHT NETWORKS INCORPORATED NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Significant components of the Company's deferred tax assets are as follows:
DECEMBER 31, ------------------------- 1996 1997 ----------- ----------- Deferred tax assets: Net operating loss carryforwards.................. $ 6,500,000 $ 8,400,000 Deferred revenue.................................. 900,000 -- Research credit carryforwards..................... 800,000 900,000 Capitalized research and development.............. 100,000 500,000 ----------- ----------- Total deferred tax assets........................... 8,300,000 9,800,000 Valuation allowances................................ (8,300,000) (9,800,000) ----------- ----------- Net deferred tax assets............................. $ -- $ -- =========== ===========
The valuation allowance increased by $3,000,000 during the year ended December 31, 1996. 7. SUBSEQUENT EVENTS (UNAUDITED) Issuance of Convertible Debt In April and May 1998, the Company issued approximately $1,184,000 of convertible subordinated promissory notes to various investors. The notes bore interest at 9.0% and were automatically converted into shares of Series G preferred stock at a conversion rate of $0.15 per share at maturity on August 15, 1998. Plan of Merger On August 14, 1998, the Company entered into a Plan of Merger (the Plan) with PictureTel Corporation. Under the Plan, the Company's outstanding preferred and common stock would be converted into shares of PictureTel Corporation common stock. The Plan can be terminated by either PictureTel Corporation or the Company. However, under certain circumstances the Company may be required to pay PictureTel Corporation a $1.0 million termination fee. As of June 30, 1998, PictureTel Corporation advanced the Company $600,000 under a term loan with interest at 9%. Subsequent to June 30, 1998, the Company received an additional $600,000 in advances from PictureTel Corporation. All advances mature on the earlier of December 31, 1998 or sixty days from the sale of the Company to a party other than PictureTel Corporation. F-47 151 ANNEX A - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AGREEMENT AND PLAN OF MERGER BY AND AMONG PICTURETEL CORPORATION AND PICTURETEL TECHNOLOGY CORPORATION AND SNI ACQUISITION CORPORATION AND STARLIGHT NETWORKS, INC. DATED AS OF AUGUST 14, 1998 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 152 TABLE OF CONTENTS
PAGE ---- ARTICLE I -- THE MERGER AND RELATED TRANSACTIONS............................ 1 SECTION 1.1 The Merger.................................................. 1 SECTION 1.2 Escrow; Stockholder Representative; Company Closing Certificate................................................. 2 SECTION 1.3 Effective Time.............................................. 2 SECTION 1.4 Effect of the Merger........................................ 2 SECTION 1.5 Articles of Incorporation; By-Laws.......................... 3 SECTION 1.6 Directors and Officers...................................... 3 SECTION 1.7 Effect on Capital Stock..................................... 3 SECTION 1.8 Exchange of Certificates.................................... 4 SECTION 1.9 Stock Transfer Books........................................ 6 SECTION 1.10 No Further Ownership Rights in Company Preferred Stock...... 6 SECTION 1.11 Lost, Stolen or Destroyed Certificates...................... 6 SECTION 1.12 Tax and Accounting Consequences............................. 6 SECTION 1.13 Taking of Necessary Action; Further Action.................. 6 SECTION 1.14 Consideration for Bonus Pool Obligation..................... 6 SECTION 1.15 Material Adverse Effect..................................... 6 ARTICLE II -- REPRESENTATIONS AND WARRANTIES OF THE COMPANY................. 7 SECTION 2.1 Organization, Qualification and Other Equity Interests...... 7 SECTION 2.2 Articles of Incorporation and By-Laws....................... 7 SECTION 2.3 Capitalization.............................................. 7 SECTION 2.4 Authority Relative to this Agreement........................ 8 SECTION 2.5 No Conflict; Required Filings and Consents.................. 8 SECTION 2.6 Compliance, Permits......................................... 9 SECTION 2.7 Financial Statements........................................ 9 SECTION 2.8 Absence of Certain Changes or Events........................ 10 SECTION 2.9 No Undisclosed Liabilities.................................. 10 SECTION 2.10 Absence of Litigation....................................... 10 SECTION 2.11 Employee Benefit Plans, Employment Agreements............... 10 SECTION 2.12 Labor Matters............................................... 11 SECTION 2.13 Restrictions on Business Activities......................... 11 SECTION 2.14 Title to Property........................................... 11 SECTION 2.15 Taxes....................................................... 12 SECTION 2.16 Environmental Matters....................................... 13 SECTION 2.17 Intellectual Property....................................... 13 SECTION 2.18 Immigration Compliance...................................... 14 SECTION 2.19 Insurance................................................... 15 SECTION 2.20 Notes and Accounts Receivable............................... 15 SECTION 2.21 Brokers..................................................... 15 SECTION 2.22 Change in Control Payments.................................. 15 SECTION 2.23 Expenses.................................................... 15 SECTION 2.24 Interested Party Transactions............................... 15 SECTION 2.25 Complete Copies of Materials................................ 15 SECTION 2.26 Registration Statement, Proxy Statement/Prospectus.......... 15 SECTION 2.27 Product Warranties; Defects; Liability...................... 16 SECTION 2.28 Employees................................................... 16 SECTION 2.29 Inventories................................................. 16
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PAGE ---- SECTION 2.30 Year 2000................................................... 16 SECTION 2.31 Indebtedness................................................ 16 SECTION 2.32 No Illegal Payments, Etc.................................... 17 SECTION 2.33 Bonus Pool Obligations...................................... 17 SECTION 2.34 Claims Against Directors and Officers....................... 17 SECTION 2.35 Full Disclosure............................................. 17 ARTICLE III -- REPRESENTATIONS AND WARRANTIES OF PARENT, PTC AND MERGER SUB....................................................................... 17 SECTION 3.1 Organization and Qualification.............................. 17 SECTION 3.2 Charter and By-Laws......................................... 18 SECTION 3.3 Capitalization.............................................. 18 SECTION 3.4 Authority Relative to this Agreement........................ 18 SECTION 3.5 No Conflict, Required Filings and Consents.................. 18 SECTION 3.6 SEC Filings; Financial Statements........................... 18 SECTION 3.7 Validity of Parent Common Stock............................. 19 SECTION 3.8 Registration Statement; Proxy Statement/Prospectus.......... 19 SECTION 3.9 Full Disclosure............................................. 19 SECTION 3.10 Absence of Material Changes................................. 19 ARTICLE IV -- CONDUCT OF BUSINESS PENDING THE MERGER........................ 20 SECTION 4.1 Conduct of Business by the Company Pending the Merger....... 20 SECTION 4.2 No Solicitation............................................. 21 ARTICLE V -- ADDITIONAL AGREEMENTS.......................................... 21 SECTION 5.1 Stockholder Meeting......................................... 21 SECTION 5.2 Access to Information....................................... 22 SECTION 5.3 Consents; Approvals......................................... 22 SECTION 5.4 Agreements with Respect to Affiliates....................... 22 SECTION 5.5 Stockholder Agreements...................................... 22 SECTION 5.6 Notification of Certain Matters............................. 22 SECTION 5.7 Further Action/Tax Treatment................................ 22 SECTION 5.8 Public Announcements........................................ 22 SECTION 5.9 Conveyance Taxes............................................ 23 SECTION 5.10 Listing of Parent Shares.................................... 23 SECTION 5.11 Tax Certificates............................................ 23 SECTION 5.12 Proxy Statement/Prospectus; Registration Statement.......... 23 SECTION 5.13 Distribution of Bonus Pool Consideration.................... 23 SECTION 5.14 Confidentiality............................................. 23 ARTICLE VI -- CONDITIONS TO THE MERGER...................................... 24 SECTION 6.1 Conditions to Obligation of Each Party to Effect the Merger...................................................... 24 SECTION 6.2 Additional Conditions to Obligations of Parent, PTC, and Merger Sub.................................................. 25 SECTION 6.3 Additional Conditions to Obligation of the Company.......... 26 ARTICLE VII -- TERMINATION.................................................. 27 SECTION 7.1 Termination................................................. 27 SECTION 7.2 Effect of Termination....................................... 28 SECTION 7.3 Fees and Expenses........................................... 28 ARTICLE VIII -- GENERAL PROVISIONS.......................................... 28 SECTION 8.1 Indemnification............................................. 28 SECTION 8.2 Disclosure Schedules........................................ 30 SECTION 8.3 Notices..................................................... 31
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PAGE ---- SECTION 8.4 Certain Definitions......................................... 31 SECTION 8.5 Amendment................................................... 32 SECTION 8.6 Waiver...................................................... 32 SECTION 8.7 Headings.................................................... 32 SECTION 8.8 Severability................................................ 32 SECTION 8.9 Entire Agreement............................................ 32 SECTION 8.10 Assignment; Guarantee of Merger Sub Obligations............. 32 SECTION 8.11 Parties in Interest......................................... 32 SECTION 8.12 Failure or Indulgence Not Waiver; Remedies Cumulative....... 32 SECTION 8.13 Governing Law............................................... 33 SECTION 8.14 Counterparts................................................ 33
iii 155 AGREEMENT AND PLAN OF MERGER AGREEMENT AND PLAN OF MERGER, dated as of August 14, 1998 (the "Agreement"), by and among PictureTel Corporation, Inc., a Delaware corporation ("Parent"), PictureTel Technology Corporation, a Delaware corporation and a wholly owned subsidiary of Parent ("PTC"), SNI Acquisition Corporation, a California corporation and a wholly owned subsidiary of PTC ("Merger Sub"), and Starlight Networks Inc., a California corporation (the "Company"). WITNESSETH: WHEREAS, the Boards of Directors of Parent, PTC, Merger Sub and the Company have each determined that it is advisable and in the best interests of their respective stockholders for Parent, PTC, and Merger Sub to enter into a business combination with the Company upon the terms and subject to the conditions set forth herein; WHEREAS, in furtherance of such combination, the Boards of Directors of Parent, PTC, Merger Sub and the Company have each approved the merger of Merger Sub with and into the Company (the "Merger") in accordance with the applicable provisions of the California Corporation Code (the "CCC") upon the terms and subject to the conditions set forth herein; and WHEREAS, immediately prior to the transfers of Parent Common Stock in accordance with this Agreement, and pursuant to a plan to effect the transactions contemplated by this Agreement, (i) Parent will transfer the Parent Common Stock to be issued in connection with the Merger to PTC as a contribution to the capital of PTC and (ii) PTC will transfer such Parent Common Stock to Merger Sub as a contribution to the capital of Merger Sub; and WHEREAS, the Company Common Stock (as defined below) and Company Preferred Stock (as defined below) intend that the Merger constitute a "liquidation" within the meaning of Section 2 of the Amended and Restated Articles of Incorporation of the Company, and pursuant to the Merger, the outstanding shares (the "Preferred Shares") of the Company's Series A Preferred Stock, no par value (the "Series A Preferred"), Series B Preferred Stock, no par value (the "Series B Preferred"), Series C Preferred Stock, no par value (the "Series C Preferred"), Series D Preferred Stock, no par value ("Series D Preferred"), Series E Preferred Stock, no par value (the "Series E Preferred"), Series F Preferred Stock, no par value (the "Series F Preferred"), and Series G Preferred Stock, no par value (the "Series G Preferred" and, together with the Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred, Series E Preferred and Series F Preferred, the "Company Preferred Stock"), shall be converted into the right to receive the Merger Consideration (as defined in Section 1.8(b)), upon the terms and subject to the conditions set forth herein, and the Company's common stock, no par value (the "Company Common Stock"), shall be canceled and shall not be entitled to receive any of the Merger Consideration, in accordance with the terms and provisions of the Amended and Restated Articles of Incorporation of the Company. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements herein contained, and intending to be legally bound hereby, Parent, PTC, Merger Sub and the Company hereby agree as follows: ARTICLE I THE MERGER AND RELATED TRANSACTIONS SECTION 1.1 The Merger. (a) Effective Time. At the Effective Time (as defined in Section 1.3), and subject to and upon the terms and conditions of this Agreement and the CCC, Merger Sub shall be merged with and into the Company, the separate corporate existence of Merger Sub shall cease, and the Company shall continue as the surviving corporation. The Company as the surviving corporation after the Merger is hereinafter sometimes referred to as the "Surviving Corporation." 1 156 (b) Closing. Unless this Agreement shall have been terminated and the transactions herein contemplated shall have been abandoned pursuant to Section 7.1 and subject to the satisfaction or waiver of the conditions set forth in Article VI, the parties shall consummate the Merger (the "Closing") as promptly as practicable (and in any event within two business days) after satisfaction or waiver of the conditions set forth in Article VI, at the offices of Ropes & Gray, One International Place, Boston, Massachusetts, unless another date, time or place is agreed to in writing by the parties hereto (the "Closing Date"). SECTION 1.2 Escrow; Stockholder Representative. (a) Escrow. At the Effective Time, Merger Sub shall deliver to [State Street Bank and Trust Company], or any successor escrow agent appointed pursuant to the Escrow Agreement (as hereinafter defined) (the "Escrow Agent"), 158,293 of the shares of Parent Common Stock (as hereinafter defined) to be issued to the holders of the Company Preferred Stock pursuant to Section 1.7(a) (the "Escrow Shares"), to be held and applied in accordance with the Escrow Agreement. The Escrow Shares to be delivered to the Escrow Agent hereunder shall be allocated pro rata among the holders of the Company Preferred Stock based on the number of shares of Parent Common Stock to be received by such holders in the Merger. (b) Stockholder Representative. The stockholders, including the Company Common Stock and Company Preferred Stock, by virtue of their approval of the Agreement, will be deemed to have irrevocably constituted and appointed, effective as of the Effective Time, James E. Long (together with his or its permitted successors, the "Stockholder Representative"), as their true and lawful agent and attorney-in-fact to enter into any agreement in connection with the transactions contemplated by this Agreement and any transactions contemplated by the Escrow Agreement, to exercise all or any of the powers, authority and discretion conferred on him or it under any such agreement, to waive any terms and conditions of any such agreement (other than the Merger Consideration), to give and receive notices on their behalf and to be their exclusive representative with respect to any matter, suit, claim, action or proceeding arising with respect to any transaction contemplated by any such agreement, including, without limitation, the defense, settlement or compromise of any claim, action or proceeding for which the Parent, PTC or the Merger Sub may be entitled to indemnification, to pay the expenses on behalf of the holders of the Company Preferred Stock as delineated in Section 7.3 hereof, and the Stockholder Representative agrees to act as, and to undertake the duties and responsibilities of, such agent and attorney-in-fact. This power of attorney is coupled with an interest. The Stockholder Representative shall not be liable for any action taken or not taken by him or it in connection with his or its obligations under this Agreement in the absence of his or its own wilful misconduct. If the Stockholder Representative shall be unable or unwilling to serve in such capacity, his, her or its successor shall be named by those persons holding a majority-in-interest of the issued and outstanding shares of the Company Preferred Stock (on an as converted basis in accordance with the terms and provisions of the Amended and Restated Articles of Incorporation of the Company in effect immediately prior to the Merger) at the Effective Time, who shall serve and exercise the powers of Stockholder Representative hereunder. SECTION 1.3 Effective Time. As promptly as practicable after the satisfaction or waiver of the conditions set forth in Article VI, the parties hereto shall cause the Merger to be consummated by filing a duly executed and delivered copy of the agreement of merger (the "Agreement of Merger") set forth on Exhibit 1.3 hereto, with the office of the Secretary of State of the State of California, in such form as required by, and executed in accordance with the relevant provisions of, the CCC (the time of such filing being the "Effective Time"). SECTION 1.4 Effect of the Merger. At the Effective Time, the effect of the Merger shall be as provided in this Agreement, the Agreement of Merger and the applicable provisions of the CCC. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time all the property, rights, privileges, powers and franchises of the Company and Merger Sub shall vest in the Surviving Corporation, and all debts, liabilities and duties of the Company and Merger Sub shall become the debts, liabilities and duties of the Surviving Corporation. 2 157 SECTION 1.5 Articles of Incorporation; By-Laws. (a) Articles of Incorporation. Unless otherwise determined by the Parent, at the Effective Time the Articles of Incorporation of the Surviving Corporation, as in effect immediately prior to the Effective Time, shall be amended and restated to read in its entirety as did the Articles of Incorporation of Merger Sub immediately prior to the Effective Time (except that the name of the Surviving Corporation shall remain unchanged) until thereafter amended in accordance with the CCC and such Articles of Incorporation. (b) By-Laws. Unless otherwise determined by Parent, at the Effective Time, the By-Laws of the Surviving Corporation, as in effect immediately prior to the Effective Time, shall be amended and restated to read as did the By-Laws of Merger Sub immediately prior to the Effective Time, except that the name of the Surviving Corporation shall remain unchanged. SECTION 1.6 Directors and Officers. The directors of Merger Sub immediately prior to the Effective Time shall be the initial directors of the Surviving Corporation, each to hold office in accordance with the Articles of Incorporation and By-Laws of the Surviving Corporation, and the officers of Merger Sub immediately prior to the Effective Time shall be the initial officers of the Surviving Corporation, in each case until their respective successors are duly elected or appointed and qualified. SECTION 1.7 Effect on Capital Stock. At the Effective Time, by virtue of the Merger and without any action on the part of the Parent, PTC, Merger Sub, the Company or the holders of any of the following securities: (a) Conversion of Securities. Subject to Section 1.7(c), each outstanding share of Company Preferred Stock, other than Company Preferred Stock held by Parent, PTC, Merger Sub or any other indirect or direct wholly owned subsidiary of Parent, shall be converted into the right to receive that number of shares of Parent's common stock, par value $0.01 per share ("Parent Common Stock," and, in the aggregate, the "Parent Shares"), as is set forth on Schedule 1.7(a) hereof. The Exchange Ratios (as set forth on Schedule 1.7(a)) will be subject to adjustment prior to Closing in accordance with Section 1.7(g) hereof. In accordance with Section 2 of the Articles of Incorporation of the Company, each share of Company Common Stock, by virtue of the Merger and without any action on the part of the holder thereof, shall cease to be outstanding, be canceled and retired without payment of any consideration therefor. Notwithstanding anything else to the contrary in this Agreement, the total number of shares of Parent Common Stock to be issued in connection with the Merger shall equal 1,331,914. Each share of Company Preferred Stock purchased by PTC from David Edwards in accordance with Section 6.1(e) hereof and held by PTC as of the Effective Time shall be converted into and exchanged for one validly issued, fully paid and nonassessable share of common stock, par value $0.01 per share, of the Surviving Corporation. (b) Stock Options and Warrants. Certain employees of the Company have been granted options (the "Company Stock Options") to purchase Company Common Stock under the Starlight Networks Inc. 1991 Stock Plan (the "Common Stock Option Plan"). As of the Effective Time, each Company Stock Option granted under the Common Stock Option Plan shall have been terminated in accordance with the terms and provisions of such Common Stock Option Plan. As of the Effective Time, all outstanding warrants and other securities convertible into or exchangeable for shares of the capital stock of the Company shall have been terminated and of no further force and effect or converted or exchanged into shares of Company Common Stock or Company Preferred Stock in accordance with the terms thereof, except for warrants and other securities or instruments of the Company convertible into or exchangeable for shares of Company Preferred Stock and, in accordance with Section 1.7(a) hereof, convertible into a maximum of three thousand (3,000) shares of Parent Common Stock, based on the Exchange Ratios and assuming the consummation of the Merger, which such warrants or other securities or instruments of the Company, by virtue of the Merger and without any further action on the part of the holders thereof, shall be assumed by Parent, and shall constitute a warrant or other security or instrument of Parent to acquire the number (rounded down to the nearest whole number) of shares of Parent Common Stock equal to the product of (i) the number of shares of Company Preferred Stock issuable upon exercise of such warrant or other security or instrument immediately prior to the Effective Time (not taking into account whether or not such warrant or other security or instrument was in fact exercisable, but excluding any Company Preferred Stock issued prior to the Effective Time pursuant to 3 158 such warrant or other security or instrument) multiplied by (ii) the Exchange Ratio, as set forth in Schedule 1.7(a) hereof, applicable to such series of Company Preferred Stock issuable upon exercise of such warrant or other security or instrument, at a price per share (rounded up to the next highest cent) equal to (i) the exercise price per share for the shares of Company Preferred Stock issuable upon exercise of such warrant or other security or instrument immediately prior to the Effective Time divided by (ii) the Exchange Ratio, as set forth in Schedule 1.7(a) hereof, applicable to such series of Company Preferred Stock issuable upon exercise of such warrant or other security or instrument; provided, however, that this sentence shall not apply to Company Stock Options granted under the Common Stock Option Plan, the termination of which is delineated in the immediately preceding sentences of this Section 1.7(b). Each share of Company Preferred Stock purchased by PTC from David Edwards in accordance with Section 6.1(e) hereof and held by PTC as of the Effective Time shall be converted into and exchanged for one validly issued, fully paid and nonassessable share of common stock, par value $0.01 per share, of the Surviving Corporation. (c) Cancellation. Each share of Company Common Stock or Company Preferred Stock, if any, held in the treasury of the Company and each share of Company Common Stock or Company Preferred Stock held by Parent, PTC, Merger Sub or any other indirect or direct wholly owned subsidiary of Parent, by virtue of the Merger and without any action on the part of the holder thereof, shall cease to be outstanding, be canceled and retired without payment of any consideration therefor and cease to exist, except as provided in Section 1.7(a) hereof with respect to shares of Company Preferred Stock held by PTC. (d) Shares of Dissenting Holders. Notwithstanding anything to the contrary contained in this Agreement, any holder of Company Common Stock or Company Preferred Stock with respect to which dissenters' rights, if any, are granted by reason of the Merger under the CCC and who does not vote in favor of the Merger and who otherwise complies with Chapter 13 of the CCC ("Company Dissenting Shares") shall not be entitled to receive shares of Parent Common Stock pursuant to Section 1.7(a) hereof, unless such holder fails to perfect, effectively withdraws or loses his right to dissent from the Merger under the CCC. Such holder shall be entitled to receive only the payment provided for by Chapter 13 of the CCC, which payments shall be made by the Company. If any such holder so fails to perfect, effectively withdraws or loses his or her dissenters' rights under the CCC, his or her Company Dissenting Shares shall thereupon be deemed to have been converted, as of the Effective Time, into the right to receive shares of Parent Common Stock pursuant to Section 1.7(a). (e) Capital Stock of Merger Sub. Each share of common stock, par value $.01 per share, of Merger Sub issued and outstanding immediately prior to the Effective Time shall be converted into and exchanged for one validly issued, fully paid and nonassessable share of common stock, par value $0.01 per share, of the Surviving Corporation. (f) Fractional Shares. No certificates or scrip representing less than one share of Parent Common Stock shall be issued upon the surrender or exchange of a certificate or certificates which immediately prior to the Effective Time represented outstanding Company Preferred Stock (the "Certificates"). In lieu of any such fractional share, each holder of Company Preferred Stock who would otherwise have been entitled to a fraction of a share of Parent Common Stock upon surrender of Certificates for exchange shall be paid upon such surrender cash, without interest, determined by multiplying (i) $9.00 (the "Merger Price") by (ii) the fractional interest of Parent Common Stock to which such holder would otherwise be entitled. (g) Adjustments to Exchange Ratios. The Exchange Ratios shall be adjusted to reflect fully the effect of any stock split, reverse split, reclassification, stock dividend (including any dividend or distribution of securities convertible into Parent Common Stock), reorganization, recapitalization or other like change with respect to Parent Common Stock occurring after the date hereof. SECTION 1.8 Exchange of Certificates. (a) Exchange Agent. Parent shall supply, or shall cause to be supplied, to or for the account of Boston EquiServe Limited Partnership (the "Exchange Agent"), in trust for the benefit of the holders of the outstanding Company Preferred Stock, for exchange in accordance with this Section 1.8, through the Exchange Agent, certificates (the "Certificates") evidencing the shares of Parent Common Stock issuable 4 159 pursuant to Section 1.7(a) (less the Escrow Shares) in exchange for the outstanding Company Preferred Stock. All of the shares of Parent Common Stock issued in the Merger shall be issued as of and be deemed to be outstanding as of the Effective Time. Parent shall cause all such shares of Parent Common Stock to be issued in connection with the Merger to be duly authorized, validly issued, fully paid and nonassessable. (b) Exchange Procedures. As soon as reasonably practicable after the Effective Time, Parent will instruct the Exchange Agent to mail to each holder of record of Certificates (i) a letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon proper delivery of the Certificates to the Exchange Agent and shall be in such form and have such other provisions as Parent may reasonably specify that are not inconsistent with the terms of this Agreement) (ii) instructions to effect the surrender of the Certificates in exchange for the certificates evidencing shares of Parent Common Stock. Upon surrender of a Certificate for cancellation to the Exchange Agent together with such letter of transmittal, duly executed, and such other customary documents as may be required pursuant to such instructions, the holder of such Certificate shall be entitled to receive in exchange therefor (A) certificates evidencing that number of whole shares of Parent Common Stock which such holder has the right to receive in accordance with the provisions of Section 1.7(a) (less that number of shares held back as Escrow Shares, as set forth in the Escrow Agreement,) in respect of the Company Preferred Stock formerly evidenced by such Certificate, (B) any dividends or other distributions to which such holder is entitled pursuant to Section 1.8(c), and (C) cash in respect of fractional shares as provided in Section 1.7(f) (the shares of Parent Common Stock, including any such shares of Parent Common Stock constituting Escrow Shares, dividends, distributions and cash being, collectively, the "Merger Consideration"), and the Certificate so surrendered shall forthwith be canceled. In the event of a transfer of ownership of Company Preferred Stock which is not registered in the transfer records of the Company as of the Effective Time, the Merger Consideration may be issued and paid in accordance with this Article I to a transferee if the Certificate evidencing such Company Preferred Stock is presented to the Exchange Agent, accompanied by all documents required to evidence and effect such transfer pursuant to this Section 1.8(b) and by evidence that any applicable stock transfer taxes have been paid and that applicable securities laws respecting such transfer have been complied with. Until so surrendered, each outstanding Certificate that, prior to the Effective Time, represented shares of Company Preferred Stock will be deemed from and after the Effective Time, for all corporate purposes, other than the payment of dividends and subject to Section 1.7(f), to evidence the ownership of the number of full shares of Parent Common Stock into which such shares of Company Preferred Stock shall have been so converted. (c) Distributions With Respect to Unexchanged Shares of Parent Common Stock. No dividends or other distributions declared or made after the Effective Time with respect to shares of Parent Common Stock with a record date after the Effective Time shall be paid to the holder of any unsurrendered Certificate with respect to the shares of Parent Common Stock they are entitled to receive until the holder of such Certificate shall surrender such Certificate in accordance with Section 1.8. Subject to applicable law, following surrender of any such Certificate, there shall be paid to the record holder of the certificates representing whole shares of Parent Common Stock issued in exchange therefor, without interest, at the time of such surrender, the amount of dividends or other distributions with a record date after the Effective Time theretofore paid with respect to such whole shares of Parent Common Stock. (d) No Liability. Neither Parent, PTC, Merger Sub nor the Company shall be liable to any holder of Company Preferred Stock for any Merger Consideration delivered to a public official pursuant to any applicable abandoned property, escheat or similar law following the passage of time specified therein. (e) Withholding Rights. Parent or the Exchange Agent shall be entitled to deduct and withhold from the Merger Consideration or any amounts paid to Company Dissenting Shares pursuant to Chapter 13 of the CCC otherwise payable pursuant to this Agreement to any holder of Company Preferred Stock such amounts as Parent or the Exchange Agent is required to deduct and withhold with respect to the making of such payment under the Code, or any provision of state, local or foreign tax law. To the extent that amounts are so withheld by Parent or the Exchange Agent, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the holder of the Preferred Shares in respect of which such deduction and withholding was made by Parent or the Exchange Agent. 5 160 SECTION 1.9 Stock Transfer Books. At the Effective Time, the stock transfer books of the Company shall be closed, and there shall be no further registration of transfers of Company Common Stock or Company Preferred Stock thereafter on the records of the Company. If, after the Effective Time, certificates representing shares of Company Common Stock or Company Preferred Stock are presented to the Surviving Corporation for any reason, they shall be canceled and exchanged as provided in this Article I. SECTION 1.10 No Further Ownership Rights in Company Preferred Stock. The Merger Consideration delivered upon the surrender for exchange of the Company Preferred Stock in accordance with the terms hereof shall be deemed to have been issued in full satisfaction of all rights pertaining to such Company Preferred Stock. SECTION 1.11 Lost, Stolen or Destroyed Certificates. In the event any Certificates shall have been lost, stolen or destroyed, Parent shall issue in exchange for such lost, stolen or destroyed Certificates, upon the making of an affidavit of that fact by the holder thereof, such shares of Parent Common Stock as may be required pursuant to Section 1.7(a) (less such holder's pro rata portion of the Escrow Shares) as well as the other Merger Consideration as provided in this Article; provided, however, that Parent may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed Certificates to deliver a bond in such sum as it may reasonably direct as indemnity against any claim that may be made against Parent with respect to the Certificates alleged to have been lost, stolen or destroyed. SECTION 1.12 Tax and Accounting Consequences. It is intended by the parties hereto that the transaction effected by the Merger shall (i) constitute a purchase of the outstanding capital stock of the Company treated for federal income tax purposes as a sale or exchange resulting in gain or loss recognition by the holders of the outstanding capital stock of the Company and (ii) be accounted for as a purchase under generally accepted accounting principles and the applicable rules and regulations of the Securities and Exchange Commission (the "SEC"). SECTION 1.13 Taking of Necessary Action; Further Action. Each of Parent, PTC, Merger Sub and the Company will take all such reasonable and lawful action as may be necessary or appropriate in order to effectuate the Merger in accordance with this Agreement as promptly as possible. If, at any time after the Effective Time, any such further action is necessary or desirable to carry out the purposes of this Agreement and to vest the Surviving Corporation with full right, title and possession to all assets, property, rights, privileges, powers and franchises of the Company and Merger Sub, the officers and directors of the Company and Merger Sub immediately prior to the Effective Time are fully authorized in the name of their respective corporations or otherwise to take, and will take, all such lawful and necessary action to effectuate the Merger in accordance with this Agreement. SECTION 1.14 Consideration for Bonus Pool Obligation. Parent hereby agrees to assume the obligations of the Company with respect to the bonus pool approved and adopted by the Board of Directors of the Company on May 7, 1997, as further amended by the Board of Directors on July 17, 1998 (the "Bonus Pool Obligation") and, no later than the next business day following the Merger, to register the shares of Parent Common Stock issuable thereunder on a Registration on Form S-8 and to pay to the beneficiaries of such Bonus Pool Obligation the amount of cash and shares of Parent Common Stock issuable thereunder (such Parent Common Stock and cash, collectively, the "Bonus Pool Consideration"), which such Bonus Pool Consideration shall satisfy in full the Bonus Pool Obligation. Notwithstanding anything else to the contrary herein, the total number of shares of Parent Common Stock to be issued in satisfaction of the Bonus Pool Obligation shall not exceed 251,082. The Bonus Pool Consideration shall be allocated in accordance with Section 2.33 of the Company Disclosure Schedule; provided; however, that the Company may, by written notice to Parent given at least two (2) days prior to Closing, revise the allocation of the Bonus Pool Consideration among the employees, directors and consultants of the Company so long as the aggregate amount of the Bonus Pool Consideration set forth on Section 2.33 of the Company Disclosure Schedule shall remain unchanged. SECTION 1.15 Material Adverse Effect. When used in this Agreement in connection with the Company, or Parent or any of its subsidiaries, as the case may be, the term "Material Adverse Effect" means any change, effect or circumstance that, individually or when taken together with all other similar or related 6 161 changes, effects or circumstances that have occurred prior to the date of determination of the occurrence of the Material Adverse Effect, (a) is or is reasonably likely to be materially adverse to the business, prospects, assets (including intangible assets), condition (financial or otherwise) or results of operations of the Company or Parent and its subsidiaries, as the case may be, taken as a whole, as applicable based on the party making the representation, warranty or disclosure or (b) is or is reasonably likely to materially delay or prevent the consummation of the transactions contemplated hereby. ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to Parent, PTC, and Merger Sub that, except as set forth in the written disclosure schedule delivered on or prior to the date hereof by the Company to Parent that is arranged in paragraphs corresponding to the numbered and lettered paragraphs contained in this Article II (the "Company Disclosure Schedule"): SECTION 2.1 Organization, Qualification and Other Equity Interests. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of California and has the requisite corporate power and authority necessary to own, lease and operate the properties it purports to own, operate or lease and to carry on its business as it is now being conducted. The Company is duly qualified or licensed as a foreign corporation to do business, and is in good standing, in each jurisdiction where the character of its properties owned, leased or operated by it or the nature of its activities makes such qualification or licensing necessary, except where the failure to be so duly qualified or licensed and in good standing would not have a Material Adverse Effect. The Company does not have any subsidiaries and does not directly or indirectly own any equity or similar interest in, or any interest convertible into or exchangeable or exercisable for, any equity or similar interest in, any corporation, partnership, joint venture or other business association or entity. SECTION 2.2 Articles of Incorporation and By-Laws. The Company has heretofore furnished to Parent a complete and correct copy of its Articles of Incorporation and By-Laws, each as amended to date and as in effect since January 1, 1998. Such Articles of Incorporation and By-Laws are in full force and effect. The Company is not in violation of any of the provisions of its Articles of Incorporation or By-Laws. SECTION 2.3 Capitalization. The authorized capital stock of the Company consists solely of 50,000,000 shares of Company Common Stock and 22,429,187 shares of Company Preferred Stock, of which (i) 2,529,999 shares have been designated as Series A Preferred, (ii) 1,594,188 shares have been designated as Series B Preferred; (iii) 2,025,000 shares have been designated as Series C Preferred, (iv) 1,780,000 shares have been designated as Series D Preferred, (v) 2,500,000 shares have been designated as Series E Preferred, (vi) 1,700,000 shares have been designated as Series F Preferred, and (vi) 10,300,000 shares have been designated as Series G Preferred. As of June 30, 1998, (a) 2,276,898 shares of Company Common Stock were issued and outstanding, all of which were duly authorized, validly issued, fully paid and nonassessable, and none of which shares were held in treasury, (b) 9,676,475 shares of Company Preferred Stock were issued and outstanding, all of which were fully authorized, validly issued, fully paid and non assessable, and none of which shares were held in treasury and (c) 2,899,531 shares of Company Common Stock were reserved for future issuance pursuant to outstanding Company Stock Options under the Common Stock Option Plan. Of the 9,676,475 shares of Company Preferred Stock issued and outstanding on June 30, 1998 (a) 2,529,999 shares were Series A Preferred, (b) 1,577,120 shares were Series B Preferred, (c) 1,931,914 shares were Series C Preferred, (d) 1,743,134 shares were Series D Preferred, (e) 692,428 shares were Series E Preferred, (f) 1,201,880 shares were Series F Preferred, and (g) no shares were Series G Preferred. No change in such capitalization has occurred between June 30, 1998 and the date hereof, except for the conversion of the notes issued under that certain Subordinated Convertible Note Purchase Agreement dated April 27, 1998 into 8,106,983 shares of Series G Preferred. Except as set forth in Section 2.3 of the Company Disclosure Schedule, there are no options, warrants or other rights, agreements, arrangements or commitments of any character relating to the issued or unissued capital stock of the Company or obligating the Company to issue or sell any shares of capital stock of, or other equity interests in, the Company. All shares of Company 7 162 Common Stock subject to issuance as aforesaid, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable as of the date hereof and immediately prior to the Effective Time, shall be duly authorized, validly issued, fully paid and nonassessable. Except as disclosed in Section 2.3 of the Company Disclosure Schedule, there are no obligations, contingent or otherwise, of the Company to repurchase, redeem or otherwise acquire any shares of Company Common Stock or Company Preferred Stock or to provide funds to or make any investment in any other entity. No holder of any share of Company Common Stock or Company Preferred Stock shall have any claim or right of action against Parent, PTC, Merger Sub, or the Company upon the consummation of the Merger, except for the Merger Consideration as described in Section 1.8(b) hereof and amounts payable to holders of Company Dissenting Shares pursuant to Chapter 13 of the CCC. Immediately prior to the consummation of the Merger, each Company Stock Option granted under the Common Stock Option Plan shall have been terminated and cease to exist and the holders thereof shall have no claim or right of action against Parent, PTC, Merger Sub or the Company with respect thereto. SECTION 2.4 Authority Relative to this Agreement. The Company has all necessary corporate power and authority to execute and deliver this Agreement and to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement by the Company and the consummation by the Company of the transactions contemplated hereby have been duly and validly authorized by all necessary corporate action (other than the Requisite Approval as hereinafter defined), and no other corporate proceedings on the part of the Company are necessary to authorize this Agreement or to consummate the transactions so contemplated. The Board of Directors of the Company has determined that it is advisable and in the best interest of the Company's stockholders for the Company to enter into a business combination with Parent, PTC, and Merger Sub upon the terms and subject to the conditions of this Agreement, and has unanimously (except for interested directors who have abstained) recommended that the Company's stockholders approve and adopt this Agreement and the Merger. This Agreement has been duly and validly executed and delivered by the Company and, assuming the due authorization, execution and delivery by Parent, PTC, and Merger Sub, as applicable, constitutes a legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms. The affirmative vote of the holders of a majority of the outstanding shares of Company Common Stock and Company Preferred Stock voting together (with the Company Preferred Stock voting on an as if converted basis) and a majority of the outstanding shares of Company Preferred Stock (voting on an as if converted basis) are the only votes (the "Requisite Approval") of any series of the Company's capital stock necessary to approve this Agreement and the Merger. The Stockholder Agreements delivered to Parent as of the date of this Agreement have been signed by the holders of a majority of the outstanding shares of Company Common Stock and a majority of the outstanding shares of Company Preferred Stock. SECTION 2.5 No Conflict; Required Filings and Consents. (a) Section 2.5(a) of the Company Disclosure Schedule includes a list of (i) all loan agreements, indentures, mortgages, pledges, conditional sale or title retention agreements, security agreements, equipment obligations, guaranties, standby letters of credit, equipment leases or lease purchase agreements to which the Company is a party or by which it is bound and which involve liabilities, obligations or payments in excess of $10,000 and (ii) all other contracts, agreements, commitments or other understandings or arrangements to which the Company is a party or by which it or any of its properties or assets are bound or affected and which involve liabilities, obligations or payments in excess of $10,000. (b) Except as disclosed in Section 2.5(b) of the Company Disclosure Schedule, (i) the Company has not breached, is not in default under, and has not received written notice of any breach of or default under, any of the agreements, contracts or other instruments referred to in clauses (i) or (ii) of Section 2.5(a), (ii) to the knowledge of the Company, no other party to any of the agreements, contracts or other instrument referred to in clauses (i) or (ii) of Section 2.5 (a) has breached or is in default of any of its obligations thereunder, and (iii) to the knowledge of the Company, each of the agreements, contracts and other instruments referred to in clauses (i) or (ii) of Section 2.5(a) is in full force and effect. 8 163 (c) The execution and delivery of this Agreement by the Company does not, and the performance of this Agreement by the Company and the consummation of the transactions contemplated hereby will not, (i) conflict with or violate the Articles of Incorporation or By-Laws of the Company, (ii) conflict with or violate any federal, foreign, state or provincial law, rule, regulation, order, judgment or decree (collectively, "Laws") applicable to the Company or by which any of its properties is bound or affected, or (iii) result in any material breach of or constitute a default (or an event that with notice or lapse of time or both would become a default) under, or impair the Company's rights or alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, or result in the creation of a security interest, lien, claim, encumbrance or any other restriction on any of the properties or assets of the Company pursuant to, any material note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other material instrument or obligation to which the Company is a party or by which the Company or any of its properties is bound or affected. (d) The execution and delivery of this Agreement by the Company does not, and the performance of this Agreement by the Company will not, require any consent, approval, authorization or permit on the part of the Company of, or filing with or notification on the part of the Company to, any federal, foreign, state or provincial governmental or regulatory authority except for (i) applicable requirements, if any, of the Securities Act of 1933, as amended, and the rules and regulations thereunder (the "Securities Act"), the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (the "Exchange Act"), state securities laws ("Blue Sky Laws"), and the filing and recordation of appropriate merger or other documents as required by the CCC, and (ii) where the failure to obtain such consents, approvals, authorizations or permits, or to make such filings or notifications, would not prevent or delay consummation of the Merger, or otherwise prevent the Company from performing its obligations under this Agreement. SECTION 2.6 Compliance, Permits. (a) The Company (i) is in material compliance with any Law applicable to the Company or by which any of its assets or properties are bound or affected and (ii) is not in conflict with, or in default or violation of any material note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other instrument or obligation to which the Company is a party or by which the Company or any of its assets or properties is bound or affected. (b) Except as disclosed in Section 2.6(b) of the Company Disclosure Schedule, the Company holds all permits, licenses, easements, variances, exemptions, consents, certificates, orders and approvals from governmental authorities which are material to the operation of the business of the Company as it is now being conducted (collectively, the "Company Permits"). The Company is in material compliance with the terms of the Company Permits. SECTION 2.7 Financial Statements. (a) Attached to the Company Disclosure Schedule are (i) the audited consolidated balance sheets of the Company as of December 31, 1996 and 1997, together with the related statements of income and cash flows for the periods then ended, all certified by Ernst & Young, L.L.P., the Company's independent public accounts (the "Audited Financial Statements") and (ii) the unaudited consolidated balance sheet of the Company as of March 31, 1998 and June 30, 1998 (the "Most Recent Balance Sheet") and the related statements of income and cash flows for the three (3) and six (6) month periods then ended (the "Unaudited Financial Statements", and together with the Audited Financial Statements, collectively the "Financial Statements"). (b) Each of the Financial Statements (including, in each case, any related notes thereto) was prepared in accordance with generally accepted accounting principles ("GAAP"), applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto), and each fairly presents in all material respects the financial position of the Company as at the respective dates thereof and the results of its operations and cash flows and stockholder equity for the periods indicated, except that the Unaudited Financial Statements are subject to normal and recurring year-end adjustments which are not expected to be material in amount and do not contain footnotes required by GAAP. 9 164 (c) Set forth on Section 2.7(c) of the Company Disclosure Schedule is a summary of the principal accounting methods, principles and practices of the Company. SECTION 2.8 Absence of Certain Changes or Events. Since December 31, 1997, the Company has conducted its business in the ordinary course and there has not occurred: (a) any change in the business, operating results, assets, properties, condition (financial or otherwise), or prospects of the Company which would have a Material Adverse Effect; provided, however, that it is understood and expressly acknowledged that the Company has experienced operating losses in prior quarters and may continue to experience operating losses in future periods; (b) any amendments to the Articles of Incorporation or By-laws of the Company; (c) any damage to, destruction or loss of any material asset of the Company (whether or not covered by insurance); (d) any change by the Company in its accounting methods, principles or practices; (e) any revaluation by the Company of any of its assets, including, without limitation, writing down the value of inventory or writing off notes or accounts receivable other than in the ordinary course of business; (f) any sale of any property or assets of the Company, except in the ordinary course of business; or (g) any other action or event that would require the consent of Parent pursuant to Section 4.1 had such action or event occurred after the date of this Agreement. SECTION 2.9 No Undisclosed Liabilities. Except as disclosed in Section 2.9 of the Company Disclosure Schedule, the Company has no liabilities (absolute, accrued, contingent or otherwise), except liabilities (a) adequately provided for on the face of the Most Recent Balance Sheet (rather than in any notes thereto), (b) incurred since the date of the Most Recent Balance Sheet in the ordinary course of business consistent with past practice (none of which liabilities results from, arises out of, relates to, is in the nature of, or was caused by any breach of contract, breach of warranty, tort, infringement, or violation of law), or (c) incurred in connection with this Agreement. SECTION 2.10 Absence of Litigation. Except as disclosed in Section 2.10 of the Company Disclosure Schedule, there are no claims, actions, suits, proceedings or investigations pending or, to the knowledge of the Company, threatened against the Company or any properties or rights of the Company before any federal, foreign, state or provincial court, arbitrator or administrative, governmental or regulatory authority or body, nor, to the knowledge of the Company, is there any basis therefor. SECTION 2.11 Employee Benefit Plans, Employment Agreements. (a) Section 2.11 (a) of the Company Disclosure Schedule lists all employee pension plans (as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA")), all employee welfare plans (as defined in Section 3(1) of ERISA), and all other bonus, stock option, stock purchase, incentive, deferred compensation, supplemental retirement, severance and other similar fringe or employee benefit plans, programs or arrangements, and any current employment, executive compensation, consulting or severance agreements, written or otherwise, for the benefit of, or relating to, any present or former employee (including any beneficiary of any such employee) of, or any present or former consultant (including any beneficiary of any such consultant) to the Company or any trade or business (whether or not incorporated) which is a member of a controlled group including the Company or which is under common control with the Company (an "ERISA Affiliate") within the meaning of Section 414 of the Code (all such plans, practices and programs are referred to as the "Company Employee Plans"). There have been made available to Parent copies of (i) the most recent annual report on Form 5500 series, with accompanying schedules and attachments, filed with respect to each Company Employee Plan required to make such a filing, and (ii) the most recent Internal Revenue Service determination letter with respect to each Company Employee Plan intended to be qualified under Section 401(a) of the Code. (b) (i) None of the Company Employee Plans promises or provides retiree medical or other retiree welfare benefits to any person, and neither the Company nor any ERISA Affiliate has ever maintained, contributed to, or been required to contribute to, any plan that is or was a "multiemployer plan" as such term is defined in Section 3(37) of ERISA, a pension plan subject to Title IV of ERISA or a plan subject to Part 3 of Title I of ERISA; (ii) there has been no "prohibited transaction," as such term is defined in Section 406 of ERISA and Section 4975 of the Code, with respect to any Company Employee Plan, which could result in any material liability to the Company; (iii) all Company Employee Plans are in compliance in all material respects 10 165 with the requirements prescribed by any and all Laws (including ERISA and the Code), currently in effect with respect thereto (including all applicable requirements for notification to participants or the Department of Labor, Internal Revenue Service (the "IRS") or Secretary of the Treasury), and the Company has performed all material obligations required to be performed by it under, is not in any material respect in default under or violation of, and has no knowledge of any default or violation by any other party to, any of the Company Employee Plans; (iv) each Company Employee Plan intended to qualify under Section 401(a) of the Code and each trust intended to qualify under Section 501(a) of the Code is the subject of a favorable determination letter from the IRS, and nothing has occurred which may reasonably be expected to impair such determination; and (v) there are no lawsuits or other claims (other than claims for benefits in the ordinary course) pending or, to the knowledge of the Company, threatened with respect to any Company Employee Plan. (c) Section 2.11(c) of the Company Disclosure Schedule sets forth a true and complete list of each current or former employee, officer or director of the Company who holds (i) any option to purchase Company Common Stock as of the date hereof, together with the number of shares of Company Common Stock subject to such option, the option price of such option (to the extent determined as of the date hereof), whether such option is intended to qualify as an incentive stock option within the meaning of Section 422(b) of the Code (an "ISO"), and the expiration date of such option; (ii) any other right, directly or indirectly, to acquire Company Common Stock, together with the number of shares of Company Common Stock subject to such right; and (iii) any shares of restricted stock or "phantom" stock awards and the terms and conditions relating thereto. Section 2.11(c) of the Company Disclosure Schedule also sets forth the total number of such ISOs, such nonqualified options and such other rights. (d) Without limiting the generality of Section 2.11(a), Section 2.11(d) of the Company Disclosure Schedule sets forth a true and complete list of (i) all employment agreements with officers of the Company; (ii) all agreements, oral or written, with employees of, or consultants to, the Company who are individuals obligating the Company to make minimum annual cash payments in an amount exceeding $50,000; (iii) all employees of, or consultants to, the Company who were paid in excess of $75,000 within the last twelve (12) month period; (iv) all employees of, or consultants to, the Company who have executed a non- competition agreement with the Company; (v) all severance agreements, programs and policies of the Company with or relating to its employees, in each case with outstanding commitments exceeding $50,000, excluding programs and policies required to be maintained by law; and (vi) all plans, programs, agreements and other arrangements of the Company with or relating to its employees which contain change in control provisions. SECTION 2.12 Labor Matters. (i) There are no controversies pending or, to the knowledge of the Company, threatened between the Company and any of its employees; (ii) the Company is not a party to any collective bargaining agreement or other labor union contract applicable to persons employed by the Company, nor does the Company know of any activities or proceedings of any labor union to organize any such employees; and (iii) the Company has no knowledge of any strikes, slowdowns, work stoppages, lockouts, or threats thereof, by or with respect to any employees of the Company. SECTION 2.13 Restrictions on Business Activities. Except for this Agreement, there is no agreement, judgment, injunction, order or decree binding upon the Company or any director or officer of the Company which has or could reasonably be expected to have the effect of prohibiting or impairing any material business practice of the Company, the acquisition of property by the Company or the conduct of business by the Company as currently conducted or as proposed to be conducted as set forth in the Company's Business Plan dated June, 1998 attached to the Company Disclosure Schedule. SECTION 2.14 Title to Property. The Company has good and marketable title to all of its material properties and assets, free and clear of all liens, charges and encumbrances, except liens for taxes not yet due and payable and such liens or other imperfections of title, if any, as do not materially detract from the value of or interfere with the present use of the property affected thereby; and, to the knowledge of the Company, all leases pursuant to which the Company leases from others real or personal property, are in good standing, valid and enforceable in accordance with their respective terms, and there is not, to the knowledge of the Company, 11 166 under any of such leases, any existing material default or event of default (or event which with notice or lapse of time, or both, would constitute a material default). The tangible assets of the Company that are material, individually or in the aggregate, to the Company's business are free from patent and latent defects, have been maintained in accordance with normal industry practice, are in good operating condition and repair (subject to normal wear and tear) and are suitable for the purposes for which they presently are used. The Company does not own any real property. SECTION 2.15 Taxes. (a) For purposes of this Agreement, "Tax" or "Taxes" shall mean taxes, fees, levies, duties, tariffs, imposts, and governmental impositions or charges of any kind in the nature of (or similar to) taxes, payable to any federal, state, local or foreign taxing authority, including, without limitation, (i) income, franchise, profits, gross receipts, ad valorem, net worth, value added, sales, use, service, real or personal property, special assessments, capital stock, license, payroll, withholding, employment, social security (or similar), workers' compensation, unemployment compensation, environmental (including Taxes under Code section 59A), customs, duties, registration, alternative and add-on minimum, estimated, utility, severance, production, excise, stamp, occupation, premiums, windfall profits, transfer and gains taxes, and (ii) interest, penalties, additional taxes and additions to tax imposed with respect thereto; and "Tax Returns" shall mean returns, reports, declarations, forms and information statements with respect to Taxes required to be filed with the IRS or any other federal, state, local or foreign taxing authority, domestic or foreign, including, without limitation, consolidated, combined and unitary tax returns, including any amendments thereto. (b) Other than as disclosed in Section 2.15(b) of the Company Disclosure Schedule, (i) the Company has timely filed all Tax Returns required to be filed by it and all such Tax Returns were correct and complete in all material respects, (ii) the Company has paid and discharged all Taxes due and payable in connection with or with respect to the periods or transactions covered by such Tax Returns and has paid all other Taxes as are due, except such as are being contested in good faith by appropriate proceedings (to the extent that any such proceedings are required) and with respect to which the Company is maintaining adequate reserves in accordance with GAAP, (iii) no Tax Return referred to in clause (i) has been the subject of examination by the IRS or the appropriate state, local or foreign taxing authority of which written notice was received; (iv) no deficiencies have been asserted or assessments made as a result of any examinations of the Tax Returns referred to in clause (i) by the IRS or the appropriate state, local or foreign taxing authority; (v) no action, suit, proceeding, audit, claim, deficiency or assessment has been claimed or raised or is pending with respect to any Taxes of the Company; (vi) the Company has withheld from their employees, customers, and other payees (and timely paid to the appropriate governmental authority) all amounts required by the Tax withholding provisions of applicable federal, state, local, and foreign laws (including, without limitation, income, social security, and employment Tax withholding for all types of compensation, and withholding on payments to non-United States persons) for all periods; (vii) there has not been filed a consent under Code Section 341(f) concerning collapsible corporations with respect to the Company; (viii) the Company has not made any payment, is not obligated to make any payment, and is not a party to any agreement that could obligate it to make any payments that will not be deductible under Code Sections 162, 280G or 404 or be subject to the excise tax of Code Section 4999; (ix) no claim has ever been made by any authority in a jurisdiction where the Company does not file Tax Returns that it is or may be subject to tax by that jurisdiction; and (x) the Company does not have any liability for the Taxes of any other person under Section 1.1502-6 of the Treasury Regulations (or any similar provision of state, local or foreign law) as a transferee or successor, by contract, or otherwise. There are no tax liens on or security interests in any assets of the Company, and the Company has not granted any waiver of any statute of limitations with respect to, or any extension of a period for the assessment of, any Tax. The accruals and reserves for Taxes (including deferred taxes) reflected in the Financial Statements are in all material respects adequate to cover all Taxes required to be accrued through the date thereof (including interest and penalties, if any, thereon and Taxes being contested) in accordance with GAAP. (c) The Company is not, and never has been, a United States real property holding corporation (as defined in Section 897(c)(2) of the Code) during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code. The Company does not own any property of a character, the indirect 12 167 transfer of which, pursuant to this Agreement, would give rise to any material documentary, stamp or other transfer tax. (d) The Company is not a party to any joint venture, partnership or other arrangement that could be treated as a partnership for Tax purposes. (e) Copies of (i) any Tax examinations, (ii) extensions of statutes of limitations, (iii) the federal, state, local and foreign income Tax Returns of the Company, and (iv) substantive correspondence between the Company and all Taxing authorities for its last three (3) taxable years have previously been furnished to the Parent and such Tax Returns are true, correct and complete. SECTION 2.16 Environmental Matters. The Company (i) has obtained all approvals which are required to be obtained under all applicable federal, state or local laws or any regulation, code, plan, order, decree, judgment, notice or demand letter issued, entered, promulgated or approved thereunder relating to pollution or protection of the environment, including laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, or hazardous or toxic materials or wastes into ambient air, surface water, ground water, or land or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport, or handling of pollutants, contaminants or hazardous or toxic materials or wastes by the Company ("Environmental Laws"); (ii) is in material compliance with all terms and conditions of such required approvals, and also is in material compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in applicable Environmental Laws; and (iii) as of the date hereof, is not aware of nor has received notice of any past or present violations by the Company of Environmental Laws or any event, condition, circumstance, activity, practice, incident, action or plan which is reasonably likely to interfere with or prevent continued compliance with or which would give rise to any common law or statutory liability, or otherwise form the basis of any claim, action, suit or proceeding, against the Company based on or resulting from the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling, or the emission, discharge or release into the environment, of any pollutant, contaminant or hazardous or toxic material or waste. SECTION 2.17 Intellectual Property. (a) The Company, directly or indirectly, owns, or is licensed or otherwise possesses legally enforceable rights to use, all inventions, patents, trademarks, trade names, service marks, copyrights, and any applications therefor, maskworks, network protocols, schematics, technology, trade secrets, research and development, know-how, technical data, computer software programs or applications (in both source code and object code form), and tangible or intangible proprietary information or material (excluding Commercial Software as defined below) that are necessary to the business of the Company as currently conducted by the Company (the "Company Intellectual Property"). All of the employees, consultants and independent contractors of the Company that have participated in the development of the Company Intellectual Property, or any portion thereof, have entered into proprietary and confidentiality agreements with the Company in the form provided to Parent. (b) Section 2.17(b) of the Company Disclosure Schedule identifies and provides a brief description of each patent or registration which has been issued to the Company with respect to each item of Company Intellectual Property, identifies each pending patent application or application for registration which the Company has made with respect to each item of Company Intellectual Property. Section 2.17(b) of the Company Disclosure Schedule also identifies each trade name or unregistered trademark used by the Company in connection with its business. With respect to each item of Company Intellectual Property (i) the item of Company Intellectual Property is not subject to any outstanding injunction, judgement, order, decree, ruling or charge and (ii) no action, suit, proceeding, hearing, investigation, charge, complaint, claim, or demand is pending or, to the knowledge of the Company, threatened, which challenges the legality, validity, enforceability, use, or ownership of the item of Company Intellectual Property and (iii) the Company has not agreed to indemnify any third party for or against any interference, infringement, misappropriation, or other conflict with respect to such item. 13 168 (c) Section 2.17(c) of the Company Disclosure Schedule sets forth a complete list of all oral or written licenses, sublicenses and other agreements as to which the Company is a party and pursuant to which the Company or any other person is authorized to use any Company Intellectual Property (excluding object code non-exclusive end-user licenses granted to end-users in the ordinary course of business that permit use of software products without a right to modify, distribute or sublicense the same ("End-User Licenses")) or other trade secret material to the Company, and includes the identity of all parties thereto. The Company is not in violation of any license, sublicense or agreement described on such list except such violations as do not materially impair the Company's rights under such license, sublicense or agreement. The execution and delivery of this Agreement by the Company, and the consummation of the transactions contemplated hereby, will not cause the Company to be in violation or default under any such license, sublicense or agreement, nor entitle any other party to any such license, sublicense or agreement to terminate or modify such license, sublicense or agreement. (d) The Company has not sold, licensed or otherwise transferred any of the Company Intellectual Property, and has not entered into any agreements, oral or written, pursuant to which it has agreed that another party has rights in any of the Company Intellectual Property. The Company is not obligated to pay any compensation to any third party as a result of the use of any of the Company Intellectual Property. The Company has not interfered with, infringed upon or misappropriated any intellectual property rights of third parties, and none of the Company and the directors and officers (and employees with responsibility for Company Intellectual Property matters) of the Company has ever received any charge, complaint, claim, demand, or notice alleging any such interference, infringement, misappropriation, or violation (including any claim that the Company must license or refrain from using any intellectual property rights of any third party). To the knowledge of any of the Company and the directors and officers (and employees with responsibility for Company Intellectual Property matters) of the Company, no third party has interfered with, infringed upon or misappropriated any Company Intellectual Property. The Company has not entered into any agreement under which the Company is restricted from selling, licensing or otherwise distributing any of its products to any class of customers, in any geographic area, during any period of time or in any segment of the market. No employee of the Company is, or will be as a result of the consummation of the Merger and the transactions contemplated thereby, in violation of any term of any employment contract, patent disclosure agreement, noncompetition agreement, or any other contract or agreement or any restrictive covenant or any other common law obligation to a former employer relating to the right of any such employee to be employed by the Company because of the nature of the business conducted or to be conducted by the Company or relating to the use of intellectual property of others. (e) "Commercial Software" means packaged commercially available software programs generally available to the public through retail dealers in computer software which have been licensed to the Company pursuant to end-user licenses and which are used in the Company's business but are in no way a component of or incorporated in or specifically required to develop or support any of the Company's products and related trademarks, technology and know-how. SECTION 2.18 Immigration Compliance. (a) The Company is in compliance in all material respects with all applicable foreign, federal, state and local laws, rules, directives and regulations relating to the employment authorization of its employees (including, without limitation, the Immigration Reform and Control Act of 1986, as amended and supplemented, and Section 212(n) and 274A of the Immigration and Nationality Act, as amended and supplemented, and all implementing regulations relating thereto), and the Company has not employed nor is it currently employing any unauthorized aliens (as such term is defined under 8 CFR 274a.1(a)). (b) The Company has not received any notice from the Immigration and Naturalization Service (the "INS") or the U.S. Department of Labor (the "DOL") of the disapproval or denial of any visa petition pending before the INS or labor certification pending before the DOL on behalf of any employee or prospective employee of the Company. 14 169 (c) Section 2.18(c) of the Company Disclosure Schedule contains a true, complete and accurate list of all non-immigrant or immigrant visa petitions pending before the INS and labor certifications pending before the DOL on behalf of any of the employees or prospective employees of the Company. (d) Since the approval of each of their respective visa petitions, there has been no material change in the terms and conditions of employment of any employees of the Company. SECTION 2.19 Insurance. Section 2.19 of the Company Disclosure Schedule sets forth an accurate and complete list of all insurance policies maintained by the Company with respect to its properties, assets and operations and sets forth the date of expiration of each such insurance policy. All of such insurance policies are in full force and effect. The Company is not in default with respect to its obligations under any of such insurance policies, except for such defaults which would not have a Material Adverse Effect. SECTION 2.20 Notes and Accounts Receivable. All notes and accounts receivable of the Company are reflected properly on the books and records of the Company in accordance with GAAP, are valid and existing and represent monies due, arose from bona fide transactions in the ordinary course or business, are current and collectible and will be collected in accordance with their terms at their recorded amount subject only to the reserves for bad debts (in the amounts set forth on the face of the Most Recent Balance Sheet), and (subject to the aforesaid reserves) are subject to no material refunds or other adjustments and to no defenses, material rights of setoff, assignments, restrictions, encumbrances or conditions enforceable by third parties on or affecting any thereof. SECTION 2.21 Brokers. No broker, finder or investment banker, other than Business Development Advisors, the fees and expenses of which will be paid by the Company, is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by or on behalf of the Company or its affiliates. The Company has heretofore furnished to Parent a complete and correct copy of all agreements between the Company and Business Development Advisors pursuant to which such firm would be entitled to any payment relating to the transactions contemplated hereunder. SECTION 2.22 Change in Control Payments. Except as set forth on Section 2.11(d) or Section 2.22 of the Company Disclosure Schedule, the Company has no plans, programs or agreements to which it is a party, or to which it is subject, pursuant to which payments may be required or acceleration of benefits may be required upon a change of control of the Company. SECTION 2.23 Expenses. Section 2.23 of the Company Disclosure Schedule attached hereto sets forth a description of all of the estimated third party expenses of the Company, including those payable to auditors, consultants and other professionals, as of the date hereof which the Company expects to incur, or has incurred, in connection with the transactions contemplated by this Agreement. SECTION 2.24 Interested Party Transactions. Except for employment and other compensation and benefit agreements and plans and stock purchase agreements disclosed on Schedule 2.11 of the Company Disclosure Schedule or to be entered into in connection with this Agreement and except as set forth in Section 2.24 of the Company Disclosure Schedule, the Company is not a party to or bound by any contract, commitment or understanding with any of the stockholders of the Company or any of their affiliates and none of the stockholders and their affiliates (other than the Company) owns any asset, tangible or intangible, which is used in the business of the Company. SECTION 2.25 Complete Copies of Materials. The Company has delivered or made available to Parent true and complete copies of each agreement, contract, commitment or other document (or summaries of the same) that is referred to or required to be referred to in the Company Disclosure Schedule. SECTION 2.26 Registration Statement, Proxy Statement/Prospectus. Subject to the accuracy of the representations of Parent in Section 3.9, the information to be supplied by the Company for inclusion in the Registration Statement (as defined in Section 3.9) shall not at the time the Registration Statement is declared effective by the SEC contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances in 15 170 which they were made, not misleading. The information supplied by the Company for inclusion in the proxy statement/prospectus to be sent to the stockholders of the Company in connection with the meeting of the stockholders of the Company to consider the Merger (such proxy statement/prospectus as amended or supplemented is referred to herein as the "Proxy Statement/Prospectus"), will not, on the date the Proxy Statement/Prospectus (or any amendment thereof or supplement thereto) is first mailed to stockholders of the Company, at the time of such stockholder meeting, or at the Effective Time, contain any statement which, at such time and in light of the circumstances under which it shall be made, is false or misleading with respect to any material fact, or shall omit to state any material fact necessary in order to make the statements made therein not false or misleading. If at any time prior to the Effective Time any event relating to the Company or any of its respective affiliates, officers or directors should be discovered by the Company which should be set forth in an amendment to the Registration Statement or a supplement to the Proxy Statement/Prospectus, the Company shall promptly inform Parent, PTC, and Merger Sub. SECTION 2.27 Product Warranties; Defects; Liability. Each product manufactured, sold, leased, or delivered by the Company has been in conformity with all applicable federal, state, local or foreign laws and regulations, contractual commitments and all express and implied warranties, and the Company does not have any liability (and there is no basis for any present or future action, suit, proceeding, hearing, investigation, charge, complaint, claim, or demand giving rise to any liability) for replacement or repair thereof or other damages in connection therewith, subject only to the reserve for product warranty claims set forth on the face of the Financial Statements (rather than in any notes thereto) which such reserve is adequate to address all such liabilities. No product manufactured, sold, leased, or delivered by the Company is subject to any guaranty, warranty, or other indemnity beyond the applicable standard terms and conditions of sale or lease. Section 2.27 of the Company Disclosure Schedule includes copies of the standard terms and conditions of sale or lease for the Company (containing applicable guaranty, warranty, and indemnity provisions). The Company does not have any liability (and, to the knowledge of the Company, there is no basis for any present or future action, suit, proceeding, hearing, investigation, charge, complaint, claim, or demand against it giving rise to any liability) arising out of any injury to individuals or property as a result of the ownership, possession, or use of any product manufactured, sold, leased, or delivered by the Company and there has been no inquiry or investigation made in respect thereof by any person including any governmental or administrative agency. SECTION 2.28 Employees. To the knowledge of the Company, no executive, key employee, or group of employees has any plans to terminate employment with the Company. The Company is in compliance with all applicable laws respecting employment and employment practices, terms and conditions of employment and wages and hours and has not been and is not engaged in any unfair labor practice as defined in the National Labor Relations Act, as amended. Except as set forth on Section 2.28 of the Company Disclosure Schedule, no director, officer or employee has any basis for any present or future action or claim against the Company other than actions or claims relating to compensation for past services. SECTION 2.29 Inventories. The Company has no inventory. SECTION 2.30 Year 2000. (a) The Company has not yet modified the computer hardware and software owned, licensed, produced, or sold by the Company to correct any malfunctions or usage problems due to the change in the calendar year from 1999 to 2000 (the "Year 2000 Problem") or the improper expiration, termination, or data loss on or following September 9, 1999 (the "9/9/99 Problem"), although the Company has included in its product engineering plans the modifications necessary to resolve any Year 2000 Problems or 9/9/99 Problems. The Company has not made any representations or warranties or provided any commitment to any other person regarding the Year 2000 Problem or the 9/9/99 Problem, except for representations and warranties given with respect to products of the Company which operate correctly, consistently and unambiguously with respect to the Year 2000 Problem or the 9/9/99 Problem. SECTION 2.31 Indebtedness; Guarantees. Except as set forth on the face of the Financial Statements, the Company does not have any indebtedness for borrowed money or for the deferred purchase price of property or services (other than trade payables and other accrued current liabilities incurred in the ordinary course of business), or capital lease obligations, conditional sale or other title retention agreements. The 16 171 Company is not a guarantor or otherwise liable for any liability or obligation of any other person. Section 2.31 of the Company Disclosure Schedule lists all creditors of the Company in excess of $25,000. SECTION 2.32 No Illegal Payments, Etc. None of the Company, nor any of the officers, employees or agents of the Company, has (a) directly or indirectly given or agreed to give any illegal gift, contribution, payment or similar benefit to any supplier, customer, governmental official or employee or other person who was, is or may be in a position to help or hinder the Company (or assist in connection with any actual or proposed transaction) or made or agreed to make any illegal contribution, or reimbursed any illegal political gift or contribution made by any other person, to any candidate for federal, state, local or foreign public office (i) which might subject the Company to any damage or penalty in any civil, criminal or governmental litigation or proceeding or (ii) the non-continuation of which has had or might have, individually or in the aggregate, a material adverse effect on the Company or (b) established or maintained any unrecorded fund or asset or made any false entries on any books or records for any purpose. SECTION 2.33 Bonus Pool Obligations. The Company has obtained or will obtain prior to the Effective Time all consents from the issued and outstanding shares of Company Common Stock and Company Preferred Stock, as well as from any creditors of the Company, necessary to permit the distribution by Parent after the Effective Time of the Bonus Pool Consideration to the employees, directors and consultants of the Company set forth in Section 2.33 of the Company Disclosure Schedule in the amounts set forth therein. Upon distribution of the Bonus Pool Consideration by Parent after the Effective Time to the employees, directors and consultants of the Company and in the amounts set forth in Section 2.33 of the Company Disclosure Schedule, the Bonus Pool Obligation shall be satisfied in full and no director, officer, employee or consultant (current or former) of the Company shall have any claim or right of action against the Company with respect thereto. SECTION 2.34 Claims Against Directors and Officers. There is no action, suit, proceeding, hearing, investigation, charge, complaint, claim or demand pending or, to the knowledge of the Company, threatened (and no reasonable basis for any of the foregoing) against any person who is now or has been at any time prior to the date hereof an officer or director of the Company for acts or omissions in such person's capacity as an officer or director of the Company. SECTION 2.35 Full Disclosure. No representation or warranty made by the Company contained in this Agreement and no statement contained in any certificate or schedule furnished by the Company to Parent, PTC, or Merger Sub in, or pursuant to the provisions of, this Agreement, including without limitation the Company Disclosure Schedule, contains as of the date hereof or shall contain as of the Effective Time any untrue statement of a material fact or omits or will omit to state any material fact necessary, in the light of the circumstances under which it was made, in order to make statements herein or therein not misleading. There is no fact known to the Company which currently causes or reasonably could be expected to cause in the future a Material Adverse Effect which has not been disclosed in writing to Parent in connection with this Agreement. ARTICLE III REPRESENTATIONS AND WARRANTIES OF PARENT, PTC AND MERGER SUB Parent, PTC, and Merger Sub hereby, jointly and severally, represent and warrant to the Company and the stockholders of the Company that, except as set forth in the written disclosure schedule delivered on or prior to the date hereof by Parent to the Company that is arranged in paragraphs corresponding to the numbered and lettered paragraphs contained in this Article III (the "Parent Disclosure Schedule"): SECTION 3.1 Organization and Qualification. Each of Parent, PTC, and Merger Sub is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has the requisite corporate power and authority necessary to own, lease and operate the properties it purports to own, operate or lease and to carry on its business as it is now being conducted. Each of Parent, PTC, and Merger Sub is duly qualified or licensed as a foreign corporation to do business, and is in good standing, in each jurisdiction where the character of its properties owned, leased or operated by it or the nature 17 172 of its activities makes such qualification or licensing necessary, except for such failures to be so duly qualified or licensed and in good standing that would not have a Material Adverse Effect. SECTION 3.2 Charter and By-Laws. Each of Parent, PTC, and Merger Sub has heretofore furnished to the Company a complete and correct copy of its Certificate of Incorporation or Articles of Incorporation, as the case may be, and By-Laws, in each case as amended to date. Such Certification of Incorporation and Articles of Incorporation, as the case may be, and By-Laws are in full force and effect. SECTION 3.3 Capitalization. The authorized capital stock of the Parent consists of (i) 80,000,000 shares of Parent Common Stock and (ii) 15,000,000 shares of preferred stock, par value $0.01 per share ("Preferred Stock"). As of June 30, 1998, there were (i) 38,338,276 shares of Parent Common Stock issued and outstanding, (ii) no shares of Preferred Stock outstanding, and (iii) 5,852,852 shares of Parent Common Stock reserved for future issuance pursuant to Parent's stock option plans (the "Parent Stock Option Plans"). SECTION 3.4 Authority Relative to this Agreement. Each of Parent, PTC, and Merger Sub has all necessary corporate power and authority to execute and deliver this Agreement and to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement by Parent, PTC, and Merger Sub and the consummation by Parent, PTC, and Merger Sub of the transactions contemplated hereby have been duly and validly authorized by all necessary corporate action on the part of Parent, PTC, and Merger Sub, and no other corporate proceedings on the part of Parent, PTC, or Merger Sub are necessary to authorize this Agreement or to consummate the transactions contemplated thereby. This Agreement has been duly and validly executed and delivered by Parent, PTC, and Merger Sub and, assuming the due authorization, execution and delivery by the Company, constitutes a legal, valid and binding obligation of Parent, PTC, and Merger Sub enforceable against each of them in accordance with its terms. SECTION 3.5 No Conflict, Required Filings and Consents. (a) Except as set forth in Section 3.5(a) of the Parent Disclosure Schedule, the execution and delivery of this Agreement by Parent, PTC, and Merger Sub do not, and the performance of this Agreement by Parent, PTC, and Merger Sub will not, (i) conflict with or violate the Certificate of Incorporation of Parent or the Certificate of Incorporation of PTC or the Articles of Incorporation of Merger Sub or the By-Laws of Parent, PTC, or Merger Sub, (ii) conflict with or violate any Laws applicable to Parent or by which its assets or properties are bound or affected, or (iii) result in any breach of or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or impair Parent's rights or alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, or result in the creation of a lien or encumbrance on any of the properties or assets of Parent pursuant to, any material note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other instrument or obligation to which Parent is a party or by which Parent or its assets or properties are bound or affected. (b) The execution and delivery of this Agreement by Parent, PTC, and Merger Sub does not, and the performance of this Agreement by Parent, PTC, and Merger Sub will not, require any consent, approval, authorization or permit on the part of the Parent, PTC, or Merger Sub of, or filing with or notification on the part of the Parent, PTC, or Merger Sub to, any federal foreign, state or provincial governmental or regulatory authority except (i) for applicable requirements, if any, of the Securities Act, the Exchange Act, the Blue Sky Laws and Nasdaq and the filing and recordation of appropriate merger or other documents as required by the CCC and (ii) where the failure to obtain such consents, approvals, authorizations or permits, or to make such filings or notifications, would not prevent or delay consummation of the Merger, or otherwise prevent Parent, PTC, or Merger Sub from performing their respective obligations under this Agreement, and otherwise would not have a Material Adverse Effect. SECTION 3.6 SEC Filings; Financial Statements. (a) Parent has filed all forms, reports and documents required to be filed with the Securities and Exchange Commission (the "SEC") and has heretofore delivered to the Company, in the form filed with the SEC, (i) its Annual Report on Form 10-K for the fiscal year ended December 31, 1997, (ii) its Quarterly 18 173 Report on Form 10-Q for the quarter ended June 28, 1998, (iii) its Proxy Statement relating to the Annual Meeting of Stockholders held June 17, 1998, (iv) Current Report on Form 8-K filed with the SEC on February 11, 1998, and (v) all amendments and supplements to all such reports and statements filed by Parent with the SEC (collectively, the "Parent SEC Reports"). The Parent SEC Reports (i) were prepared in all material respects in accordance with the requirements of the Securities Act or the Exchange Act, as the case may be, and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (b) Each of the consolidated financial statements (including, in each case, any related notes thereto) contained in the Parent SEC Reports has been prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto) and each fairly presents in all material respects the consolidated financial position of Parent and its subsidiaries as at the respective dates thereof and the consolidated results of its operations and cash flows for the periods indicated, except that the unaudited interim financial statements were or are subject to normal and recurring year-end adjustments which were not or are not expected to be material in amount. SECTION 3.7 Validity of Parent Common Stock. The shares of Parent Common Stock to be issued pursuant to this Agreement will be, when issued, duly authorized, validly issued, fully paid and nonassessable and subject to no preemptive rights. SECTION 3.8 Registration Statement; Proxy Statement/Prospectus. Subject to the accuracy of the representations of the Company in Section 2.26, the registration statement (the "Registration Statement") pursuant to which the Parent Common Stock to be issued in the Merger will be registered with the SEC shall not, at the time the Registration Statement (including any amendments or supplements thereto) is declared effective by the SEC, contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements included therein, in light of the circumstances under which they were made, not misleading. The information supplied by Parent for inclusion in the Proxy Statement/ Prospectus will not, on the date the Proxy Statement/Prospectus (or any amendment or supplement thereto) is first mailed to stockholders of the Company, at the time of such stockholder meeting and at the Effective Time, contain any statement which, at such time and in light of the circumstances under which it shall be made, is false or misleading with respect to any material fact, or will omit to state any material fact necessary in order to make the statements therein not false or misleading. If at any time prior to the Effective Time any event relating to Parent, PTC, Merger Sub or any of their respective affiliates, officers or directors should be discovered by Parent, PTC, or Merger Sub which should be set forth in an amendment to the Registration Statement or a supplement to the Proxy Statement/Prospectus, Parent, PTC, or Merger Sub will promptly inform the Company. Notwithstanding the foregoing, Parent, PTC, and Merger Sub make no representation or warranty with respect to any information supplied by the Company or the stockholders of the Company which is contained in any of the foregoing documents. The Registration Statement and Proxy Statement/ Prospectus shall comply in all material respects as to form with the requirements of the Securities Act, the Exchange Act and the rules and regulations thereunder. SECTION 3.9 Full Disclosure. No representation or warranty made by Parent contained in this Agreement and no statement contained in any certificate or schedule furnished by Parent, PTC, or Merger Sub to the Company in, or pursuant to the provisions of, this Agreement, including without limitation the Parent Disclosure Schedule, contains or shall contain any untrue statement of a material fact or omits or will omit to state any material fact necessary, in the light of the circumstances under which it was made, in order to make the statements herein or therein not misleading. SECTION 3.10 Absence of Material Changes. Since the date of last Parent SEC Report, there have been no changes in the business, operating results, assets or condition of Parent that could reasonably be expected to have a Material Adverse Effect, other than changes resulting from this Agreement; provided, however, that it is understood and expressly acknowledged that Parent has experienced operating losses for several quarters and may continue to experience operating losses in future periods. 19 174 ARTICLE IV CONDUCT OF BUSINESS PENDING THE MERGER SECTION 4.1 Conduct of Business by the Company Pending the Merger. The Company covenants and agrees that, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Time, unless Parent shall otherwise agree in writing, the Company shall conduct its business only in, and the Company shall not take any action except in, the ordinary course of business and in a manner consistent with past practice other than actions taken by the Company in contemplation of the Merger; and the Company shall use all reasonable commercial efforts to preserve substantially intact the business organization of the Company, to keep available the services of the present officers, employees and consultants of the Company and to preserve the present relationships of the Company with customers, suppliers and other persons with which the Company has business relations. By way of amplification and not limitation, except as contemplated by this Agreement, the Company shall not, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Time, directly or indirectly do, or propose to do, any of the following without the prior written consent of Parent: (a) amend the Articles of Incorporation or By-Laws of the Company except pursuant to the Merger Agreement; (b) issue, sell, pledge, dispose of or encumber, or authorize the issuance, sale, pledge, disposition or encumbrance of, any shares of capital stock of any class, or any options, warrants, convertible securities or other rights of any kind to acquire any shares of capital stock, or any other ownership interest (including, without limitation, any phantom interest) in the Company (other than upon exercise of options, warrants or other rights to purchase Company Common Stock or Company Preferred Stock outstanding on the date hereof); (c) except in the ordinary course of business, sell, pledge, dispose of or encumber any assets, tangible or intangible, of the Company except for dispositions of obsolete or worthless assets; (d)(i) declare, set aside, make or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of any of its capital stock, (ii) split, combine or reclassify any of its capital stock or issue or authorize or propose the issuance of any other securities in respect of, in lieu of or in substitution for shares of its capital stock or (iii) amend the terms or change the period of exercisability of, purchase, repurchase, redeem or otherwise acquire any of its securities, including without limitation, shares of Company Common Stock or Company Preferred Stock or any option, warrant or right, directly or indirectly, to acquire shares of Company Common Stock or Company Preferred Stock, or propose to do any of the foregoing; (e)(i) acquire (by merger, consolidation, or acquisition of stock or assets) any corporation, partnership, association or other business organization or division thereof; (ii) incur any indebtedness for borrowed money or issue any debt securities or assume, guarantee or endorse or otherwise as an accommodation become responsible for, the obligations of any person or, except in the ordinary course of business consistent with past practice, make any loans or advances; (iii) enter into or amend any material contract or agreement involving obligations in excess of $50,000; (iv) authorize any capital expenditures or purchases of fixed assets; or (v) enter into or amend any contract, agreement, commitment or arrangement to effect any of the matters prohibited by this Section 4.1(e); (f) except for allocations of the Bonus Pool Consideration, increase the compensation payable or to become payable to its officers or key employees or consultants, increase compensation payable or to become payable to its employees or consultants other than in the ordinary course of business, or grant any severance or termination pay to, or enter into any employment or severance agreement with, any director, officer or other employee of the Company, or establish, adopt, enter into or amend any collective bargaining, bonus, profit sharing, thrift, compensation, stock option, restricted stock, pension, retirement, deferred compensation, employment, termination, severance or other plan, agreement, trust, fund, policy 20 175 or arrangement for the benefit of any current or former directors, officers or employees, except in each case, as may be required by law; (g) take any action to change accounting policies or procedures (including, without limitation, procedures with respect to revenue recognition, Taxes, payments of accounts payable and collection of accounts receivable); (h) make any material tax election or settle or compromise any federal, state, local or foreign tax liability or agree to an extension of a statute of limitations; (i) pay, discharge, settle or satisfy any claims, liabilities or obligations (absolute, accrued, asserted or unasserted, contingent or otherwise), other than the payment, discharge or satisfaction in the ordinary course of business and consistent with past practice of liabilities reflected or reserved against in the Financial Statements or incurred in the ordinary course of business and consistent with past practice; (j) commence any litigation; or (k) take, or agree in writing or otherwise to take, any of the actions described in Sections 4.1 (a) through (j) above, or any action which would make any of the representations or warranties of the Company contained in this Agreement untrue or incorrect or prevent the Company from performing or cause the Company not to perform its covenants hereunder. SECTION 4.2 No Solicitation. (a) The Company shall not, directly or indirectly, through any officer, director, employee, representative or agent of the Company, (i) solicit, initiate or encourage the initiation of any inquiries or proposals regarding any merger, sale of substantial assets, sale of shares of capital stock (including without limitation by way of a tender offer) or similar transactions involving the Company other than the Merger (any of the foregoing inquiries or proposals being referred to herein as an "Acquisition Proposal"), (ii) engage in negotiations or discussions concerning, or provide any nonpublic information to any person relating to, any Acquisition Proposal or (iii) agree to, approve or recommend any Acquisition Proposal. (b) The Company shall immediately notify Parent after receipt of any Acquisition Proposal, or any modification of or amendment to any Acquisition Proposal, or any request for nonpublic information relating to the Company in connection with an Acquisition Proposal or for access to the properties, books or records of the Company by any person or entity that informs the Board of Directors of the Company that it is considering making, or has made, an Acquisition Proposal. Such notice to Parent shall be made orally and in writing. (c) The Company shall immediately cease and cause to be terminated any existing discussions or negotiations with any persons (other than Parent, PTC, and Merger Sub) conducted heretofore with respect to any of the foregoing. The Company agrees not to release any third party from the confidentiality provisions of any confidentiality agreement to which the Company is a party. (d) The Company shall ensure that the officers, directors and employees of the Company and any investment banker or other advisor or representative retained by the Company are aware of the restrictions described in this Section 4.2. ARTICLE V ADDITIONAL AGREEMENTS SECTION 5.1 Stockholder Meeting. The Company shall call and hold a meeting of the stockholders of the Company, or in lieu thereof cause an effective written action of the stockholders to be executed (the "Company Stockholders Meeting"), which meeting shall be held or written action obtained as promptly as practicable after the date of this Agreement and in accordance with applicable laws for the purpose of obtaining the approval of the Merger, this Agreement and the transactions contemplated hereby. The Company shall use its reasonable efforts to obtain the approval of all of its stockholders in respect of the Merger, this Agreement and in respect of the transactions contemplated hereby. 21 176 SECTION 5.2 Access to Information. Upon reasonable notice, the Company shall afford to each of the officers, employees, accountants, counsel and other representatives of Parent, reasonable access, during the period from the date of this Agreement to the Effective Time, to all its properties, books, contracts, commitments and records and, during such period, the Company shall furnish promptly to Parent all information concerning its business, properties and personnel as Parent may reasonably request, and shall make available to Parent the appropriate individuals (including attorneys, accountants and other professionals) for discussion of the Company's business, properties and personnel as Parent may reasonably request. SECTION 5.3 Consents; Approvals. The Company and Parent shall each use their reasonable efforts to obtain all consents, waivers, approvals, authorizations or orders (including, without limitation, all United States governmental and regulatory rulings and approvals), and the Company and Parent shall make all filings (including, without limitation, all filings with United States governmental or regulatory agencies) required in connection with the authorization, execution and delivery of this Agreement by the Company, on the one hand, and Parent, PTC and Merger Sub, on the other hand, and the consummation by them of the transactions contemplated hereby, in each case as promptly as practicable. The Company and Parent shall furnish promptly all information required to be included in any application or other filing to be made pursuant to the rules and regulations of any United States or foreign governmental body in connection with the transactions contemplated by this Agreement. SECTION 5.4 Agreements with Respect to Affiliates. Schedule 5.4 contains a true and complete list identifying all persons who, in the Company's reasonable judgment, are, or will be, at the time of the Company Stockholders Meeting (or at the time of the effectiveness of any written consent), "affiliates" of the Company within the meaning of Rule 145 under the Securities Act ("Rule 145"). The Company shall cause each person who is identified as an "affiliate" to deliver to Parent, prior to the Effective Time, a written agreement (an "Affiliate Agreement") in connection with restrictions on affiliates under Rule 145, in substantially the form of Exhibit 5.4. SECTION 5.5 Stockholder Agreements. The Company shall use reasonable efforts to cause each stockholder of the Company to execute a Stockholder Agreement (each a "Stockholder Agreement") in the form of Exhibit 5.5 concurrently with the execution of this Agreement or as promptly as practicable after (a) the date of this Agreement (with respect to stockholders as of the date of this Agreement) or (b) the date such persons become stockholders prior to the Effective Time. SECTION 5.6 Notification of Certain Matters. The Company shall give prompt notice to Parent, and Parent shall give prompt notice to the Company, of (i) the occurrence or nonoccurrence of any event the occurrence or nonoccurrence of which would be likely to cause any representation or warranty contained in this Agreement to become materially untrue or inaccurate or (ii) any failure of the Company, Parent, PTC, or Merger Sub, as the case may be, materially to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it hereunder; provided, however, that the delivery of any notice pursuant to this Section shall not limit or otherwise affect the remedies available hereunder to the party receiving such notice; and provided, further that failure to give such notice shall not be treated as a breach of covenant for the purposes of Sections 6.2(b) or 6.3(b) unless the failure to give such notice results in material prejudice to the other party. SECTION 5.7 Further Action/Tax Treatment. Upon the terms and subject to the conditions hereof each of the parties hereto shall use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all other things necessary, proper or advisable to consummate and make effective as promptly as practicable the transactions contemplated by this Agreement, to obtain in a timely manner all necessary waivers, consents and approvals and to effect all necessary registrations and filings, and otherwise to satisfy or cause to be satisfied all conditions precedent to its obligations under this Agreement. Parent, PTC, Merger Sub and the Company will each treat the transaction effected through the Merger as a purchase of stock treated for federal income tax purposes as a sale or exchange resulting in the recognition of gain or loss by the holders of the outstanding capital stock of the Company. SECTION 5.8 Public Announcements. Parent, PTC, Merger Sub and the Company shall consult with each other before issuing any press release with respect to the Merger or this Agreement and shall not 22 177 issue any such press release or make any such public statement without the prior consent of the other party, which consent shall not be unreasonably withheld, it being expressly understood that unless notified in writing by the President of Parent, Gregory Lazar shall be the only individual to authorize such release or public statement on behalf of Parent and, unless notified in writing by the President of the Company, James Long shall be the only individual to authorize such release or public statement on behalf of the Company; provided, however, that Parent may, without the prior consent of the Company, issue such press release or make such public statement at any time as may upon the advice of counsel be required by law or the rules and regulations of the Nasdaq National Market if it has used reasonable efforts to consult with the Company prior thereto. SECTION 5.9 Conveyance Taxes. Parent, PTC, Merger Sub and the Company shall cooperate in the preparation, execution and filing of all returns, questionnaires, applications, or other documents regarding any gains, sales, use, transfer, value added, stock transfer and stamp taxes, any transfer, recording, registration and other fees, and any similar taxes which become payable in connection with the transactions contemplated hereby that are required or permitted to be filed at or before the Effective Time. SECTION 5.10 Listing of Parent Shares. Parent shall promptly file an additional share listing application with the Nasdaq Stock Market for the listing of the Parent Shares to be issued in connection with the Merger and shall use its reasonable efforts to have such application accepted. SECTION 5.11 Tax Certificates. The Company shall deliver to Parent on the Closing Date, an affidavit, in form and substance reasonably satisfactory to Parent, meeting the requirements necessary to establish that the disposition of Company Common Stock or Company Preferred Stock is eligible for the exemption from the withholding provided by Section 1445(b)(3) of the Code. SECTION 5.12 Proxy Statement/Prospectus; Registration Statement. (a) As promptly as practicable after the execution of this Agreement, the Company and Parent shall prepare and file with the SEC preliminary proxy materials which shall constitute the Proxy Statement/Prospectus and the Registration Statement of the Parent with respect to the Parent Common Stock to be issued in connection with the Merger and shall use all reasonable efforts to cause the Registration Statement to become effective as soon as practicable, and to mail the Proxy Statement/Prospectus to the stockholders of the Company, as soon thereafter as practicable. The Proxy Statement/Prospectus shall include the recommendation of the Board of Directors of the Company in favor of the Merger. (b) The Company shall furnish Parent with all information, including without limitation financial statements and financial information in any form reasonably requested by Parent, concerning the Company and/or the holders of its capital stock and shall take such further action as Parent may reasonably request in connection with the Proxy Statement/Prospectus and the issuance of the Parent Common Stock. Parent shall provide the Company with two (2) business days' notice prior to the effectiveness of the Registration Statement or prior to the mailing of any Proxy Statement/Prospectus (or any amendment thereof or supplement thereto) and provide the Company with the opportunity to update the information set forth therein. If at any time prior to the Effective Time any event or circumstance relating to the Company, Parent or any of their respective subsidiaries, affiliates, officers or directors should be discovered by such party which should be set forth in an amendment or a supplement to the Proxy Statement/Prospectus, such party shall promptly inform the other thereof and take appropriate action in respect thereof. SECTION 5.13 Distribution of Bonus Pool Consideration. As promptly as possible after the Effective Time, Parent shall prepare and file with the SEC a Registration Statement on Form S-8 to register the shares of Parent Common Stock issuable in satisfaction of the Bonus Pool Obligation and Parent shall distribute such shares of Parent Common Stock to the employees set forth in Section 2.33 of the Company Disclosure Schedule that are still employed as of the Effective Time in accordance with the terms of the Bonus Pool Obligation. SECTION 5.14 Confidentiality. Each of the Company, Parent, PTC, and Merger Sub (and the officers, directors and employees of such respective parties) will treat and hold as such all Confidential Information of the other party, refrain from using any Confidential Information of the other party except in connection with this Agreement, and deliver promptly to the other party or destroy, at the request of such 23 178 party, all tangible embodiments (and all copies) of any Confidential Information which are in its possession. In the event that any of the parties is requested or required (by oral question or request for information or documents in any legal proceeding, interrogatory, subpoena, civil investigative demand, or similar process) to disclose any such Confidential Information, that party will notify the appropriate party promptly of the request or requirement so that such other party may seek an appropriate protective order or waive compliance with the provisions of this Section 5.14. If, in the absence of a protective order or the receipt of a waiver hereunder, any party is, on the advice of counsel, compelled to disclose any Confidential Information to any tribunal or else stand liable for contempt, that party may disclose the Confidential Information to the tribunal; provided, however, that the disclosing party shall use its best effort to obtain, at the request of the party whose Confidential Information is to be disclosed, an order or other assurance that confidential treatment will be accorded to such portion of the Confidential Information required to be disclosed as such party shall so designate. "Confidential Information" means any and all information concerning the businesses and affairs of the Company or Parent, as the case may be, other than that information which is already generally or readily obtainable by the public or is publicly known or becomes publicly known through no fault of Parent (with respect to Confidential Information of the Company) or the Company (with respect to Confidential Information of Parent). SECTION 5.15 Operational Funding. The Company shall provide to Parent at the date hereof and on the last business day of each week a budget of its operating cash requirements for the following week and a reconciliation of the budget and actual cash spending of the Company for the current week. Subject to the Company's continued compliance with its obligations under this Agreement and until November 30, 1998, Parent shall loan to the Company (collectively, the "Operational Loans"), on the first business day of the week following the submission of such budget and reconciliation reports, such amounts as may be mutually agreed upon after negotiations in good faith by the Company and Parent to fund the Company's operational requirements for such week. The Operational Loans shall be represented by promissory notes in the form previously employed by Parent and the Company. The Company covenants and agrees that the Operational Loans will be used solely to fund its operational cash requirements through November 30, 1998. SECTION 5.16 Tax Information. The Company agrees to provide Parent prior to the Closing Date (A) the Company's Tax basis in its assets as of December 31, 1997 and as utilized in the Tax Returns, (B) the amount of any net operating loss, net capital loss, unused investment or other credit, unused foreign Tax, excess charitable contribution, adjustments under Section 481 of the Code and other Tax attributes allocable to the Company as shown on the Tax Returns, (C) its best determination of the limitations on the use of any of those Tax attributes under Sections 382 or 383 of the Code, and (D) the amount of any deferred gain or loss allocable to the Company arising out of any deferred intercompany transaction and any excess loss account attributable to the Company. The information provided to Parent under this Section 5.16 shall be set forth on Schedule 5.16 and included as part of this Agreement. SECTION 5.17 Section 280G Stockholder Consent. The Company shall use its reasonable best efforts to obtain any stockholder approvals required under Section 280G(b)(5)(A)(ii) of the Code prior to the Closing Date. ARTICLE VI CONDITIONS TO THE MERGER SECTION 6.1 Conditions to Obligation of Each Party to Effect the Merger. The respective obligations of each party to effect the Merger shall be subject to the satisfaction at or prior to the Effective Time of the following conditions: (a) Requisite Approval. This Agreement and the Merger shall have received the Requisite Approval. (b) No Injunctions or Restraints; Illegality. No temporary restraining order, preliminary or permanent injunction or other order issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Merger shall be in effect, nor shall any proceeding 24 179 brought by any administrative agency or commission or other governmental authority or instrumentality, seeking any of the foregoing be pending; and there shall not be any action taken, or any statute, rule, regulation or order enacted, entered, enforced or deemed applicable to the Merger, which makes the consummation of the Merger illegal. (c) Governmental Actions. There shall not have been instituted, pending or threatened any action or suit or proceeding (or any investigation or other inquiry that might result in such an action, suit or proceeding) by any governmental authority or administrative agency before any governmental authority, administrative agency or court of competent jurisdiction, nor shall there be in effect any judgment, decree or order of any governmental authority, administrative agency or court of competent jurisdiction, in either case, seeking to prohibit or limit Parent from exercising all material rights and privileges pertaining to its ownership of the Surviving Corporation or the ownership or operation by Parent or any of its subsidiaries of all or a material portion of the business or assets of Parent or any of its subsidiaries as a result of the Merger or the transactions contemplated by this Agreement. (d) Tax Opinion. The holders of the Company Preferred Stock shall have received a written opinion of Wilson, Sonsini, Goodrich & Rosati, P.C., in form and substance reasonably satisfactory to the Company and Parent, to the effect that the transaction effected by the Merger will constitute a purchase of Company stock treated for federal income tax purposes as a sale or exchange resulting in gain or loss recognition by the holders of the outstanding capital stock of the Company. (e) Stock Purchase Agreement. PTC and David Edwards shall have entered into and performed all of their respective obligations under a Stock Purchase Agreement pursuant to which, immediately prior to the Closing, PTC will purchase from David Edwards, and David Edwards will sell to PTC, Five Thousand (5,000) shares of Series B Preferred, which constitute all of the shares of Company Preferred Stock owned by David Edwards, for an aggregate purchase price of Three Thousand Thirty Nine Dollars ($3,039). (f) Registration Statement. The Registration Statement on Form S-4 shall have been declared effective by the Securities and Exchange Commission and no stop orders shall have been issued suspending the effectiveness of such Registration Statement. SECTION 6.2 Additional Conditions to Obligations of Parent, PTC, and Merger Sub. The obligations of Parent, PTC and Merger Sub to effect the Merger are also subject to the following conditions: (a) Representations and Warranties. The representations and warranties of the Company contained in this Agreement shall have been true and correct at and as of the date made, and shall be true and correct in all material respects as of the Closing Date. In addition, all representations and warranties of the Company that are qualified by materiality or similar words shall have been true and correct (giving effect to such qualification) in all respects when made and as of the Closing Date. Parent shall have received a certificate to such effect signed on behalf of the Company by its President or its Chief Financial Officer. (b) Agreements and Covenants. The Company shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it at or prior to the Effective Time, and Parent, PTC, and Merger Sub shall have received a certificate to such effect signed on behalf of the Company by its President or its Chief Financial Officer. (c) Consents Obtained. All consents, waivers, approvals, authorizations or orders required to be obtained, and all filings required to be made, by the Company for the due authorization, execution and delivery of this Agreement and the consummation by it of the transactions contemplated hereby shall have been obtained and made by the Company. (d) Opinion of Counsel to the Company. Parent shall have received an opinion of Wilson, Sonsini, Goodrich & Rosati, P.C., counsel to the Company, in substantially the form attached hereto as Exhibit 6.2(d). 25 180 (e) Affiliate Agreements. Parent shall have received from each person who is identified in Schedule 5.4 as an "affiliate" of the Company, an Affiliate Agreement and such Affiliate Agreement shall be in full force and effect. (f) Escrow Agreement. Each of Escrow Agent, the Company and the Stockholder Representative shall have executed and delivered to Parent an Escrow Agreement substantially in the form of Exhibit 6.2(f). (g) Stockholder Agreement. Parent shall have received executed Stockholder Agreements from holders of at least seventy-five percent (75%) of the Company Preferred Stock. (h) Company Dissenting Shares. The Company Dissenting Shares shall constitute less than seven percent (7%) of the fully diluted Company Common Stock at the Effective Time (assuming conversion of all Company Preferred Stock). (i) Registration and Other Rights. All existing registration rights, preemptive rights and rights of first refusal with respect to the purchase of the capital stock of the Company shall have been terminated and Parent, PTC and Merger Sub shall have received a certificate to such effect signed on behalf of the Company by its President or its Chief Financial Officer. (j) Employment Agreements. Each of James E. Long and David A. Edwards shall have entered into employment agreements with the Company in substantially the forms attached as Exhibit 6.2(j)(i) and Exhibit 6.2(j)(ii). Such agreements shall be in full force and effect as of the Effective Time and each such person shall be in the employ of the Company immediately prior to the Effective Time and neither shall have indicated his intention to terminate his employment with the Surviving Corporation following the Effective Time and Merger Sub shall have received a certificate to such effect signed on behalf of the Company by its President or its Chief Financial Officer. (k) Stock Options, Warrants and Other Rights. All Company Stock Options issued under the Common Stock Option Plan shall have been terminated in accordance with the provisions of such Common Stock Option Plan. All warrants and other securities or instruments convertible into or exchangeable for shares of any class of capital stock of the Company shall have been terminated or shall have been converted into shares of the capital stock of the Company, except, assuming the consummation of the Merger and based on the Exchange Ratios, warrants and other securities or instruments of the Company convertible into or exchangeable for shares of Company Preferred Stock and, in accordance with Section 1.7(a) hereof, convertible into a maximum of three thousand (3,000) shares of Parent Common Stock. Parent, PTC, and Merger Sub shall have received a certificate to such effect signed on behalf of the Company by its President or its Chief Financial Officer. (l) Exchange Ratios. Parent, PTC, and Merger Sub shall have received a certificate signed on behalf of the Company by its President or its Chief Financial Officer to the effect that Schedule 1.7(a) is true and complete in all respects as of the Closing Date. SECTION 6.3 Additional Conditions to Obligation of the Company. The obligation of the Company to effect the Merger is also subject to the following conditions: (a) Representations and Warranties. The representations and warranties of the Parent, PTC, and Merger Sub contained in this Agreement shall have been true and correct at and as of the date made, and shall be true and correct in all material respects as of the Closing Date. In addition, all representations and warranties of the Parent, PTC, and Merger Sub that are qualified by materiality or similar words shall have been true and correct (giving effect to such qualification) in all respects when made and as of the Closing Date. The Company shall have received a certificate to such effect signed on behalf of Parent by its President or its Chief Financial Officer. (b) Agreements and Covenants. Parent, PTC, and Merger Sub shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by them on or prior to the Effective Time, and the Company shall have received a certificate to such effect signed on behalf of Parent by its President or its Chief Financial Officer. 26 181 (c) Consents Obtained. All consents, waivers, approvals, authorizations or orders required to be obtained, and all filings required to be made, by Parent, PTC, and Merger Sub for the due authorization, execution and delivery of this Agreement and the consummation by them of the transactions contemplated hereby shall have been obtained and made by Parent, PTC, and Merger Sub. (d) Opinion of Counsel to Parent. The Company shall have received an opinion of Ropes & Gray, counsel to Parent, PTC, and Merger Sub, in substantially the form attached hereto as Exhibit 6.3(d). (e) Employment Agreements. Each of James E. Long and David A. Edwards shall have entered into employment agreements with the Company in substantially the forms attached as Exhibit 6.2(j)(i) and Exhibit 6.2(j)(ii). Such agreements shall be in full force and effect as of the Effective Time. ARTICLE VII TERMINATION SECTION 7.1 Termination. This Agreement may be terminated at any time prior to the Effective Time, notwithstanding approval thereof by the stockholders of the Company or Parent: (a) by mutual written consent duly authorized by each of the Boards of Directors of Parent and the Company; or (b) by either Parent or the Company if the Merger shall not have been consummated by November 30, 1998 (provided that the right to terminate this Agreement under this Section 7.1(b) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of or resulted in the failure of the Merger to occur on or before such date); or (c) by either Parent or the Company if a court of competent jurisdiction or governmental, regulatory or administrative agency or commission shall have issued a nonappealable final order, decree or ruling or taken any other action having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger (provided that the right to terminate this Agreement under this Section 7.1(c) shall not be available to any party who has not complied with its obligations under Section 5.3 and such noncompliance materially contributed to the issuance of any such order, decree or ruling or the taking of such action); or (d) by Parent, if the Requisite Approval shall not have been obtained by November 25, 1998; or (e) by Parent or the Company, (i) if any representation or warranty of the Company or Parent, respectively, set forth in this Agreement shall be untrue when made, or (ii) upon a breach of any covenant or agreement on the part of the Company or Parent, respectively, set forth in this Agreement, such that the conditions set forth in Section 6.2(a) or 6.2(b), or Section 6.3(a) or 6.3(b), as the case may be, would not be satisfied (either (i) or (ii) above being a "Terminating Breach"), provided, however, that, if such Terminating Breach is curable prior to November 30, 1998 by the Company or Parent, as the case may be, through the exercise of its reasonable efforts and for so long as the Company or Parent, as the case may be, continues to exercise such reasonable efforts, neither Parent nor the Company, respectively, may terminate this Agreement under this Section 7.1(e); (f) by Parent, if any representation or warranty of the Company shall have become untrue such that the condition set forth in Section 6.2(a) would not be satisfied, or by the Company, if any representation or warranty of Parent shall have become untrue such that the condition set forth in Section 6.3(a) would not be satisfied, in either case other than by reason of a Terminating Breach; or (g) by Parent, if: (i) the Board of Directors of the Company shall withdraw, modify or change its approval or recommendation of this Agreement or the Merger in a manner adverse to Parent or shall have resolved to do so or (ii) the Board of Directors of the Company shall have recommended to the stockholders of the Company an alternative Acquisition Proposal. 27 182 SECTION 7.2 Effect of Termination. In the event of the termination of this Agreement pursuant to Section 7.1, this Agreement shall forthwith become void and there shall be no liability on the part of any party hereto or any of its affiliates, directors, officers or shareholders except (i) as set forth below in this Section 7.2 and in Section 7.3 hereof and (ii) nothing herein shall relieve any party from liability for any breach hereof. Notwithstanding anything else to the contrary herein, if this Agreement is terminated by Parent pursuant to Section 7.1(g), the Company shall pay to Parent One Million Dollars ($1,000,000), payable by wire transfer within five (5) days of Parent's notice to the Company terminating this Agreement. Notwithstanding anything else to the contrary herein, Sections 5.14 and 7.3 shall survive the termination of this Agreement. SECTION 7.3 Fees and Expenses. All fees and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses, whether or not the Merger is consummated; provided, however, that in the event the Merger is consummated, the Company shall pay up to only $400,000 of legal, accounting and investment banking fees incurred in connection with this Agreement and the consummation of the Merger and thereafter the holders of the Company Preferred Stock immediately prior to the Effective Time shall be responsible for any fees or expenses incurred in excess thereof, to the extent of the Escrow Fund. ARTICLE VIII GENERAL PROVISIONS SECTION 8.1 Indemnification. (a) Charters and By-Laws. Parent agrees to indemnify the employees, agents, directors and officers of the Company to the extent of all rights to indemnification or exculpation now existing in favor of the employees, agents, directors or officers of the Company (each a "Company Indemnified Party") as provided in its Articles of Incorporation or By-Laws and that such rights shall continue in full force and effect for a period of not less than six (6) years from the Closing Date; provided, however, that, in the event any claim or claims are asserted or made within such six-year period, all rights to indemnification in respect of any such claim or claims shall continue until disposition of any and all such claims. Any determination required to be made with respect to whether a Company Indemnified Party's conduct complies with the standards set forth in the Articles of Incorporation or By-Laws of the Company or otherwise, in each case subject to California law, shall be made by independent counsel selected by the Company Indemnified Party reasonably satisfactory to the Surviving Corporation (whose fees and expenses shall be paid by the Surviving Corporation). (b) Survival of Representations and Warranties. The representations and warranties of the Company made in this Agreement (except for those representations and warranties set forth in Section 2.3) and in the documents and certificates delivered in connection herewith and the representations and warranties of Parent made in this Agreement and in the documents and certificates delivered in connection herewith shall survive the Merger for a period of twelve (12) months from the Closing Date (the "Indemnity Period") and shall remain operative and in full force and effect through the end of the Indemnity Period regardless of any investigation made by or on behalf of any other party hereto, any person controlling any such party or any of their officers or directors, whether prior to or after the execution of this Agreement. No claim for indemnification under this Section 8.1 for breach of a representation or warranty may be commenced after the Indemnity Period, provided, however, that claims made within the applicable time period shall survive to the extent of such claim until such claim is finally determined and, if applicable, paid. Notwithstanding anything else to the contrary herein, the representations and warranties of the Company made in Section 2.3, as well as claims based upon fraud, shall survive and continue in full force and effect until the expiration of the statutes of limitations applicable to such underlying claim, subject to any extensions thereof, or if no statutes of limitation are applicable, indefinitely. (c) Escrow Fund. The shares to be held in Escrow (the "Escrow Shares") shall be registered in the names of the holders of the Company Preferred Stock, who shall be considered the owners of the Escrow Shares for all purposes, but shall be deposited (together with assignments in blank executed by the registered holder(s) of the Company) with the Escrow Agent, such deposits, along with any dividends or distributions in 28 183 respect of such Escrow Shares deposited with the Escrow Agent pursuant to the terms of the Escrow Agreement, to constitute an escrow fund to be governed by the terms set forth herein and in the Escrow Agreement (the "Escrow Fund"). To the extent that Parent, PTC, Merger Sub, or the Surviving Corporation makes a claim against the Escrow Fund pursuant to the Escrow Agreement, then for purposes of such payment, the shares of Parent Common Stock shall be valued at the Merger Price. Subject to Section 8.1(h) hereof and assuming the consummation of the Merger in accordance with this Agreement and the payment of the Merger Consideration, all claims, damages, actions, suits, proceedings, demands, assessments, adjustments, costs and expenses (including specifically, but without limitation, reasonable attorneys' fees and expenses of investigation) incurred by a Parent Indemnitee arising out of or in connection with this Agreement or any certificate or other document delivered in connection herewith shall be paid solely from the Escrow Fund and no Parent Indemnitee shall have any rights other than to the Escrow Funds. (d) Indemnification of the Parent, PTC and Merger Sub. By their approval of this Agreement and their acceptance of the Merger Consideration, the holders of the Company Preferred Stock agree that the Escrow Fund established under the Escrow Agreement shall be available to indemnify, defend, protect, and hold harmless each of Parent, PTC, Merger Sub, the Surviving Corporation and each of their respective subsidiaries and affiliates (each in its capacity as an indemnified party, a "Parent Indemnitee") from and against all claims, damages, actions, suits, proceedings, demands, assessments, adjustments, costs and expenses (including specifically, but without limitation, reasonable attorneys' fees and expenses of investigation) (collectively "Damages") incurred by such Parent Indemnitee as a result of or incident to (i) any breach of any representation or warranty of the Company set forth herein or in any certificate or other document delivered in connection herewith as of the date made (as such representation or warranty would read if all qualifications as to knowledge and materiality were deleted from it) with respect to which a claim for indemnification is brought by a Parent Indemnitee during the Indemnity Period, (ii) any breach or nonfulfillment by the Company, or any noncompliance by the Company with, any covenant, agreement, or obligation contained herein or in any certificate or other document delivered in connection herewith, and (iii) any claim by a stockholder or former stockholder of the Company or any other person, firm, corporation or entity, seeking to assert, or based upon: (A) ownership or rights of ownership to any shares of capital stock of the Company; (B) any rights of a stockholder to receive the Merger Consideration pursuant to this Agreement, as well as any rights under any option or other security convertible into or exercisable for shares of the Company's capital stock, preemptive rights, or rights to notice or to vote; (C) any rights of a stockholder arising under the appraisal rights provisions of the CCC; (D) any rights under the Articles of Incorporation or By-Laws of the Company; or (E) any claim that his, her or its shares were wrongfully repurchased by the Company, regardless of whether an action, suit or claim can be or has been made against the Company. (e) Third Person Claims. Promptly after a Parent Indemnitee has received notice of or has knowledge of any claim by a person not a party to this Agreement ("Third Person") or the commencement of any action or proceeding by a Third Person, the Parent Indemnitee shall, as a condition precedent to a claim with respect thereto being made against the Escrow Agreement, give the Stockholder Representative written notice of such claim or the commencement of such action or proceeding; provided, however, that the failure to give such notice will not effect the Parent Indemnitees' right to indemnification hereunder with respect to such claim, action or proceeding, except to the extent that the Stockholder Representative has, or the holders of the Company Preferred Stock have, been actually prejudiced as a result of such failure. If the Stockholder Representative notifies the Parent Indemnitee within thirty (30) days from the receipt of the foregoing notice that he wishes to defend against the claim by the Third Person and if the estimated amount of the claim, together with all other claims made against the Escrow Fund that have not been settled, is less than the remaining balance of the Escrow Funds, then the Stockholder Representative shall have the right to assume and control the defense of the claim by appropriate proceedings with counsel reasonably acceptable to Parent Indemnitee, and the Stockholder Representative shall be entitled to reimbursement out of the Escrow Funds for such defense. The Parent Indemnitee may participate in the defense, at its sole expense, of any such claim for which the Stockholder Representative shall have assumed the defense pursuant to the preceding sentence, provided, however, that counsel for the Stockholder Representative shall act as lead counsel in all matters pertaining to the defense or settlement of such claims, suit or proceedings; provided, however, that Parent Indemnitee shall control the defense of any claim or proceeding that in Parent Indemnitee's reasonable 29 184 judgment could have a material and adverse effect on Parent Indemnitee's business apart from the payment of money damages. The Parent Indemnitee shall be entitled to indemnification for the reasonable fees and expenses of its counsel for any period during which the Stockholder Representative has not assumed the defense of any claim. Whether or not the Stockholder Representative shall have assumed the defense of any claim, neither the Parent Indemnitee nor the Stockholder Representative shall make any settlement with respect to any such claim, suit or proceeding without the prior written consent of the other, which consent shall not be unreasonably withheld or delayed. It is understood and agreed that in situations where failure to settle a claim expeditiously could have an adverse effect on the party wishing to settle, the failure of a party controlling the defense to act upon a request for consent to such settlement within five (5) business days of receipt of notice thereof shall be deemed to constitute consent to such settlement for purposes of this Section 8.1 but shall not be dispositive of the amount of Damages as between the holders of the Company Preferred Stock and the Parent Indemnitees. (f) Indemnification by Parent. Subject to the provisions of this Section 8.1, Parent agrees to indemnify, defend, protect and hold harmless each of the holders of the Company Preferred Stock (the "Stockholder Indemnitees") from and against any and all Damages incurred or suffered by such Stockholder Indemnitees as a result of or incident to (i) any breach of any representation or warranty of Parent, PTC or Merger Sub set forth herein or in any certificate or other document delivered in connection herewith as of the date made (as such representation or warranty would read if all qualifications as to knowledge and materiality were deleted from it) with respect to which a claim for indemnification is brought by such Stockholder Indemnitees during the Indemnity Period (ii) any breach or nonfulfillment by Parent, PTC or Merger Sub, or any noncompliance by Parent, PTC or Merger Sub with, any covenant, agreement, or obligation of Parent contained herein or in any certificate or other document delivered in connection herewith as of the date made. Parent shall reimburse the Stockholder Indemnitees for any Damages to which this Section 8.1 relates only if a claim for indemnification is made by the Stockholder Indemnitees within the survival period described in Section 8.1(b); provided, however, that the aggregate liability of Parent shall not exceed $1,000,000. (g) No Contribution; Mitigation. The holders of the Company Preferred Stock acknowledge and agree that they shall not have and shall not exercise or assert any right of contribution, indemnification, subrogation or other remedy or right against the Surviving Corporation in connection with any indemnification obligation or other liability to which they may become subject under or in connection with this Agreement, the Escrow Agreement or any certificate or other document delivered in connection herewith or therewith. The Parent Indemnitees shall use all reasonable efforts to mitigate any Damages. (h) Method of Payment; Exclusive Remedy. Except as specifically provided in this Section 8.1(h), indemnification under this Section 8.1 shall be the sole and exclusive remedy of the parties with respect to any and all matters, including Damages, arising out of, or relating to, this Agreement or any certificate or other document delivered in connection herewith and shall be subject to all of the terms and provisions of this Section 8.1. Notwithstanding anything else to the contrary in this Agreement or this Section 8.1(h), indemnification under this Section 8.1 shall not be the sole and exclusive remedy of the parties (and hence the limitations set forth in Section 8.1(c) and Section 8.1(f) shall not apply) with respect to (i) any claim based on fraud or intentional misrepresentation, (ii) any claim based on the breach by the Company of the representations and warranties in Section 2.3 hereof, (iii) any claim by the Stockholder Indemnitees based on (A) either Parent's, PTC's or Merger Sub's termination of this Agreement other than in accordance with Section 7.1 hereof or (B) either Parent's, PTC's or Merger Sub's failure to consummate the Closing by November 30, 1998, provided, however, that all of the conditions set forth in Sections 6.1 and 6.2 shall have been met as of such date, and (iv) any claim by a Parent Indemnitee based on (A) the Company's termination of this Agreement other than in accordance with Section 7.1 hereof and (B) the Company's failure to consummate the Closing by November 30, 1998, provided, however, that all of the conditions set forth in Sections 6.1(b), 6.1(c) and 6.3 shall have been met as of such date. SECTION 8.2 Disclosure Schedules. An item disclosed in one section of the Company Disclosure Schedule or Parent Disclosure Schedule, as the case may be, as an exception to one particular representation or warranty shall be deemed adequately disclosed on another section of the Company Disclosure Schedule or Parent Disclosure Schedule, as the case may be, as an exception to the representations and warranties 30 185 corresponding thereto if the applicability of such item to such other representation and warranty is reasonably apparent based solely on the information contained in the Company Disclosure Schedule or Parent Disclosure Schedule, as the case may be; provided, however, that each of the Company and Parent shall use reasonable efforts to cross-reference as appropriate. SECTION 8.3 Notices. All notices and other communications given or made pursuant hereto shall be in writing and shall be deemed to have been duly given or made if and when delivered personally or by overnight courier to the parties at the following addresses or sent by electronic transmission, with confirmation received, to the telecopy numbers specified below (or at such other address or telecopy number for a party as shall be specified by like notice): (a) If to Parent, PTC or Merger Sub: PictureTel Corporation 100 Minuteman Road Andover, MA 01810 Attention: W. Robert Kellegrew, Esq. General Counsel Telephone No.: (978) 292-5000 Telecopier No.: (978) 292-3338 Copy to: Ropes & Gray One International Place Boston, MA 02110 Attention: Howard K. Fuguet, Esq. Telephone No.: (617) 951-7000 Telecopier No.: (617) 951-7050 (b) If to the Company: Starlight Network, Inc. 205 Ravendale Drive Mountain View, CA 94043 Attention: James E. Long Telephone No.: (650) 967-2774 Telecopier No.: (650) 967-4426 Copy to: Wilson Sonsini Goodrich & Rosati, P.C. 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: John B. Goodrich, Esq. Telephone No.: (650) 493-9300 Telecopier No.: (650) 493-6811 SECTION 8.4 Certain Definitions. For purposes of this Agreement, the term: (a) "affiliates" means a person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the first mentioned person; (b) "business day" means any day in which the New York Stock Exchange is open for trading; (c) "control" (including the terms "controlled by" and "under common control with") means the possession, directly or indirectly or as trustee or executor, of the power to direct or cause the direction of the management or policies of a person, whether through the ownership of stock, as trustee or executor, by contract or credit arrangement or otherwise; 31 186 (d) "knowledge" or awareness or any substantially similar term means the actual knowledge of the officers and directors of such party after reasonable investigation. (e) "person" means an individual, corporation, partnership, association, trust, unincorporated organization, other entity or group (as defined in Section 13(d)(3) of the Exchange Act); and (f) "subsidiary" or "subsidiaries" of the Company, Parent or any other person means any corporation, partnership, joint venture or other legal entity of which the Company, the Surviving Corporation, Parent or such other person, as the case may be (either alone or through or together with any other subsidiary), owns, directly or indirectly, more than fifty percent (50%) of the stock or other equity interests the holders of which are generally entitled to vote for the election of the board of directors or other governing body of such corporation or other legal entity. SECTION 8.5 Amendment. This Agreement may be amended by the parties hereto by action taken by or on behalf of their respective Boards of Directors at any time prior to the Effective Time; provided, however, that, after approval of the Merger by the stockholders of the Company, no amendment may be made which by law requires further approval by such stockholders without such further approval. This Agreement may not be amended except by an instrument in writing signed by the parties hereto. SECTION 8.6 Waiver. At any time prior to the Effective Time, any party hereto may with respect to any other party hereto (a) extend the time for the performance of any of the obligations or other acts, (b) waive any inaccuracies in the representations and warranties contained herein or in any document delivered pursuant hereto, or (c) waive compliance with any of the agreements or conditions contained herein. Any such extension or waiver shall be valid only if set forth in an instrument in writing signed by the party or parties to be bound thereby. SECTION 8.7 Headings. The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 8.8 Severability. If any term or other provision of this Agreement is invalid, illegal or incapable of being enforced by any rule of law, or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated hereby are fulfilled to the fullest extent possible. SECTION 8.9 Entire Agreement. This Agreement constitutes the entire agreement and supersedes all prior agreements and undertakings, both written and oral, among the parties, or any of them, with respect to the subject matter hereof. SECTION 8.10 Assignment; Guarantee of Merger Sub Obligations. This Agreement shall not be assigned by operation of law or otherwise, except that Merger Sub may assign all or any of its rights hereunder to any affiliate thereof, provided, however, that no such assignment shall relieve the assigning party of its obligations hereunder. Parent guarantees the full and punctual performance by Merger Sub of all the obligations hereunder of Merger Sub or any such assignees. SECTION 8.11 Parties in Interest. This Agreement shall be binding upon and inure solely to the benefit of each party hereto, the stockholders of the Company (with respect to Article III and Article VIII only) and the Stockholders Representative, and nothing in this Agreement, express or implied, is intended to or shall confer upon any other person any right, benefit or remedy of any nature whatsoever under or by reason of this Agreement, including, without limitation, by way of subrogation. SECTION 8.12 Failure or Indulgence Not Waiver; Remedies Cumulative. No failure or delay on the part of any party hereto in the exercise of any right hereunder shall impair such right or be construed to be a waiver of, or acquiescence in, any breach of any representation, warranty or agreement herein, nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or of any other right. 32 187 All rights and remedies existing under this Agreement are cumulative to, and not exclusive of, any rights or remedies otherwise available. SECTION 8.13 Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of The Commonwealth of Massachusetts without giving effect to the conflict of laws principles thereof. SECTION 8.14 Counterparts. This Agreement may be executed in one or more counterparts, and by the different parties hereto in separate counterparts, each of which when executed shall be deemed to be an original but all of which taken together shall constitute one and the same agreement. IN WITNESS WHEREOF, Parent, PTC, Merger Sub and the Company have caused this Agreement to be executed as of the date first written above by their respective officers thereunto duly authorized. PICTURETEL CORPORATION By: /s/ RICHARD B. GOLDMAN ------------------------------------ Name: Richard B. Goldman Title: Chief Financial Officer SNI ACQUISITION CORPORATION By: /s/ RICHARD S. HAAK, JR. ------------------------------------ Name: Richard S. Haak, Jr. Title: Chief Financial Officer By: /s/ ROXANNE A. WILKERSON ------------------------------------ Name: Roxanne A. Wilkerson Title: Assistant Secretary PICTURETEL TECHNOLOGY CORPORATION By: /s/ TIMOTHY C. GAINES ------------------------------------ Name: Timothy C. Gaines Title: Vice President STARLIGHT NETWORKS, INC. By: /s/ JAMES E. LONG ------------------------------------ Name: James E. Long Title: Chairman By: /s/ R. J. KNITTEL ------------------------------------ Name: R. J. Knittel Title: Chief Financial Officer 33 188 ANNEX B CHAPTER 13 GENERAL CORPORATION LAW OF CALIFORNIA DISSENTERS RIGHTS SECTION 1300. RIGHT TO REQUIRE PURCHASE; "DISSENTING SHARES" AND "DISSENTING SHAREHOLDER" DEFINED. (a) If the approval of the outstanding shares (Section 152) of a corporation is required for a reorganization under subdivisions (a) and (b) or subdivision (e) or (f) of Section 1201, each shareholder of such corporation entitled to vote on the transaction and each shareholder of a subsidiary corporation in a short-form merger may, by complying with this chapter, require the corporation in which the shareholder holds shares to purchase for cash at their fair market value the shares owned by the shareholder which are dissenting shares as defined in subdivision (b). The fair market value shall be determined as of the day before the first announcement of the terms of the proposed reorganization or short-form merger, excluding any appreciation or depreciation in consequence of the proposed action, but adjusted for any stock split or share dividend which becomes effective thereafter. (b) As used in this chapter, "dissenting shares" means shares which come within all of the following descriptions: (1) Which were not immediately prior to the reorganization or short-form merger either (A) listed on any national securities exchange certified by the Commissioner of Corporations under subdivision (o) of Section 25100 or (B) listed on the list of OTC margin stocks issued by the Board of Governors of the Federal Reserve System, and the notice of meeting of shareholders to act upon the reorganization summarizes this section and Sections 1301, 1302, 1303 and 1304; provided, however, that this provision does not apply to any shares with respect to which there exists any restriction on transfer imposed by the corporation or by any law or regulation; and provided, further, that this provision does not apply to any class of shares described in subparagraph (A) or (B) if demands for payment are filed with respect to five percent or more of the outstanding shares of that class. (2) Which were outstanding on the date for the determination of shareholders entitled to vote on the reorganization and (A) were not voted in favor of the reorganization or, (B) if described in subparagraph (A) or (B) of paragraph (1) (without regard to the provisos in that paragraph), were voted against the reorganization, or which were held of record on the effective date of a short-form merger; provided, however, that subparagraph (A) rather than subparagraph (B) of this paragraph applies in any case where the approval required by Section 1201 is sought by written consent rather than at a meeting. (3) Which the dissenting shareholder has demanded that the corporation purchase at their fair market value, in accordance with Section 1301. (4) Which the dissenting shareholder has submitted for endorsement, in accordance with Section 1302. (c) As used in this chapter, "dissenting shareholder" means the record holder of dissenting shares and includes a transferee of record. SECTION 1301. DEMAND FOR PURCHASE. (a) If, in the case of a reorganization, any shareholders of a corporation have a right under Section 1300, subject to compliance with paragraphs (3) and (4) of subdivision (b) thereof, to require the corporation to purchase their shares for cash, such corporation shall mail to each such shareholder a notice of the approval of the reorganization by its outstanding shares (Section 152) within ten (10) days after the date of such approval accompanied by a copy of Sections 1300, 1302, 1303, 1304 and this section, a statement of the price determined by the corporation to represent the fair market value of the dissenting shares, and a brief 1 189 description of the procedure to be followed if the shareholder desires to exercise the shareholder's right under such sections. The statement of price constitutes an offer by the corporation to purchase at the price stated any dissenting shares as defined in subdivision (b) of Section 1300, unless they lose their status as dissenting shares under Section 1309. (b) Any shareholder who has a right to require the corporation to purchase the shareholder's shares for cash under Section 1300, subject to compliance with paragraphs (3) and (4) of subdivision (b) thereof, and who desires the corporation to purchase such shares shall make written demand upon the corporation for the purchase of such shares and payment to the shareholder in cash of their fair market value. The demand is not effective for any purpose unless it is received by the corporation or any transfer agent thereof (1) in the case of shares described in clause (i) or (ii) of paragraph (1) of subdivision (b) of Section 1300 (without regard to the provisos in that paragraph), not later than the date of the shareholders' meeting to vote upon the reorganization, or (2) in any other case within thirty (30) days after the date on which the notice of the approval by the outstanding shares pursuant to subdivision (a) or the notice pursuant to subdivision (i) of Section 1110 was mailed to the shareholder. (c) The demand shall state the number and class of the shares held of record by the shareholder which the shareholder demands that the corporation purchase and shall contain a statement of what such shareholder claims to be the fair market value of those shares as of the day before the announcement of the proposed reorganization or short-form merger. The statement of fair market value constitutes an offer by the shareholder to sell the shares at such price. SECTION 1302. ENDORSEMENT OF SHARES. Within thirty (30) days after the date on which notice of the approval by the outstanding shares or the notice pursuant to subdivision (i) of Section 1110 was mailed to the shareholder, the shareholder shall submit to the corporation at its principal office or at the office of any transfer agent thereof, (a) if the shares are certificated securities, the shareholder's certificates representing any shares which the shareholder demands that the corporation purchase, to be stamped or endorsed with a statement that the shares are dissenting shares or to be exchanged for certificates of appropriate denomination so stamped or endorsed or (b) if the shares are uncertificated securities, written notice of the number of shares which the shareholder demands that the corporation purchase. Upon subsequent transfers of the dissenting shares on the books of the corporation, the new certificates, initial transaction statement, and other written statements issued therefor shall bear a like statement, together with the name of the original dissenting holder of the shares. SECTION 1303. AGREED PRICE; TIME FOR PAYMENT. (a) If the corporation and the shareholder agree that the shares are dissenting shares and agree upon the price of the shares, the dissenting shareholder is entitled to the agreed price with interest thereon at the legal rate on judgments from the date of the agreement. Any agreements fixing the fair market value of any dissenting shares as between the corporation and the holders thereof shall be filed with the secretary of the corporation. (b) Subject to the provisions of Section 1306, payment of the fair market value of dissenting shares shall he made within thirty (30) days after the amount thereof has been agreed or within thirty (30) days after any statutory or contractual conditions to the reorganization are satisfied, whichever is later, and in the case of certificated securities, subject to surrender of the certificates therefor, unless provided otherwise by agreement. SECTION 1304. DISSENTER'S ACTION TO ENFORCE PAYMENT. (a) If the corporation denies that the shares are dissenting shares, or the corporation and the shareholder fail to agree upon the fair market value of the shares, then the shareholder demanding purchase of such shares as dissenting shares or any interested corporation, within six (6) months after the date on which notice of the approval by the outstanding shares (Section 152) or notice pursuant to subdivision (i) of Section 1110 was mailed to the shareholder, but not thereafter, may file a complaint in the superior court of the proper county 2 190 praying the court to determine whether the shares are dissenting shares or the fair market value of the dissenting shares or both or may intervene in any action pending on such a complaint. (b) Two or more dissenting shareholders may join as plaintiffs or be joined as defendants in any such action and two or more such actions may be consolidated. (c) On the trial of the action, the court shall determine the issues. If the status of the shares as dissenting shares is in issue, the court shall first determine that issue. If the fair market value of the dissenting shares is in issue, the court shall determine, or shall appoint one or more impartial appraisers to determine, the fair market value of the shares. SECTION 1305. APPRAISER'S REPORT; PAYMENT; COSTS. (a) If the court appoints an appraiser or appraisers, they shall proceed forthwith to determine the fair market value per share. Within the time fixed by the court, the appraisers, or a majority of them, shall make and file a report in the office of the clerk of the court. Thereupon, on the motion of any party, the report shall be submitted to the court and considered on such evidence as the court considers relevant. If the court finds the report reasonable, the court may confirm it. (b) If a majority of the appraisers appointed fail to make and file a report within ten (10) days from the date of their appointment or within such further time as may be allowed by the court or the report is not confirmed by the court, the court shall determine the fair market value of the dissenting shares. (c) Subject to the provisions of Section 1306, judgment shall be rendered against the corporation for payment of an amount equal to the fair market value of each dissenting share multiplied by the number of dissenting shares which any dissenting shareholder who is a party, or who has intervened, is entitled to require the corporation to purchase, with interest thereon at the legal rate from the date on which judgment was entered. (d) Any such judgment shall be payable forthwith with respect to uncertificated securities and, with respect to certificated securities, only upon the endorsement and delivery to the corporation of the certificates for the shares described in the judgment. Any party may appeal from the judgment. (e) The costs of the action, including reasonable compensation to the appraisers to be fixed by the court, shall be assessed or apportioned as the court considers equitable, but, if the appraisal exceeds the price offered by the corporation, the corporation shall pay the costs (including in the discretion of the court attorneys' fees, fees of expert witnesses and interest at the legal rate on judgments from the date of compliance with Sections 1300, 1301 and 1302 if the value awarded by the court for the shares is more than 125 percent of the price offered by the corporation under subdivision (a) of Section 1301). SECTION 1306. DISSENTING SHAREHOLDER'S STATUS AS CREDITOR. To the extent that the provisions of Chapter 5 prevent the payment to any holders of dissenting shares of their fair market value, they shall become creditors of the corporation for the amount thereof together with interest at the legal rate on judgments until the date of payment, but subordinate to all other creditors in any liquidation proceeding, such debt to be payable when permissible under the provisions of Chapter 5. SECTION 1307. DIVIDENDS PAID AS CREDIT AGAINST PAYMENT. Cash dividends declared and paid by the corporation upon the dissenting shares after the date of approval of the reorganization by the outstanding shares (Section 152) and prior to payment for the shares by the corporation shall be credited against the total amount to be paid by the corporation therefor. SECTION 1308. CONTINUING RIGHTS AND PRIVILEGES OF DISSENTING SHAREHOLDERS. Except as expressly limited in this chapter, holders of dissenting shares continue to have all the rights and privileges incident to their shares, until the fair market value of their shares is agreed upon or determined. A dissenting shareholder may not withdraw a demand for payment unless the corporation consents thereto. 3 191 SECTION 1309. TERMINATION OF DISSENTING SHAREHOLDER STATUS. Dissenting shares lose their status as dissenting shares and the holders thereof cease to be dissenting shareholders and cease to be entitled to require the corporation to purchase their shares upon the happening of any of the following: (a) The corporation abandons the reorganization. Upon abandonment of the reorganization, the corporation shall pay on demand to any dissenting shareholder who has initiated proceedings in good faith under this chapter all necessary expenses incurred in such proceedings and reasonable attorneys' fees. (b) The shares are transferred prior to their submission for endorsement in accordance with Section 1302 or are surrendered for conversion into shares of another class in accordance with the articles. (c) The dissenting shareholder and the corporation do not agree upon the status of the shares as dissenting shares or upon the purchase price of the shares, and neither files a complaint or intervenes in a pending action as provided in Section 1304, within six (6) months after the date on which notice of the approval by the outstanding shares or notice pursuant to subdivision (i) of Section 1110 was mailed to the shareholder. (d) The dissenting shareholder, with the consent of the corporation, withdraws the shareholder's demand for purchase of the dissenting shares. SECTION 1310. SUSPENSION OF PROCEEDINGS FOR PAYMENT PENDING LITIGATION. If litigation is instituted to test the sufficiency, or regularity of the votes of the shareholders in authorizing a reorganization, any proceedings under Sections 1304 and 1305 shall be suspended until final determination of such litigation. SECTION 1311. EXEMPT SHARES. This chapter, except Section 1312, does not apply to classes of shares whose terms and provisions specifically set forth the amount to be paid in respect to such shares in the event of a reorganization or merger. SECTION 1312. ATTACKING VALIDITY OF REORGANIZATION OR MERGER. (a) No shareholder of a corporation who has a right under this chapter to demand payment of cash for the shares held by the shareholder shall have any right at law or in equity to attack the validity of the reorganization or short-form merger, or to have the reorganization or short-form merger set aside or rescinded, except in an action to test whether the number of shares required to authorize or approve the reorganization have been legally voted in favor thereof; but any holder of shares of a class whose terms and provisions specifically set forth the amount to be paid in respect to them in the event of a reorganization or short-form merger is entitled to payment in accordance with those terms and provisions or, if the principal terms of the reorganization are approved pursuant to subdivision (b) of Section 1202, is entitled to payment in accordance with the terms and provisions of the approved reorganization. (b) If one of the parties to a reorganization or short-form merger is directly or indirectly controlled by, or under common control with, another party to the reorganization or short-form merger, subdivision (a) shall not apply to any shareholder of such party who has not demanded payment of cash for such shareholder's shares pursuant to this chapter, but if the shareholder institutes any action to attack the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded, the shareholder shall not thereafter have any right to demand payment of cash for the shareholder's shares pursuant to this chapter. The court in any action attacking the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded shall not restrain or enjoin the consummation of the transaction except upon ten (10) days' prior notice to the corporation and upon a determination by the court that clearly no other remedy will adequately protect the complaining shareholder or the class of shareholders of which such shareholder is a member. 4 192 ANNEX C ESCROW AGREEMENT ESCROW AGREEMENT dated as of October , 1998 by and among PictureTel Corporation, a Delaware corporation ("Parent"), James E. Long (the "Stockholder Representative"), as representative of the stockholders, and State Street Bank and Trust Company, as escrow agent (the "Escrow Agent"). Capitalized terms used but not otherwise defined herein shall have the meanings ascribed to them in the Merger Agreement (as defined below), a copy of which is attached as Exhibit A. RECITALS WHEREAS, Parent, PictureTel Technology Corporation, a Delaware corporation and a wholly owned subsidiary of Parent ("PTC"), and SNI Acquisition Corporation, a California corporation and a wholly owned subsidiary of PTC ("Merger Sub"), have executed a definitive Agreement and Plan of Merger dated as of August 14, 1998 (the "Merger Agreement") with Starlight Networks Inc., a California corporation (the "Company"), pursuant to which Merger Sub will merge with and into the Company; WHEREAS, the holders of the Company Preferred Stock have consented to this Agreement to secure their indemnification obligations under Article VIII of the Merger Agreement in the manner set forth herein and the appointment of James E. Long as their representative (the "Stockholder Representative") for purposes of this Agreement and as attorney-in-fact and agent for and on behalf of each such stockholders, and the taking by the Stockholder Representative of any and all actions and the making of any decisions required or permitted to be taken or made by it under this Agreement and all of the other terms, conditions and limitations in this Agreement; WHEREAS, Parent and the Stockholder Representative desire to appoint the Escrow Agent to act hereunder in the manner hereinafter set forth and the Escrow Agent is willing to act in such capacity; WHEREAS, pursuant to the Merger Agreement, Parent will arrange for the prompt delivery to the Escrow Agent of 158,293 shares of common stock, par value $.01 per share, of Parent (the "Escrow Shares" and together with any other property received by the Escrow Agent to be held by it hereunder, the "Escrow Property") to be held in escrow by the Escrow Agent pursuant hereto and released in accordance with the terms hereof. WHEREAS, the number of Escrow Shares to be held back from the consideration to be paid to each of the holders of the Company Preferred Stock shall equal approximately 11.88% of the number of shares of Parent Common Stock to be received by each holder of Company Preferred Stock. NOW, THEREFORE, the parties agree as follows: ARTICLE IX ESCROW PROPERTY SUBJECT TO AGREEMENT. The Escrow Agent hereby agrees to act as Escrow Agent for the Escrow Property. The percentage interest of each of the holders of the outstanding Company Preferred Stock (the "Stockholders") in the Escrow Property is set forth in Exhibit B hereto. ARTICLE X PAYMENT BY ESCROW AGENT WITH RESPECT TO THE ESCROW PROPERTY. SECTION 10.1 Notices of Claims and Dispute Notices. (a) During the Indemnity Period, if (A) Parent reasonably believes that it, or any other Indemnitee entitled to indemnification under Section 8.1 of the Merger Agreement (the "Parent Indemnitees") has or is reasonably likely to suffer any Damages that entitles or is reasonably likely to entitle it to indemnification under the Merger Agreement, or (B) Parent reasonably believes it is entitled to be paid in respect of Company expenses which exceed the amounts provided for in Section 7.3 of the Merger Agreement and are unpaid as of the consummation of the Merger, Parent may deliver to the Escrow Agent a notice (a "Notice of Claim") setting forth in reasonable detail the nature of the claim, the basis for indemnification and an estimate of the 1 193 aggregate amount at that time to which Parent believes it or such Parent Indemnitee is, or may be, entitled to be paid pursuant to the Merger Agreement. Parent shall send a copy of each Notice of Claim to the Stockholder Representative no later than the date on which such Notice of Claim is sent to the Escrow Agent. Each Notice of Claim delivered to the Escrow Agent shall include a certification that Parent has sent a copy of such Notice of Claim to the Stockholder Representative. The Escrow Agent shall have no responsibility as to the accuracy of the information set forth in a Notice of Claim, whether the description of the nature of the claim in the Notice of the Claim is set forth in reasonable detail or whether a Notice of Claim describes a claim for which Parent or a Parent Indemnitee is entitled to be paid pursuant to the Merger Agreement. (b) The Escrow Agent shall deliver to such Parent Indemnitee Escrow Property having a value (such value to be determined pursuant to Section 2(e) hereof) equal to the amount set forth in a Notice of Claim as soon as practicable, but no earlier than twenty-five (25) business days following receipt by the Escrow Agent of such Notice of Claim; provided, however, that if within the period of twenty-five (25) business days following receipt by the Escrow Agent of such Notice of Claim the Escrow Agent shall have received from the Stockholder Representative a notice (a "Dispute Notice") disputing the validity or the amount specified in such Notice of Claim or any portion thereof (a "Disputed Amount"), the Escrow Agent shall not deliver to Parent Escrow Property for any such Disputed Amount other than pursuant to Section 2(b). Without altering the Escrow Agent's obligations set forth in the previous sentence, the Stockholder Representative shall include in each Dispute Notice reasonable detail of the nature of the Stockholder Representative's dispute. The Stockholder Representative shall send a copy of each Dispute Notice to Parent no later than the date on which such Dispute Notice is sent to the Escrow Agent. Each Dispute Notice delivered to the Escrow Agent shall include a certification that the Stockholder Representatives has sent a copy of such Dispute Notice to Parent. (c) If the Escrow Agent shall not have received a Dispute Notice with respect to the validity or amount specified in a Notice of Claim, or a portion thereof, within the period of twenty-five (25) business days following its receipt of such Notice of Claim, the Stockholder Representative shall be forever barred and precluded from contesting in any manner or forum whatsoever the distribution of Escrow Property on account of such amount not so disputed. SECTION 10.2 Disputed Amounts. Upon receipt by the Escrow Agent of a notice (a "Resolution Notice") from Parent and/or the Stockholder Representative with respect to a Disputed Amount specifying the amount of such Disputed Amount to which any Parent Indemnitee is entitled, accompanied by (A) a written agreement executed on behalf of Parent and by the Stockholder Representative with respect to such Disputed Amount, or (B) a final order from an arbitrator pursuant to Section 2(c) of this Agreement determining that such Parent Indemnitee is entitled to indemnification, the Escrow Agent shall deliver to such Parent Indemnitee the Escrow Property, to the extent that Escrow Property then remains available, having a value equal to the amount to which such Parent Indemnitee, or any other Parent Indemnitee is entitled, if any, pursuant to this (A) or (B) of this Section 2(b). Parent and the Stockholder Representative agree that the only methods for resolving a Disputed Amount will be through negotiating between themselves or through use of an arbitrator pursuant to Section 2(c). SECTION 10.3 Arbitration. In the event of a Disputed Amount, Parent and the Stockholder Representative shall in good faith negotiate to settle such Disputed Amount. If no resolution is reached within thirty (30) days after delivery of the Dispute Notice to the Escrow Agent, either party may commence an arbitration proceeding (a "Proceeding") by submitting the Disputed Amount to arbitration. Any such arbitration shall be before an arbitral tribunal composed of three arbitrators: one selected by Parent, one selected by the Stockholder Representative and one selected by mutual agreement of the parties (the "Panel"). If the parties are unable to agree on such third arbitrator, the arbitrator shall be selected by the American Arbitration Association (the "AAA") in accordance with its Commercial Arbitration Rules. The Panel shall resolve the Disputed Amount in accordance with the rules of the AAA. The venue for the arbitration shall be Wilmington, Delaware or such other venue mutually agreed to by Parent and the Stockholder Representative. The Panel shall apply the laws of The Commonwealth of Massachusetts without reference to any rules of conflict of law. At the request of either party hereto, the Panel shall enter an appropriate order to maintain the confidentiality of information produced or exchanged in the course of the Proceeding. The Panel's award or order shall be final and binding on Parent, the Stockholder Representative 2 194 and the stockholders and all costs of such proceeding shall be borne as specified in the award or order. The provisions of this Section may be enforced in any court having competent jurisdiction. SECTION 10.4 Release of Escrow Property. (a) At the end of the twelfth month following the date hereof (the "Distribution Date"), the Escrow Agent shall release for distribution to the Stockholders the Escrow Property then remaining in escrow hereunder, if any, in excess of Escrow Property having a value equal to the sum of (A) the aggregate amount of all Disputed Amounts not paid or otherwise resolved as of the Distribution Date plus (B) the aggregate of all other amounts specified in Notices of Claims received by the Escrow Agent as of the Distribution Date and not paid as of such date from Escrow Property (such excess, if any, being the "Remaining Escrow Property"). On or about the Distribution Date, the Escrow Agent shall deliver such Remaining Escrow Property to Parent's transfer agent, Boston EquiServe Limited Partnership (the "Transfer Agent"), with instructions to distribute such property to the Stockholders in accordance with the instructions of the Stockholder Representative. (b) After the Distribution Date, the Escrow Agent shall, upon receipt of each Resolution Notice and the distribution of the Escrow Property in accordance with Section 2(b) hereof, release to the Transfer Agent for distribution to the Stockholders all of the Escrow Property then held by Escrow Agent in excess of the sum of (A) all Disputed Amounts then not paid or otherwise resolved, and (B) all other amounts specified in Notices of Claims then not paid. The Escrow Agent shall deliver such Escrow Property to the Transfer Agent, with instructions to distribute such property to the Stockholders in accordance with the instructions of the Stockholder Representative. (c) Upon each distribution of Escrow Property to the Stockholders, the Stockholder Representative shall instruct the Transfer Agent to distribute the Escrow Property to the Stockholders pro rata to their relative interests as set forth in Exhibit B hereto (with rounding of fractional share distributions to whole shares to reasonably approximate such relative interests); provided, however, that if, and only if, after the Distribution Date all Disputed Amounts have been paid or otherwise resolved and there are no other amounts specified in Notices of Claims which have not been paid, the Stockholder Representative may direct the distribution of the remaining Escrow Property, or any portion thereof, in payment or reimbursement of expenses incurred by the Stockholder Representative hereunder, under the Stockholder Agreement or under the Merger Agreement or in payment or reimbursement of indemnifiable losses incurred by the Stockholder Representative in connection with the performance of his or her obligations under this Agreement the Stockholder Agreement and the Merger Agreement. SECTION 10.5 Valuation of Escrow Shares. For purposes of this Section 2, Escrow Shares shall be valued at the Merger Price; provided, however, that for purposes of determining the number of Escrow Shares to be directed to the account of the Stockholder Representative in accordance with the proviso of Section 2(d)(iii) hereof, the Escrow Shares shall be valued at the closing price of the Parent Common Stock, as quoted on the NASDAQ National Market System, on the date such payment shall have become due. In lieu of distributing any fractional shares to Parent pursuant hereto, the Escrow Agent shall round the number of Escrow Shares delivered to Parent down to the nearest whole share. The Escrow Agent shall be under no duty or responsibility with regard to the valuation of the Escrow Shares. SECTION 10.6 Voting, Etc. (a) Except for dividends paid in stock declared with respect to the Escrow Shares and excluded from gross income for U.S. federal income tax purposes pursuant to Section 305(a) of the Internal Revenue Code of 1986, as amended, (which such dividends shall be delivered to the Escrow Agent pursuant to written instructions received by the Escrow Agent and held by it hereunder as Escrow Property) any cash dividends, dividends payable in securities or other distributions of any kind made in respect of the Escrow Shares will be distributed currently to the Stockholders pro rata to their relative interests as set forth in Exhibit B and, if distributed to the Escrow Agent, shall promptly be paid over to the Stockholders in the same manner. Each Stockholder will have voting rights with respect to the Escrow Shares deposited hereunder with respect to such Stockholder so long as such Escrow Shares are held in escrow, and Parent shall take all reasonable steps 3 195 necessary to allow the exercise of such rights. While the Escrow Shares remain in the Escrow Agent's possession pursuant to this Agreement, the Stockholders will retain and will be able to exercise all other incidents of ownership of said Escrow Shares which are not inconsistent with the terms and conditions of this Agreement. The Escrow Agent shall be under no obligation to preserve, protect or exercise rights with respect to the Escrow Shares, and shall be responsible only for reasonable measures to maintain the physical safekeeping thereof, and otherwise to perform and observe such duties on its part as are expressly set forth in this Agreement. (b) No Stockholder will offer, sell, assign, pledge, hypothecate, transfer or otherwise dispose of any Escrow Shares until released from the Escrow. (c) The parties hereby authorize the Escrow Agent to apply to the Transfer Agent (or any successor transfer agent) for the Escrow Shares for any division of certificates evidencing Escrow Shares which may be required in connection with the distribution of Escrow Shares pursuant to this Agreement, and Parent agrees to provide any assistance with respect thereto reasonably requested by the Escrow Agent. (d) Parent and the Stockholder Representative shall have the right to inspect and obtain copies of the records of the Escrow Agent upon reasonable notice and during reasonable business hours and to receive monthly reports of the status of the Escrow Property. (e) Parent shall assume and be responsible for all reporting and related requirements regarding any dividends or other distributions with respect to the Escrow Property, and the Escrow Agent shall have no liability therefor. ARTICLE XI ADMINISTRATIVE PROVISIONS. SECTION 11.1 The Escrow Agent may resign as escrow agent by notice to the other parties hereto (the "Resignation Notice"). If, prior to the expiration of sixty (60) business days after the delivery of the Resignation Notice, the Escrow Agent shall not have received written instructions from Parent and the Stockholder Representative designating a banking corporation or trust company organized either under the laws of the United States or of any state having capital and surplus of at least $100,000,000 as successor escrow agent, which written instructions shall have been consented to in writing by such successor escrow agent, the Escrow Agent may apply to a court of competent jurisdiction to appoint a successor escrow agent. Alternatively, if the Escrow Agent shall have received such written instructions, it shall promptly transfer the Escrow Property to such successor escrow agent. Upon the appointment of a successor escrow agent and the transfer of the Escrow Property thereto, the duties of the Escrow Agent hereunder shall terminate. Any company into which the Escrow Agent may be merged or with which it may be consolidated, or any company to whom Escrow Agent may transfer a substantial amount of its global escrow business, shall be the successor to the Escrow Agent under this Agreement without the execution or filing of any paper or any further act on the part of any of the parties hereto, anything herein to the contrary notwithstanding. SECTION 11.2 In the event of a dispute as to the proper disposition of the Escrow Property which continues for ninety (90) days or more, the Escrow Agent shall be entitled to submit the dispute to a court of competent jurisdiction and shall thereupon be relieved of any obligations or liability. SECTION 11.3 Each of Parent and the Stockholder Representative hereby agrees, jointly and severally, to pay the Escrow Agent reasonable compensation for its services hereunder in accordance with the fee schedule attached hereto as Exhibit C and to reimburse the Escrow Agent for all expenses, disbursements and advances incurred or made by it in the preparation of this Agreement and in the performance of its duties hereunder (including, without limitation, the reasonable fees, expenses and disbursements of its counsel) and to indemnify and hold the Escrow Agent harmless from and against any and all taxes, expenses (including reasonable counsel fees), assessments, liabilities, claims, damages, actions, suits or other charges incurred by or assessed against it for any thing done or omitted by it in the performance of its duties hereunder, except as a result of its own gross negligence or willful misconduct. Without altering or limiting the joint and several liability of the Parent and the Stockholder Representative to the Escrow Agent, each of the Parent and the Stockholder Representative agrees as between themselves that Parent alone shall reimburse the Escrow Agent for its initial costs of entering into this Agreement, but Parent and the Stockholder Representative (on behalf 4 196 of the Stockholders) shall share equally in all subsequent payments owing under this Section 3(c), although liability for such payments if not paid in a timely manner shall be joint and not several. This Section 3(c) shall survive the termination of this Agreement. SECTION 11.4 The Escrow Agent shall have no duties or responsibilities, except those expressly set forth herein. The Escrow Agent does not have and, under no circumstances shall it have, a duty to review or interpret the Merger Agreement. The Escrow Agent shall not be subject to or bound by the terms of the Merger Agreement or any other related agreement to which the Escrow Agent is not a party regardless of whether the Escrow Agent has knowledge of such agreement. It may consult with counsel of its choice, including in-house counsel, and shall be fully protected with respect to any action taken or omitted in good faith on advice of counsel. The Escrow Agent shall have no liability hereunder except for willful misconduct or gross negligence. The Escrow Agent shall have no responsibility as to the validity, collectibility or value of the Escrow Property or for investment losses related thereto, and it may rely on any notice, instruction, certificate, statement, request, consent, confirmation, agreement or other instrument which it believes to be genuine and to have been signed or presented by a proper person or persons. If the Escrow Agent shall be uncertain as to its duties or rights hereunder or shall receive instructions from any of the undersigned with respect to the Escrow Property, which, in its opinion, are in conflict with any of the provisions of this Escrow Agreement, it shall be entitled to refrain from taking any action hereunder until it shall be directed otherwise in writing by all of the other parties hereto or by order of a court of competent jurisdiction. The Escrow Agent shall not be obligated to take any legal or other action hereunder which might in its judgment involve or cause it to incur any expense or liability unless it shall have been furnished with acceptable indemnification. In no event shall the Escrow Agent be liable for any indirect, punitive, special or consequential damage or loss (including, but not limited to, lost profits) whatsoever, even if the Escrow Agent has been informed of the likelihood of such loss or damage and regardless of the form of action. Notwithstanding any provision to the contrary contained in any other agreement between any of the parties hereto, the Escrow Agent shall have no interest in the Escrow Property except as provided in this Escrow Agreement. SECTION 11.5 All notices, consents and other communications under this Escrow Agreement shall be in writing and shall, except as otherwise provided herein, be deemed to have been duly given when (i) delivered by hand, (ii) sent by telecopier, with receipt confirmed, provided, however, that a copy is mailed by certified mail, return receipt requested, or (iii) when received by the addressee, if sent by Express Mail, Federal Express or other express delivery service (receipt requested), in each case, at the appropriate addresses, and telecopier numbers as set forth below: Escrow Agent: State Street Bank and Trust Company Two International Place, 4th Floor Boston, MA 02110 Attention: Corporate Trust Department (PictureTel Corporation 1998 Escrow) Telecopier No.: (617) 664-5374 Parent: PictureTel Corporation 100 Minuteman Road Andover, MA 01810 Attention: W. Robert Kellegrew, Esq. General Counsel Telephone No.: (978) 292-5000 Telecopier No.: (978) 292-3338 5 197 Copy to: Ropes & Gray One International Place Boston, Massachusetts 02110-2624 Attention: Howard K. Fuguet, Esq. Telecopier: (617) 951-7050 Telephone: (617) 951-7000 If to the Stockholder Representative, to: Starlight Networks Inc. Attention: James E. Long 205 Ravendale Drive Mountain View, CA 94043 Telephone No.: (650) 967-2774 Telecopier No.: (650) 967-4426 Copy to: Wilson Sonsini Goodrich & Rosati, P.C. 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: John B. Goodrich, Esq. Telephone No.: (650) 493-9300 Telecopier No.: (650) 493-6811 (or to such other addresses, and telecopier numbers as a party may designate as to itself by notice to the other parties). Notwithstanding any of the foregoing, no notice or instructions to the Escrow Agent shall be deemed to have been received by it prior to actual receipt, no notice to the Escrow Agent shall be deemed effective until such actual receipt by it, and any computation of a time period which is to begin after receipt of a notice by the Escrow Agent shall run from the date of such actual receipt by it. SECTION 11.6 Nothing in this Agreement shall be construed to limit the right of Parent or any other Parent Indemnitee under any provision of the Merger Agreement. SECTION 11.7 This Escrow Agreement shall be governed by, and construed in accordance with, the laws (other than the choice or conflicts of laws rules and provisions) of The Commonwealth of Massachusetts. SECTION 11.8 This Escrow Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original instrument and all of which together shall constitute a single agreement. SECTION 11.9 Each of the Parent and the Stockholder Representative hereby absolutely and irrevocably consents and submits to the jurisdiction of any state or federal court sitting in The Commonwealth of Massachusetts in connection with any actions or proceedings brought against either Parent or the Stockholder Representative, or each of them, by the Escrow Agent arising out of or relating to this Agreement. In any such action or proceeding, each of the Parent and the Stockholder Representative hereby absolutely and irrevocably (i) waives any objection to jurisdiction or venue, (ii) waives personal service of any summons, complaint, declaration or other process, and (iii) agrees that the service thereof may be made by certified or registered first-class mail directed to such party, as the case may be, at their respective addresses in accordance with Section hereof. SECTION 11.10 The Escrow Agent shall not be responsible for delays or failures in performance resulting from acts beyond its control. Such acts shall include but not be limited to acts of God, strikes, lockouts, riots, acts of war, epidemics, governmental regulations superimposed after the fact, fire, communication line failures, computer viruses, power failures, earthquakes and other disasters. SECTION 11.11 This Agreement shall be binding upon the parties hereto and their respective heirs, executors, successors and assigns. 6 198 SECTION 11.12 This Agreement may not be altered or modified without the express written consent of the parties hereto. No course of conduct shall constitute a waiver of any of the terms and conditions of this Agreement, unless such waiver is specified in writing, and then only to the extent so specified. A waiver of any of the terms and conditions of this Escrow Agreement on one occasion shall not constitute a waiver of the other terms of this Escrow Agreement, or of such terms and conditions on any other occasion. SECTION 11.13 This Agreement and all documents relating thereto, including, without limitation, (a) consents, waivers and modifications which may hereafter be executed, and (b) certificates and other information previously or hereafter furnished, may be reproduced by any photographic, photostatic, microfilm, optical disk, micro-card, miniature photographic or other similar process. The parties agree that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding, whether or not the original is in existence and whether or not such reproduction was made by a party in the regular course of business, and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. ARTICLE XII THE STOCKHOLDER REPRESENTATIVE. SECTION 12.1 As long as there are shares held in escrow pursuant to this Agreement, the Stockholders, and each of them, will be represented by the Stockholder Representative, who is empowered to receive any notice under this Agreement for the Stockholders, and each of them, and to give any and all notices and instructions and take any and all action for and on behalf of the Stockholders, and each of them, under this Agreement. The Stockholders will have the right to remove the Stockholder Representative and, upon such removal or, in the event of the Stockholder Representative's death or resignation, to appoint a new Stockholder Representative at any time and from time to time during the period when any shares are held in escrow, by a vote of Stockholders holding a majority interest in the Escrow Shares held in escrow at such time, evidenced in each case by a writing executed by such majority Stockholders. The appointment of a new Stockholder Representative following the removal, death or resignation of the Stockholder Representative will be of no force or effect whatsoever upon Parent or the Escrow Agent or otherwise under this Agreement until Parent and the Escrow Agent are deemed to have received written notice of such appointment, which notice must include at least: (i) the identity and address of the new Stockholder Representative and a statement that such Stockholder Representative has been appointed by a vote of Stockholders holding a majority-in-interest of the Escrow Shares then held in escrow; (ii) the signatures of each of the Stockholders voting for the new Stockholder Representative; and (iii) a statement executed on behalf of the new Stockholder Representative that any non-signing Stockholder has been notified in writing of the appointment of the new Stockholder Representative. Parent and the Escrow Agent will be entitled to rely on any notice received in such form without conducting an investigation of the contents thereof. Parent and the Escrow Agent will disregard any notice or instruction received from any person other than the then acting Stockholder Representative with regard to this Agreement. Until notified in writing by the Stockholder Representative that such Stockholder Representative has resigned or by the holders of a majority-in-interest of the Escrow Shares then held in escrow that such Stockholder Representative has been removed, the Escrow Agent may act upon the directions, instructions and notices of the Stockholder Representative named herein and, thereafter, upon the directions, instructions and notices of any successor Stockholder Representative named in writing executed by the holders of a majority-in-interest of the Escrow Shares then held in escrow. Notwithstanding anything to the contrary herein, the Stockholder Representative shall be entitled to resign at any time for any reason, such resignation to be effective upon notice to Parent, the Escrow Agent and holders of at least a majority-in-interest of the Escrow Shares. If the holders of at least a majority-in-interest of the Escrow Shares have not appointed a successor Stockholder Representative within thirty (30) days following any such resignation, all actions to be taken hereunder by the Stockholder Representative shall be taken by the consent of holders of at least a majority-in-interest of the Escrow Shares held in escrow at such time. For example, if Parent delivers a Notice of Claim and the holders of at least a majority-in-interest of the Escrow Shares do not deliver a Dispute Notice in accordance with Section 2(a)(ii) hereof, such Notice of Claim shall be deemed to be valid and Parent shall be entitled to draw on the Escrow Shares to the extent set forth in such Notice of Claim. (b) The Stockholder Representative shall not be liable for any action taken or not taken by him in connection with his obligations under the Merger Agreement or this Agreement (i) with the consent of the 7 199 Stockholders who, as of the Effective Time, owned a majority-in-interest of the outstanding shares of Company Preferred Stock, on a fully diluted basis, or (ii) in the absence of his own willful misconduct. In no event shall the Company, Parent, [Existing Sub] or Merger Sub have any liability to the Stockholder for any act or omission of the Stockholder Representative, including without limitation negligence and willful misconduct. The Stockholder Representative shall not be responsible or liable in any respect for the sufficiency or accuracy of the form, execution, validity or genuineness of documents or securities now or hereafter deposited hereunder, or of any endorsement thereof or for any lack of endorsement thereof or for any description therein, nor shall he or she be responsible or liable in any respect on account of the identity, authority or rights of the persons executing or delivering or purporting to execute or deliver any such document, security or endorsement, and the Stockholder Representative shall be fully protected in relying upon any written notice, demand, certificate or document which he or she in good faith believes to be genuine. (c) The Stockholder Representative shall be entitled to employ such legal counsel and other experts as he or she may deem necessary to advise him or her properly with respect to his or her rights and obligations hereunder and to evaluate claims and to pursue challenges to claims or to defend Third Person Claims or to evaluate and defend claims for Damages by a Parent Indemnitee. The Stockholder Representative shall be fully protected for any act taken, suffered, permitted, or omitted in good faith in accordance with the advice of such legal counsel or experts. The reasonable expenses and fees of such counsel and experts, and any reasonable, documented out of pocket expenses which the Stockholder Representative incurs acting as such under this Agreement shall be reimbursed solely by the Stockholders on a pro rata basis. To the extent permitted hereunder, the Stockholder Representative shall be entitled to offset such expenses by directing the Escrow Agent to transfer a portion of the Escrow Shares from the account of the Stockholders to the account of the Stockholder Representative. (d) The Stockholder Representative hereby agrees to do such acts, and execute further documents, as shall be necessary to carry out the provisions of this Agreement or to transfer any Escrow Shares pursuant to the terms hereof. (e) The Stockholders shall indemnify, defend and hold the Stockholder Representative harmless from and against any and all loss, damage, tax, liability and expense that may be incurred by the Stockholder Representative arising out of or in connection with his or her acceptance of the appointment as Stockholder Representative and/or the performance of his or her obligations as such pursuant to this Agreement or the Merger Agreement (including the legal costs and expenses of defending himself against any claim or liability in connection with his performance pursuant to this Agreement or the Merger Agreement), except as caused by the willful misconduct of the Stockholder Representative. The foregoing indemnification obligation shall be several and not joint and shall be pro rata among the Stockholders, and to the extent permitted hereunder, the Stockholder Representative shall be entitled to offset any such indemnification amount by directing the Escrow Agent to transfer Escrow Shares from the account of the Stockholders to the account of the Stockholder Representative. (f) For purposes of determining how many Escrow Shares shall be directed to the account of the Stockholder Representative in payment or reimbursement of expenses or indemnifiable losses incurred by the Stockholder Representative, the Escrow Shares shall be valued at the closing price, as quoted on the National Market System of NASDAQ, of the Parent Common Stock on the date such payment became due. (g) In the event of the removal or resignation of the Stockholder Representative, any rights of the Stockholder Representative pursuant to paragraph (b), paragraph (c) and paragraph (e) hereof shall continue to apply for the benefit of the removed Stockholder Representative; provided, however, that such paragraphs shall not apply to any action taken by the Stockholder Representative after receipt by him of written notice of his or her removal or after his or her resignation. (h) The Stockholder Representative represents and warrants to the Escrow Agent that he has the right, power and authority (i) to enter into and perform this Agreement and bind all of the Stockholders to its terms, (ii) to give and receive directions and notices hereunder, and (iii) to make all determinations that may be required or that he deems appropriate under this Agreement. 8 200 IN WITNESS WHEREOF, the undersigned have executed this Escrow Agreement as of the date first written above. STATE STREET BANK AND TRUST COMPANY as Escrow Agent By ____________________________________ Title: PICTURETEL CORPORATION By ____________________________________ Title: STOCKHOLDERS REPRESENTATIVE ______________________________________ James E. Long 9 201 ANNEX D PICTURETEL CORPORATION 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). HZ: cycles per second 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. 1 202 KBPS: kilobits per second, 1 kbps = 1,000 bits per second. KHZ: thousand cycles 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." 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. WAN: Wide Area Network, generic term used to describe the connectivity environment across a large geographic area. LANs are connected by a WAN. Can be switched circuits or packet networks. 2 203 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Section 145 of the Delaware General Corporation Law, as amended, provides that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal or investigative (other than an action by or in the right of the corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe such person's conduct was unlawful. Section 145 further provides that a corporation similarly may indemnify any such person serving in any such capacity who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor, against expenses actually and reasonably incurred in connection with the defense or settlement of such action or suit if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interest of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Delaware Court of Chancery or such other court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. Section 102(b)(7) of the Delaware General Corporation Law, as amended, permits a corporation to include in its certificate of incorporation a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided, however, that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law (relating to unlawful payment of dividends and unlawful stock purchase and redemption) or (iv) for any transaction from which the director derived an improper personal benefit. The Registrant's Third Restated Certificate of Incorporation provides that the Registrant's Directors shall not be liable to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent and only to the extent that exculpation from liabilities is not permitted under the Delaware General Corporation Law as in effect at the time such liability is determined. The Third Restated Certificate of Incorporation further provides that the Registrant shall indemnify its directors and officers to the full extent permitted by the law of the State of Delaware. II-1 204 ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following Exhibits are filed with, or incorporated by reference in, this Registration Statement:
EXHIBIT NO. DESCRIPTION - ------- ----------- 2.1 Agreement and Plan of Merger by and among the Registrant, PictureTel Technology Corporation, SNI Acquisition Corporation, and Starlight Networks Incorporated dated as of August 14, 1998 (the "Merger Agreement") (ANNEX A to the Proxy Statement/Prospectus contained in this Registration Statement). The Exhibits and Schedules to the Merger Agreement and the Disclosure Schedules of the Registrant and of Starlight Networks Incorporated are not included with the Merger Agreement. 3.1 Third Restated Certificate of Incorporation of Registrant (Incorporated by Reference to Exhibit 3.1.4 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 27, 1992). 3.2 Amended and Restated By-laws of Registrant (Incorporated by Reference to Exhibit 1 to the Registrant's Current Report on Form 8-K as filed with the Commission on September 14, 1994). 4.1 Form of Common Stock Certificate of Registrant (Incorporated by Reference to Exhibit 4(b) to Registrant's Registration Statement on Form S-8, No. 33-36315, as filed with the Commission on August 10, 1990). 4.2.1 Shareholders' Rights Agreement by and between the Registrant and The First National Bank of Boston, as Rights Agent, dated March 25, 1992 (Incorporated by Reference to Exhibit 1 to the Registrant's Registration of Certain Classes of Securities on Form 8-A, as filed with the Commission on March 26, 1992). 4.2.2 Form of Certificate of Designation with respect to Junior Preference Stock (Incorporated by Reference to Exhibit 2 of the Registrant's Registration of Certain Classes of Securities on Form 8-A, as filed with the Commission on March 26, 1992). 4.2.3 Form of Rights Certificate (Incorporated by Reference to Exhibit 3 to the Registrant's Registration of Certain Classes of Securities on Form 8-A, as filed with the Commission on March 26, 1992). 4.2.4 Summary of Purchase Rights (Incorporated by Reference to Exhibit 4 to the Registrant's Registration of Certain Classes of Securities on Form 8-A, as filed with the Commission on March 26, 1992). 4.2.5 Amendment to Shareholders' Rights Agreement dated January 13, 1995 (Incorporated by Reference to Exhibit 4.2.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 5 Opinion of Ropes & Gray.* 8 Opinion of Wilson Sonsini Goodrich & Rosati, P.C.* 10.1 1984 Amended and Restated Stock Option Plan, as amended through December 13, 1988, (Incorporated by Reference to Exhibit 10.10 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988).+ 10.1.1 Amendment to 1984 Amended and Restated Stock Option Plan dated October 26, 1994 (Incorporated by Reference to Exhibit 10.10.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).+ 10.2.1 PictureTel Corporation Equity Incentive Plan, as amended through October 26, 1994, (Incorporated by Reference to Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).+ 10.2.2 Amendment to PictureTel Corporation Equity Incentive Plan dated June 29, 1995 (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended July 1, 1995).+
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EXHIBIT NO. DESCRIPTION - ------- ----------- 10.3 1992 Non-Employee Director Stock Option Plan, as amended through April 10, 1996, (Incorporated by Reference to Exhibit 4(a) to the Registrant's Registration Statement on Form S-8, No. 333-10163, as filed with the Commission on September 2, 1997).+ 10.4 PictureTel Corporation 1994 Employee Stock Purchase Plan (Incorporated by Reference to Exhibit 4 to the Registrant's Registration Statement on Form S-8, No. 33-81848, as filed with the Commission on July 22, 1994).+ 10.5 401(k) Profit Sharing Retirement Plan, as amended through July 1, 1994, (Incorporated by Reference to Exhibit 10.45 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).+ 10.6.1 Employment Agreement by and between PictureTel Corporation and Norman E. Gaut dated July 29, 1988 (Incorporated by Reference to Exhibit 10.12 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988).+ 10.6.2 Amendment to the Employment Agreement by and between PictureTel Corporation and Norman E. Gaut dated January 15, 1995 (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995).+ 10.7 Agreement by and between PictureTel Corporation and Les Strauss, as amended through January 15, 1995, (Incorporated by Reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995).+ 10.8 Agreement by and between PictureTel Corporation and Domenic J. LaCava, as amended through January 17, 1995, (Incorporated by Reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995).+ 10.9.1 Agreement by and between PictureTel Corporation and Lawrence Bornstein, as amended through January 16, 1995, (Incorporated by Reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995).+ 10.9.2 Employment Agreement by and between PictureTel Corporation and Lawrence Bornstein dated December 5, 1997 (Incorporated by Reference to Exhibit 10.9.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.9.3 Change in Control Agreement by and between PictureTel Corporation and Lawrence Bornstein dated December 5, 1997 (Incorporated by Reference to Exhibit 10.9.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.10.1 Employment Agreement by and between PictureTel Corporation and Richard B. Goldman dated June 11, 1997 (Incorporated by Reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 29, 1997).+ 10.10.2 Employment Agreement by and between PictureTel Corporation and Richard B. Goldman dated December 5, 1997 (Incorporated by Reference to Exhibit 10.10.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.10.3 Change in Control Agreement by and between PictureTel Corporation and Richard B. Goldman dated December 5, 1997 (Incorporated by Reference to Exhibit 10.10.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.10.4 Amendment to the Employment Agreement by and between PictureTel Corporation and Richard B. Goldman dated July 13, 1998 (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 28, 1998).+ 10.11.1 Employment Agreement by and between PictureTel Corporation and David Grainger dated August 10, 1994 (Incorporated by Reference to Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1997).+
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EXHIBIT NO. DESCRIPTION - ------- ----------- 10.11.2 Employment Agreement by and between PictureTel Corporation and David Grainger dated December 5, 1997 (Incorporated by Reference to Exhibit 10.11.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.11.3 Change in Control Agreement by and between PictureTel Corporation and David Grainger dated December 5, 1997 (Incorporated by Reference to Exhibit 10.11.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997).+ 10.12 Form of Indemnification Agreement for Directors and Officers (Incorporated by Reference to Exhibit 10.34 to the Registrant's Registration Statement on Form S-1, No. 33-6368, effective August 12, 1986).+ 10.13.1 Agreement by and between PictureTel Corporation and Khoa Nguyen, as amended through March 6, 1995, (Incorporated by Reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 1, 1995).+ 10.13.2 Separation Agreement by and between PictureTel Corporation and Khoa Nguyen dated September 13, 1996 (Incorporated by Reference from Exhibit 10.13.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1997).+ 10.14.1 Lease Agreement by and between PictureTel Corporation and 100 Minuteman Limited Partnership ("100 Minuteman Lease") dated October 7, 1995 (Incorporated by Reference to Exhibit 10.47 to Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.14.3 Amendment No. 2 to 100 Minuteman Lease dated July 10, 1996 (Incorporated by Reference to Exhibit 10.14.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1997). 10.15.1 Lease Agreement by and between PictureTel Corporation and Andover Mills Realty Limited Partnership ("Andover Lease") dated February 10, 1994 (Incorporated by Reference to Exhibit 10.51 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.15.2 Amendment No. 1 to Andover Lease dated October 10, 1995 (Incorporated by Reference to Exhibit 10.15.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1997). 10.15.3 Amendment No. 2 to Andover Lease dated May 28, 1996 (Incorporated by Reference to Exhibit 10.15.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1997). 10.16.1 Lease Agreement by and between PictureTel Corporation and Minuteman Limited Partnership ("50 Minuteman Lease") dated August 26, 1996 (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 28, 1996). 10.16.2 Amendment No. 1 to 50 Minuteman Lease dated March 19, 1997.* 10.16.3 Sublease Agreement by and between PictureTel Corporation and Cabletron Systems, Inc. dated June 4, 1998 under the 50 Minuteman Lease.* 10.17.1 Lease Agreement by and between PictureTel Corporation and 200 Minuteman Limited Partnership ("200 Minuteman Lease") dated March 19, 1997 (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 29, 1997). 10.17.2 Amendment No. 1 to 200 Minuteman Lease dated June 4, 1998.* 10.18.1 Employment Agreement by and between PictureTel Corporation and Bruce R. Bond dated March 1, 1998. (Incorporated by Reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1998).+ 10.18.2 Change in Control Agreement by and between PictureTel Corporation and Bruce R. Bond dated February 25, 1998 (Incorporated by Reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1998).+
II-4 207
EXHIBIT NO. DESCRIPTION - ------- ----------- 10.18.3 Options to Bruce R. Bond effective January 31, 1998 (Incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1998.)+ 10.19 Secured Second Amended and Restated Revolving Credit Agreement by and between PictureTel Corporation and BankBoston, N.A., as agent, dated August 12, 1998.* 21 Subsidiaries of the Registrant (Incorporated by Reference to Exhibit 21 of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 23.1 Consent of Ropes & Gray (Exhibit 5).* 23.2 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (Exhibit 8).* 23.3 Consent of PricewaterhouseCoopers LLP.* 23.4 Consent of Ernst & Young LLP.* 24 Power of Attorney (Signature Page).* 27.1 Financial Data Schedule for year ended December 31, 1995.* 27.2 Financial Data Schedule for year ended December 31, 1996.* 27.3 Financial Data Schedule for the year ended December 31, 1997.* 27.4 Financial Data Schedule for the Six Month Period ended June 28, 1998.* 99 Form of Written Consent.*
- --------------- * Filed Herewith + Management Contract or Compensation Plan (b) The following Financial Statement Schedules of the Registrant for the Three Years Ended December 31, 1997 are included in this Registration Statement: Schedule II -- Valuation and Qualifying Accounts. All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements of PictureTel or notes thereto. ITEM 22. UNDERTAKINGS. (1) The undersigned Registrant hereby undertakes that prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this Registration Statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c), the Registrant undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other items of the applicable form. (2) The undersigned Registrant undertakes that every prospectus (i) that is filed pursuant to the immediately preceding paragraph, or (ii) that purports to meet the requirements of Section 10(a)(3) of the Securities Act and is used in connection with an offering of securities subject to Rule 415, will be filed as a part of an amendment to the Registration Statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) That insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of II-5 208 expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (4) The undersigned Registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the Registration Statement through the date of responding to the request. (5) The undersigned Registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the Registration Statement when it became effective. II-6 209 SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE TOWN OF ANDOVER, THE COMMONWEALTH OF MASSACHUSETTS. PICTURETEL CORPORATION /s/ BRUCE R. BOND -------------------------------------- Bruce R. Bond Chairman of the Board, President and Chief Executive Officer Dated: September 21, 1998 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION STATEMENT HAS BEEN SIGNED BELOW ON SEPTEMBER , 1998 BY THE FOLLOWING PERSONS IN THE CAPACITIES INDICATED. EACH PERSON WHOSE SIGNATURE APPEARS BELOW HEREBY AUTHORIZES W. ROBERT KELLEGREW AND BRUCE R. BOND, AND EACH OF THEM, WITH FULL POWER TO THEM, TO EXECUTE IN THE NAME AND ON BEHALF OF SUCH PERSON ANY AMENDMENT OR ANY POST-EFFECTIVE AMENDMENTS TO THIS REGISTRATION STATEMENT AND TO FILE THE SAME, WITH EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, MAKING SUCH CHANGES IN THIS REGISTRATION STATEMENT AND THE REGISTRANT DEEMS APPROPRIATE, AND APPOINTS EACH OF W. ROBERT KELLEGREW AND BRUCE R. BOND, EACH WITH FULL POWER OF SUBSTITUTION, ATTORNEY-IN-FACT TO SIGN ANY AMENDMENT AND ANY POST-EFFECTIVE AMENDMENT TO THIS REGISTRATION STATEMENT AND TO FILE THE SAME, WITH EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH.
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ BRUCE R. BOND Chairman of the Board, September 21, 1998 - --------------------------------------------- President, Chief Executive Bruce R. Bond Officer and Director (Principal Executive Officer) /s/ NORMAN E. GAUT Director September 21, 1998 - --------------------------------------------- Norman E. Gaut /s/ DAVID B. LEVI Director September 21, 1998 - --------------------------------------------- David B. Levi /s/ ROBERT T. KNIGHT Director September 21, 1998 - --------------------------------------------- Robert T. Knight /s/ ENZO TORRESI Director September 21, 1998 - --------------------------------------------- Enzo Torresi /s/ RICHARD S. HAAK, JR. Vice President and Corporate September 21, 1998 - --------------------------------------------- Controller (Principal Financial Richard S. Haak, Jr. Officer and Principal Accounting Officer)
II-7 210 REPORT OF INDEPENDENT ACCOUNTANTS Our report on the consolidated financial statements of PictureTel Corporation is included on Page F-2 of this Registration Statement on Form S-4. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 21(b) of this Registration Statement on Form S-4. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. Boston, Massachusetts February 25, 1998 211 SCHEDULE II -- PICTURETEL VALUATION AND QUALIFYING ACCOUNTS
CHARGE TO BALANCE AT COSTS AND BALANCE AT BEGINNING OF YEAR EXPENSES DEDUCTIONS END OF YEAR ----------------- ---------- ---------- ----------- Year Ended December 31, 1995: Accounts receivable reserves........ $1,785,000 $ 446,000 $ 432,000(a) $1,799,000 Inventory reserves.................. $3,171,000 $3,036,000 $3,339,000(b) $2,868,000 Warranty reserves................... $1,657,000 $2,181,000 $1,343,000(c) $2,495,000 Year Ended December 31, 1996: Accounts receivable reserves........ $1,799,000 $2,926,000 $1,389,000(a) $3,336,000 Inventory reserves.................. $2,868,000 $3,449,000 $4,766,000(b) $1,551,000 Warranty reserves................... $2,495,000 $4,348,000 $3,938,000(c) $2,905,000 Year Ended December 31, 1997: Accounts receivable reserves........ $3,336,000 $5,137,000 $2,158,000(a) $6,315,000 Inventory reserves.................. $1,551,000 $4,476,000 $ 760,000(b) $5,267,000 Warranty reserves................... $2,905,000 $7,396,000 $5,574,000(c) $4,727,000
- --------------- (a) Specific write-offs (b) Specific dispositions (c) Specific usage 212 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ------- ----------- 2.1 Agreement and Plan of Merger by and among the Registrant, PictureTel Technology Corporation, SNI Acquisition Corporation, and Starlight Networks Incorporated dated as of August 14, 1998 (the "Merger Agreement") (ANNEX A to the Proxy Statement/Prospectus contained in this Registration Statement). The Exhibits and Schedules to the Merger Agreement and the Disclosure Schedules of the Registrant and of Starlight Networks Incorporated are not included with the Merger Agreement. 5 Opinion of Ropes & Gray. 8 Opinion of Wilson Sonsini Goodrich & Rosati, P.C. 10.16.2 Amendment No. 1 to 50 Minuteman Lease dated March 19, 1997. 10.16.3 Sublease Agreement by and between PictureTel Corporation and Cabletron Systems, Inc. dated June 4, 1998. 10.17.2 Amendment No. 1 to 200 Minuteman Lease dated June 4, 1998. 10.19 Secured Second Amended and Restated Revolving Credit Agreement by and between PictureTel Corporation and BankBoston, N.A. dated August 12, 1998. 23.1 Consent of Ropes & Gray (Exhibit 5). 23.2 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (Exhibit 8). 23.3 Consent of PricewaterhouseCoopers LLP. 23.4 Consent of Ernst & Young LLP. 27.1 Financial Data Schedule for year ended December 31, 1995. 27.2 Financial Data Schedule for year ended December 31, 1996. 27.3 Financial Data Schedule for year ended December 31, 1997. 27.4 Financial Data Schedule for the Six Month Period ended June 28, 1998. 99 Form of Written Consent.
EX-5 2 OPINION OF ROPES & GRAY 1 EXHIBIT 5 OPINION OF ROPES & GRAY September 21, 1998 PictureTel Corporation 100 Minuteman Road Andover, MA 01810 Ladies and Gentlemen: This opinion is furnished to you in connection with a Registration Statement on Form S-4 (the "Registration Statement") filed with the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933, as amended, for the registration of 1,331,914 shares of Common Stock, par value $0.01 per share (the "Shares"), of PictureTel Corporation, a Delaware corporation (the "Company"). The Shares are to be issued in exchange for shares of preferred stock, no par value, of Starlight Networks Incorporated ("Starlight") pursuant to an Agreement and Plan of Merger dated as of August 14, 1998 (the "Merger Agreement") by and among the Company, PictureTel Technology Corporation, Starlight and SNI Acquisition Corporation, a Delaware corporation and an indirect wholly owned subsidiary of the Company ("Merger Sub"). The Merger Agreement provides for Merger Sub to merge with and into Starlight (the "Merger") and for Starlight to survive the Merger as an indirect wholly owned subsidiary of the Company. We have acted as counsel for the Company in connection with the issuance of the Shares pursuant to the Merger. For purposes of our opinion, we have examined and relied upon such documents, records, certificates and other instruments as we have deemed necessary. Based upon the foregoing, we are of the opinion that the Shares being issued by the Company have been duly authorized and, when issued in accordance with the Merger Agreement, will be fully paid and nonassessable. We hereby consent to the filing of this opinion as part of the Registration Statement and to the use of our name therein and in the related Information Statement/Prospectus under the caption "Legal Matters." This opinion is to be used only in connection with the issuance of the Shares while the Registration Statement is in effect. Very truly yours, /s/ Ropes & Gray Ropes & Gray EX-8 3 OPINION OF WILSON SONSINI GOODRICH & ROSATI,P.C. 1 EXHIBIT 8 [WSGR LETTERHEAD] September 21, 1998 Starlight Networks Incorporated 205 Ravendale Drive Mountain View, California 94043 RE: Registration Statement on Form S-4 of PictureTel dated September 21, 1998 Ladies and Gentlemen: We have acted as counsel to Starlight Networks Incorporated, a California corporation ("Starlight"), in connection with the proposed merger (the "Merger") of SNI Acquisition Corporation, a California corporation ("Merger Sub") and an indirect wholly owned subsidiary of PictureTel Corporation, a Delaware corporation ("PictureTel"), with and into Starlight pursuant to an Agreement and Plan of Merger dated as of August 14, 1998, as amended (the "Merger Agreement"), among Starlight, PictureTel, PictureTel Technology Corporation, a Delaware corporation, and Merger Sub. The Merger and certain related transactions incident thereto are described in the Registration Statement on Form S-4 (the "Registration Statement") of PictureTel which contains a prospectus and key information statement. This opinion is being rendered pursuant to the requirements of Item 21(a) of Form S-4 under the Securities Act of 1933, as amended. Unless otherwise indicated, any capitalized terms used herein and not otherwise defined have the meaning ascribed to them in the Registration Statement. The facts, as we understand them, are set forth in the Registration Statement. Based on such facts and on representations expected to be formalized in connection with our closing opinion described in the Registration Statement, it is our opinion that the material United States federal income tax consequences to the shareholders of Starlight expected to result from the receipt of PictureTel Common Stock and cash in exchange for Starlight Preferred Stock pursuant to the Merger under currently applicable law, are as set forth under the caption "THE MERGER -- Material Federal Tax Consequences" in the Registration Statement. This opinion is furnished to you solely for use in connection with the Registration Statement. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement. We also consent to the reference to our firm name whenever appearing in the Registration Statement with respect to the opinion and discussion of the material federal income tax consequences of the Merger, including the prospectus and information statement constituting a part thereof, and any amendment thereto. In giving this consent, we do not thereby admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission thereunder, nor do we thereby admit that we are experts with respect to any part of such Registration Statement within the meaning of the term "experts" as used in the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission thereunder. Very truly yours, /s/ Wilson Sonsini Goodrich & Rosati -------------------------------------------- WILSON SONSINI GOODRICH & ROSATI Professional Corporation EX-10.16.2 4 AMEND #1 TO 50 MINUTEMAN LEASE DATED MAR. 19, 1997 1 EXHIBIT 10.16.2 AMENDMENT #1 TO LEASE (50 MINUTEMAN) 1. Parties. This Amendment, dated as of March 19, 1997, is between 50 Minuteman Limited Partnership ("Landlord") and PictureTel Corporation ("Tenant"). 2. Recitals. 2.1 Landlord and Tenant have entered into a Lease, dated August 26, 1996, for improved property located at 50 Minuteman Road, Andover, Massachusetts. This Lease, together with all amendments thereto, collectively is called the "Lease." Unless otherwise defined, terms used herein have the same meanings as those used in the Lease. 2.2 Landlord and Tenant wish to amend the Lease. To accomplish this, for good and valuable consideration, the receipt and sufficiency of which is acknowledged, the parties agree and the Lease is amended as follows: 3. Amendments. 3.1 In Section 7.1(d), the phrase "(other than pursuant to Section 4(b))" is inserted after the phrase "terms of this Lease" in the third line thereof. 3.2 In Section 18.3, the first two sentences are deleted and replaced by the following: "Landlord will not unreasonably withhold or delay its consent to an assignment or sublease by Tenant, but Landlord may withhold its consent to any other Transfer (including, without limitation, any hypothecation or assignment for security purposes) arbitrarily and in its sole discretion." 3.3 In Section 19.4, the second to last paragraph beginning with the words "In any case..." is deleted. 3.4 The phrase "(or its successor)" is added after the phrase "Bank of Boston" in the sixth line of Section 22.2(e) and the fourth line of Section 24.17(a). 3.5 Section 24.17(b) is deleted and the following is substituted therefor: "(b) Each loan obtained from time to time by Landlord in compliance with this Lease which is secured by the Letter of Credit (other than the initial mortgage construction loan) sometimes is referred to as the "Letter of Credit Loan." Until and unless the Letter of Credit is drawn upon, starting as of one (1) year after the Commencement Date, and on each annual anniversary thereafter (or, if the Letter of Credit Loan has not funded within one (1) year after the Commencement Date, then starting as of fifteen (15) months and fifteen (15) days after the Commencement Date, and on each annual anniversary thereafter), the face amount of the Letter of Credit shall be reduced in an amount equal to the annual principal reduction that would result from a direct reduction loan amortization schedule, assuming an interest rate equal to the interest rate used to calculate principal amortization under the Letter of Credit Loan (such schedule to be provided or approved by the lender of the Letter of Credit Loan), which will have the effect of reducing the Letter of Credit to zero over the initial term of the Lease (as it may be extended pursuant to Section 4(b)) . However, subject to the foregoing but 2 notwithstanding anything else to the contrary, even if the Letter of Credit has been drawn upon, if and to the extent that those amounts are repaid to Tenant, Tenant shall thereupon cause the face amount, and the amount that may again be drawn, under the Letter of Credit to be increased by an amount equal to the amount so repaid. (For example, if $2 Million were to be drawn under the Letter of Credit pursuant to Section 24.17(f), and if that $2 Million were then repaid, the face amount and the amount that could be drawn under the Letter of Credit again would be $7.8 Million.) Tenant shall cause the Letter of Credit to be renewed continuously on the same terms as described above for successive one (1)-year terms (or longer terms) so that the Letter of Credit is continuously maintained for a term expiring at the end of the initial term of the Lease (as it may be extended pursuant to Section 4(b)). Each succeeding Letter of Credit shall be effective on or before the date that the then-existing Letter of Credit expires. Tenant's failure to deliver these renewals of the Letter of Credit to the beneficiary at least thirty (30) days prior to each expiration date shall be a default under this Lease, and at the beneficiary's option, and notwithstanding anything to the contrary, the beneficiary shall have the immediate right thereon and thereafter to draw under the Letter of Credit for all or any portion thereof; provided, however, that if Tenant delivers the required renewal of the Letter of Credit to the beneficiary before the expiration of the existing Letter of Credit and before the beneficiary has drawn under the existing Letter of Credit, then Tenant shall be deemed to have cured such default." 3.6 Section 24.17(d) is deleted. 3.7 Exhibit "J" attached hereto is incorporated as part of and in addition to the rest of Exhibit "J" attached to the Lease. 3.8 Tenant did not exercise and no longer has a third Purchase Option, and so Section 4 of Addendum #2 is deleted. 3.9 Addendum #3, Addendum #4 and Addendum #5 are deleted, and Addendum #3, Addendum #4 and Addendum #5 attached to this Amendment, respectively, are substituted therefor. 4. No Other Changes. Except as set forth above, the Lease remains unchanged and in full force and effect. IN WITNESS WHEREOF, intending to be legally bound, the parties have executed this Amendment as of the date in Article 1 above. 50 MINUTEMAN LIMITED PARTNERSHIP PICTURETEL CORPORATION By: Niuna-50 Minuteman, Inc., its general partner By: /s/ Authorized Signatory __________________________ Name: By: /s/ John Kusmiersky Title: __________________________ Authorized Signature John Kusmiersky, President By: /s/ Authorized Signatory __________________________ Name: Title: Authorized Signature 3 ADDENDUM #3 NET PROCEEDS 1. Cash Proceeds. "Cash Proceeds" means: all cash proceeds actually received by or on behalf of Landlord that Landlord is permitted to retain (for example, if Landlord must refund an overpayment to Tenant or a third party, the amount refunded will not be deemed to be "retained" by Landlord nor shall it be a part of Cash Proceeds hereunder) from the sale, leasing (including base rent and additional rent), assignment, subleasing, initial financing (including, without limitation, the initial financing secured by the Premises and any financing secured by the Letter of Credit, but subject, however, to Addendum #7), refinancing, encumbrance, Condemnation or other disposition of all or any portion of the Premises or any interest therein (including any additional buildings constructed on the Premises), and any casualty and rental insurance proceeds received by or on behalf of Landlord that Landlord is permitted to retain in connection with all or any portion of the Premises, any loans, advances or capital contributions made to Landlord, indemnities paid by Tenant to Landlord and any interest or investment income received by Landlord on such cash proceeds. Notwithstanding the foregoing, Cash Proceeds do not include any amounts paid to or receivable by Landlord for, as a result of or in connection with: an exercise of any Purchase Options; Tenant's defaults, or any judgments, settlements or awards paid by Tenant or its Affiliates; amounts drawn under the Letter of Credit or the application(s) of any cash security deposit, or any late charges or interest payable by Tenant; the Transfer of any interest in Landlord or in any of its partners or other Control Affiliates; or development fees, management fees or fees in lieu thereof payable to Landlord or its Affiliates pursuant to this Lease or in connection with Landlord's Work or in connection with the construction of any additional buildings on the Premises or the enlargement or other modification of the Building or the rest of the Premises; or any Net Proceeds distributed or distributable to Landlord pursuant to Section 3 below. 2. Costs. "Costs" means: all bona fide costs and expenses of any type paid by Landlord or its Affiliates, or reasonably anticipated by Landlord to be payable by Landlord or its Affiliates, for, as a result of or in connection with all or any portion of the Premises or any interest therein or any ownership, operation, management, maintenance, repair, restoration, replacement, improvement, leasing (other than the payment of Net Proceeds hereunder), financing, refinancing or Transfer by Landlord thereof (whether or not included as part of Operating Costs, but not including any sale or conveyance to any of Landlord's Control Affiliates), or the establishment and maintenance of Landlord's existence in good standing as an entity, or any rights or Liabilities in connection with any of the foregoing, including, without limitation, costs and expenses for: the acquisition, sale or other disposition of all or any portion of the Premises and any rights appurtenant thereto (including, without limitation, all costs for due diligence, investigations, remedial work, closing costs, escrow and title fees, legal fees, professional fees and commissions); Landlord's Work and all other labor, services and materials supplied to or for the benefit of the Premises (including any additional buildings constructed on the Premises) and/or Tenant under or in connection with this Lease (including, without limitation, costs for designers, architects, engineers, draftsmen, supervision, permits and approvals, development fees (other than those payable to Landlord or its Affiliates which are excluded from Cash Proceeds as set forth in Section 1 above), fees, profit and savings payable to construction managers, contractors and subcontractors, and all other reasonably related "hard" and "soft" costs); financing, refinancing and encumbrance of the Premises or any interest therein (including, without limitation, payment of all principal, interest, fees, commissions, appraisals, escrow and title fees, other closing costs, interest rate hedges, "caps" or "flors," and other costs in connection therewith and other amounts owed under any of the loan documents); the repayment of all bona fide capital contributions, loans or advances made by Landlord or its partners or their respective Affiliates (including, without limitation, the repayment of such amounts and commercially reasonable interest on such loans and a commercially reasonable rate of return on 4 such contributions or advances, which in any case will be at least equal to the Bank of Boston's (or its successor's) prime rate plus one percent (1%), or the maximum rate permitted by law, whichever is less, and commercially reasonable closing costs, commissions and/or loan fees or similar fees in order to obtain such loans, contributions or advances); the payment and performance of all of Landlord's Liabilities and the exercise of Landlord's rights under or in connection with this Lease or the Premises or agreements in connection therewith (including, without limitation, costs for Taxes, Operating Costs, amounts in connection with Hazardous Substances and environmental protection, compliance will all Laws, indemnity and defense costs, and other costs in connection therewith and other amounts owed under any of the loan documents); attorneys' fees and other costs in connection with the defense or prosection of any litigation, proceedings, claims or counterclaims or as otherwise deemed necessary by Landlord; judgments, claims, awards or settlements, whether due to the fault of Landlord or its partners or otherwise; an amount per calendar year equal to forty percent (40%) of an amount (the "Tax Payments") equal to: Landlord's taxable income (if any) in the prior calendar year (other than the taxable income resulting solely from the sale or the conveyance of the Premises) less the amounts paid to Landlord for that prior calendar year pursuant to this Subclause of this Section 2, and if in any year the Tax Payments are not fully paid, then the unpaid Tax Payments shall cumulate and be paid as Costs as soon as there are sufficient Cash Proceeds; the preparation of Landlord's annual audited financial statements and any other information to be provided y Landlord under this Lease (including audits of Net Proceeds) and tax returns; corporate or partnership license fees, filing fees, business and franchise taxes and fees, and similar charges; and reserves deemed reasonably necessary by Landlord in connection with any of the foregoing. Unless otherwise specifically agreed and set forth in this Lease (e.g., with respect to the interest rate on loans or the return on capital, or with respect to management fees or fees in lieu thereof, or budgeted development fees), amounts payable as Costs by Landlord to any of its Affiliates for services rendered shall not exceed the prevailing rates that would be payable to unaffiliated third parties in an arms-length transaction. Costs do not include any of the above amounts which are directly paid by Tenant or which are funded by insurance. 3. Payment of Net Proceeds. "Net Proceeds" means, from time to time, an amount equal to the positive amount, if any, obtained by taking an amount equal to the current amount of Cash Proceeds and deducting therefrom an amount equal to the current amount of Costs. Prior to any distribution of Net Proceeds to any of Landlord's Control Affiliates, Landlord first will pay to Tenant Net Proceeds in amount equal to: the unrepaid Reconstruction Costs (if any) until the Reconstruction Costs have been repaid in full; and the unrepaid Cure Payments (if any) until the unrepaid Cure Payments have been repaid in full; and the reasonable costs and expenses incurred by Tenant in good faith to third parties in validly exercising its Right of Self Help as set forth in Section 14.4, but excluding therefrom any of such costs and expenses that otherwise would qualify as Operating Costs under Article 7. Thereafter, Landlord will pay to Tenant one-half (1/2) of all Net Proceeds available for distribution at the same times as Net Proceeds are distributed by Landlord to its Control Affiliates. These payments to Tenant will be deemed to be a reduction in Tenant's rent already paid from time to time under this Lease (although they may not be credited, offset or deducted against Tenant's current or future rent payments owed). Payments of Net Proceeds to Tenant during any year shall be subject to an annual reconciliation for that year (which shall occur after the end of that year), and any amounts overpaid to Tenant or owed by Landlord shall be adjusted in cash between the parties within thirty (30) days after such annual reconciliation is delivered. Upon Tenant's written request in each instance, Landlord will furnish to Tenant reasonable backup information for its annual reconciliations, including copies of Landlord's most recent financial statements. Within ninety (90) days after delivery of each of Landlord's annual reconciliations, and upon at least fourteen (14) days' prior written notice to Landlord, not more than once in each calendar year Tenant may audit Landlord's books and records applicable to the period after the last annual reconciliation in order to verify the accuracy of Landlord's calculation of Net Proceeds. Such audit will be conducted only during regular business hours where Landlord maintains its books and records (which Landlord agrees will be in Massachusetts or California) and Tenant will deliver a copy of the audit to Landlord within 5 fifteen (15) days after receipt by Tenant. All audits will be conducted at Tenant's cost and expense and shall be conducted only by Tenant or its designated professional representatives. 4. Termination of Rights. Notwithstanding anything to the contrary, as of the date of the first occurrence of any or all of the following, at Landlord's election all of Tenant's rights and Landlord's obligations under or in connection with this Addendum will terminate and lapse completely, except that the entity that is the Landlord immediately prior to the occurrence of any or all of the following shall remain obligated to pay to Tenant (or at such entity's election credit against amounts owed by Tenant to such entity) Tenant's share of undistributed Net Proceeds (if any) existing as of the date of such occurrence: (a) The termination or expiration of this Lease in accordance with its terms. (b) A default by Tenant under this Lease. (c) The closing of any Purchase Option, or the closing of another bona fide sale or other conveyance by Landlord of all or any portion of the Premises, or any interest therein (which shall not be deemed to include an interest in Landlord), which sale or conveyance is not prohibited under this Lease, but Tenant's rights and Landlord's obligations with respect to Net Proceeds shall continue with respect to the portions of the Premises or interests therein, if any, still retained by Landlord and with respect to any Net Proceeds received by Landlord in connection with such sale or other conveyance (except with respect to a sale pursuant to a Purchase Option or a sale associated with an "LC Return" as defined in Subsection (d) below). (d) The sale or other conveyance by Landlord of all or any portion of the Premises or any interest therein, which sale or conveyance is not prohibited under this Lease, provided that prior to or on or about the closing of such sale or conveyance, the Letter of Credit is returned to Tenant undrawn (or if drawn upon, with any outstanding LC Advances repaid in full) and with no obligation on the part of Tenant to supply additional Letters of Credit under this Lease, and in such event Tenant shall not have any continuing rights nor shall Landlord have any continuing obligations with respect to Net Proceeds, whether received by Landlord in connection with such sale or conveyance or otherwise. The return of the Letter of Credit to Tenant as described above is called the "LC Return." 5. Unaffected Parties. Notwithstanding anything to the contrary, Tenant's rights and Landlord's obligations under this Addendum will not be binding on and will not affect or otherwise apply in any way to: (a) Any party that, in a bona fide transaction, purchases or otherwise acquires all or any portion of the Premises or any interest therein, or its successors, assigns and purchasers, or their respective Affiliates (unless any such sale or conveyance is prohibited under this Lease); or (b) Landlord's Mortgagees, whether or not they take title to or acquire all or any portion of the Premises or any interest therein, and their successors, assigns and purchasers, or their respective Affiliates. 6 6. Personal Rights. Notwithstanding anything to the contrary, the rights granted to Tenant under or in connection with this Addendum are granted to and may be exercised only by the Tenant originally named in this Lease, and they may not be exercised by anyone else (other than by an assignee to whom such rights have been entirely assigned pursuant to a valid assignment of this Lease, if at the time of such assignment the assignor and the assignee deliver to Landlord a jointly executed written notice stating unconditionally that the assignee has the right to exercise such rights), and Tenant shall not, and shall not have the right or power to, otherwise assign or Transfer any of these rights. If at the time of a valid assignment the assignor and the assignee deliver to Landlord a jointly executed written notice directing Landlord to pay a portion of the Net Proceeds otherwise payable to the assignee instead to the assignor, then Landlord will continue to pay that portion of the Net Proceeds to the assignor until and unless Landlord receives from the assignor and the assignee a jointly executed written notice changing such direction to Landlord and then Landlord shall pay in accordance with the new direction. 7 ADDENDUM #4 PURCHASE OPTIONS 1. Grant and Exercise. Provided that this Lease is in full force and effect and subject to the terms hereof, Landlord grants to Tenant two (2) options (the "Purchase Options") to purchase the Premises from Landlord, which Purchase Options must be exercised during the following periods: (a) The first (1st) Purchase Option can be exercised only during the first month of the fifth (5th) Lease Year. (b) The second (2nd) Purchase Option can be exercised only during the first month of the tenth (10th) Lease Year. The Purchase Options can be exercised only by Tenant delivering unconditional written notice of exercise to Landlord as and when required together with a cashier's check or the wire transfer of funds to Landlord in an amount equal to five percent (5%) of the total purchase price under the applicable Purchase Option. These funds shall be placed by Landlord into a separate interest-bearing account or other mutually agreeable investment instrument and these funds and all interest earned thereon collectively are called the "Deposit." When and if the closing under the applicable Purchase Option occurs, the Deposit shall be credited against the cash portion of the purchase price payable by Tenant thereunder. If the Deposit is in excess of the cash portion of the purchase price payable by Tenant, the excess shall be returned to Tenant as of the closing. If for any reason Landlord does not actually receive this unconditional written notice of exercise and the Deposit as and when required, at Landlord's option the applicable Purchase Option will lapse and become null and void. At Landlord's election, the Purchase Options and all of Tenant's rights and Landlord's obligations under this Addendum and Addendum #5 shall lapse and become null and void if: (i) Tenant defaults under the rest of this Lease at any time prior to the exercise of a Purchase Option or any closing thereunder; or (ii) Tenant defaults under this Addendum, or defaults in connection with any closing under, or fails to close as required after the exercise of, a Purchase Option (a "Purchase Option Default"). If Tenant commits a Purchase Option Default Tenant also shall waive as against Landlord and its Affiliates all Liabilities and defaults (if any) of or by any of them under this Lease that directly arise from or in connection with the Purchase Option Default, and Landlord shall retain the Deposit as its sole and liquidated damages for the Purchase Option Default, and if Tenant commits more than one Purchase Option Default, at Landlord's election the Purchase Options and all of Tenant's rights and Landlord's obligations under this Addendum and Addendum #5 shall lapse and become null and void. (A Purchase Option Default is not the same as a default described in Section 4(c) of this Addendum.) 8 2. Purchase Price. (a) The cash portion of the purchase price for the Premises shall be payable by cashier's check or wire transfer of immediately available funds to or at the direction of Landlord and will be payable in full on or before the scheduled closing date. In addition to the cash portion of the purchase price, as of the closing Tenant shall either repay in full all mortgage loan(s) secured by the Premises, and any other loan secured by the Letter of Credit (if separate from such mortgage loan(s)), other than those that are Unpermitted Financing (the "Existing Loans") (including, without limitation, any prepayment or "breakage" fees or similar charges) or assume the Existing Loans, and in any case Tenant will cause the lender(s) to release Landlord and its Affiliates as of the closing from all Liabilities in connection with the Existing Loans and Tenant shall indemnify and hold Landlord and its Affiliates harmless from all further Liabilities in connection with the Existing Loans. In addition to the purchase price, Tenant shall pay all closing costs of any type (other than Landlord's attorneys' fees and costs), including, without limitation, commissions (if any) and the costs of deed stamps and documentary and transfer taxes and fees, surveys, title insurance, escrows, recording and other similar fees and costs. Base rent will be prorated between the parties as of the closing date, but there will be no other prorations or adjustments. (b) The cash portion of the purchase price for the Premises shall be never be less than zero, but otherwise shall be equal to the following amounts: (i) For the first (1st) Purchase Option, an amount equal to: (x) ten (10) times the "Current Base Rent Amount" (defined below); less (y) the "Existing Mortgage Balance" (as defined below). The "Current Base Rent Amount" means the scheduled annual base rent payable under this Lease as of the date of closing, without any deductions, offsets or abatements of any type, and including, without limitation, scheduled annual base rent payable in connection with any other space leased or agreed to be leased from Landlord in a new building or new buildings, or an enlargement of the Building, on the Premises. If an agreement has been entered into to lease such other space or a right to lease such other space has been exercised prior to closing but the full base rent applicable thereto has not commenced or cannot be accurately determined as of the closing, then the scheduled annual base rent applicable to that Purchase Option shall be reasonably estimated by Landlord. (As a hypothetical example, if the scheduled annual base rent at the closing is $2,352,900, the Current Base Rent Amount for the first (1st) Purchase Option would be $2,352,900.) The "Existing Mortgage Balance" means the outstanding principal balance (not including any prepayment or "breakage" fees or similar charges) as of the closing date under an exercised Purchase Option of any Existing Loans. (ii) For the second (2nd) Purchase Option, an amount equal to: (x) eight and one-half (8 1/2) times the Current Base Rent Amount; less (y) the Existing Mortgage Balance. As a hypothetical example, if the second (2nd) Purchase Option is validly exercised, the Current Base Rent Amount is $2,352,900, and as of the closing the Existing Mortgage Balance is $13 Million, then the cash portion of the purchase price payable to Landlord would be only $6,999,650 and Tenant would repay or assume the existing $13 Million mortgage loan secured by the Premises, for a total purchase price of $19,999,650. 3. Closing. The closing under an exercised Purchase Option will occur at a location in Massachusetts and on a date specified by Landlord pursuant to written notice to Tenant, which date will be: during the last four (4) months of the fifth (5th) Lease Year (for the first (1st Purchase Option); and during the last four (4) months of the tenth (10th) Lease Year (for the second (2nd) Purchase Option). At the closing, Landlord will execute and deliver to Tenant a Massachusetts Quitclaim Deed (which will be subject to all matters of record and all title and survey exceptions), an affidavit of Landlord stating Landlord's U.S. taxpayer identification number and that Landlord is not a "foreign person" within the meaning of Section 1445(f)(3) of 9 the Internal Revenue Code of 1986, as amended or Landlord shall provide the necessary forms if Landlord is a "foreign person") , and a blanket assignment to Tenant of all third party guaranties, warranties, permits, certificates, consents and approvals pertaining to the Premises that are assignable by Landlord, to the extent assignable at no cost or Liabilities to Landlord (unless Tenant advances such costs and discharges such Liabilities, in which case they shall be assigned to the extent assignable by Landlord). 4. Additional Terms. 10 (a) Tenant specifically acknowledges and agrees that Landlord will sell and Tenant will purchase the Premises on an "as is with all faults" basis, subject to all exceptions to and defects of title, whether or not of record (but subject also to Tenant's rights and Landlord's obligations as set forth below), and that Tenant will not rely on nor will Landlord or any of its Affiliates be deemed to have made, any representations or warranties of any kind, express or implied including, without limitation, those in connection with the physical condition of the Premises (including, without limitation, any matters involving Hazardous Substances or compliance with any Laws), or the nature of title to the Premises, or the advisability of Tenant's purchase of the Premises). However, until and unless Tenant otherwise agrees in writing or defaults Landlord will not voluntarily execute any documents affecting title that materially adversely affect Tenant's operations or that render title to the Premises unmarketable (but easements, dedications or other documents for access, drainage, utilities or services (including cabling), curb cuts, or as otherwise may be needed to comply with applicable Laws or to enable Landlord to meet its obligations under this Lease or in connection with the construction of any new building(s) or the enlargement of the Building per this Lease, will not be deemed to be violations of this restriction). If this restriction is violated after the exercise of a Purchase Option, Tenant shall have the right to terminate that Purchase Option without liability and receive the Deposit back. Notwithstanding the foregoing, even if Tenant has validly exercised a Purchase Option, Tenant shall have the right to terminate that Purchase Option without liability (except for Landlord's out-of-pocket costs) and shall not be required to close the purchase if, after the exercise of the Purchase Option but prior to closing, there is a casualty that causes damage of the type and to the extent described in Section 16.2(b)(x) such that Tenant otherwise would have the right to terminate this Lease, and in the reasonable judgement of a qualified independent contractor hired by Landlord it will take more than two (2) years from the date of the damage to restore access or restore or replace the destroyed parking spaces or substantially complete the repairs that Landlord would have been required to make, and Tenant notifies Landlord of its intent to terminate within thirty (30) days after receiving the notice from Landlord's contractor, which shall be provided as soon as reasonably practicable after the damage occurs. If these circumstances occur, the closing date shall be extended as necessary to accommodate this thirty (30)-day period. If Tenant does not so terminate, or if Tenant is not permitted to so terminate as a result of a casualty, as of the closing Landlord will assign to Tenant all casualty insurance proceeds otherwise payable to Landlord on account of the damage and all rights and claims in connection therewith (other than those which Landlord was entitled to receive for the period and/or for the work and services performed prior to the closing). Notwithstanding anything to the contrary, if Landlord is in the process of repairing or rebuilding casualty damage and Tenant subsequently validly exercises a Purchase Option: Landlord will continue the process of repairing or rebuilding as otherwise required in this Lease until the closing date under the Purchase Option; Tenant will be deemed to have waived its right to terminate this Lease under Article 16, and its right to terminate the Purchase Option in connection with that casualty or any repairs or rebuilding in connection therewith; Landlord will assign to Tenant as of the closing all casualty insurance proceeds otherwise payable to Landlord on account of the damage and all rights and claims in connection therewith (other than those which Landlord was entitled to receive for the period and/or for the work and services performed prior to the closing), and Landlord shall assign to Tenant and Tenant shall assume all rights and Liabilities of Landlord under the contracts entered into in connection with the repair or rebuilding to the extent assignable and Tenant shall indemnify Landlord and its Affiliates for and hold them harmless from all Liabilities in connection therewith; and Landlord shall be obligated to continue to repair or rebuild after the closing date only if and to the extent actually agreed to by Landlord and Tenant in good faith and in writing at the time. (b) As of the closing, Tenant and its Affiliates will be deemed to have released and discharged Landlord and its Affiliates from, and to have waived, all Liabilities of any type, known or unknown, including, without limitation, Liabilities under or in connection with this Lease and/or the Premises (except as set forth in the last sentence of Subsection (c) below). As a condition to closing, Landlord may require that Landlord's Mortgagees release Landlord and its 11 Affiliates from Liabilities under or in connection with any Superior Leases or Mortgages. From and after the closing, Tenant shall indemnify, defend and hold Landlord free and harmless from all Liabilities under or in connection with this Lease and/or the Premises and/or the purchase thereof (except as set forth in the last sentence of Subsection (c) below). (c) Time is of the essence in this Addendum. If Tenant defaults hereunder after the closing under a Purchase Option or Tenant or Landlord defaults under any of the documents delivered by it in connection therewith, in addition to any rights and remedies available to each of the respective parties, each party shall have all rights and remedies at law and in equity, all of which are cumulative and not exclusive, including, without limitation, the right to require specific performance. The exercise of a Purchase Option or any closing as a result thereof shall not relieve Tenant or Landlord from any Liabilities for any defaults under this Lease, nor will they extinguish Liabilities for any indemnities or other obligations that survive pursuant to the terms of the rest of this Lease or this Addendum. (d) Notwithstanding anything to the contrary, as of the date of the first occurrence of any of the following, at Landlord's election all of Tenant's rights and Landlord's obligations under or in connection with this Addendum will lapse and become null and void upon: (i) The expiration of the Lease term (as validly extended) or termination of this Lease in accordance with its terms prior to the exercise of a Purchase Option or any closing thereunder; or (ii) The bona fide purchase or other acquisition of all or substantially all of the Premises by any person or entity (including, without limitation, Tenant or its Affiliates) other than by any of Landlord's Control Affiliates prior to the exercise of a Purchase Option and other than any sale or conveyance which is prohibited under this Lease; or (iii) [INTENTIONALLY OMITTED] (e) Notwithstanding anything to the contrary, Tenant's rights and Landlord's obligations under or in connection with this Addendum will not be binding on and will not affect or otherwise apply in any way to Landlord's Mortgagees or their successors, assigns and purchasers, or their respective Affiliates, whether or not they take title to or acquire all or substantially all of the Premises. 5. Personal Rights. Notwithstanding anything to contrary, the Purchase Options are granted only to and may be exercised only by the Tenant originally named in this Lease, and they may not be exercised by anyone else (other than by an assignee to whom the right to exercise a Purchase Option has been assigned pursuant to a valid assignment of this Lease, if at the time of such assignment the assignor and the assignee deliver to Landlord a jointly executed written notice stating unconditionally that the assignee has the right to exercise such Purchase Option) and Tenant shall not, and shall not have the right or power to, otherwise assign or otherwise Transfer any of the Purchase Options or any rights in connection therewith. Tenant may assign this Lease without granting to the assignee the right to exercise any or all of the Purchase Options, and in such event Tenant will retain the rights to exercise any Purchase Options whose exercise rights have not been validly assigned as set forth in this Addendum, if and only if Tenant has not become a Released Assignor in connection with its assignment of this Lease. 12 ADDENDUM #5 RIGHT OF FIRST OFFER TO PURCHASE 1. Grant of Rights. (a) Subject to the terms of this Addendum, before Landlord sells or conveys the Premises during the initial Lease term (other than pursuant to a sale or conveyance to any of Landlord's Control Affiliates) Landlord shall notify Tenant in writing (the "Offer Notice") of the purchase price and the terms of payment thereof (e.g., all cash, or cash and purchase money financing or assumption of debt) that Landlord intends to accept for the Premises (the "Offer Price"). (b) Within ninety (90) days after delivery of the Offer Notice, Tenant shall notify Landlord in writing that it unconditionally elects one of the three (3) following alternatives: (i) To purchase the Premises for the applicable Offer Price and otherwise on the terms of this Addendum. (Tenant's election of the alternative described in this Subsection (i) is referred to as the "Purchase Election.") (ii) To cause Landlord not to sell the Property, which prohibition on sale shall be effective only during the first ten (10) Lease Years. (Tenant's valid election of the alternative described in this Subsection (ii) is referred to as the "No-sale Election.") (iii) To permit Landlord to sell or convey the Premises in accordance with this Addendum and to continue to lease the Premises on the terms of this Lease. (Tenant's election of the alternative described in this Subsection (iii) is called the "Existing Lease Election.") (c) TIME IS ABSOLUTELY OF THE ESSENCE. If for any reason Landlord does not actually receive Tenant's unconditional written notice of election as and when required during the first nine (9) Lease Years, Tenant shall be deemed to have elected the No-sale Election. If for any reason Landlord does not actually receive Tenant's unconditional written notice of election as and when required after the first nine (9) Lease Years, Tenant shall be deemed to have elected the Existing Lease Election. At Landlord's election, all of Tenant's rights and Landlord's obligations under or in connection with this Addendum and Addendum #4 shall lapse and become null and void if Tenant defaults hereunder or under the rest of this Lease at any time prior to any closing hereunder, or if Tenant defaults in connection with any closing hereunder or fails to close as required after its election of the Purchase Election (an "Offer Default"). Any amounts payable under this Addendum in connection with the Purchase Election are deemed to be amounts payable under the Lease, and any default hereunder will be deemed to be a default under the Lease and in such case Landlord shall be entitled to all rights and remedies hereunder and under the rest of the Lease, including, without limitation, the right to require specific performance from Tenant. If Tenant commits an Offer Default, Tenant also shall indemnify and hold Landlord harmless from and against all Liabilities incurred by Landlord that arise from or in connection with the Offer Default. 13 2. Purchase Election. If Tenant validly exercises the Purchase Election, then Landlord shall sell and Tenant shall purchase the Premises and the following terms and conditions of Addendum #4 are incorporated herein and shall apply with respect to this Addendum and such sale and purchase as if it were the sale and purchase under an exercised Purchase Option: Section 2(a) (except that the applicable purchase price and the terms of the payment thereof shall be as set forth in the Offer Price, or if there is an outstanding mortgage or mortgages on the Premises at such time Tenant shall assume the mortgage(s) and the cash portion of the Offer Price shall be deemed reduced by the outstanding principal balance of the mortgage(s) assumed); Section 3 (except that the closing date will be a date specified by Landlord that will be at least three (3) months but no more than six (6) months after Tenant's notice of election); and Sections 4(a), (b), (c) and (e). 3. No-sale Election. If Tenant validly elects the No-sale Election, then: (a) Until and unless Tenant otherwise agrees in writing, or Tenant defaults under this Lease or Tenant's rights under this Addendum #5 terminate, or the tenth (10th) Lease Year expires (whichever is earliest), Landlord will not sell or convey the Premises except to one of Landlord's Control Affiliates or to Tenant or one of its Related Entities or pursuant to the exercise of a Purchase Option; and (b) If Tenant validly elects the No-sale Election with respect to a particular Offer Notice and the No-sale Election subsequently terminates or expires, if Landlord wishes to proceed with the transaction which is the subject of that particular Offer Notice, Landlord shall deliver to Tenant another Offer Notice for that transaction, and Tenant shall have the right to elect the Purchase Election or the Existing Lease Election in connection therewith in accordance with Section 1(b) of this Addendum, except that Tenant shall make such election within thirty (30) days after delivery of the new Offer Notice, rather than ninety (90) days as otherwise provided in Section 1(b). 4. Existing Lease Election. (a) If Tenant validly elects (or is deemed to have elected) the Existing Lease Election, then for the next twelve (12) months after Tenant's election, Landlord may not sell or convey the Premises (other than pursuant to a sale or conveyance to any of Landlord's Control Affiliates) for a purchase price which is less than ninety-seven percent (97%) of the applicable Offer Price without first delivering to Tenant a new Offer Notice with an Offer Price equal to such new, lower purchase price. If Landlord delivers such a new Offer Notice, then Tenant shall have the right to elect either the Purchase Election or the No-sale Election (if the tenth (10th) Lease Year has not yet ended) or the Existing Lease Election in accordance with the procedures established in Section 1 above, except that Tenant will have forty-five (45) days, and not ninety (90) days, within which to respond to Landlord's new Offer Notice. If within twelve (12) months after Tenant validly elects (or is deemed to have elected) the Existing Lease Election in accordance with this Section 3 Landlord has not executed a binding agreement to sell or convey the Premises for a purchase price which is equal to or greater than ninety-seven percent (97%) of the new, lower Offer Price, or if Landlord has entered into such a binding agreement within the twelve (12)-month period but fails to close thereunder, then the terms and conditions in Section 1 above again will apply. (b) If Tenant validly elects (or is deemed to have elected) the Existing Lease Election, then Tenant will have the right, upon written request to Landlord, to participate reasonably and in good faith with Landlord in the negotiations conducted by Landlord to sell or convey the Premises, which negotiations will be subject to Landlord's control and direction. Tenant acknowledges and agrees that the manner and substance of these negotiations are critical to Landlord, and so Tenant will support Landlord's negotiating positions (provided that, unless Tenant otherwise agrees, such negotiating positions do not attempt to change Tenant's rights and 14 obligations under this Lease) and will not attempt to delay, obstruct or hinder these negotiations. Landlord will have the right at any time and in its sole discretion to suspend, terminate or continue such negotiations and, subject to Subsection (a) above, Articles 6 and 7 of this Addendum and the parenthetical in the preceding sentence, to accept or reject terms offered by prospective buyers and to execute documents and agreements, binding or otherwise, in connection with a sale or conveyance of the Premises. Tenant shall not have the right or power nor shall it attempt to bind Landlord in connection with a sale or conveyance of the Premises or to deal directly or negotiate alone with any prospective buyer or its agents without Landlord's prior written consent. 5. Termination of Rights. Notwithstanding anything to contrary, at Landlord's election all of Tenant's rights and Landlord's obligations under or in connection with this Addendum will lapse and become null and void upon: (a) The termination or expiration of the Lease term in accordance with its terms, prior to any closing hereunder; or (b) The bona fide purchase or other acquisition of all or substantially all of the Premises other than by any of Landlord's Control Affiliates prior to the valid exercise of the Purchase Election hereunder and other than any sale or conveyance which is prohibited under this Lease; or (c) As set forth in Section 9 below; or (d) At the end of the initial Lease term. 6. No Sale to Direct Competitors. Unless and until Tenant's rights under this Addendum have lapsed or terminated, Landlord shall not sell or convey the Premises to: AT&T, Intel, VTEL Corp., and Sony. 7. Restrictions on Landlord's Sale Rights. In addition to the other restrictions and limitations set forth in this Addendum on Landlord's right to sell or convey the Premises, until and unless Tenant defaults hereunder or the rest of the Lease, or the Lease expires or terminates, Landlord agrees that it will not sell or convey the Premises to anyone other than Tenant or any of its Control Affiliates or any of Landlord's Control Affiliates: for the first five (5) Lease Years; or other than for cash or cash equivalents (which will be deemed to include, without limitation, purchase money financing and/or the purchaser assuming or taking subject to debt). 8. Unaffected Parties. Notwithstanding anything to the contrary, Tenant's rights and Landlord's obligations under or in connection with this Addendum will not be binding on and will not affect or otherwise apply in any way to Landlord's Mortgagees or their successors, assigns and purchasers or their respective Affiliates, whether or not they take title to or acquire all or substantially all of the Premises. 9. Personal Rights. Notwithstanding anything to contrary, the rights of Tenant in this Addendum are granted only to and may be exercised only by the Tenant originally named in this Lease, and they may not be exercised by anyone else (other than by an assignee to whom such rights have been entirely assigned pursuant to a valid assignment of this Lease pursuant to which Tenant has become a Released Assignor, if at the time of such assignment the assignor and the assignee deliver to Landlord a jointly executed written notice stating unconditionally that the assignee has the right to exercise such rights) and Tenant shall not, and shall not have the right or power to, otherwise assign or otherwise Transfer any of its rights under or in connection this Addendum. Tenant may assign this Lease without granting to the assignee the rights of Tenant under this Addendum, and in such event: Tenant will retain those rights if and only if 15 Tenant has not become a Released Assignor in connection with its valid assignment of this Lease; and Tenant no longer will have the right thereafter to exercise the No-sale Election, and if Tenant fails to make its written election as and when required it will be deemed to have elected the Existing Lease Election. EX-10.16.3 5 SUBLEASE AGREEMENT 1 Exhibit 10.16.3 50 MINUTEMAN ROAD ANDOVER, MASSACHUSETTS SUBLEASE SUBLESSOR: PICTURETEL CORPORATION, A DELAWARE CORPORATION SUBLESSEE: CABLETRON SYSTEMS SALES & SERVICE, INC., A DELAWARE CORPORATION DATE: June 4, 1998 SUBLEASE 2 THIS SUBLEASE, dated and effective as of June 4, 1998, is between PICTURETEL CORPORATION, a Delaware corporation ("Sublessor"), and CABLETRON SYSTEMS SALES & SERVICE, INC., a Delaware corporation ("Sublessee"). RECITALS: A. Pursuant to that certain Amended and Restated Lease, dated as of August 25, 1998 (the "Main Lease"), between 50 Minuteman Limited Partnership ("Landlord"), as the landlord, and Sublessor, as the tenant, Sublessor is leasing from Landlord the improved real property commonly known as 50 Minuteman Road in Andover, Massachusetts, which is improved with, among other things, a building of approximately 151,800 square feet. This improved real property is described as the "Premises" in the Main Lease. Capitalized terms not otherwise defined herein shall have the meanings set forth in the Main Lease. B. Sublessor has agreed to sublease to Sublessee, and Sublessee has agreed to sublease from Sublessor, the entire Premises, for the Sublease Term, on the terms and conditions stated herein. AGREEMENTS: In consideration of the mutual covenants herein contained and for Ten Dollars ($10.00) and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. INCORPORATION OF MAIN LEASE. Except to the extent inconsistent with or modified by the terms and conditions of this Sublease, all terms and conditions of the Main Lease are hereby incorporated into this Sublease and shall govern Sublessee's use and occupancy of the Premises and its rights, obligations and liabilities with respect thereto, in the same manner as if Sublessee were the Tenant and Sublessor were the Landlord under the Main Lease, and the Sublease Term were the term under the Main Lease: PROVIDED, HOWEVER, that Sublessor shall not be obligated to pay for or provide any services to Sublessee or to or for the benefit of the Premises, or to repair or maintain the Premises or to pay for or perform the obligations of Landlord under the Main Lease, and whenever the obligations of Sublessor to Sublessee hereunder derive from the obligations of Landlord to Sublessor (including, without limitation, any consent or approval of Landlord or the provision of any services by Landlord under the Main Lease), the sole obligation of Sublessor shall be to use reasonably diligent efforts to obtain appropriate action on the part of Landlord (or omission to take action) in accordance with the terms of the Main Lease, but Sublessor shall not be liable to Sublessee if it fails to obtain such consent or approval or if Landlord takes any action or fails to take such appropriate action. However, if Landlord defaults under the Main Lease Sublessee shall have the right to avail itself of the "Right of Self Help" as set forth in Section 14.4 of the Main Lease (except that, in accordance with Section 1(h) hereof, the parenthetical at the end of Section 14.4 of the Main Lease shall be deemed deleted and shall not apply with respect to Sublessee). Subject to the foregoing, Sublessor and Sublessee each shall comply with and perform the terms and provisions of the Main Lease as if they were Landlord and Tenant, respectively, thereunder, to the extent the same are not inconsistent with or modified by the terms and provisions 2 3 of this Sublease (including, without limitation, obtaining approval or consent from Sublessor hereunder where such approval would be required under the Main Lease, and, in addition, obtaining such approval or consent from Landlord). The following provisions of the Main Lease shall NOT be incorporated into this Sublease (or shall be incorporated in modified form as set forth below): (a) Sections 1.1(a) and 1.1(b). The Commencement Date of this Sublease is the date first set forth above, and the Sublease Term begins on the Commencement Date and ends ten (10) Lease Years thereafter, unless terminated earlier per this Sublease or the Main Lease. (b) Section 1.1(g). (c) Section 1.1(l). (d) Section 2. (e) The first sentence of Section 4(a). (f) The last three sentences of Section 5(a) starting with the words "Notwithstanding the foregoing, if and for so long as...," and Section 5(b). (g) Sections 7.1(c) and 7.1(d), and the words "until the end of the ninth Lease Year," in the first and second lines of Section 7.1(b). (h) Addenda # 2, 3 and 4, and all references to any of them, including, without limitation, all references to Extension Options and Net Proceeds. (i) Section 9.3. (j) All of Section 18.4 after the words "other obligations under this Lease," in the fourth line thereof, and all references to a Released Assignor. (k) Sections 19.4 and 19.5. (l) Section 22.2(g). (m) The first sentence of Section 24.9 after the words "agreements or understandings" in the third line thereof. (n) Section 24.17 and all references to the Letter of Credit and the Letter of Credit Loan. (o) Exhibits "C", "D", "DD", "L" and "M". 3 4 2. DEMISE OF PREMISES; SUBLEASE TERM. Sublessor hereby leases to Sublessee, and Sublessee hereby leases from Sublessor, the Premises on the terms and conditions set forth herein, TO HAVE AND TO HOLD for the Sublease Term as defined in Section 1(a) hereof, except that this Sublease shall terminate when and if the Main Lease terminates. Sublessee has no right to extend the Sublease Term. This Sublease is and shall remain subject and subordinate in all respect to the Main Lease and to all extensions, modifications, consolidations and replacements thereof. It is the intention of the parties that Landlord shall retain all of its rights and remedies under the Main Lease and that Sublessee shall cooperate in connection with the exercise thereof and take (or omit to take) all actions as may be required of the Tenant under the Main Lease. 3. RENT. (a) Subject to Section 3(b) below, all rent payable by Sublessee (including, without limitation, Taxes, Operating Costs and utilities) shall be payable beginning as of the Commencement Date of this Sublease, and the annual base rent payable by Sublessee during the Sublease Term shall be as set forth below and shall be payable in equal monthly installments in advance beginning on the Commencement Date of this Sublease and thereafter on the first day of each month during the Sublease Term, prorated for any portion of a month. Base rent and all other rent payable by Sublessee shall be paid directly to or as directed by Landlord under the Main Lease (except that on request of Landlord or Sublessor, pursuant to Section 5(a) of the Main Lease, base rent shall be payable into the collection account described in said Section 5(a)), and receipt of such payments by Landlord or the collection account (as to base rent only) shall be deemed receipt by Sublessor hereunder, except that if and to the extent that Landlord or the collection account already has received from Sublessee for each month during the fifth through tenth Lease Years base rent of One Hundred Ninety Six Thousand and Seventy Five Dollars ($196,075), and Landlord receives all other rent due for such month, base rent hereunder for each such month in excess of $196,075 (i.e., $5,060) shall be paid directly to or as directed by Sublessor for so long as Sublessor is not in default under the Main Lease. Otherwise, all rent will be payable in accordance with Section 5(a) of the Main Lease. Lease Year Annual Base Rent ---------- ---------------- 1-4 $ 2,352,900 5-10 2,413,620 (b) Notwithstanding Section 3(a) above, Sublessee's obligation to pay base rent, Taxes and Operating Costs shall be entirely abated until October 1, 1998. 4. DEFAULT BY SUBLESSEE. Notwithstanding anything in the Main Lease to the contrary, for the purposes of determining applicable cure periods hereunder for a default by Sublessee, Sublessee's cure period hereunder shall be two (2) business days less than any such cure period granted to Sublessor as Tenant under the Main Lease. In addition, a valid notice of default from 4 5 Landlord under the Main Lease that is delivered to Sublessee (whether or not it is addressed to Sublessee) shall be deemed to be a valid notice of default delivered by Sublessor to Sublessee hereunder. 5. QUIET ENJOYMENT. Sublessor, with respect to the Sublease Term, covenants and agrees with Sublessee, that upon Sublessee paying the rent and performing the covenants of this Sublease, and subject to the terms and conditions of this Sublease, Sublessee shall peacefully and quietly have, hold and enjoy the Premises and all rights granted to Sublessee in this Sublease throughout the Sublease Term without hindrance or molestation by anyone claiming by or through Sublessor. 6. CONDITION OF THE PREMISES. By its execution hereto, Sublessee agrees that it accepts the Premises "as is" in all respects. Except as specifically set forth in Section 13 hereof, Sublessor is not making and Sublessee has not relied on any representations or warranties of any type, express or implied, in connection with the condition of the Premises or its fitness for any particular use. Sublessor shall have no obligation or duty to Sublessee regarding the preparation of the Premises for occupancy by Sublessee or the payment of any amounts in connection therewith. 7. INFRASTRUCTURE PAYMENT. The Building will be delivered to Sublessee with the existing above-standard finishes, Lucent switch, UPS system, generator and cabling, which shall remain Sublessor's property to the extent that such items are deemed to be "Tenant's Property" under the Main Lease, and Sublessee shall not remove any of the foregoing items at the expiration of the Sublease Term or otherwise. As payment for the use of these above-standard items during the Sublease Term, which were originally paid for by Sublessor, concurrently with its execution of this Sublease Sublessee shall pay to Sublessor the amount of One Million Dollars ($1,000,000) by cashier's check or wire transfer in good U.S. funds, which amount shall be in addition to, and shall not be credited against or reduce, any base rent or other rent payable by Sublessee hereunder. If and to the extent that Sublessee makes additions to these items during the Sublease Term and such additions would be deemed to be "Tenant's Property" under the Main Lease if made by Tenant thereunder, the additions shall be and remain Sublessee's property and may be removed by Sublessee at the end of the Sublease Term, provided that Sublessee shall repair any damage to these items caused thereby. 8. CASUALTY AND CONDEMNATION. If the Premises or any part thereof are damaged or destroyed by fire or other casualty or are Condemned, then: if and to the extent that the rent payable by Sublessor as Tenant under the Main Lease is abated as a result thereof, then rent under this Sublease shall be similarly abated to the same extent for the same period. If the Condemnation, damage or destruction is of the type which entitles either Landlord or Tenant to terminate the Main Lease in whole or in part and either such party elects to terminate, then this Sublease shall terminate to the same extent as of the same date. In addition, if the Condemnation, damage or destruction is of the type that would entitle Sublessor to terminate the Main Lease, then Sublessee shall have the right to terminate this Sublease to the same extent, subject to and in accordance with the terms and conditions of Article 17 or Section 16.2 of the Main Lease, as applicable. Sublessee agrees that Sublessor shall not, in any case, have any obligation whatsoever to rebuild or repair the Premises or pay any amounts in connection therewith. 5 6 9. INDEMNIFICATION AND INSURANCE. Sublessee acknowledges and agrees that: (a) Sublessee's indemnification and defense obligations hereunder, whether set forth specifically in this document or by incorporation of the Main Lease, shall also include the obligation to indemnify and defend Landlord and its Affiliates to the same extent; (b) all waivers and releases by Sublessee in this Sublease, whether set forth specifically in this document or by incorporation of the Main Lease or in some other document (including, without limitation, the waiver of subrogation required of Sublessee's insurers under Section 8.3 of the Main Lease), shall apply with respect to Sublessor and Landlord and its Affiliates; (c) all insurance required to be carried by Sublessee as set forth in Section 8.1 of the Main Lease shall comply with that Section and shall name as additional insureds Sublessor, Landlord and its general partners, Landlord's Mortgagees and any property managers; (d) Sublessor shall not be required to (although it may) carry any of the insurance required to be carried by Landlord under the Main Lease nor does Sublessor make any representations and warranties about the adequacy of any insurance to protect Sublessee's interests; and (e) nothing in this Sublease is intended to, nor shall it, affect any of the rights and obligations of Landlord and Sublessor under the Main Lease. 10. SIGNAGE. Subject to and in accordance with the terms and conditions of the Main Lease, Sublessee shall have the right at its cost to replace Sublessor's signage on and in the Building and to have its name placed on a monument sign outside of the Building. 11. ACTION WITH RESPECT TO MAIN LEASE. Sublessor shall not amend or modify (nor agree to amend or modify) the Main Lease in any way that would materially increase Sublessee's obligations or materially diminish Sublessee's rights under this Sublease without Sublessee's prior written consent. Sublessee shall not do or permit to be done anything that would increase Sublessor's obligations under the Main Lease nor shall Sublessor or Sublessee do or permit anything to be done that would cause a default under the Main Lease prior to the end of the Sublease Term. 12. SUBLESSOR'S RIGHTS AND REMEDIES. If Sublessee defaults hereunder Sublessor shall have all of the rights and remedies of Landlord under the Main Lease with respect to Sublessee's default, to the extent same are applicable thereto, provided, however, that notwithstanding anything contained in Exhibit "H" to the Main Lease to the contrary, for the purposes of this Sublease, the "Unamortized Costs" as shown in Exhibit "H" shall be reduced, as of any point in time during the term hereof, by the amount of the "Unamortized Costs" as shown in Exhibit "H" which are effective as of the date of the stated expiration date of the Sublease. 13. REPRESENTATIONS AND WARRANTIES: (a) Sublessor hereby represents and warrants that: (i) Sublessor is the Tenant under the Main Lease; (ii) the Main Lease is in full force and effect, and attached hereto as EXHIBIT AA is a true, correct and complete copy of the Main Lease; (iii) Sublessor has not received any notice of default under the Main Lease from Landlord relating to a default, or alleged default, which, as of the date hereof, remains uncured or has not been waived by Landlord; (iv) Sublessor is not insolvent and is able to pay its debts and other obligations as they come due, has not declared bankruptcy or filed a petition to take advantage of any law relating to bankruptcy, insolvency, reorganization, winding up or composition or adjustment of debts, and no such proceeding has been commenced against Sublessor seeking such relief, and Sublessor has no 6 7 knowledge that any such proceeding is threatened; (v) the execution and delivery of this Sublease by Sublessor has been authorized by all requisite corporate action; and (vi) to the best of Sublessor's knowledge, Sublessor has not created, released or disposed of any hazardous or toxic substances on, in or under the Premises in amounts that would require remediation under any applicable Laws. (b) Sublessee hereby represents and warrants that: Sublessee is not insolvent and is able to pay its debts and other obligations as they come due; Sublessee has not declared bankruptcy or filed a petition to take advantage of any law relating to bankruptcy, insolvency, reorganization, winding-up or composition or adjustment of debts and no such proceeding has been commenced against Sublessee seeking such relief, and Sublessor has no knowledge that any such proceeding is threatened; and the execution and delivery of this Sublease by Sublessee has been authorized by all requisite corporate action. (c) Except as specifically set forth in this Sublease, the parties are not making or relying on any representations or warranties of any kind, express or implied. 14. NO ASSIGNMENT OR SUBLEASE BY SUBLESSEE. Notwithstanding anything herein or in the Main Lease to the contrary, Sublessee shall have no right, power or authority to assign its rights under this Sublease or to sublease or sub-sublease the Premises or to otherwise engage in a Transfer (and Sublessor shall have no obligation to consent thereto), except for: (a) A valid assignment of this Sublease in accordance with the terms of Section 18 of the Main Lease, as modified by Section 1(j) hereof; or (b) A valid sub-sublease of a portion of the Premises in accordance with the terms of Section 18 of the Main Lease, as modified by Section 1(j) hereof, provided that at all times Sublessee still continues to sublease and occupy at least fifty percent (50%) of the Building, there shall be no more than one (1) sub-sublease/sub-sublessee, and prior to termination of this Sublease Sublessee shall, at its sole cost, remove any Alterations made in order to demise the Premises for the sub-sublessee, repair all damage and restore the Premises to the condition existing prior to such demising. 15. COMMUNICATION WITH LANDLORD. So long as Sublessee is not in default hereunder, and subject to all of the terms and conditions of this Sublease, Sublessee shall have the right, without the prior consent of Sublessor, to send notices to and communicate directly with Landlord under the Main Lease with respect to Landlord's obligations under the Main Lease, provided that copies of all such notices given to or received from Landlord by Sublessee (including, without limitation, requests for approvals, consents or waivers) are concurrently delivered to Sublessor, and that such notices or other communications shall not be deemed to modify the Main Lease or this Sublease or a party's rights and obligations thereunder. 16. NOTICES. All notices required or permitted hereunder shall be given and deemed effective in accordance with Section 24.16 of the Main Lease, and the addresses of Sublessor and Sublessee shall be as follows: If to Sublessor: PictureTel Corporation 7 8 100 Minuteman Road Andover, Massachusetts 01810 Attention: Chief Financial Officer with a copy to: PictureTel Corporation 100 Minuteman Road Andover, Massachusetts 01810 Attention: Vice President, Human Resources If to Sublessee: (FOR NOTICES OTHER THAN INVOICES) c/o Cabletron Systems, Inc. 35 Industrial Way Rochester, New Hampshire 03866 Attention: Legal Department (FOR INVOICES) c/o Cabletron Systems, Inc. PO Box 5010 Rochester, New Hampshire 03866 Any of the parties named in this Section may change its address by written notice sent to each of the other persons at the addresses as set forth herein. Copies of all notices also shall be delivered to Landlord at the then-current address for Landlord under the Main Lease, such delivery to be concurrent with the delivery of notices to Sublessor and Sublessee. 17. BROKERAGE. Within two (2) business days after receiving the One Million Dollar ($1,000,000) infrastructure payment from Sublessee, Sublessor shall pay as full and complete consideration $40,000 to Avalon Partners, Inc. (Sublessor's broker), and $460,000 to Grubb & Ellis and R.M. Bradley & Co., Inc. by joint check. Sublessee warrants and represents to Sublessor and Landlord that Sublessee has not dealt with any agent, broker or finder in connection with this Sublease or the Premises except Avalon Partners, Inc.and Grubb & Ellis and R.M. Bradley & Co., Inc., and agrees to indemnify and defend Sublessor and Landlord and hold them harmless from any loss, cost, damage, claims and liabilities of any type, including, without limitation, reasonable attorneys' fees and costs, incurred by Sublessor or Landlord for any breach of this representation and warranty and any claims by anyone (other than Avalon Partners, Inc.) claiming by, under or through Grubb & Ellis and R.M. Bradley & Co., Inc. for commissions or consideration. 8 9 18. AMENDMENT. This Sublease (and this Section) shall not be amended, altered or modified except by an instrument in writing executed by Sublessor and Sublessee and consented to by Landlord. 19. CONTINGENT EFFECTIVENESS AND SPECIAL TERMINATION CONDITIONS. This Sublease shall be effective as of the date first set forth above but may be terminated by Sublessor at any time, without Sublessor incurring any liability to Sublessee, if the following conditions are not satisfied: (a) concurrently with the delivery of this Sublease, Landlord, Sublessor, Sublessee and Cabletron Systems, Inc. ("Guarantor") each execute and deliver a letter agreement whereby Landlord consents to this Sublease (the "Consent Letter"); (b) concurrently with delivery of this Sublease, Landlord and Sublessor each receive from Sublessee Certificates of Insurance as required under this Sublease and the Consent Letter; (c) concurrently with the delivery of this Sublease, Guarantor executes and delivers a Continuing Guaranty of Sublease guarantying the payment and performance of Sublessee's obligations under this Sublease (the "Guaranty"); and (d) within fourteen (14) days after the date first set forth above, Landlord and Sublessor each receive certified copies of Board of Directors' Resolutions approving the execution and delivery of this Sublease, the Consent Letter and related documents by Sublessee, and the execution and delivery of the Guaranty, the Consent Letter and related documents by Guarantor. Sublessee also shall have the right to terminate this Sublease at any time without incurring any liability to Sublessor if within fourteen (14) days after the date first set forth above Sublessee has not received certified copies of the Board of Directors Resolution approving the execution and delivery of this Sublease, the Consent Letter and related documents by Sublessor. 9 10 IN WITNESS WHEREOF, intending to be legally bound, the parties have executed this Sublease under seal as of the date first above written. Sublessor: WITNESS: PICTURETEL CORPORATION, a Delaware corporation _______________________________ By: /s/ Authorized Signatory Name Printed: _____________________________________ Name: Title: Authorized Signature Sublessee: WITNESS: CABLETRON SYSTEMS SALES & SERVICE, INC., a Delaware corporation ________________________________ By: /s/ Authorized Signatory Name Printed: _____________________________________ Name: Title: Authorized Signature 10 11 EXHIBIT AA ---------- Main Lease 11 EX-10.17.2 6 AMEND #1 TO 200 MINUTEMAN LEASE DATED JUN.4, 1998 1 Exhibit 10.17.2 AMENDMENT #1 TO LEASE (200 MINUTEMAN) 1. Parties. This Amendment, dated as of June 4, 1998, is between 200 Minuteman Limited Partnership ("Landlord") and PictureTel Corporation ("Tenant"). 2. Recitals. 2.1 Landlord and Tenant have entered into a Lease, dated 3/19/97, for improved property located at 200 Minuteman Road, Andover, Massachusetts. This Lease, together with all amendments thereto, collectively are called the "Lease." Unless otherwise defined, terms used herein have the same meanings as those used in the Lease. 2.2 Landlord and Tenant wish to amend the Lease. To accomplish this, for good and valuable consideration, the receipt and sufficiency of which is acknowledged, the parties agree and the Lease is amended as follows: 3. Amendments. 3.1 Section 1.1(aa) is deleted and is replaced by the following: "(aa) "Commencement Date": The later of: September 15, 1998; or thirty (30) days after the Occupancy Date." 3.2 Addendum #4 and Addendum #5 are deleted, and Addendum #5 attached to and incorporated into this Amendment is substituted for Addendum #5 attached to the Lease. All references in this Lease to Addendum #4 and/or to any Purchase Options are deleted. 4. No Other Changes. The Lease remains in full force and effect, and except as set forth above it remains unchanged. IN WITNESS WHEREOF, intending to be legally bound, the parties have executed this Amendment under seal as of the date in Article 1 above. 200 MINUTEMAN LIMITED PARTNERSHIP, PICTURETEL CORPORATION, a Delaware a Delaware limited partnership corporation By: /s/ Authorized Signatory By: NIUNA-200 MINUTEMAN, INC., ______________________________ its general partner Name: Title: Authorized Signature By: /s/ Authorized Signatory _________________________ Name: Title: Authorized Signature By: /s/ Authorized Signatory ______________________________ Name: Title: Authorized Signature 2 ADDENDUM #5 RIGHT OF FIRST OFFER TO PURCHASE 1. Grant of Rights. (a) Subject to the terms of this Addendum, before Landlord sells or conveys the Premises during the initial Lease term (other than pursuant to a sale or conveyance to any of Landlord's Control Affiliates) Landlord shall notify Tenant in writing (the "Offer Notice") of the purchase price and the terms of payment thereof (e.g., all cash, or cash and purchase money financing or assumption of debt) that Landlord intends to accept for the Premises (the "Offer Price"). (b) Within sixty (60) days after delivery of the Offer Notice, Tenant shall notify Landlord in writing that it unconditionally elects one of the two (2) following alternatives: (i) To purchase the Premises for the applicable Offer Price and otherwise on the terms of this Addendum. (Tenant's election of the alternative described in this Subsection (i) is referred to as the "Purchase Election.") (ii) [INTENTIONALLY OMITTED] (iii) To permit Landlord to sell or convey the Premises in accordance with this Addendum and to continue to lease the Premises on the terms of this Lease. (Tenant's election of the alternative described in this Subsection (iii) is called the "Existing Lease Election.") (c) TIME IS ABSOLUTELY OF THE ESSENCE. If for any reason Landlord does not actually receive Tenant's unconditional written notice of election as and when required, Tenant shall be deemed to have elected the Existing Lease Election. At Landlord's election, all of Tenant's rights and Landlord's obligations under or in connection with this Addendum shall lapse and become null and void if Tenant defaults hereunder or under the rest of this Lease at any time prior to any closing hereunder, or if Tenant defaults in connection with any closing hereunder or fails to close as required after its election of the Purchase Election (an "Offer Default"). Any amounts payable under this Addendum in connection with the Purchase Election are deemed to be amounts payable under the Lease, and any default hereunder will be deemed to be a default under the Lease and in such case Landlord shall be entitled to all rights and remedies hereunder and under the rest of the Lease, including, without limitation, the right to require specific performance from Tenant. If Tenant commits an Offer Default, Tenant also shall indemnify and hold Landlord harmless from and against all Liabilities incurred by Landlord that arise from or in connection with the Offer Default. 2. Purchase Election. If Tenant validly exercises the Purchase Election, then Landlord shall sell and Tenant shall purchase the Premises on the following terms and conditions: (a) The Offer Price for the Premises shall be as specified in the Offer Notice, and the cash portion of the purchase price for the Premises shall be payable by cashier's check or wire transfer of immediately available funds to or at the direction of Landlord and will be payable in full on or before the scheduled closing date. In addition to the cash portion of the purchase price, as of the closing Tenant shall, as and to the extent set forth in the Offer Notice, either repay in full all mortgage loan(s) secured by the Premises, and any other loan secured by the Letter of Credit (if separate from such mortgage loan(s)), other than those that are Unpermitted Financing (the "Existing Loans") (including, without limitation, any prepayment or "breakage" fees or similar charges) or assume the Existing Loans, and in any case Tenant will cause the lender(s) to release Landlord and its Affiliates as of the closing from all Liabilities in connection with the Existing Loans and Tenant shall indemnify and hold Landlord and its Affiliates harmless from all further Liabilities in connection ADDENDUM #5 Page 1 of 4 3 with the Existing Loans. In addition to the purchase price, Tenant shall pay all closing costs of any type (other than Landlord's attorneys' fees and costs), including, without limitation, commissions (if any) and the costs of deed stamps and documentary and transfer taxes and fees, surveys, title insurance, escrows, recording and other similar fees and costs. Base rent will be prorated between the parties as of the closing date, but there will be no other prorations or adjustments. (b) The closing will occur at a location in Massachusetts and on a date specified by Landlord pursuant to written notice to Tenant, which date will be at least three (3) months but no more than six (6) months after the Purchase Election. At the closing, Landlord will execute and deliver to Tenant a Massachusetts Quitclaim Deed (which will be subject to all matters of record and all title and survey exceptions), an affidavit of Landlord stating Landlord's U.S. taxpayer identification number and that Landlord is not a "foreign person" within the meaning of Section 1445(f)(3) of the Internal Revenue Code of 1986, as amended or Landlord shall provide the necessary forms if Landlord is a "foreign person"), and a blanket assignment to Tenant of all third party guaranties, warranties, permits, certificates, consents and approvals pertaining to the Premises that are assignable by Landlord, to the extent assignable at no cost or Liabilities to Landlord (unless Tenant advances such costs and discharges such Liabilities, in which case they shall be assigned to the extent assignable by Landlord). (c) Tenant specifically acknowledges and agrees that Landlord will sell and Tenant will purchase the Premises on an "as is with all faults" basis, subject to all exceptions to and defects of title, whether or not of record (but subject also to Tenant's rights and Landlord's obligations as set forth below), and that Tenant will not rely on nor will Landlord or any of its Affiliates be deemed to have made, any representations or warranties of any kind, express or implied including, without limitation, those in connection with the physical condition of the Premises (including, without limitation, any matters involving Hazardous Substances or compliance with any Laws), or the nature of title to the Premises, or the advisability of Tenant's purchase of the Premises). However, until and unless Tenant otherwise agrees in writing or defaults Landlord will not voluntarily execute any documents affecting title that materially adversely affect Tenant's operations or that render title to the Premises unmarketable (but easements, dedications or other documents for access, drainage, utilities or services (including cabling), curb cuts, or as otherwise may be needed to comply with applicable Laws or to enable Landlord to meet its obligations under this Lease or in connection with the construction of any new building(s) or the enlargement of the Building per this Lease, will not be deemed to be violations of this restriction). If this restriction is violated after the exercise of the Purchase Election, Tenant shall have the right to terminate that Purchase Election without liability and receive any deposit back. Notwithstanding the foregoing, even if Tenant has validly exercised a Purchase Election, Tenant shall have the right to terminate that Purchase Election without liability (except for Landlord's out-of-pocket costs) and shall not be required to close the purchase if, after the exercise of the Purchase Election but prior to closing, there is a casualty that causes damage of the type and to the extent described in Section 16.2(b)(x) such that Tenant otherwise would have the right to terminate this Lease, and in the reasonable judgment of a qualified independent contractor hired by Landlord it will take more than two (2) years from the date of the damage to restore access or restore or replace the destroyed parking spaces or substantially complete the repairs that Landlord would have been required to make, and Tenant notifies Landlord of its intent to terminate within thirty (30) days after receiving the notice from Landlord's contractor, which shall be provided as soon as reasonably practicable after the damage occurs. If these circumstances occur, the closing date shall be extended as necessary to accommodate this thirty (30)-day period. If Tenant does not so terminate, or if Tenant is not permitted to so terminate as a result of a casualty, as of the closing Landlord will assign to Tenant all casualty insurance proceeds otherwise payable to Landlord on account of the damage and all rights and claims in connection therewith (other than those which Landlord was entitled to receive for the period and/or for the work and services performed prior to the closing). Notwithstanding anything to the contrary, if Landlord is in the process of repairing or rebuilding casualty damage and Tenant subsequently validly exercises a Purchase Election: Landlord will continue the process of repairing or rebuilding as otherwise required in this Lease until ADDENDUM #5 Page 2 of 4 4 the closing date under the Purchase Election; Tenant will be deemed to have waived its right to terminate this Lease under Article 16, and its right to terminate the Purchase Election in connection with that casualty or any repairs or rebuilding in connection therewith; Landlord will assign to Tenant as of the closing all casualty insurance proceeds otherwise payable to Landlord on account of the damage and all rights and claims in connection therewith (other than those which Landlord was entitled to receive for the period and/or for the work and services performed prior to the closing), and Landlord shall assign to Tenant and Tenant shall assume all rights and Liabilities of Landlord under the contracts entered into in connection with the repair or rebuilding to the extent assignable and Tenant shall indemnify Landlord and its Affiliates for and hold them harmless from all Liabilities in connection therewith; and Landlord shall be obligated to continue to repair or rebuild after the closing date only if and to the extent actually agreed to by Landlord and Tenant in good faith and in writing at the time. (d) As of the closing, Tenant and its Affiliates will be deemed to have released and discharged Landlord and its Affiliates from, and to have waived, all Liabilities of any type, known or unknown, including, without limitation, Liabilities under or in connection with this Lease and/or the Premises (except as set forth in the last sentence of Subsection (e) below). As a condition to closing, Landlord may require that Landlord's Mortgagees release Landlord and its Affiliates from Liabilities under or in connection with any Superior Leases or Mortgages. From and after the closing, Tenant shall indemnify, defend and hold Landlord free and harmless from all Liabilities under or in connection with this Lease and/or the Premises and/or the purchase thereof (except as set forth in the last sentence of Subsection (e) below). (e) Time is of the essence in this Addendum. If Tenant defaults hereunder after the closing under a Purchase Election or Tenant or Landlord defaults under any of the documents delivered by it in connection therewith, in addition to any rights and remedies available to each of the respective parties, each party shall have all rights and remedies at law and in equity, all of which are cumulative and not exclusive, including, without limitation, the right to require specific performance. The exercise of a Purchase Election or any closing as a result thereof shall not relieve Tenant or Landlord from any Liabilities for any defaults under this Lease, nor will they extinguish Liabilities for any indemnities or other obligations that survive pursuant to the terms of the rest of this Lease or this Addendum. 3. [INTENTIONALLY OMITTED] 4. Existing Lease Election. (a) If Tenant validly elects (or is deemed to have elected) the Existing Lease Election, then for the next twelve (12) months after Tenant's election, Landlord may not sell or convey the Premises (other than pursuant to a sale or conveyance to any of Landlord's Control Affiliates) for a purchase price which is less than ninety-seven percent (97%) of the applicable Offer Price without first delivering to Tenant a new Offer Notice with an Offer Price equal to such new, lower purchase price. If Landlord delivers such a new Offer Notice, then Tenant shall have the right to elect either the Purchase Election or the Existing Lease Election in accordance with the procedures established in Section 1 above, except that Tenant will have forty-five (45) days, and not sixty (60) days, within which to respond to Landlord's new Offer Notice. If within twelve (12) months after Tenant validly elects (or is deemed to have elected) the Existing Lease Election in accordance with this Section 3 Landlord has not executed a binding agreement to sell or convey the Premises for a purchase price which is equal to or greater than ninety-seven percent (97%) of the new, lower Offer Price, or if Landlord has entered into such a binding agreement within the twelve (12)-month period but fails to close thereunder, then the terms and conditions in Section 1 above again will apply. (b) If Tenant validly elects (or is deemed to have elected) the Existing Lease Election, then Tenant will have the right, upon written request to Landlord, to participate reasonably and in ADDENDUM #5 Page 3 of 4 5 good faith with Landlord in the negotiations conducted by Landlord to sell or convey the Premises, which negotiations will be subject to Landlord's control and direction. Tenant acknowledges and agrees that the manner and substance of these negotiations are critical to Landlord, and so Tenant will support Landlord's negotiating positions (provided that, unless Tenant otherwise agrees, such negotiating positions do not attempt to change Tenant's rights and obligations under this Lease) and will not attempt to delay, obstruct or hinder these negotiations. Landlord will have the right at any time and in its sole discretion to suspend, terminate or continue such negotiations and, subject to Subsection (a) above, Articles 6 and 7 of this Addendum and the parenthetical in the preceding sentence, to accept or reject terms offered by prospective buyers and to execute documents and agreements, binding or otherwise, in connection with a sale or conveyance of the Premises. Tenant shall not have the right or power nor shall it attempt to bind Landlord in connection with a sale or conveyance of the Premises or to deal directly or negotiate alone with any prospective buyer or its agents without Landlord's prior written consent. 5. Termination of Rights. Notwithstanding anything to contrary, at Landlord's election all of Tenant's rights and Landlord's obligations under or in connection with this Addendum will lapse and become null and void upon: (a) The termination or expiration of the Lease term in accordance with its terms, prior to any closing hereunder; or (b) The bona fide purchase or other acquisition of all or substantially all of the Premises other than by any of Landlord's Control Affiliates prior to the valid exercise of the Purchase Election hereunder and other than any sale or conveyance which is prohibited under this Lease; or (c) As set forth in Section 9 below; or (d) At the end of the initial Lease term. 6. No Sale to Direct Competitors. Unless and until Tenant's rights under this Addendum have lapsed or terminated, Landlord shall not sell or convey the Premises to: AT&T, Intel, VTEL Corp., and Sony. 7. [INTENTIONALLY OMITTED] 8. Unaffected Parties. Notwithstanding anything to the contrary, Tenant's rights and Landlord's obligations under or in connection with this Addendum will not be binding on and will not affect or otherwise apply in any way to Landlord's Mortgagees or their successors, assigns and purchasers or their respective Affiliates, whether or not they take title to or acquire all or substantially all of the Premises. 9. Personal Rights. Notwithstanding anything to contrary, the rights of Tenant in this Addendum are granted only to and may be exercised only by the Tenant originally named in this Lease, and they may not be exercised by anyone else (other than by an assignee to whom such rights have been entirely assigned pursuant to a valid assignment of this Lease pursuant to which Tenant has become a Released Assignor, if at the time of such assignment the assignor and the assignee deliver to Landlord a jointly executed written notice stating unconditionally that the assignee has the right to exercise such rights) and Tenant shall not, and shall not have the right or power to, otherwise assign or otherwise Transfer any of its rights under or in connection this Addendum. Tenant may assign this Lease without granting to the assignee the rights of Tenant under this Addendum, but in such event Tenant will retain those rights if and only if Tenant has not become a Released Assignor in connection with its valid assignment of this Lease. ADDENDUM #5 Page 4 of 4 EX-10.19 7 SECURED CREDIT AGREEMENT 1 Exhibit 10.19 SECOND AMENDED AND RESTATED SECURED REVOLVING CREDIT AGREEMENT Dated as of August 12, 1998 THIS SECOND AMENDED AND RESTATED SECURED REVOLVING CREDIT AGREEMENT is made as of August 12, 1998, by and among PICTURETEL CORPORATION (the "COMPANY"), a Delaware corporation having its chief executive office at 100 Minuteman Road, Andover, Massachusetts 01810 and BANKBOSTON, N.A., a national banking association, acting as agent for the Banks and the lending institutions listed on SCHEDULE 1 hereto. PRELIMINARY STATEMENT The Company, BankBoston, N.A. and certain other lending institutions have executed and delivered the Amended and Restated Revolving Credit Agreement dated as of December 19, 1996, (as amended and in effect from time to time, the "PRIOR CREDIT AGREEMENT"). The Company, the Agent and the Banks now wish to amend and restate the Prior Credit Agreement in full to reflect prior amendments to the Prior Credit Agreement and further amend the terms and conditions of the credit facilities provided in the Prior Credit Agreement. Accordingly, the Prior Credit Agreement is hereby amended and restated in its entirety as follows: SECTION I --------- DEFINITIONS ----------- 1.1. DEFINITIONS. All capitalized terms used in this Agreement or in any other Loan Document, certificate, report or other document made or delivered pursuant to this Agreement (unless otherwise defined therein) shall have the meanings assigned to them below: ADJUSTED EUROCURRENCY RATE. Applicable to any Interest Period, shall mean a rate per annum determined pursuant to the following formula: AER = [ IOR ]* ------- [1.00 - RP] AER = Adjusted Eurocurrency Rate IOR = Inter bank Offered Rate RP = Reserve Percentage *The amount in brackets shall be rounded upwards, if necessary, to the next higher 1/100 of 1%. 2 -2- Where: "INTER BANK OFFERED RATE" applicable to any Eurocurrency Loan for any Interest Period means the rate of interest determined by the Agent to be the prevailing rate per annum at which deposits in Dollars, or in the case of any Eurocurrency Loan denominated in an Alternative Currency, the relevant Alternative Currency, are offered to the Agent by first-class banks in the interbank Eurocurrency market in which it regularly participates on or about 11:00 a.m. (London time) two Business Days before the first day of such Interest Period in an amount approximately equal to the principal amount of the Eurocurrency Loan to which such Interest Period is to apply for a period of time approximately equal to such Interest Period. "RESERVE PERCENTAGE" applicable to any Interest Period means the rate (expressed as a decimal) applicable to the Agent during such Interest Period under regulations issued from time to time by the Board of Governors of the Federal Reserve System for determining the maximum reserve requirement (including, without limitation, any basic, supplemental, emergency or marginal reserve requirement) of the Agent, in the case of Eurocurrency Loans denominated in Dollars, with respect to "Eurocurrency liabilities" as that term is defined under such regulations, and in the case of all other Eurocurrency Loans, such reserve percentage, if any, with respect to any other category of liabilities which includes deposits by reference to which the interest rate of such Eurocurrency Loans is determined or any other category or extensions of credit or other assets of the Agent which includes any Eurocurrency Loans. The Adjusted Eurocurrency Rate shall be adjusted automatically as of the effective date of any change in the Reserve Percentage. AFFECTED LOANS. See Section 2.9(a). AFFILIATE. Any Person that would be considered to be an affiliate of the Company under Rule 144(a) of the Rules and Regulations of the Securities and Exchange Commission, as in effect on the date hereof, if the Company were issuing securities. AGENT. BankBoston, N.A. acting as agent for the Banks. AGENT'S HEAD OFFICE. The Agent's head office located at 100 Federal Street, Boston, Massachusetts 02110, or at such other location as the Agent may designate from time to time. 3 -3- AGENT'S SPECIAL COUNSEL. Bingham Dana LLP or such other counsel as may be approved by the Agent. AGREEMENT. This Agreement, as the same may be supplemented or amended from time to time. ALTERNATIVE CURRENCY. Australian Dollars, Deutche Marks, Swedish Krona, Sterling, Swiss Francs, Yen and French Francs, or any other currency (other than Dollars) approved by each of the Banks that is commonly dealt with in the interbank Eurocurrency market in which each of the Banks regularly participates, in each case so long as such currency is freely transferable and convertible into Dollars, but excluding any such currency for which the central bank or other governmental authorization in the country of issue is required to permit the use of such currency by any of the Banks for making any Loan hereunder and/or to permit the Company and the Borrowing Subsidiaries to borrow and repay the principal thereof and to pay the interest thereon, if such authorization has not been obtained. APPLICABLE MARGIN. One percent (1%). ASSIGNMENT AND ACCEPTANCE. See Section 10.1. BANKS. BankBoston, N.A. and the other lending institutions listed on SCHEDULE 1 hereto and any other lending institution which becomes an assignee of any rights and obligations of a Bank pursuant to Section 10. BASE RATE. The greater of (i) the rate of interest announced from time to time by the Agent at its head office as its Base Rate, and (ii) the Federal Funds Effective Rate plus 1/2 of 1% per annum (rounded upwards, if necessary, to the next 1/8 of 1%). BASE RATE LOAN. Any Loan bearing interest determined with reference to the Base Rate. BORROWING SUBSIDIARY. A Subsidiary that executes and delivers to the Bank a Letter Agreement. BUSINESS DAY. (i) For all purposes other than as covered by clause (ii) below, any day on which banks in Boston, Massachusetts are open for the conduct of a substantial part of their commercial banking business; and (ii) with respect to all notices and determinations in connection with, and payments of principal and interest on, Eurocurrency Loans, any day which is a Business Day described in clause (i) and which is also a day for trading by and between banks in Dollar and Alternative Currency deposits in the interbank Eurocurrency market in which the Agent regularly participates. CASH EQUIVALENTS. As at any date of determination, (i) marketable securities (a) issued or directly and unconditionally guaranteed as to 4 -4- interest and principal by the United States Government or (b) issued by any agency of the United States the obligations of which are backed by the full faith and credit of the United States, in each case maturing within one year after such date; (ii) marketable direct obligations issued by any state of the United States of America or any political subdivision of any such state or any public instrumentality thereof, in each case maturing within one year after such date and having, at the time of the acquisition thereof, the highest rating obtainable from either S&P or Moody's; (iii) commercial paper maturing no more than one year from the date of creation thereof and having, at the time of the acquisition thereof, a rating of at least A-1 from S&P or at least P-1 from Moody's'; (iv) certificates of deposit or bankers' acceptances maturing within one year after such date and issued or accepted by any Bank or by any commercial bank organized under the laws of the United States of America or any state thereof or the District of Columbia having, at the time of acquisition thereof, a rating of at least A-1 from S&P and at least P-1 from Moody's; (v) shares of any money market mutual fund that (a) has at least 95% of its assets invested continuously in the types of investments referred to in clauses (i), (ii), (iii) and (iv) above, (b) has net assets of not less than $500,000,000, and (c) has the highest rating obtainable from either S&P or Moody's; (vi) repurchase agreements collateralized by investments referred to in clause (i) above; and (vii) loan participations maturing within one year of acquisition thereof of obligors having, at the time of acquisition thereof, a rating of at least A-1 from S&P and at least P-1 from Moody's. CODE. The Internal Revenue Code of 1986 and the rules and regulations thereunder, collectively, as the same may from time to time be supplemented or amended and remain in effect. COLLATERAL. All of the property, rights and interests of the Company and its Subsidiaries that are or are intended to be subject to the security interests created by the Security Documents. COMMITMENT. With respect to each Bank, the amount set forth on SCHEDULE 1 hereto as the amount of such Bank's commitment to make Loans to, and to participate in the issuance, extension and renewal of Letters of Credit for the account of, the Company, as the same may be reduced from time to time; or if such commitment is terminated pursuant to the provisions hereof, zero. COMMITMENT PERCENTAGE. With respect to each Bank, the percentage set forth on SCHEDULE 1 hereto as such Bank's percentage of the Commitment Amount. COMMITMENT AMOUNT. $40,000,000 or any lesser amount, including zero, resulting from a termination or reduction of such amount in accordance with Section 2.5 or Section 8.2. COMMITMENT FEE. As defined in Section 2.4 hereof. 5 -5- COMPANY. See Preamble. COMPANY GUARANTY OR GUARANTIES. A guaranty or guaranties in substantially the form of EXHIBIT D hereto executed by the Company with respect to the Obligations of each Borrowing Subsidiary. CONSOLIDATED EBITDA. At any date as of which the amount thereof shall be determined, the consolidated earnings before interest and tax expense, depreciation and amortization of the Company and its Subsidiaries as of the last day of the immediately preceding fiscal quarter, for the four fiscal quarters then completed, as set forth on the financial statements of the Company most recently delivered pursuant to Section 6.1(a) or (b), as applicable. CONSOLIDATED NET INCOME. The consolidated net income (or deficit) of the Company and its Subsidiaries, after deduction of all expenses, taxes and other proper charges, determined in accordance with generally accepted accounting principles, after eliminated therefrom all extraordinary items of income; provided, however, for purpose of this Credit Agreement, Consolidated Net Income shall not include (a) the noncash writedown of research and development costs taken in connection with the Starlight Acquisition of up to a maximum aggregate amount of not more than $15,000,000; and (b) the noncash charge associated with the Company's deferred taxes of up to a maximum aggregate amount of not more than $42,000,000, which writedown and charges referred to in (a) and (b) above must be taken by not later than December 31, 1998. CONSOLIDATED TANGIBLE NET WORTH. At any date as of which the amount thereof shall be determined, the consolidated total assets of the Company and its Subsidiaries MINUS (i) the sum of any amounts attributable to (a) goodwill, (b) intangible items such as unamortized debt discount and expense, patents, trade and service marks and names, copyrights and research and development expenses except prepaid expenses, (c) all reserves not already deducted from assets, (d) any write-up in the book value of assets resulting from any revaluation thereof subsequent to the date of the financial statements referred to in Section 5.6 and (e) the value of any minority interests in Subsidiaries AND (ii) Consolidated Total Liabilities. CONSOLIDATED TOTAL LIABILITIES. At any date as of which the amount thereof shall be determined, all obligations that should, in accordance with generally accepted accounting principles, be classified as liabilities on the consolidated balance sheet of the Company and its Subsidiaries, including in any event all Indebtedness. CONTROLLED GROUP. All trades or businesses (whether or not incorporated) under common control that, together with the Company, are 6 -6- treated as a single employer under Section 414(b) or 414(c) of the Code or Section 4001 of ERISA. DEFAULT. An Event of Default or event or condition that, but for the requirement that time elapse or notice be given, or both, would constitute an Event of Default. DOLLAR EQUIVALENT. With respect to any Eurocurrency Loan denominated in an Alternative Currency, on any date of determination, the amount in Dollars that would be required to purchase such Alternative Currency in the amount of such Loan on the date two Business Days prior to such date of determination, at the Agent's spot buying rate for such Alternative Currency at the close of business on the Business Day immediately preceding such date of determination. DOLLARS AND $. Lawful money of the United States of America. DRAWDOWN DATE. The date on which any Loan is made or is to be made, and the date on which any Loan is converted or continued in accordance with Section 2.3. ELIGIBLE ASSIGNEE. Any of (i) a commercial bank organized under the laws of the United States, or any State thereof or the District of Columbia, and having total assets in excess of $1,000,000,000; (ii) a savings and loan association or savings bank organized under the laws of the United States, or any State thereof or the District of Columbia, and having a net worth of at least $100,000,000, calculated in accordance with generally accepted accounting principles; (iii) a commercial bank organized under the laws of any other country which is a member of the Organization for Economic Cooperation and Development (the "OECD"), or a political subdivision of any such country, and having total assets in excess of $1,000,000,000, PROVIDED that such bank is acting through a branch or agency located in the country in which it is organized or another country which is also a member of the OECD; (iv) the central bank of any country which is a member of the OECD; and (v) if, but only if, any Event of Default has occurred and is continuing, any other bank, insurance company, commercial finance company or other financial institution or other Person approved by the Agent, such approval not to be unreasonably withheld. ENCUMBRANCES. See Section 7.1. ENVIRONMENTAL LAWS. Any and all applicable foreign, federal, state and local environmental, health or safety statutes, laws, regulations, rules, ordinances, policies and rules or common law (whether now existing or hereafter enacted or promulgated), of all governmental agencies, bureaus or departments which may now or hereafter have jurisdiction over the Company or any of its Subsidiaries and all applicable judicial and administrative and regulatory decrees, judgments and orders, including common law rulings and determinations, relating to injury to, or the 7 -7- protection of, real or personal property or human health or the environment, including, without limitation, all requirements pertaining to reporting, licensing, permitting, investigation, remediation and removal of emissions, discharges, releases or threatened releases of Hazardous Materials, chemical substances, pollutants or contaminants whether solid, liquid or gaseous in nature, into the environment or relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of such Hazardous Materials, chemical substances, pollutants or contaminants. ERISA. The Employee Retirement Income Security Act of 1974 and the rules and regulations thereunder, collectively, as the same may from time to time be supplemented or amended and remain in effect. EUROCURRENCY LOAN. Any Loan bearing interest at a rate determined with reference to the Adjusted Eurocurrency Rate. EVENT OF DEFAULT. Any event described in Section 8.1. FEDERAL FUNDS EFFECTIVE RATE. For any day, a fluctuating interest rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent. GERMAN OVERDRAFT AMOUNT. The outstanding principal amount of all loans or other advances made to PictureTel GmbH by the Overdraft Lender pursuant to the Overdraft Documents maintained by such Overdraft Lender to PictureTel GmbH and any outstanding amounts owed pursuant to any guarantee thereof by the Company. GUARANTEES. As applied to the Company and its Subsidiaries, all guarantees, endorsements or other contingent or surety obligations with respect to obligations of others whether or not reflected on the consolidated balance sheet of the Company and its Subsidiaries, including any obligation to furnish funds, directly or indirectly (whether by virtue of partnership arrangements, by agreement to keep-well or otherwise), through the purchase of goods, supplies or services, or by way of stock purchase, capital contribution, advance or loan, or to enter into a contract for any of the foregoing, for the purpose of payment of obligations of any other person or entity. HAZARDOUS MATERIAL. Any substance (i) the presence of which requires or may hereafter require notification, investigation or remediation under any Environmental Law; (ii) which is or becomes defined as a "hazardous 8 -8- waste", "hazardous material" or "hazardous substance" or "controlled industrial waste" or "pollutant" or "contaminant" under any present or future Environmental Law or amendments thereto including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act (42 U.S.C. Section 9601 ET SEQ.) and any applicable local statutes and the regulations promulgated thereunder; (iii) which is toxic, explosive, corrosive, flammable, infectious, radioactive, carcinogenic, mutagenic or otherwise hazardous and is or becomes regulated by any governmental authority, agency, department, commission, board, agency or instrumentality of any foreign country, the United States, any state of the United States, or any political subdivision thereof to the extent any of the foregoing has or had jurisdiction over the Company; or (iv) without limitation, which contains gasoline, diesel fuel or other petroleum products, asbestos or polychlorinated biphenyls ("PCB's"). INDEBTEDNESS. As applied to the Company and its Subsidiaries, (i) all obligations for borrowed money or other extensions of credit whether or not secured or unsecured, absolute or contingent, including, without limitation, unmatured reimbursement obligations with respect to letters of credit or guarantees issued for the account of or on behalf of the Company and its Subsidiaries and all obligations representing the deferred purchase price of property, other than accounts payable arising in the ordinary course of business, (ii) all obligations evidenced by bonds, notes, debentures or other similar instruments, (iii) all obligations secured by any mortgage, pledge, security interest or other lien on property owned or acquired by the Company or any of its Subsidiaries whether or not the obligations secured thereby shall have been assumed, (iv) that portion of all obligations arising under capital leases that is required to be capitalized on the consolidated balance sheet of the Company and its Subsidiaries, (v) all Guarantees, and (vi) all obligations that are immediately due and payable out of the proceeds of or production from property now or hereafter owned or acquired by the Company or any of its Subsidiaries. INTEREST PERIOD. With respect to each Eurocurrency Loan, the period commencing on the date of the making or continuation of or conversion to such Eurocurrency Loan and ending one, two, three or six months thereafter, as the Company may elect in the applicable Notice of Borrowing or Conversion, PROVIDED that: (i) any Interest Period (other than an Interest Period determined pursuant to clause (iii) below) that would otherwise end on a day that is not a Business Day shall be extended to the next succeeding Business Day unless, in the case of Eurocurrency Loans, such Business Day falls in the next calendar month, in which case such Interest Period shall end on the immediately preceding Business Day; (ii) any Interest Period applicable to a Eurocurrency Loan that begins on the last Business Day of a calendar month (or on a day 9 -9- for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (iii) below, end on the last Business Day of a calendar month; (iii) any Interest Period that would otherwise end after the Termination Date shall end on the Termination Date; and (iv) notwithstanding clause (iii) above, no Interest Period applicable to a Eurocurrency Loan shall have a duration of less than one month, and if any Interest Period applicable to any such Loan would be for a shorter period, such Interest Period shall not be available hereunder. INVESTMENTS. All expenditures made and all liabilities incurred (contingently or otherwise) for the acquisition of stock or Indebtedness of, or for loans, advances, capital contributions or transfers of property to, or in respect of any guaranties (or other commitments as described under Indebtedness), or obligations of, any Person. In determining the aggregate amount of Investments outstanding at any particular time: (i) the amount of any Investment represented by a guaranty shall be taken at not less than the principal amount of the obligations guaranteed and still outstanding; (ii) there shall be included as an Investment all interest accrued with respect to Indebtedness constituting an Investment unless and until such interest is paid; (iii) there shall be deducted in respect of each such Investment any amount received as a return of capital (but only by repurchase, redemption, retirement, repayment, liquidating dividend or liquidating distribution); (iv) there shall not be deducted in respect of any Investment any amounts received as earnings on such Investment, whether as dividends, interest or otherwise, except that accrued interest included as provided in the foregoing clause (ii) may be deducted when paid; and (v) there shall not be deducted from the aggregate amount of Investments any decrease in the value thereof. LENDING OFFICE. The office of each Bank designated by such Bank to the Agent from time to time PROVIDED that any Bank may, with respect to any Loan, designate a different Lending Office for such Loan by notice to the Agent and the Company or the applicable Borrowing Subsidiary. LETTER AGREEMENT. A letter agreement between the Agent and a Borrowing Subsidiary, in substantially the form of EXHIBIT C hereto. LETTER OF CREDIT. A documentary or standby letter of credit opened for the account of the Company pursuant to the terms of Section 2.2 of this Agreement, and "LETTERS OF CREDIT" means all of such Letters of Credit, collectively. LETTER OF CREDIT APPLICATION. A Letter of Credit Application and Agreement, substantially in the form of EXHIBIT B hereto, or such other form as is used by the Agent in the ordinary course of its business, delivered to 10 -10- the Agent pursuant to Section 2.2 hereof, and "LETTER OF CREDIT APPLICATIONS" means all of such Letter of Credit Applications, collectively. To the extent any provision of any Letter of Credit Application is inconsistent with the provisions of this Agreement, the provisions of this Agreement shall prevail. LETTER OF CREDIT PARTICIPATION. See Section 2.2.1.4. LOAN. A loan made to the Company or a Borrowing Subsidiary by the Banks pursuant to Section II of this Agreement, and "LOANS" means all of such loans, collectively. LOAN DOCUMENTS. This Agreement, the Notes, the Letter of Credit Applications and each Letter of Credit issued thereunder, the Letter Agreements, the Company Guaranties, the Security Documents and all other documents and agreements required to be executed in connection herewith and therewith. MAJORITY BANKS. As of any date, not less than two Banks holding at least fifty-one percent (51%) of the outstanding principal amount of the Notes on such date; and if no such principal is outstanding, not less than two Banks whose aggregate commitment Percentages constitutes at least fifty-one percent (51%). MATERIAL SUBSIDIARY. Any Borrowing Subsidiary and any other Subsidiary of the Company whose proportionate share of (i) the consolidated total assets (after intercompany eliminations) of the Company and its Subsidiaries as of the end of the most recently completed fiscal quarter or (ii) the consolidated total revenues for the portion of the year then ended exceeds 10%. MAXIMUM DRAWING AMOUNT. The maximum aggregate amount that the beneficiaries may at any time draw under outstanding Letters of Credit, as such aggregate amount may be reduced from time to time pursuant to the terms of the Letters of Credit. NOTE(S). Promissory notes of the Company or a Borrowing Subsidiary, substantially in the form of EXHIBIT A hereto, evidencing the obligation of the Company or such Borrowing Subsidiary to each Bank to repay its Loans. NOTICE OF BORROWING OR CONVERSION. See Section 2.3(a). OBLIGATIONS. Collectively (a) any and all obligations of the Company and the Borrowing Subsidiaries to any of the Agent and the Banks hereunder and under the other Loan Documents, of every kind and description, direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter arising, regardless of how they arise or by what agreement or instrument, if any, and including obligations to perform acts and refrain from taking action as well as 11 -11- obligations to pay money; (b) any and all obligations of PictureTel UK Ltd., PictureTel GmbH and the Company to the Overdraft Lender under the other Overdraft Documents, of every kind and description, direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter arising, regardless of how they arise or by what agreement or instrument, if any, and including obligations to perform acts and refrain from taking action as well as obligations to pay money; and (c) any and all obligations of the Company or any of its Subsidiaries to any of the Banks, up to a maximum aggregate amount of $1,000,000 for each Bank, under any foreign exchange contracts or other similar arrangements, of every kind and description, direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter arising, regardless of how they arise or by what agreement or instrument, if any, and including obligations to perform acts and refrain from taking action as well as obligations to pay money. OVERDRAFT AMOUNT. Collectively, the UK Overdraft Amount and the German Overdraft Amount. OVERDRAFT DOCUMENTS. Collectively, those documents, instruments and agreements executed by each of PictureTel UK Limited, PictureTel GmbH, the Company and the Overdraft Lender pertaining to each of the overdraft facilities maintained by such Overdraft Lender to each of PictureTel UK Ltd. and PictureTel GmbH and any guarantees thereof by the Company. OVERDRAFT LENDER. BankBoston, N.A., acting through its London branch. PBGC. The Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. PERMITTED ENCUMBRANCES. See Section 7.1. PERSON. Any individual, corporation, partnership, trust, unincorporated association, business, or other legal entity, and any government or any governmental agency or political subdivision thereof. PLAN. At any time, an employee pension or other benefit plan that is subject to Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Code and is either (i) maintained by the Company or any member of the Controlled Group for employees of the Company or any member of the Controlled Group or (ii) if such Plan is established, maintained pursuant to a collective bargaining agreement or any other arrangement under which more than one employer makes contributions and to which the Company or any member of the Controlled Group is then making or accruing an obligation to make contributions or has within the preceding five Plan years made contributions. 12 -12- PLEDGE AGREEMENT. That certain Pledge Agreement dated as of March 3, 1998 between the Company and the Agent, and in form and substance satisfactory to the Agent and the Banks. REIMBURSEMENT OBLIGATION. The Company's obligation to reimburse the Agent and the Banks on account of any drawing under any Letter of Credit as provided in Section 2.2.2. SECURITY DOCUMENTS. Collectively, the Pledge Agreement and all other instruments and documents, including without limitation Uniform Commercial Code financing statements, required to be executed or deliver pursuant to the Pledge Agreement. STARLIGHT ACQUISITION. See Section 7.5 hereof. SUBSIDIARY. Any corporation, association, joint stock company, business trust or other similar organization of which 50% or more of the ordinary voting power for the election of a majority of the members of the board of directors or other governing body of such entity is held or controlled by the Company or a Subsidiary of the Company; or any other such organization the management of which is directly or indirectly controlled by the Company or a Subsidiary of the Company through the exercise of voting power or otherwise; or any joint venture, whether incorporated or not, in which the Company has a 50% ownership interest. TERMINATION DATE. October 4, 1999. UK OVERDRAFT AMOUNT. The outstanding principal amount of all loans or other advances made to PictureTel UK Limited by the Overdraft Lender pursuant to the Overdraft Documents maintained by such Overdraft Lender to PictureTel UK Limited and any outstanding amounts owed pursuant to any guarantee thereof by the Company. UNIFORM CUSTOMS. With respect to any Letter of Credit, the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500 or any successor version thereto adopted by the Agent in the ordinary course of its business as a letter of credit issuer and in effect at the time of issuance of such Letter of Credit. UNPAID REIMBURSEMENT OBLIGATION. Any Reimbursement Obligation for which the Company does not reimburse the Agent and the Banks on the date specified in, and in accordance with, Section 2.2.2. 1.2. ACCOUNTING TERMS. All terms of an accounting character shall have the meanings assigned thereto by generally accepted accounting principles applied on a basis consistent with the financial statements referred to in Section 5.6 of this Agreement, modified to the extent, but only to the extent, that such meanings are specifically modified herein. 13 -13- SECTION II ---------- DESCRIPTION OF CREDIT --------------------- 2.1. THE LOANS. (a) Subject to the terms and conditions hereof, each Bank severally agrees to make Loans to the Company, from time to time until the close of business on the Termination Date, in such sums as the Company may request; PROVIDED that the aggregate principal amount of all Loans to the Company at any one time outstanding hereunder shall not exceed the Commitment Amount LESS the amount of all then outstanding Loans of the Borrowing Subsidiaries LESS the Overdraft Amount and LESS the Maximum Drawing Amount of outstanding Letters of Credit and all Unpaid Reimbursement Obligations. Such Loans may be Base Rate Loans or Eurocurrency Loans, as the Company may elect. Subject to the terms and conditions hereof, the Banks will also make Loans to any Borrowing Subsidiary, from time to time until the close of business on the Termination Date, in such sums as such Borrowing Subsidiary may request; PROVIDED that the aggregate principal amount of all Loans to such Borrowing Subsidiary at any one time outstanding hereunder shall not exceed the Commitment Amount LESS the amount of all then outstanding Loans of the Company and all other Borrowing Subsidiaries LESS the Overdraft Amount and LESS the Maximum Drawing Amount of outstanding Letters of Credit and all Unpaid Reimbursement Obligations. Such Loans may be Base Rate Loans or Eurocurrency Loans, as such Borrowing Subsidiary shall elect. Within the above limitations, the Company and the Borrowing Subsidiaries may borrow, prepay pursuant to Section 2.11 and reborrow, from the date of this Agreement until the Termination Date, the full amount of the Commitment Amount or any lesser sum that is, in the case of Base Rate Loans, at least $50,000 and an integral multiple of $10,000 and, in the case of Eurocurrency Loans, at least $500,000 and an integral multiple of $10,000. Any Loan not repaid by the Termination Date shall be due and payable on the Termination Date. (b) Provided that no Default shall have occurred and be continuing, the Company may convert all or any part (in the case of Base Rate Loans, in a minimum amount of $50,000 and an integral multiple of $10,000 and, in the case of Eurocurrency Loans, in a minimum amount of $500,000 and an integral multiple of $10,000) of any outstanding Loan into a Loan of any other type provided for in this Agreement in the same aggregate principal amount, on any Business Day (which, in the case of a conversion of a Eurocurrency Loan, shall be the last day of the Interest Period applicable to such Eurocurrency Loan). The Company shall give the Agent prior notice of each such conversion (which notice shall be effective upon receipt) in accordance with Section 2.3. (c) For purposes of determining whether the amount of any requested borrowing, when added to the aggregate principal amount of all then outstanding Loans, would exceed the Commitment Amount, the 14 -14- amount of each outstanding Eurocurrency Loan denominated in an Alternative Currency shall be deemed to be the Dollar Equivalent of such Loan on the date of the requested borrowing. 2.2. LETTERS OF CREDIT. 2.2.1. LETTER OF CREDIT COMMITMENTS. 2.2.1.1. COMMITMENT TO ISSUE LETTERS OF CREDIT. Subject to the terms and conditions hereof and the execution and delivery by the Company of a Letter of Credit Application, the Agent on behalf of the Banks and in reliance upon the agreement of the Banks set forth in Section 2.2.1.4 and upon the representations and warranties of the Company contained herein, agrees, in its individual capacity, to issue, extend and renew for the account of the Company one or more standby or documentary Letters of Credit, in such form as may be requested from time to time by the Company and agreed to by the Agent; provided, however, that, after giving effect to such request, (a) the sum of the aggregate Maximum Drawing Amount and all Unpaid Reimbursement Obligations shall not exceed $30,000,000 at any one time and (b) the sum of (i) the Maximum Drawing Amount on all Letters of Credit, (ii) all Unpaid Reimbursement Obligations, and (iii) the amount of all Loans outstanding and the Overdraft Amount shall not exceed the Commitment Amount. 2.2.1.2. LETTER OF CREDIT APPLICATIONS. Each Letter of Credit Application shall be completed to the satisfaction of the Agent. In the event that any provision of any Letter of Credit Application shall be inconsistent with any provision of this Agreement, then the provisions of this Agreement shall, to the extent of any such inconsistency, govern. 2.2.1.3 TERMS OF LETTERS OF CREDIT. Each Letter of Credit issued, extended or renewed hereunder shall, among other things, (i) provide for the payment of sight drafts for honor thereunder when presented in accordance with the terms thereof and when accompanied by the documents described therein or otherwise provide for payment as specified in such Letter of Credit, and (ii) have an expiry date no later than the date which is fourteen (14) days (or, if the Letter of Credit is confirmed by a confirmer or otherwise provides for one or more nominated persons, forty-five (45) days) prior to the Termination Date. Each Letter of Credit so issued, extended or renewed shall be subject to the Uniform Customs. 2.2.1.4. REIMBURSEMENT OBLIGATIONS OF BANKS. Each Bank severally agrees that it shall be absolutely liable, without regard to the occurrence of any Default or Event of Default or any other condition precedent whatsoever, to the extent of such Bank's Commitment Percentage, to reimburse the Agent on demand for the amount of each draft paid by the Agent under each Letter of Credit to the extent that such amount is not reimbursed by the Company pursuant to Section 2.2.2 (such 15 -15- agreement for a Bank being called herein the "Letter of Credit Participation" of such Bank). 2.2.1.5. PARTICIPATIONS OF BANKS. Each such payment made by a Bank shall be treated as the purchase by such Bank of a participating interest in the Company's Reimbursement Obligation under Section 2.2.2 in an amount equal to such payment. Each Bank shall share in accordance with its participating interest in any interest which accrues pursuant to Section 2.2.2. 2.2.2. REIMBURSEMENT OBLIGATION OF THE COMPANY. In order to induce the Agent to issue, extend and renew each Letter of Credit and the Banks to participate therein, the Company hereby agrees to reimburse or pay to the Agent, for the account of the Agent or (as the case may be) the Banks, with respect to each Letter of Credit issued, extended or renewed by the Agent hereunder, (a) except as otherwise expressly provided in Section 2.2.2(b) and (c), on each date that any draft presented under such Letter of Credit is honored by the Agent, or the Agent otherwise makes a payment with respect thereto, (i) the amount paid by the Agent under or with respect to such Letter of Credit, and (ii) the amount of any taxes, fees, charges or other costs and expenses whatsoever incurred by the Agent or any Bank in connection with any payment made by the Agent or any Bank under, or with respect to, such Letter of Credit, (b) upon the reduction (but not termination) of the Commitment Amount to an amount less than the Maximum Drawing Amount, an amount equal to such difference, which amount shall be held by the Agent for the benefit of the Banks and the Agent as cash collateral for all Reimbursement Obligations, and (c) upon the termination of the Commitment Amount, or the acceleration of the Reimbursement Obligations with respect to all Letters of Credit in accordance with Section 8.2, an amount equal to the then Maximum Drawing Amount on all Letters of Credit, which amount shall be held by the Agent for the benefit of the Banks and the Agent as cash collateral for all Reimbursement Obligations. Each such payment shall be made to the Agent at the Agent's Head Office in immediately available funds. Interest on any and all amounts remaining unpaid by the Company under this Section 2.2.2 at any time from the date such amounts become due and payable (whether as stated in this Section 2.2.2, by acceleration or otherwise) until payment in full (whether before or after judgment) shall be payable to the Agent on demand at the rate specified in Section 2.13 for overdue principal on the Loans. 2.2.3. LETTER OF CREDIT PAYMENTS. If any draft shall be presented or other demand for payment shall be made under any Letter of Credit, the 16 -16- Agent shall notify the Company of the date and amount of the draft presented or demand for payment and of the date and time when it expects to pay such draft or honor such demand for payment. If the Company fails to reimburse the Agent as provided in Section 2.2 on or before the date that such draft is paid or other payment is made by the Agent, the Agent may at any time thereafter notify the Banks of the amount of any such Unpaid Reimbursement Obligation. No later than 3:00 p.m. (Boston time) on the Business Day next following the receipt of such notice, each Bank shall make available to the Agent, at its Head Office, in immediately available funds, such Bank's Commitment Percentage of such Unpaid Reimbursement Obligation, together with an amount equal to the product of (i) the average, computed for the period referred to in clause (iii) below, of the weighted average interest rate paid by the Agent for federal funds acquired by the Agent during each day included in such period, times (ii) the amount equal to such Bank's Commitment Percentage of such Unpaid Reimbursement Obligation, times (iii) a fraction, the numerator of which is the number of days that elapse from and including the date the Agent paid the draft presented for honor or otherwise made payment to the date on which such Bank's Commitment Percentage of such Unpaid Reimbursement obligation shall become immediately available to the Agent, and the denominator of which is 360. The responsibility of the Agent to the Company and the Banks shall be only to determine that the documents (including each draft) delivered under each Letter of Credit in connection with such presentment shall be in conformity in all material respects with such Letter of Credit. 2.2.4. OBLIGATIONS ABSOLUTE. The Company's obligations under this Section 2.2 shall be absolute and unconditional under any and all circumstances and irrespective of the occurrence of any Default or Event of Default or any condition precedent whatsoever or any setoff, counterclaim or defense to payment which the Company may have or have had against the Agent, any Bank or any beneficiary of a Letter of Credit. The Company further agrees with the Agent and the Banks that the Agent and the Banks shall not be responsible for, and the Company's Reimbursement Obligations under Section 2.2.2 shall not be affected by, among other things, the validity or genuineness of documents or of any endorsements thereon, even if such documents should in fact prove to be in any or all respects invalid, fraudulent or forged, or any dispute between or among the Company, the beneficiary of any Letter of Credit or any financing institution or other party to which any Letter of Credit may be transferred or any claims or defenses whatsoever of the Company against the beneficiary of any Letter of Credit or any such transferee. The Agent and the Banks shall not be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit. The Company agrees that any action taken or omitted by the Agent or any Bank under or in connection with each Letter of Credit and the related drafts and documents, if done in good faith, shall be binding upon the Company and shall not result in any liability on the part of the Agent or any Bank to the Company. 17 -17- 2.2.5. RELIANCE BY AGENT. To the extent not inconsistent with Section 2.2.4, the Agent shall be entitled to rely, and shall be fully protected in relying upon, any Letter of Credit, draft, writing, resolution, notice, consent, certificate, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. The Agent shall be fully justified in failing or refusing to take any action under this Agreement unless it shall first have received such advice or concurrence of the Majority Banks as it reasonably deems appropriate or it shall first be indemnified to its reasonable satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Agent shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement in accordance with a request of the Majority Banks, and such request and any action taken or failure to act pursuant thereto shall be binding upon the Banks and all future holders of the Notes or of a Letter of Credit Participation. 2.3. MAKING LOANS. 2.3.1. NOTICE AND MANNER OF BORROWING OR CONVERSION OF LOANS. (a) Whenever the Company or a Borrowing Subsidiary desires to obtain or continue a Loan hereunder or convert an outstanding Loan into a Loan of another type provided for in this Agreement, the Company or such Borrowing Subsidiary shall notify the Agent (which notice shall be irrevocable) by telex, telegraph, telephone or facsimile transmission received no later than 10:00 a.m. Boston time (i) on the date on which the requested Loan is to be made as a Base Rate Loan; and (ii) on the date three Business Days before the day on which the requested Loan is to be made or continued as or converted to a Eurocurrency Loan. Such notice shall specify (i) the effective date and amount of each Loan or portion thereof to be made, continued or converted, subject to the limitations set forth in Section 2.1, (ii) the interest rate option to be applicable thereto, (iii) the duration of the applicable Interest Period, if any (subject to the provisions of the definition of Interest Period and Section 2.7), and (iv) if such Loan is to be made as a Eurocurrency Loan in an Alternative Currency, the currency thereof. Each such notification (a "NOTICE OF BORROWING OR CONVERSION") shall be immediately followed by a written confirmation thereof by the Company or such Borrowing Subsidiary in substantially the form of EXHIBIT E hereto, PROVIDED that if such written confirmation differs in any material respect from the action taken by the Agent, the records of the Agent shall control absent manifest error. (b) Subject to the terms and conditions hereof, the Agent shall make each Loan on the effective date specified therefor by crediting the amount of such Loan to the demand deposit account of the Company maintained at the Agent's Head Office, or to such other account as such 18 -18- Borrowing Subsidiary shall direct, in immediately available funds (or, in the case of Eurocurrency Loans denominated in an Alternative Currency, in such funds as may then be customary for the settlement of transactions in the Alternative Currency). 2.3.2. FUNDING PROCEDURES. Not later than 11:00 a.m. (Boston time) on the proposed Drawdown Date of any Loan, each of the Banks will make available to the Agent, at its Head Office, in immediately available funds, the amount of such Bank's Commitment Percentage of the amount of the requested Loans. Upon receipt from each Bank of such amount, and upon receipt of the documents required by Sections 4.1 and 4.2 and the satisfaction of the other conditions set forth therein, to the extent applicable, the Agent will make available to the Company the aggregate amount of such Loans made available to the Agent by the Banks. The failure or refusal of any Bank to make available to the Agent at the aforesaid time and place on any Drawdown Date the amount of its Commitment Percentage of the requested Loans shall not relieve any other Bank from its several obligation hereunder to make available to the Agent the amount of such other Bank's Commitment Percentage of any requested Loans. 2.3.3. ADVANCES BY AGENT. The Agent may, unless notified to the contrary by any Bank prior to a Drawdown Date, assume that such Bank has made available to the Agent on such Drawdown Date the amount of such Bank's Commitment Percentage of the Loans to be made on such Drawdown Date, and the Agent may (but it shall not be required to), in reliance upon such assumption, make available to the Company a corresponding amount. If any Bank makes available to the Agent such amount on a date after such Drawdown Date, such Bank shall pay to the Agent on demand an amount equal to the product of (i) the average computed for the period referred to in clause (iii) below, of the weighted average interest rate paid by the Agent for federal funds acquired by the Agent during each day included in such period, times (ii) the amount of such Bank's Commitment Percentage of such Loans, times (iii) a fraction, the numerator of which is the number of days that elapse from and including such Drawdown Date to the date on which the amount of such Bank's Commitment Percentage of such Loans shall become immediately available to the Agent, and the denominator of which is 365. A statement of the Agent submitted to such Bank with respect to any amounts owing under this paragraph shall be prima facie evidence of the amount due and owing to the Agent by such Bank. If the amount of such Bank's Commitment Percentage of such Loans is not made available to the Agent by such Bank within three (3) Business Days following such Drawdown Date, the Agent shall be entitled to recover such amount from the Company on demand, with interest thereon at the rate per annum applicable to the Loans made on such Drawdown Date. 2.4. COMMITMENT AND OTHER FEES. (a) The Company agrees to pay to the Agent for the accounts of the Banks in accordance with their respective Commitment Percentages a commitment fee (the "Commitment 19 -19- Fee") calculated at the rate of one-quarter of one percent (.25%) per annum on the average daily amount during each calendar quarter or portion thereof from the Closing Date to the Termination Date by which the Total Commitment minus the sum of the sum of the Maximum Drawing Amount and all Unpaid Reimbursement Obligations exceeds the outstanding amount of Loans during such calendar quarter. The commitment fee shall be payable quarterly in arrears on the first day of each calendar quarter for the immediately preceding calendar quarter commencing on the first such date following the date hereof, with a final payment on the Termination Date or any earlier date on which the Commitments shall terminate. (b) The Company shall pay to the Agent (i) in the case of Letters of Credit outstanding on the date of this Agreement, a Letter of Credit fee equal to 1-1/8% per annum of the face amount of such Letter of Credit (pro-rated for the number of days such Letter of Credit is outstanding) payable on the date of this Agreement, of which 1/8% shall be for the account of the Agent and the remainder shall be for the account of the Banks in accordance with their respective Commitment Percentages, and in the case of each Letter of Credit issued after the date of this Agreement, a Letter of Credit fee equal to the Applicable Margin times the face amount of such Letter of Credit (pro-rated for the number of days such Letter of Credit is outstanding, of which 1/8% shall be for the account of the Agent and the remainder shall be for the account of the Banks in accordance with their respective Commitment Percentages; and (ii) for the account of the Agent, on demand from time to time, such fees and expenses as are customarily charged by the Agent in connection with the opening, amendment, negotiation and administration of each Letter of Credit. (c) The Company shall pay to the Agent for the Agent's own account an Agent's fee in accordance with a letter agreement between the Company and the Agent dated September 23, 1996. 2.5. REDUCTION OF COMMITMENT AMOUNT. The Company may from time to time by written notice delivered to the Agent at least five Business Days prior to the date of the requested reduction, reduce by integral multiples of $1,000,000 any unborrowed portion of the Commitment Amount. No reduction of the Commitment Amount shall be subject to reinstatement. For purposes of determining the unborrowed or outstanding portion of the Commitment Amount for this Section 2.5, the amount of the outstanding Eurocurrency Loans denominated in an Alternative Currency on the date of any reduction shall be deemed to be the Dollar Equivalent of such Loans on such date. 2.6. THE NOTES. (a) The Loans to the Company and each Borrowing Subsidiary shall be evidenced by a Note of the Company or such Borrowing Subsidiary, payable to the order of each Bank and having a final maturity on the Termination Date. Each Note shall be dated on or before the date of the first Loan thereunder (including any Loan made pursuant to the Prior 20 -20- Credit Agreement) and shall have the blanks therein appropriately completed. (b) Each Bank shall, and is hereby irrevocably authorized by the Company and each Borrowing Subsidiary to, enter on the schedule forming a part of the Notes or otherwise in its records appropriate notations evidencing the date, amount and currency of each Loan, the interest rate applicable thereto and the date and amount of each payment of principal made by the Company or such Borrowing Subsidiary with respect thereto; and in the absence of manifest error, such notations shall constitute presumptive evidence thereof. Each Bank is hereby irrevocably authorized by the Company and each Borrowing Subsidiary to attach to and make a part of each Note a continuation of any such schedule as and when required. No failure on the part of any Bank to make any notation as provided in this subsection (b) shall in any way affect any Loan or the rights or obligations of any Bank or the Company or any Borrowing Subsidiary with respect thereto. 2.7. DURATION OF INTEREST PERIODS. (a) Subject to the provisions of the definition of Interest Period, the duration of each Interest Period applicable to a Loan shall be as specified in the applicable Notice of Borrowing or Conversion. The Company or the applicable Borrowing Subsidiary shall have the option to elect a subsequent Interest Period to be applicable to each Eurocurrency Loan by giving notice of such election to the Agent received no later than 10:00 a.m. Boston time on the date one Business Day before the end of the then applicable Interest Period if such Loan is to be converted to a Base Rate Loan and three Business Days before the end of the then applicable Interest Period is such Loan is to be continued as or converted to a Eurocurrency Loan. (b) If the Agent does not receive a notice of election of duration of an Interest Period for a Eurocurrency Loan pursuant to subsection (a) above within the applicable time limits specified therein, or if, when such notice must be given, a Default exists, the Company or the applicable Borrowing Subsidiary shall be deemed to have elected to convert such Loan in whole into a Base Rate Loan on the last day of the then current Interest Period with respect thereto. (c) Notwithstanding the foregoing, neither the Company nor any Borrowing Subsidiary may select an Interest Period that would end, but for the provisions of the definition of Interest Period, after the Termination Date. 2.8. INTEREST RATES AND PAYMENTS OF INTEREST. (a) Each Base Rate Loan shall bear interest on the outstanding principal amount thereof at a rate per annum equal to the Base Rate, which rate shall change contemporaneously with any change in the Base Rate. Such interest shall be payable on the last day of each calendar quarter of each year, 21 -21- commencing September 30, 1998, and when such Loan is due (whether at maturity, by reason of acceleration or otherwise). (b) Each Eurocurrency Loan shall bear interest on the outstanding principal amount thereof, for each Interest Period applicable thereto, at a rate per annum equal to the Adjusted Eurocurrency Rate plus the Applicable Margin, payable in Dollars or in the same Alternative Currency as such Eurocurrency Loan is denominated, as appropriate. Such interest shall be payable for such Interest Period on the last day thereof and when such Eurocurrency Loan is due (whether at maturity, by reason of acceleration or otherwise) and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof. 2.9. CHANGED CIRCUMSTANCES. (a) In the event that: (i) on any date on which the Adjusted Eurocurrency Rate would otherwise be set the Agent shall have determined in good faith (which determination shall be final and conclusive) that adequate and fair means do not exist for ascertaining the Interbank Offered Rate, or (ii) at any time the Agent or any Bank shall have determined in good faith (which determination shall be final and conclusive) that: (A) the making or continuation of or conversion of any Loan to a Eurocurrency Loan has been made impracticable or unlawful by (1) the occurrence of a contingency that materially and adversely affects the interbank Eurocurrency market for Dollar or Alternative Currency deposits or (2) compliance by any Bank in good faith with any applicable law or governmental regulation, guideline or order or interpretation or change thereof by any governmental authority charged with the interpretation or administration thereof or with any request or directive of any such governmental authority (whether or not having the force of law); or (B) the Adjusted Eurocurrency Rate shall no longer represent the effective cost to any Bank for U.S. dollar deposits in the interbank market for Dollar or Alternative Currency deposits in which it regularly participates; or (C) in the case of Eurocurrency Loans denominated in an Alternative Currency, the relevant Alternative Currency is not available in the relevant amounts or for the relevant periods, or that due to national or international financial, political or economic conditions or exchange controls any Bank is no longer willing to make, fund or maintain its Eurocurrency Loans to be made in such Alternative Currency; 22 -22- then, and in any such event, any affected Bank shall endeavor to designate a different Lending Office for the type of Loan affected by the circumstances described in this Section 2.9(a) (herein called "AFFECTED LOANS") if such designation will avoid the contingencies described in this Section 2.9(a) and will not, in the sole opinion of the affected Bank, be disadvantageous to the affected Bank. If the affected Bank is not able to so designate an alternative Lending Office, the Agent shall forthwith so notify the Company and each Borrowing Subsidiary thereof. Until the Agent notifies the Company and each Borrowing Subsidiary that the circumstances giving rise to such notice no longer apply, the obligation of the Banks to allow selection by the Company or any Borrowing Subsidiary of Affected Loans shall be suspended. If at the time the Agent so notifies the Company and each Borrowing Subsidiary, the Company or a Borrowing Subsidiary has previously given the Agent a Notice of Borrowing or Conversion with respect to one or more Affected Loans but such Loans have not yet gone into effect, such notification shall be deemed to be void and the Company or such Borrowing Subsidiary may borrow Loans of a non-affected type by giving a substitute Notice of Borrowing or Conversion pursuant to Section 2.3 hereof. Upon such date as shall be specified in such notice (which shall not be earlier than the date such notice is given) the Company or applicable Borrowing Subsidiary shall, with respect to the outstanding Affected Loans, prepay the same, together with interest thereon and any amounts required to be paid pursuant to Section 2.14, and may borrow a Loan of another type in accordance with Section 2.1 hereof by giving a Notice of Borrowing or Conversion pursuant to Section 2.3 hereof. (b) In case any law, regulation, treaty or official directive or the interpretation or application thereof by any court or by any governmental authority charged with the administration thereof or the compliance with any guideline or request of any central bank or other governmental authority (whether or not having the force of law): (i) subjects any Bank to any tax with respect to payments of principal or interest or any other amounts payable hereunder by the Company or otherwise with respect to the transactions contemplated hereby (except for taxes on the overall net income of a Bank imposed by the United States of America or any political subdivision thereof), or (ii) imposes, modifies or deems applicable any deposit insurance, reserve, special deposit or similar requirement against assets held by, or deposits in or for the account of, or loans by, any Bank (other than such requirements as are already included in the determination of the Adjusted Eurocurrency Rate), or (iii) imposes upon any Bank any other condition with respect to its performance under this Agreement, 23 -23- and the result of any of the foregoing is to increase the cost to such Bank, reduce the income receivable by such Bank or impose any expense upon such Bank with respect to any Loans, such Bank shall endeavor to designate a different Lending Office for such Loans if such designation will avoid the need for, or reduce the amount of, such cost or reduction and will not, in the sole opinion of such Bank, be disadvantageous to such Bank. If such Bank is not able to so designate an alternative Lending Office, such Bank shall forthwith notify the Company thereof. The Company agrees to pay to any Bank the amount of such increase in cost, reduction in income or additional expense as and when such cost, reduction or expense is incurred or determined, upon presentation by such Bank of a statement in the amount and setting forth such Bank's calculation thereof, which statement shall be deemed true and correct absent manifest error. 2.10. CAPITAL REQUIREMENTS. If after the date hereof any Bank determines that (i) the adoption of or change in any law, rule, regulation or guideline regarding capital requirements for banks or bank holding companies, or any change in the interpretation or application thereof by any governmental authority charged with the administration thereof, or (ii) compliance by such Bank or its parent bank holding company with any guideline, request or directive of any such entity regarding capital adequacy (whether or not having the force of law), has the effect of reducing the return on such Bank's or such holding company's capital as a consequence of such Bank's commitment to make Loans or issue Letters of Credit hereunder to a level below that which the Bank or such holding company could have achieved but for such adoption, change or compliance (taking into consideration such Bank's or such holding company's then existing policies with respect to capital adequacy and assuming the full utilization of such entity's capital) by any amount deemed by such Bank to be material, then such Bank shall notify the Company thereof. The Company agrees to pay to such Bank the amount of such reduction of capital as and when such reduction is determined, upon presentation by such Bank of a statement in the amount and setting forth such Bank's calculation thereof, which statement shall be deemed true and correct absent manifest error. In determining such amount, such Bank may use any reasonable averaging and attribution methods. 2.11. PAYMENTS AND PREPAYMENTS OF THE LOANS. (a) All Base Rate Loans and Eurocurrency Loans shall be due and payable on the Termination Date. (b) Base Rate Loans may be prepaid at any time, without premium or penalty, upon notice received not later than 11:00 a.m. on the day of the proposed prepayment. Eurocurrency Loans may be prepaid at any time, without premium or penalty, on the last day of any Interest Period applicable thereto, upon three Business Days' notice in the case of a Eurocurrency Loan. Any interest accrued on the amounts so prepaid to the date of such payment must be paid at the time of any such payment. No 24 -24- prepayment of the Loans prior to the Termination Date shall affect the Commitment Amount or impair the right of the Company and the Borrowing Subsidiaries to borrow as set forth in Section 2.1. (c) If at any time the sum of (i) the Dollar Equivalent of all Eurocurrency Loans denominated in an Alternative Currency then outstanding, plus (ii) the aggregate principal amount of all Loans denominated in Dollars then outstanding, shall exceed the Commitment Amount, then the Company shall repay the amount of such excess by prepaying Loans then outstanding, upon demand by the Agent. Any such prepayments shall be made first from outstanding Base Rate Loans, then from Eurocurrency Advances denominated in Dollars, and then from Eurocurrency Advances denominated in an Alternative Currency, and any prepayments of Eurocurrency Loans shall be accompanied by any amounts required to be paid pursuant to Section 2.14. (d) If at any time the sum of the outstanding amount of the Loans to the Company, the outstanding amount of the Loans to the Borrowing Subsidiaries, the Overdraft Amount, the Maximum Drawing Amount and all Unpaid Reimbursement Obligations exceeds the Commitment Amount then the Borrower shall immediately pay the amount of such excess to the Agent for the respective accounts of the Banks for application: first, to any Unpaid Reimbursement Obligation; second, on a pro rata basis to the Loans and the Overdraft Amounts; and third, to provide the Agent cash collateral for Reimbursement Obligations. 2.12. METHOD OF PAYMENT. All payments and prepayments of principal and all payments of interest in respect of Base Rate Loans and Eurocurrency Loans denominated in Dollars, all reimbursement payments of drawings under any Letter of Credit and all other amounts payable in respect thereof shall be made by the Company or the applicable Borrowing Subsidiary to the Agent at the Agent's Head Office in immediately available funds, on or before 2:00 p.m. (Boston, Massachusetts time) on the due date thereof, free and clear of, and without any deduction or withholding for, any taxes or other payments. All payments of principal and interest in respect of Eurocurrency Loans denominated in an Alternative Currency and all other amounts payable in respect thereof shall be made by the Company or the applicable Borrowing Subsidiary to the Agent at the place designated therefor by the Agent in such funds as may then be customary for the settlement of international transactions in such Alternative Currency, on or before 11:00 a.m. (London time) on the due date thereof, in such Alternative Currency, free and clear of, and without any deduction or withholding for, any taxes or other payments. All such payments made after such times on such due dates will be deemed to have been made on the next succeeding Business Day. The Agent may, and the Company hereby authorizes the Agent to, debit the amount of any payment not made by such time to the demand deposit account of the Company with the Agent. 25 -25- 2.13. OVERDUE PAYMENTS. Overdue principal of Base Rate Loans (whether at maturity, by reason of acceleration or otherwise) and, to the extent permitted by applicable law, overdue interest and fees or any other amounts payable hereunder or under the Notes or any Letter of Credit Application or Letter of Credit issued thereunder shall bear interest from and including the due date thereof until paid, compounded daily and payable on demand, at a rate per annum equal to 2% above the Base Rate. Overdue principal of Eurocurrency Loans (whether at maturity, by reason of acceleration or otherwise) and, to the extent permitted by law, overdue interest thereon shall bear interest from and including the due date thereof until paid at the rate per annum which shall be at all times equal to 2% above the rate per annum at which one day (or, if such amount due remains unpaid more than three Business Days, then for such other period of time not longer than six months as the Bank may elect) deposits in Dollars or the relevant Alternative Currency in an amount approximately equal to such overdue payment are offered to the Agent in the interbank Eurocurrency market in which the Agent regularly participates for the applicable period determined as provided above. 2.14. PAYMENTS PRIOR TO END OF INTEREST PERIOD. If the Company or any Borrowing Subsidiary for any reason makes any payment of principal with respect to any Eurocurrency Loan on any day prior to the last day of an Interest Period applicable to such Eurocurrency Loan, or fails to borrow or continue or convert to a Eurocurrency Loan after giving a Notice of Borrowing or Conversion pursuant to Section 2.3, or if any Eurocurrency Loan is accelerated pursuant to Section 8.2(b), the Company or such Borrowing Subsidiary shall pay to the Agent for the account of the Banks in accordance with their respective Commitment Percentages an amount computed pursuant to the following formula: L = (R - T) X P X D --------------- 360 L= amount payable to the Agent R= interest rate on such Loan (Base Rate, Adjusted Eurocurrency Rate plus applicable margin applicable to such Loan) T= in the case of Eurocurrency Loans, the effective rate at which deposits in Dollars or the relevant Alternative Currency can be placed by the Agent in the interbank Eurocurrency market in which the Agent regularly participates for an Interest Period maturing on or near the last day of the Interest Period of such Loan in approximately the same amount as such Loan on the day of such payment of principal or failure to borrow. P= the amount of principal prepaid or the amount of the requested Loan 26 -26- D= the number of days remaining in the Interest Period as of the date of such payment or the number of days of the requested Interest Period The Company or the applicable Borrowing Subsidiary shall pay such amount upon presentation by the Agent of a statement setting forth the amount and the Agent's calculation thereof pursuant hereto, which statement shall be deemed true and correct absent manifest error. 2.15. COMPUTATION OF INTEREST AND FEES. Interest and all fees payable hereunder shall be computed daily on the basis of a year of 360 days and paid for the actual number of days for which due. If the due date for any payment of principal is extended by operation of law, interest shall be payable for such extended time. If any payment required by this Agreement becomes due on a day that is not a Business Day such payment may be made on the next succeeding Business Day (subject to clause (i) of the definition of Interest Period), and such extension shall be included in computing interest in connection with such payment. 2.16. JUDGMENT CURRENCY. If for the purposes of obtaining a judgment in any court or obtaining an order enforcing a judgment it is necessary to convert any amount due from the Company or any Borrowing Subsidiary hereunder or under any of the Notes or Letter of Credit Applications or any Letters of Credit issued thereunder or any of the other Loan Documents in the currency expressed to be payable herein or under any of the Notes or Letter of Credit Applications or any Letters of Credit issued thereunder or any of the other Loan Documents (the "SPECIFIED CURRENCY") into another currency, then the conversion shall be made at the Agent's spot rate of exchange for buying the specified currency with such other currency, in accordance with normal banking procedures, prevailing at the Agent's close of business on the business day next preceding the day on which the judgment is given or the order is made. In the event that there is a difference between the rate of exchange on the basis of which the amount of such judgment or order is determined and the rate of exchange prevailing on the date of payment, the Company or such Borrowing Subsidiary shall pay such additional amount as may be necessary to ensure that the amount paid is the amount of such other currency which permits the Agent to purchase the amount of the specified currency due when such judgment or order is issued at the Agent's spot rate of exchange for buying the specified currency with such other currency, in accordance with normal banking procedures, prevailing at the Agent's opening of business on the date of payment. 2.17. DOCUMENTARY TAXES. The Company shall pay to the Agent for the account of the Banks on demand any and all transfer taxes, documentary taxes, assessments or charges determined to be payable by any governmental authority by reason of the execution and delivery of this Agreement, the Notes or any Letter of Credit Application or Letter of Credit issued thereunder and the other Loan Documents and shall reimburse and 27 -27- indemnify the Agent and each Bank for and against any claims, losses, liabilities or expenses resulting from any delay in paying or failure to pay any such taxes, assessments or charges. SECTION III ----------- SPECIAL PROVISIONS WITH RESPECT TO BORROWING SUBSIDIARIES --------------------------------------------------------- 3.1. TAXES, ETC. All payments by each Borrowing Subsidiary of principal of and interest on its Notes and of all other amounts payable under this Agreement and the other Loan Documents shall be made without any counterclaim or setoff, free and clear of, and without reduction by reason of, any taxes, levies, imposts, charges and withholdings, restrictions or conditions of any nature that are now or may hereafter be imposed, levied or assessed by an country, political subdivision or taxing authority, all of which will be for the account of and paid by such Borrowing Subsidiary. If for any reason any such reduction is made or any such taxes are paid by any Bank, such Borrowing Subsidiary will pay to such Bank such additional amounts as may be necessary to ensure that such Bank receives the same net amount which it would have received had no reduction been made or taxes paid. If any Bank announces that it is closing its office in a country in which a Borrowing Subsidiary is located and such closing would increase the amount payable hereunder, such Bank will promptly notify the Company and the Agent of such closing. 3.2. CONSENT TO JURISDICTION; SERVICE OF PROCESS. Each Borrowing Subsidiary: (a) irrevocably submits to the jurisdiction of any Massachusetts state or Federal court sitting in Boston over any suit, action or proceeding arising out of or relating to this Agreement or any of the Notes or other Loan Documents; (b) irrevocably waives, to the fullest extent permitted by law, any objection which it may have or hereafter have to the laying of the venue of any such suit, action or proceeding brought in such a court and any claim that any such suit, action or proceeding brought in such a court has been brought in an inconvenient forum; (c) hereby appoints the Company as its authorized agent to accept and acknowledge service of any and all processes which may be served in any suit, action or proceeding of the nature referred to in this Section 3.2 and consents to process being served in any such suit, action or proceeding upon the Company in any manner or by the mailing of a copy thereof by registered or certified air mail, postage prepaid, return receipt requested, to such Borrowing Subsidiary's address specified in its Letter Agreement with the Bank; and (d) agrees that such service: 28 -28- (i) shall be deemed in every respect effective service of process upon it in any such suit, action or proceeding, and (ii) shall, to the fullest extent permitted by law, be taken and held to be valid personal service upon and personal delivery to it. Nothing in this Section 3.2 shall affect the right of the Agent or any Bank to serve process in any manner permitted by law or limit the right of the Agent or any Bank to bring proceedings against the Company or any Borrowing Subsidiary in the courts of any jurisdiction or jurisdictions. SECTION IV ---------- CONDITIONS OF LOANS ------------------- 4.1. CONDITIONS PRECEDENT TO EFFECTIVENESS OF THIS AGREEMENT. The effectiveness of this Agreement and the obligation of each Bank to make the initial Loan to the Company hereunder is subject to the condition precedent that the Agent shall have received, in form and substance satisfactory to the Agent and its counsel, the following: (a) this Agreement, duly executed by the Company; (b) a certificate of the Secretary or an Assistant Secretary of the Company (i) with respect to resolutions of the Board of Directors of the Company authorizing the execution and delivery of this Agreement and each other Loan Document to be executed by the Company and identifying the officers authorized to execute, deliver and take all other actions required hereunder and thereunder, and providing specimen signatures of such officers; and (ii) certifying that no changes to the Company's certificate of incorporation and by-laws have occurred since December 19, 1996; (c) an opinion addressed to the Agent and each of the Banks from Leah Maher, Esq. Associate General Counsel of the Company, substantially in the form of EXHIBIT J hereto; (d) payment to the Agent for the pro rata accounts of the Banks a closing fee (in cash) in the aggregate amount of $50,000; and (e) such other documents, and completion of such other matters, as counsel for the Agent reasonably may deem necessary or appropriate. 4.2. CONDITIONS PRECEDENT TO THE INITIAL LOAN TO EACH BORROWING SUBSIDIARY. The obligation of each Bank to make the initial Loan to each Borrowing Subsidiary is subject to the condition precedent that the Agent shall have received, on or before the day of such initial Loan, in form and substance satisfactory to the Agent and its counsel, all of the following: 29 -29- (a) a Letter Agreement and Notes, duly executed by such Borrowing Subsidiary; (b) a certificate of the Secretary or an Assistant Secretary of such Borrowing Subsidiary with respect to resolutions of the Board of Directors of such Borrowing Subsidiary authorizing the execution and delivery of such Borrowing Subsidiary's Letter Agreement and Notes and each other Loan Document to be executed by it and identifying the officers authorized to execute, deliver and take all other actions required hereunder and thereunder, and providing specimen signatures of such officers; (c) evidence that all necessary exchange control approvals, if any, relative to such Borrowing Subsidiary's Loans have been obtained; (d) a Company Guaranty guaranteeing payment of such Borrowing Subsidiary's obligations under its Letter Agreement and hereunder, if such Borrowing Subsidiary is not already subject to a Company Guaranty; and (e) such other documents, and completion of such other matters, as counsel for the Agent reasonably may deem necessary or appropriate. 4.3. CONDITIONS PRECEDENT TO ALL LOANS AND LETTERS OF CREDIT. The obligation of the Bank to make each Loan, including the initial Loan to the Company and each Borrowing Subsidiary, or continue or convert Loans to Loans of another type, and the obligation of the Agent to issue Letters of Credit, is further subject to the following conditions: (a) timely receipt by the Agent of the Notice of Borrowing or Conversion as provided in Section 2.3 or the applicable Letter of Credit Application as provided in Section 2.2(b); (b) the representations and warranties contained in Section V of this Agreement and, in the case of all Borrowings by a Borrowing Subsidiary, the representations and warranties contained in Section 2 of the applicable Letter Agreement, shall be true and accurate in all material respects on and as of the date of such Notice of Borrowing or Conversion or Letter of Credit Application and on the effective date of the making, continuation or conversion of each Loan or issuance of each Letter of Credit as though made at and as of each such date (except to the extent that such representations and warranties expressly relate to an earlier date), and no Default shall have occurred and be continuing, or would result from such Loan; (c) the resolutions referred to in Section 4.1(b) and 4.2(b) shall remain in full force and effect; (d) no change shall have occurred in any law or regulation or interpretation thereof that, in the opinion of counsel for any Bank, would make it illegal or against the policy of any governmental agency or authority 30 -30- for such Bank to make Loans or for the Agent to issue Letters of Credit hereunder; and (e) receipt by the Agent and the Banks within thirty days after the date of this Agreement of an opinion in a form reasonably satisfactory to the Agent and each of the Banks, from outside counsel to the Company. The making of each Loan shall be deemed to be a representation and warranty by the Company and the applicable Borrowing Subsidiary on the date of the making, continuation or conversion of such Loan as to the accuracy of the facts referred to in subsection (b) of this Section 4.3. SECTION V --------- REPRESENTATIONS AND WARRANTIES ------------------------------ In order to induce the Agent and the Banks to enter into this Agreement and to extend credit hereunder, the Company represents and warrants to the Agent and the Banks that: 5.1. ORGANIZATION AND QUALIFICATION. Each of the Company and its Subsidiaries (a) is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, (b) has all requisite corporate power to own its property and conduct its business as now conducted and as presently contemplated and (c) is duly qualified and in good standing as a foreign corporation and is duly authorized to do business in each jurisdiction where the nature of its properties or business requires such qualification, except where the failure to be so qualified would not have a material adverse effect on the business, financial condition, assets or properties of the Company or of the Company and its Subsidiaries taken as a whole. 5.2. CORPORATE AUTHORITY. The execution, delivery and performance of this Agreement and each other Loan Document to be executed by it and the transactions contemplated hereby and thereby are within the corporate power and authority of the Company and have been authorized by all necessary corporate proceedings, and do not and will not (a) require any consent or approval of the stockholders of the Company, (b) contravene any provision of the charter documents or by-laws of the Company or any law, rule or regulation applicable to the Company, (c) contravene any provision of, or constitute an event of default or event that, but for the requirement that time elapse or notice be given, or both, would constitute an event of default under, any other agreement, instrument, order or undertaking binding on the Company, or (d) result in or require the imposition of any Encumbrance on any of the properties, assets or rights of the Company. 5.3. VALID OBLIGATIONS. This Agreement and each other Loan Document to be executed by the Company and all of their respective terms and provisions are the valid and binding obligations of the Company, 31 -31- enforceable in accordance with their respective terms except as limited by bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally, and except as the remedy of specific performance or of injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. 5.4. CONSENTS OR APPROVALS. The execution, delivery and performance by the Company of this Agreement and each other Loan Document to be executed or performed by it and the transactions contemplated herein and therein do not require any approval or consent of, or filing or registration with, any governmental or other agency or authority, or any other party. 5.5. TITLE TO PROPERTIES; ABSENCE OF ENCUMBRANCES. The Company has good and marketable title to all of the properties, assets and rights of every name and nature now purported to be owned by it, including, without limitation, such properties, assets and rights as are reflected in the financial statements referred to in Section 5.6 (except such properties, assets or rights as have been disposed of in the ordinary course of business since the date thereof or as otherwise disclosed on SCHEDULE 5.5 hereto), free from all Encumbrances except Permitted Encumbrances or those Encumbrances disclosed in EXHIBIT F hereto, and, except as so disclosed, free from all defects of title that might materially adversely affect such properties, assets or rights, taken as a whole; PROVIDED that this representation and warranty shall not constitute a representation that such properties, assets or rights do not infringe on the intellectual property rights of others. Except for claims disclosed on EXHIBIT G hereto, to the best of the Company's knowledge, the use of such properties, assets and rights by the Company does not infringe on the intellectual property rights of others. 5.6. FINANCIAL STATEMENTS. The Company has furnished each of the Banks its consolidated balance sheet as of December 31, 1995 and its consolidated statements of income, changes in stockholders' equity and cash flow for the fiscal year then ended, and related footnotes, audited and certified by Coopers & Lybrand, LLP. The Company has also furnished each of the Banks its consolidated balance sheet as of September 28, 1996 and its consolidated statements of income, changes in stockholders' equity and cash flow for the fiscal quarter then ended, certified by the chief financial officer of the Company but subject, however, to normal, recurring year-end adjustments that shall not in the aggregate be material in amount. All such financial statements were prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the periods specified and present fairly the financial position of the Company and its Subsidiaries as of such dates and the results of the operations of the Company and its Subsidiaries for such periods. 5.7. CHANGES. Since the date of the most recent financial statements referred to in Section 5.6, there have been no changes in the 32 -32- assets, liabilities, financial condition or business of the Company or any of its Subsidiaries other than changes in the ordinary course of business, the effect of which has not, in the aggregate, been materially adverse. 5.8. DEFAULTS. As of the date of this Agreement, no Default exists. 5.9. TAXES. The Company and each Subsidiary have filed all federal, state and other tax returns required to be filed, and all taxes, assessments and other governmental charges due from the Company and each Subsidiary have been fully paid, other than such taxes, assessments and other governmental charges that are being contested in good faith by appropriate proceedings and with respect to which adequate reserves have been established and are being maintained in accordance with generally accepted accounting principles. The Company and each Subsidiary have established on their books reserves adequate for the payment of all federal, state and other tax liabilities. 5.10. LITIGATION. Except as set forth on EXHIBIT G hereto, there is no litigation, arbitration, proceeding or investigation pending, or, to the knowledge of the Company's or any Subsidiary's officers, threatened, against the Company or any Subsidiary that, if adversely determined, could result in a material judgment not fully covered by insurance, could result in a forfeiture of all or any substantial part of the property of the Company or its Subsidiaries, or could otherwise have a material adverse effect on the assets, business or prospects of the Company or any Subsidiary. 5.11. USE OF PROCEEDS. No portion of any Loan is to be used for the "purpose of purchasing or carrying" any "margin stock" as such terms are used in Regulations U and X of the Board of Governors of the Federal Reserve System, 12 C.F.R. 221 and 224, as amended; and following the application of the proceeds of each Loan, the value of all "margin stock" of the Company will not exceed 25% of the value of the total assets of the Company that are subject to the restrictions set forth in Section 7.1 and 7.2. 5.12. SUBSIDIARIES. As of the date of this Agreement, all the Subsidiaries of the Company are listed on EXHIBIT H hereto. Except as set forth on EXHIBIT H hereto, the Company or a Subsidiary of the Company is the owner, free and clear of all liens and encumbrances, of all of the issued and outstanding stock of each Subsidiary. All shares of such stock have been validly issued and are fully paid and nonassessable, and no rights to subscribe to any additional shares have been granted, and no options, warrants or similar rights are outstanding. 5.13. INVESTMENT COMPANY ACT. Neither the Company nor any of its Subsidiaries is subject to regulation under the Investment Company Act of 1940, as amended. 33 -33- 5.14. COMPLIANCE WITH ERISA. The Company and each member of the Controlled Group have fulfilled their obligations under the minimum funding standards of ERISA and the Code with respect to each Plan and are in compliance in all material respects with the applicable provisions of ERISA and the Code, and have not incurred any liability to the PBGC or a Plan under Title IV of ERISA; and no "prohibited transaction" or "reportable event" (as such terms are defined in ERISA) has occurred with respect to any Plan. 5.15. ENVIRONMENTAL MATTERS. (a) The Company, each of its Material Subsidiaries and, to the best of the Company's knowledge, each of its other Subsidiaries have obtained all permits, licenses and other authorizations which are required under all Environmental Laws, except to the extent failure to have any such permit, license or authorization would not have a material adverse effect on the business, financial condition or operations of the Company and its Subsidiaries. The Company, each of its Material Subsidiaries and, to the best of the Company's knowledge, each of its other Subsidiaries are in compliance with the terms and conditions of all such permits, licenses and authorizations, and are also in compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in any applicable Environmental Law or in any regulation, code, plan, order, decree, judgment, injunction, notice or demand letter issued, entered, promulgated or approved thereunder, except to the extent failure to comply would not have a material adverse effect on the business, financial condition or operations of the Company and its Subsidiaries. (b) No notice, notification, demand, request for information, citation, summons or order has been issued, no complaint has been filed, no penalty has been assessed and no investigation or review is pending or threatened by any governmental or other entity with respect to any alleged failure by the Company or any of its Material Subsidiaries or, to the best of the Company's knowledge, each of its other Subsidiaries to have any permit, license or authorization required in connection with the conduct of its business or with respect to any Environmental Laws, including, without limitation, Environmental Laws relating to the generation, treatment, storage, recycling, transportation, disposal or release of any Hazardous Materials, except to the extent that such notice, complaint, penalty or investigation did not or could not result in the remediation of any property owned or used by the Company or any of its Subsidiaries costing in excess of $100,000 per occurrence or $500,000 in the aggregate. (c) To the best of the Company's knowledge no material oral or written notification of a release of a Hazardous Material has been filed by or on behalf of the Company or any of its Material Subsidiaries or, to the best of the Company's knowledge, any of its other Subsidiaries and no property now or previously owned, leased or used by the Company or any of its Material Subsidiaries or, to the best of the Company's knowledge, any of its other Subsidiaries is listed or proposed for listing on the National Priorities 34 -34- List under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or on any similar state list of sites requiring investigation or clean-up. (d) There are no liens or encumbrances arising under or pursuant to any Environmental Laws on any of the real property or properties owned, leased or used by the Company or any of its Material Subsidiaries or, to the best of the Company's knowledge, any of its other Subsidiaries and no governmental actions have been taken or are in process which could subject any of such properties to such liens or encumbrances or, as a result of which the Company or any of its Subsidiaries would be required to place any notice or restriction relating to the presence of Hazardous Materials at any property owned by it in any deed to such property. (e) Neither Company nor any of its Subsidiaries nor, to the best knowledge of the Company, any previous owner, tenant, occupant or user of any property owned, leased or used by the Company or any of its Subsidiaries has (i) engaged in or permitted any operations or activities upon or any use or occupancy of such property, or any portion thereof, for the purpose of or in any way involving the handling, manufacture, treatment, storage, use, generation, release, discharge, refining, dumping or disposal (whether legal or illegal, accidental or intentional) of any Hazardous Materials on, under, in or about such property, except to the extent commonly used in day-to-day operations of such property by the Company or such others and in such case only in compliance with all Environmental Laws, or (ii) transported any Hazardous Materials to, from or across such property except to the extent commonly used in day-to-day operations of such property by the Company or such others and, in such case, in compliance with, all Environmental Laws; nor to the best knowledge of the Company have any Hazardous Materials migrated from other properties upon, about or beneath such property, nor, to the best knowledge of the Company, are any Hazardous Materials presently constructed, deposited, stored or otherwise located on, under, in or about such property except to the extent commonly used in day-to-day operations of such property by the Company or such others and, in such case, in compliance with, all Environmental Laws. 5.16. PERFECTION OF SECURITY INTEREST. All filings, assignments, pledges and deposits have been made and all other actions have been taken that are necessary or advisable, under applicable law, to establish and perfect the Agent's first priority security interest in the Collateral. The Collateral and the Agent's rights with respect to the Collateral are not subject to any setoff, claims, withholdings or other defenses. The Company is the owner of the Collateral free from any lien, security interest, encumbrance and any other claim or demand, except for liens expressly permitted by this Credit Agreement. 5.17. YEAR 2000 PROBLEM. The Company and its Subsidiaries have reviewed the areas within their businesses and operations which could be 35 -35- adversely affected by, and have developed or are developing a program to address on a timely basis, the "Year 2000 Problem" (i.e. the risk that computer applications used by the Company or any of its Subsidiaries may be unable to recognize and perform properly date-sensitive functions involving certain dates prior to and any date after December 31, 1999). Based upon such review, the Company reasonably believes that the "Year 2000 Problem" will not have any materially adverse effect on the business or financial condition of the Company or any of its Subsidiaries. SECTION VI ---------- AFFIRMATIVE COVENANTS --------------------- So long as any Bank has any commitment to extend credit hereunder or any Loan, Letter of Credit or other Obligation remains outstanding, the Company covenants as follows: 6.1. FINANCIAL STATEMENTS AND OTHER REPORTING REQUIREMENTS. The Company shall furnish to each Bank: (a) as soon as available to the Company, but in any event within 97 days after the end of each of its fiscal years, (i) a consolidated and consolidating balance sheet as of the end of such year, and the related consolidated and consolidating statements of income, changes in stockholders' equity and cash flow for, such year, audited and certified by PricewaterhouseCoopers, LLP (or other independent certified public accountants acceptable to the Agent) in the case of such consolidated statements, and certified by the chief financial officer, Treasurer, Director of Finance, Tax and Treasury Services or Vice President and Corporate Controller, in the case of such consolidating statements; and, as soon as available, a copy of said certified public accountants' management report; and (ii) the Company's financial projections for the next fiscal year of the Company; (b) as soon as available to the Company, but in any event within 52 days after the end of each of its fiscal quarters, a consolidated and consolidating balance sheet as of the end of such fiscal quarter, and the related consolidated and consolidating statements of income for the period then ended, certified by the chief financial officer, Treasurer, Director of Finance, Tax and Treasury Services or Vice President and Corporate Controller of the Company but subject, however, to normal, recurring year-end adjustments that shall not in the aggregate be material in amount; (c) concurrently with the delivery of each financial statement pursuant to subsections (a) and (b) of this Section 6.1, a report in substantially the form of EXHIBIT I hereto signed on behalf of the Company by its chief financial officer or Treasurer; 36 -36- (d) promptly after the receipt thereof by the Company, copies of any reports submitted to the Company by independent public accountants in connection with any interim or annual review of the accounts of the Company made by such accountants; (e) promptly after the same are available, copies of all proxy statements, financial statements and reports as the Company shall send to its stockholders or as the Company may file with the Securities and Exchange Commission or any governmental authority at any time having jurisdiction over the Company or its Subsidiaries; (f) if and when the Company gives or is required to give notice to the PBGC of any "Reportable Event" (as defined in Section 4043 of ERISA) with respect to any Plan that might constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that any member of the Controlled Group or the plan administrator of any Plan has given or is required to give notice of any such Reportable Event, a copy of the notice of such Reportable Event given or required to be given to the PBGC; (g) immediately upon becoming aware of the existence of any condition or event that constitutes a Default, written notice thereof specifying the nature and duration thereof and the action being or proposed to be taken with respect thereto; (h) promptly upon becoming aware of any litigation or of any investigative proceedings by a governmental agency or authority commenced or threatened against the Company or any of its Subsidiaries of which it has notice, the outcome of which could result in a forfeiture of a substantial part of the Company's or such Subsidiary's property or which would or might have a materially adverse effect on the assets, business or prospects of the Company or the Company and its Subsidiaries on a consolidated basis, written notice thereof and the action being or proposed to be taken with respect thereto; (i) promptly upon becoming aware of any investigative proceedings by a governmental agency or authority commenced or threatened against the Company or any of its Subsidiaries regarding any potential violation of Environmental Laws or any spill, release, discharge or disposal of any Hazardous Material, written notice thereof and the action being or proposed to be taken with respect thereto; (j) from time to time, such other financial data and information about the Company or its Subsidiaries as the Agent or any Bank may reasonably request; (k) within five Business Days of the end of each calendar month, a report signed on behalf of the Company by its chief financial officer or treasurer as to compliance with Section 6.11 as of the last day of such calendar month; and 37 -37- (l) simultaneously with the Company making an acquisition which is permitted pursuant to Section 7.5 hereof, incurring Indebtedness which is permitted to be incurred pursuant to Section 7.6(e)(ii) hereof, or making an Investment which is permitted to be made pursuant to Section 7.7(g) hereof, as the case may be, information evidencing the aggregate purchase price of all acquisitions made to date (including the contemplated acquisition), in the case of an acquisition, information detailing the outstanding Indebtedness of the Company and its Subsidiaries on such date (including the Indebtedness to be incurred), or information detailing all Investments made by the Company and its Subsidiaries through such date (including the Investments to be made), as the case may be. 6.2. CONDUCT OF BUSINESS. Each of the Company and its Subsidiaries shall: (a) duly observe and comply in all material respects with all applicable laws and valid requirements of any governmental authorities relative to its corporate existence, rights and franchises, to the conduct of its business and to its property and assets (including without limitation all Environmental Laws and ERISA), and shall maintain and keep in full force and effect all licenses and permits necessary in any material respect to the proper conduct of its business; (b) maintain its corporate existence; and (c) remain engaged substantially in the business of video conferencing systems design, manufacturing and distribution. 6.3. MAINTENANCE AND INSURANCE. Each of the Company and its Subsidiaries shall maintain its properties in good repair, working order and condition as required for the normal conduct of its business, subject to normal wear and tear and obsolescence. Each of the Company and its Subsidiaries shall at all times maintain liability and casualty insurance with financially sound and reputable insurers in such amounts as the officers of the Company in the exercise of their reasonable judgment deem to be adequate. 6.4. TAXES. The Company shall pay or cause to be paid all taxes, assessments or governmental charges on or against it or any of its Subsidiaries or its or their properties on or prior to the time when they become due; PROVIDED that this covenant shall not apply to any tax, assessment or charge that is being contested in good faith by appropriate proceedings and with respect to which adequate reserves have been established and are being maintained in accordance with generally accepted accounting principles. 6.5. INSPECTION BY THE BANK. The Company shall permit the Banks, through the Agent or any of the Banks' other designees, at any reasonable 38 -38- time and upon reasonable notice (or if a Default shall have occurred and is continuing, at any time and without prior notice), to (i) visit and inspect the properties of the Company and its Subsidiaries, (ii) examine and make copies of and take abstracts from the financial books and records of the Company and its Subsidiaries, and (iii) discuss the affairs, finances and accounts of the Company and its Subsidiaries with their appropriate officers, employees and accountants. In handling such information the Agent and each of the Banks shall exercise the same degree of care that it exercises with respect to its own proprietary information of the same types to maintain the confidentiality of any non-public information thereby received except that disclosure of such information may be made (i) to the subsidiaries or affiliates of the Agent of such Bank in connection with their present or prospective business relations with the Company, (ii) to prospective transferees or purchasers of an interest in the Loans, (iii) as required by law, regulation, rule or order, subpoena, judicial order or similar order and (iv) as may be required in connection with the examination, audit or similar investigation of the Bank. 6.6. MAINTENANCE OF BOOKS AND RECORDS. Each of the Company and its Subsidiaries shall keep adequate books and records of account in accordance with generally accepted accounting principles consistently applied and applicable law. 6.7. CONSOLIDATED TOTAL LIABILITIES TO CONSOLIDATED TANGIBLE NET WORTH RATIO. The Company shall at all times maintain a ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth of not greater than 1.00 to 1.00. 6.8. QUICK RATIO. The Company shall at all times maintain a ratio of Consolidated Quick Assets to Consolidated Current Liabilities of not less than 1.50 to 1.00. As used in this Section 6.8, "CONSOLIDATED QUICK ASSETS" shall mean, at any date as of which the amount thereof shall be determined, the consolidated cash, accounts receivable and marketable securities of the Company and its Subsidiaries. "CONSOLIDATED CURRENT LIABILITIES" shall mean, at any such date, all amounts that should, in accordance with generally accepted accounting principles, be included as current liabilities on the consolidated balance sheet of the Company and its Subsidiaries as at such date, plus, to the extent not already included therein, all Loans and all Indebtedness under this Agreement, excluding standby letters of credit supporting real estate lease obligations, plus other Indebtedness that is payable upon demand or within one year from the date of determination thereof unless such Indebtedness is renewable or extendable at the option of the Company or any Subsidiary to a date more than one year from the date of determination. 6.9 MINIMUM CASH AND CASH COLLATERAL. The Company shall at all times maintain in a cash collateral account with the Agent not less than $47,000,000 of unencumbered consolidated cash and Cash Equivalents of 39 -39- the Company and its Subsidiaries (with a "Collateral Value" as defined in the Pledge Agreement) as required by the terms of the Pledge Agreement. 6.10 MINIMUM QUARTERLY LOSSES/POSITIVE NET INCOME. The Company will not permit the Company and its Subsidiaries to (a) have a negative Consolidated Net Income of greater than $3,000,000 for the fiscal quarter ending September 30, 1998; and (b) permit Consolidated Net Income to be less than $1.00 for any fiscal quarter ending thereafter. 6.11 SECURITY. The Company acknowledges that the Obligations shall be secured by a perfected first priority security interest in the cash and Cash Equivalents required to be deposited with the Agent (or, if not deposited with the Agent, with any Bank which the Company may elect, or such other third party selected by the Company and approved in writing in advance by the Agent and the Banks) pursuant to the terms of the Pledge Agreement; provided, however, if the Collateral is to be held by any party other the Agent, all actions which the Agent deems necessary shall be taken in order to maintain the first priority perfected security interest in the Collateral. 6.12 GOOD STANDING CERTIFICATE. The Company shall deliver to the Agent, not later than fifteen (15) days after the date hereof, a certificate of the Secretary of State of Delaware, as to its legal existence and good standing in such state and listing all documents on file in the office of said Secretary of State. 6.13 FURTHER ASSURANCES. At any time and from time to time the Company shall, and shall cause each of its Subsidiaries to, execute and deliver such further instruments, excluding financing statements, and take such further action as may reasonably be requested by the Agent or any Bank to effect the purposes of this Agreement and the other Loan Documents. SECTION VII ----------- NEGATIVE COVENANTS ------------------ So long as any Bank has any commitment to extend credit hereunder or any Loan, Letter of Credit or other Obligation remains outstanding, the Company covenants as follows: 7.1. ENCUMBRANCES. Neither the Company nor any of its Subsidiaries shall create, incur, assume or suffer to exist any mortgage, pledge, security interest, lien or other charge or encumbrance, including the lien or retained security title of a conditional vendor upon or with respect to any of its property or assets ("ENCUMBRANCES"), or assign or otherwise convey any right to receive income, including the sale or discount of accounts receivable with or without recourse, except the following ("PERMITTED ENCUMBRANCES"): 40 -40- (a) Encumbrances in favor of the Agent or any of its affiliates to secure the Obligations; (b) Encumbrances existing as of the date of this Agreement and disclosed in EXHIBIT F hereto; (c) liens for taxes, fees, assessments and other governmental charges to the extent that payment of the same may be postponed or is not required in accordance with the provisions of Section 6.4; (d) landlords' and lessors' liens in respect of rent not in default or liens in respect of pledges or deposits under workmen's compensation, unemployment insurance, social security laws, or similar legislation (other than ERISA) or in connection with appeal and similar bonds incidental to litigation; mechanics', laborers' and materialmen's and similar liens, if the obligations secured by such liens are not then delinquent; liens securing the performance of bids, tenders, contracts (other than for the payment of money); and statutory obligations incidental to the conduct of its business and that do not in the aggregate materially detract from the value of its property or materially impair the use thereof in the operation of its business; (e) judgment liens that shall not have been in existence for a period longer than 30 days after the creation thereof or, if a stay of execution shall have been obtained, for a period longer than 30 days after the expiration of such stay; (f) rights of lessors under capital leases permitted under Section 7.6; (g) Encumbrances in respect of any purchase money obligations for tangible property used in its business (other than purchases of inventory in the ordinary course of business) that at any time shall not exceed $5,000,000, PROVIDED that any such Encumbrances shall not extend to property and assets of the Company or any such Subsidiary not financed by such a purchase money obligation; (h) easements, rights of way, restrictions and other similar charges or Encumbrances relating to real property and not interfering in a material way with the ordinary conduct of its business; (i) Encumbrances arising from the sale or discount without recourse of accounts receivable generated in connection with the Company's vendor leasing programs; and (j) Encumbrances on its property or assets created in connection with the refinancing of Indebtedness secured by Permitted Encumbrances on such property, PROVIDED that the amount of Indebtedness secured by any 41 -41- such Encumbrance shall not be increased as a result of such refinancing and no such Encumbrance shall extend to property and assets of the Company or any such Subsidiary not encumbered prior to any such refinancing. 7.2. MERGER; CONSOLIDATION; SALE OR LEASE OF ASSETS. Neither the Company nor any of its Subsidiaries shall sell, lease or otherwise dispose of all or substantially all of its assets or properties; or liquidate, merge or consolidate into or with any other person or entity, PROVIDED if no Default has occurred and is continuing or would result from such merger, (i) the Company may merge or consolidate into or with any other person or entity if the Company is the surviving company and such merger is permitted by Section 7.5, and (ii) any Subsidiary of the Company may merge or consolidate into or with (a) the Company if the Company is the surviving company, or (b) any other wholly-owned Subsidiary of the Company. 7.3. ADDITIONAL STOCK ISSUANCE. The Company shall not permit any of its Subsidiaries to issue any additional shares of its capital stock or other equity securities, any options therefor or any securities convertible thereto other than to the Company; PROVIDED that any Subsidiary may issue additional shares of its capital stock or other equity securities if the Company shall thereafter retain the power to elect the majority of such Subsidiary's board of directors and direct the management and policies of such Subsidiary. Neither the Company nor any of its Subsidiaries shall sell, transfer or otherwise dispose of any of the capital stock or other equity securities of a Subsidiary, except (i) to the Company or any of its wholly-owned Subsidiaries, or (ii) in connection with a transaction permitted by Section 7.2, unless the Company or such Subsidiary shall thereafter retain the power to elect the majority of its Subsidiary's board of directors and direct the management and policies of such Subsidiary. 7.4. ERISA. Neither the Company nor any member of the Controlled Group shall permit any Plan maintained by it to (i) engage in any "prohibited transaction" (as defined in Section 4975 of the Code, (ii) incur any "accumulated funding deficiency" (as defined in Section 302 of ERISA) whether or not waived, or (iii) terminate any Plan in a manner that could result in the imposition of a lien or encumbrance on the assets of the Company or any of its Subsidiaries pursuant to Section 4068 of ERISA. 7.5. MERGERS AND ACQUISITIONS. Neither the Company nor any of its Subsidiaries shall become a party to any merger or consolidation, or agree to or effect any asset acquisition or stock acquisition; PROVIDED, HOWEVER, the Company shall be permitted to (a) consummate the acquisition of Starlight Networks, Inc. (the "Starlight Acquisition") so long as (i) no Default or Event of Default has occurred and is continuing or would exist as a result of such acquisition; (ii) the Company has demonstrated to the Agent satisfaction on a pro forma basis with all the financial covenants contained in Article 6 hereof both immediately prior to and after giving effect to such acquisition; (iii) the Company has not incurred any Indebtedness in 42 -42- connection with such acquisition except as expressly permitted by Section 7.6; (iv) the Person being acquired has no liens, security interests or other encumbrances on its assets at the time of the consummation of such acquisition, except as otherwise permitted by Section 7.1 hereof; and (v) the aggregate consideration to be paid for such acquisition shall not exceed, in the aggregate, (1) 1,600,000 shares of the common stock of the Company and (2) $3,000,000 in cash; and (b) consummate other acquisitions of the assets or stock of any Person so long as (i) such Person is in the same or a similar line of business as the Company; (ii) no Default or Event of Default has occurred and is continuing or would exist as a result of such acquisition; (iii) the Company has demonstrated to the Agent satisfaction on a pro forma basis with all the financial covenants contained in Article 6 hereof both immediately prior to and after giving effect to such acquisition; (iv) the Company has not incurred any Indebtedness in connection with such merger, consolidation or acquisition except as expressly permitted by Section 7.6; (v) the Person being acquired has no liens, security interests or other encumbrances on its assets at the time of the consummation of such merger, consolidation or acquisition, as the case may be, except as otherwise permitted by Section 7.1 hereof; and (vi) the aggregate consideration to be paid for all acquisitions (other than the Starlight Acquisition) from the date hereof through the term of this Credit Agreement shall not exceed $5,000,000. 7.6. RESTRICTIONS ON INDEBTEDNESS. Neither the Company nor any of its Subsidiaries shall create, incur, assume, guarantee or be or remain liable, contingently or otherwise, with respect to any Indebtedness other than: (a) Indebtedness to the Banks and the Agent arising under any of the Loan Documents; (b) obligations under capitalized leases not exceeding $45,000,000 in aggregate amount at any time outstanding; (c) Indebtedness existing on the date of this Agreement and listed and described on Schedule 7.6 hereto; (d) Indebtedness of a Subsidiary of the Borrower to the Borrower or another Subsidiary of the Borrower, or Indebtedness of the Borrower to a Subsidiary of the Borrower; and (e) (i) Indebtedness of PictureTel GmbH and PictureTel UK Ltd. to the Overdraft Lender in an amount not to exceed, in the aggregate, $5,000,000; and (ii) other Indebtedness of the Company or any Subsidiary of the Company, provided that the aggregate amount of Indebtedness permitted to be incurred and/or assumed under this Section 7.6(e) shall not exceed $12,000,000 in the aggregate at any time outstanding. 43 -43- 7.7. RESTRICTIONS ON INVESTMENTS. The Company will not, and will not permit any of its Subsidiaries to, make or permit to exist or to remain outstanding any Investment except Investments in: (a) marketable direct or guaranteed obligations of the United States of America or those other specific governments or jurisdictions listed on SCHEDULE 7.7(a) hereto that mature within one (1) year from the date of purchase by the Company; (b) demand deposits, certificates of deposit, bankers acceptances and time deposits of United States banks or banks organized under the laws of those specific other jurisdictions (if any) listed on SCHEDULE 7.7(B) hereto having in each case total assets in excess of $1,000,000,000; (c) securities commonly known as "commercial paper" issued by a corporation organized and existing under the laws of the United States of America or any state thereof that at the time of purchase have been rated and the ratings for which are not less than "P 1" if rated by Moody's Investors Service, Inc., and not less than "A 1" if rated by Standard and Poor's Rating Group; (d) Investments existing on the date hereof and listed on SCHEDULE 7.7 hereto; (e) Investments with respect to Indebtedness permitted by Section 7.6(d) so long as such entities remain Subsidiaries of the Borrower; (f) Investments consisting of the Guaranty; and (g) other Investments not specifically provided for in this Section 7.7, provided, however, the aggregate amount of all such Investments made pursuant to this Section 7.7(g) shall not exceed $2,000,000 during the term of this Credit Agreement. SECTION VIII ------------ DEFAULTS -------- 8.1. EVENTS OF DEFAULT. There shall be an Event of Default hereunder if any of the following events occurs: (a) the Company shall fail to pay (i) any amount of principal of any of its Loans, or any Reimbursement Obligation, when due, or (ii) any amount of interest thereon within five days of the due date therefor, or (iii) the Commitment Fee or any other fees or expenses payable hereunder or 44 -44- under its Notes or any Letter of Credit Application or Letter of Credit issued thereunder within five days of demand therefor; or (b) any Borrowing Subsidiary shall fail to pay (i) any amount of principal of any of its Loans when due, or (ii) any amount of interest thereon within five days of the due date therefor, or (iii) any fees or expenses payable under its Notes within five days of demand therefor; or (c) The Company shall fail to perform any term, covenant or agreement contained in Sections 6.1(a), (b), (c) or (g), 6.2(b) (only with respect to the Company), 6.5, 6.7 through 6.13 or contained in Section VII; or (d) the Company shall fail to perform any covenant contained in Sections 6.1(f), 6.1(h) or 6.2 (other than with respect to the corporate existence of the Company), and such failure shall continue for 30 days; or (e) the Company shall fail to perform any term, covenant or agreement (other than in respect of subsections 8.1(a), (b), (c) or (d) hereof) contained in the Loan Documents and such default shall continue for 30 days after notice thereof has been sent to the Company by the Agent; or (f) any representation or warranty of the Company made in this Agreement or in any other Loan Document, or any representation or warranty of any Borrowing Subsidiary made in its Letter Agreement shall prove to have been false in any material respect upon the date when made or deemed to have been made; or (g) the Company or any of its Subsidiaries shall fail to pay at maturity, or within any applicable period of grace, any obligations in excess of $500,000 in the aggregate for borrowed monies or advances, or for the use of real or personal property, or fail to observe or perform any term, covenant or agreement evidencing or securing such obligations for borrowed monies or advances, or relating to such use of real or personal property, the result of which failure is to permit the holder or holders of such Indebtedness to cause such Indebtedness to become due prior to its stated maturity upon delivery of required notice, if any; or (h) the Company or any of its Material Subsidiaries shall (i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, liquidator or similar official of itself or of all or a substantial part of its property, (ii) be generally not paying its debts as such debts become due, (iii) make a general assignment for the benefit of its creditors, (iv) commence a voluntary case under the Federal Bankruptcy Code (as now or hereafter in effect), (v) take any action or commence any case or proceeding under any law relating to bankruptcy, insolvency, reorganization, winding-up or composition or adjustment of debts, or any other law providing for the relief of debtors, (vi) fail to contest in a timely or appropriate manner, or acquiesce in writing to, any petition filed against it 45 -45- in an involuntary case under the Federal Bankruptcy Code or other law, (vii) take any action under the laws of its jurisdiction of incorporation or organization similar to any of the foregoing, or (viii) take any corporate action for the purpose of effecting any of the foregoing; or (i) a proceeding or case shall be commenced, without the application or consent of the Company or any of its Material Subsidiaries in any court of competent jurisdiction, seeking (i) the liquidation, reorganization, dissolution, winding up, or composition or readjustment of its debts, (ii) the appointment of a trustee, receiver, custodian, liquidator or the like of it or of all or any substantial part of its assets, or (iii) similar relief in respect of it, under any law relating to bankruptcy, insolvency, reorganization, winding-up or composition or adjustment of debts or any other law providing for the relief of debtors, and such proceeding or case shall continue undismissed, or unstayed and in effect, for a period of 45 days; or an order for relief shall be entered in an involuntary case under the Federal Bankruptcy Code, against the Company or such Material Subsidiary; or action under the laws of the jurisdiction of incorporation or organization of the Company or any of its Material Subsidiaries similar to any of the foregoing shall be taken with respect to the Company or such Material Subsidiary and shall continue unstayed and in effect for any period of 45 days; or (j) a judgment or order for the payment of money shall be entered against the Company or any of its Subsidiaries by any court, or a warrant of attachment or execution or similar process shall be issued or levied against property of the Company or such Subsidiary, that in the aggregate exceeds $500,000 in value and such judgment, order, warrant or process shall continue undischarged or unstayed for 30 days; or (k) the Company or any member of the Controlled Group shall fail to pay when due any amount that it shall have become liable to pay to the PBGC or to a Plan under Title IV of ERISA; or notice of intent to terminate a Plan or Plans shall be filed under Title IV of ERISA by the Company, any member of the Controlled Group, any plan administrator or any combination of the foregoing; or the PBGC shall institute proceedings under Title IV of ERISA to terminate or to cause a trustee to be appointed to administer any such Plan or Plans or a proceeding shall be instituted by a fiduciary of any such Plan or Plans against the Company and such proceedings shall not have been dismissed within 30 days thereafter; or a condition shall exist by reason of which the PBGC would be entitled to obtain a decree adjudicating that any such Plan or Plans must be terminated; or (l) any Loan Document shall at any time for any reason be determined to be invalid or unenforceable or cease to be in full force and effect or shall be declared to be null and void while any Obligations are outstanding hereunder or thereunder, or the Agent's security interests or liens in a substantial portion of the Collateral shall cease to be perfected, or 46 -46- shall cease to have the priority contemplated by the Security Documents, in each case otherwise than in accordance with the terms thereof or with the express prior written agreement, consent or approval of the Banks, or the validity or enforceability of any of the Loan Documents shall be contested by the Company or any Borrowing Subsidiary party thereto or the Company or any such Borrowing Subsidiary shall deny that it has any or further liability or obligation thereunder. 8.2. REMEDIES. Upon the occurrence of an Event of Default described in subsections 8.1(h) and (i), immediately and automatically, and upon the occurrence of any other Event of Default, at any time thereafter while such Event of Default is continuing, at the Agent's option or upon the request of the Majority Banks, and upon the Agent's declaration: (a) the Agent's and the Banks' commitment to make any further Loans or issue, extend or renew Letters of Credit hereunder shall terminate; (b) the unpaid principal amount of the Loans together with accrued interest and all other Obligations shall become immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived; (c) the Agent may, and upon the request of the Majority Banks shall, demand that the Company deposit and maintain in a special interest-bearing cash collateral account at the Bank cash in an amount sufficient to pay at all times the Maximum Drawing Amount of all outstanding Letters of Credit and all fees with respect thereto, and the Company shall have no control over the funds so deposited; and (d) the Agent may, and upon the request of the Majority Banks shall, exercise any and all rights it has under this Agreement and the other Loan Documents, or at law or in equity, and proceed to protect and enforce the rights of the Agent and the Banks by any action at law, in equity or other appropriate proceeding. 8.3. DISTRIBUTION OF PROCEEDS. In the event that, following the occurrence or during the continuance of any Default or Event of Default, the Agent, any Bank or the Overdraft Lender, as the case may be, receives any monies in connection with the enforcement of any of the Security Documents, or otherwise with respect to the realization upon any of the Collateral, or the Agent or any Bank receives any monies from the Company as a repayment of the Loans or any Overdraft Amounts, such monies shall be distributed for application as follows: (a) First, to the payment of, or (as the case may be) the reimbursement of the Agent for or in respect of all reasonable costs, expenses, disbursements and losses which shall have been incurred or sustained by the Agent in connection with the collection of such monies by the Agent, for the exercise, 47 -47- protection or enforcement by the Agent of all or any of the rights, remedies, powers and privileges of the Agent under this Credit Agreement or any of the other Loan Documents or in respect of the Collateral or in support of any provision of adequate indemnity to the Agent against any taxes or liens which by law shall have, or may have, priority over the rights of the Agent to such monies; (b) Second, to all other Obligations in such order or preference as the Majority Banks may determine; provided, however, that (i) distributions shall be made (A) pari passu among Obligations with respect to the Agent's fee payable pursuant to the terms of the Credit Agreement, the Obligations owing to the Overdraft Lender pursuant to the Overdraft Documents and all other Obligations; and (B) with respect to each type of Obligation owing to the Banks and the Overdraft Lender, such as interest, principal, fees and expenses, among the Banks and the Overdraft Lender pro rata, and (ii) the Agent may in its discretion make proper allowance to take into account any Obligations not then due and payable; (c) Third, upon payment and satisfaction in full or other provisions for payment in full satisfactory to the Banks, the Overdraft Lender and the Agent of all of the Obligations, to the payment of any obligations required to be paid pursuant to Section 9-504(1)(c) of the Uniform Commercial Code of the Commonwealth of Massachusetts; and (d) Fourth, the excess, if any, shall be returned to the Company or to such other Persons as are entitled thereto. SECTION IX ---------- THE AGENT --------- 9.1. AUTHORIZATION. (a) The Agent is authorized to take such action on behalf of each of the Banks and to exercise all such powers as are hereunder and under any of the other Loan Documents and any related documents delegated to the Agent, together with such powers as are reasonably incident thereto, PROVIDED that no duties or responsibilities not expressly assumed herein or therein shall be implied to have been assumed by the Agent. (b) The relationship between the Agent and each of the Banks is that of an independent contractor. The use of the term "Agent" is for convenience only and is used to describe, as a form of convention, the independent contractual relationship between the Agent and each of the 48 -48- Banks. Nothing contained in this Agreement nor the other Loan Documents shall be construed to create an agency, trust or other fiduciary relationship between the Agent and any of the Banks. (c) As an independent contractor empowered by the Banks to exercise certain rights and perform certain duties and responsibilities hereunder and under the other Loan Documents, the Agent is nevertheless a "representative" of the Banks, as that term is defined in Article 1 of the Uniform Commercial Code, for purposes of actions for the benefit of the Banks and the Agent with respect to all collateral security and guaranties contemplated by the Loan Documents. Such actions include the designation of the Agent as "secured party", "mortgagee" or the like on all financing statements and other documents and instruments, whether recorded or otherwise, relating to the attachment, perfection, priority or enforcement of any security interests, mortgages or deeds of trust in collateral security intended to secure the payment or performance of any of the Obligations, all for the benefit of the Banks and the Agent. 9.2. EMPLOYEES AND AGENTS. The Agent may exercise its powers and execute its duties by or through employees or agents and shall be entitled to take, and to rely on, advice of counsel concerning all matters pertaining to its rights and duties under this Agreement and the other Loan Documents. The Agent may utilize the services of such Persons as the Agent in its sole discretion may reasonably determine, and all reasonable fees and expenses of any such Persons shall be paid by the Company. 9.3. NO LIABILITY. Neither the Agent nor any of its shareholders, directors, officers or employees nor any other Person assisting them in their duties nor any agent or employee thereof, shall be liable for any waiver, consent or approval given or any action taken, or omitted to be taken, in good faith by it or them hereunder or under any of the other Loan Documents, or in connection herewith or therewith, or be responsible for the consequences of any oversight or error of judgment whatsoever, except that the Agent or such other Person, as the case may be, may be liable for losses due to its willful misconduct or gross negligence. 9.4. NO REPRESENTATIONS. The Agent shall not be responsible for the execution or validity or enforceability of this Agreement, the Notes, the Letters of Credit, any of the other Loan Documents or any instrument at any time constituting, or intended to constitute, collateral security for the Notes, or for the value of any such collateral security or for the validity, enforceability or collectability of any such amounts owing with respect to the Notes, or for any recitals or statements, warranties or representations made herein or in any of the other Loan Documents or in any certificate or instrument hereafter furnished to it by or on behalf of the Company or any of its Subsidiaries, or be bound to ascertain or inquire as to the performance or observance of any of the terms, conditions, covenants or agreements herein or in any instrument at any time constituting, or intended to constitute, collateral security for the Notes or to inspect any of 49 -49- the properties, books or records of the Company or any of its Subsidiaries. The Agent shall not be bound to ascertain whether any notice, consent, waiver or request delivered to it by the Company or any holder of any of the Notes shall have been duly authorized or is true, accurate and complete. The Agent has not made nor does it now make any representations or warranties, express or implied, nor does it assume any liability to the Banks, with respect to the credit worthiness or financial conditions of the Company or any of its Subsidiaries. Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank, and based upon such information and documents as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. 9.5. PAYMENTS. 9.5.1. PAYMENTS TO AGENT. A payment by the Company to the Agent hereunder or any of the other Loan Documents for the account of any Bank shall constitute a payment to such Bank. The Agent agrees, within four (4) Business Days after receipt of any payments by the Company, distribute to each Bank such Bank's PRO RATA share of payments received by the Agent for the account of the Banks except as otherwise expressly provided herein or in any of the other Loan Documents. 9.5.2. DISTRIBUTION BY AGENT. If in the opinion of the Agent the distribution of any amount received by it in such capacity hereunder, under the Notes or under any of the other Loan Documents might involve it in liability, it may refrain from making distribution until its right to make distribution shall have been adjudicated by a court of competent jurisdiction. If a court of competent jurisdiction shall adjudge that any amount received and distributed by the Agent is to be repaid, each Person to whom any such distribution shall have been made shall either repay to the Agent its proportionate share of the amount so adjudged to be repaid or shall pay over the same in such manner and to such Persons as shall be determined by such court. 9.5.3. DELINQUENT BANKS. Notwithstanding anything to the contrary contained in this Agreement or any of the other Loan Documents, any Bank that fails (i) to make available to the Agent its PRO RATA share of any Loan or to purchase any Letter of Credit Participation or (ii) to comply with the provisions of Section 11.3 with respect to making dispositions and arrangements with the other Banks, where such Bank's share of any payment received, whether by setoff or otherwise, is in excess of its PRO RATA share of such payments due and payable to all of the Banks, in each case as, when and to the full extent required by the provisions of this Agreement, shall be deemed delinquent (a "Delinquent Bank") and shall be deemed a Delinquent Bank until such time as such delinquency is satisfied. A Delinquent Bank shall be deemed to have assigned any and all payments due to it from the Company or any Borrowing Subsidiary, whether on account of outstanding Loans, Unpaid Reimbursement Obligations, interest, fees or otherwise, to the remaining nondelinquent Banks for application to, 50 -50- and reduction of, their respective PRO RATA shares of all outstanding Loans and Unpaid Reimbursement Obligations. The Delinquent Bank hereby authorizes the Agent to distribute such payments to the nondelinquent Banks in proportion to their respective PRO RATA shares of all outstanding Loans and Unpaid Reimbursement Obligations. A Delinquent Bank shall be deemed to have satisfied in full a delinquency when and if, as a result of application of the assigned payments to all outstanding Loans and Unpaid Reimbursement Obligations of the nondelinquent Banks, the Banks' respective PRO RATA shares of all outstanding Loans and Unpaid Reimbursement Obligations have returned to those in effect immediately prior to such delinquency and without giving effect to the nonpayment causing such delinquency. 9.6. HOLDERS OF NOTES. The Agent may deem and treat the payee of any Note or the purchaser of any Letter of Credit Participation as the absolute owner or purchaser thereof for all purposes hereof until it shall have been furnished in writing with a different name by such payee or by a subsequent holder, assignee or transferee. 9.7. INDEMNITY. The Banks ratably agree hereby to indemnify and hold harmless the Agent from and against any and all claims, actions and suits (whether groundless or otherwise), losses, damages, costs, expenses (including any expenses for which the Agent has not been reimbursed by the Company) and liabilities of every nature and character arising out of or related to this Agreement, the Notes, or any of the other Loan Documents or the transactions contemplated or evidenced hereby or thereby, or the Agent's actions taken hereunder or thereunder, except to the extent that any of the same shall be directly caused by the Agent's willful misconduct or gross negligence. 9.8. AGENT AS BANK. In its individual capacity, The First National Bank of Boston shall have the same obligations and the same rights, powers and privileges in respect to its commitment and the Loans made by it, and as the holder of any of the Notes and as the purchaser of any Letter of Credit Participations, as it would have were it not also the Agent. 9.9. RESIGNATION. The Agent may resign at any time by giving sixty (60) days prior written notice thereof to the Banks and the Company. Upon any such resignation, the Majority Banks shall have the right to appoint a successor Agent. Unless a Default or Event of Default shall have occurred and be continuing, such successor Agent shall be reasonably acceptable to the Company. If no successor Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment within thirty (30) days after the retiring Agent's giving of notice of resignation, then the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a financial institution having a rating of not less than A or its equivalent by Standard & Poor's Corporation. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, 51 -51- powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation, the provisions of this Agreement and the other Loan Documents shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as Agent. SECTION X --------- ASSIGNMENT AND PARTICIPATION ---------------------------- 10.1 CONDITIONS TO ASSIGNMENT BY BANKS. Except as provided herein, each Bank may assign to one or more Eligible Assignees all or a portion of its interests, rights and obligations under this Agreement (including all or a portion of its Commitment Percentage and Commitment and the same portion of the Loans at the time owing to it, the Notes held by it and its participating interest in the risk relating to any Letters of Credit); PROVIDED that (i) each of the Agent and, unless a Default or Event of Default shall have occurred and be continuing, the Company shall have given its prior written consent to such assignment, which consent, in the case of the Company, will not be unreasonably withheld, (ii) each such assignment shall be of a constant, and not a varying, percentage of all the assigning Bank's rights and obligations under this Agreement, (iii) each assignment shall be in an amount that is a whole multiple of $1,000,000 and (iv) the parties to such assignment shall execute and deliver to the Agent, for recording in the Register (as hereinafter defined), an Assignment and Acceptance, substantially in the form of EXHIBIT K hereto (an "Assignment and Acceptance"), together with any Notes subject to such assignment. Upon such execution, delivery, acceptance and recording, from and after the effective date specified in each Assignment and Acceptance, which effective date shall be at least five (5) Business Days after the execution thereof, (i) the assignee thereunder shall be a party hereto and, to the extent provided in such Assignment and Acceptance, have the rights and obligations of a Bank hereunder, and (ii) the assigning Bank shall, to the extent provided in such assignment and upon payment to the Agent of the registration fee referred to in Section 10.3 be released from its obligations under this Agreement. 10.2 CERTAIN REPRESENTATIONS AND WARRANTIES; LIMITATIONS; COVENANTS. By executing and delivering an Assignment and Acceptance, the parties to the assignment thereunder confirm to and agree with each other and the other parties hereto as follows: (a) other than the representation and warranty that it is the legal and beneficial owner of the interest being assigned thereby free and clear of any adverse claim, the assigning Bank makes no representation or warranty, express or implied, and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement, the other Loan 52 -52- Documents or any other instrument or document furnished pursuant hereto or the attachment, perfection or priority of any security interest or mortgage; (b) the assigning Bank makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Company and its Subsidiaries or any other Person primarily or secondarily liable in respect of any of the Obligations, or the performance or observance by the Company and its Subsidiaries or any other Person primarily or secondarily liable in respect of any of the Obligations of any of their obligations under this Agreement or any of the other Loan Documents or any other instrument or document furnished pursuant hereto or thereto; (c) such assignee confirms that it has received a copy of this Agreement, together with copies of the most recent financial statements referred to in Section 5.6 and Section 6.1 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (d) such assignee will, independently and without reliance upon the assigning Bank, the Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (e) such assignee represents and warrants that it is an Eligible Assignee; (f) such assignee appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under this Agreement and the other Loan Documents as are delegated to the Agent by the terms hereof or thereof, together with such powers as are reasonably incidental thereto; (g) such assignee agrees that it will perform in accordance with their terms all of the obligations that by the terms of this Agreement are required to be performed by it as a Bank; (h) such assignee represents and warrants that it is legally authorized to enter into such Assignment and Acceptance; and (i) such assignee acknowledges that it has made arrangements with the assigning Bank satisfactory to such assignee with respect to its PRO RATA share of Letter of Credit Fees in respect of outstanding Letters of Credit. 10.3. REGISTER. The Agent shall maintain a copy of each Assignment and Acceptance delivered to it and a register or similar list (the "Register") for the recordation of the names and addresses of the Banks and the Commitment Percentage of, and principal amount of the Loans owing to and Letter of Credit Participations purchased by, the Banks from time to time. 53 -53- The entries in the Register shall be conclusive, in the absence of manifest error, and the Company, the Agent and the Banks may treat each Person whose name is recorded in the Register as a Bank hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Company and the Banks at any reasonable time and from time to time upon reasonable prior notice. Upon each such recordation, the assigning Bank agrees to pay to the Agent a registration fee in the sum of $3,500. 10.4. NEW NOTES. Upon its receipt of an Assignment and Acceptance executed by the parties to such assignment, together with each Note subject to such assignment, the Agent shall (i) record the information contained therein in the Register, and (ii) give prompt notice thereof to the Company and the Banks (other than the assigning Bank). Within five (5) Business Days after receipt of such notice, the Company and each Borrowing Subsidiary, at its own expense, shall execute and deliver to the Agent, in exchange for each surrendered Note, a new Note to the order of such Eligible Assignee in an amount equal to the amount assumed by such Eligible Assignee pursuant to such Assignment and Acceptance and, if the assigning Bank has retained some portion of its obligations hereunder, a new Note to the order of the assigning Bank in an amount equal to the amount retained by it hereunder. Such new Notes shall provide that they are replacements for the surrendered Notes, shall be in an aggregate principal amount equal to the aggregate principal amount of the surrendered Notes, shall be dated the effective date of such in Assignment and Acceptance and shall otherwise be substantially the form of the assigned Notes. Within five (5) days of issuance of any new Notes pursuant to this Section 10.4, the Company shall deliver an opinion of counsel, addressed to the Banks and the Agent, relating to the due authorization, execution and delivery of the new Notes executed by the Company and the legality, validity and binding effect of such Notes and each Company Guaranty, in form and substance satisfactory to the Banks. The surrendered Notes shall be cancelled and returned to the Company. 10.5. PARTICIPATIONS. Each Bank may sell participations to one or more banks or other entities in all or a portion of such Bank's rights and obligations under this Agreement and the other Loan Documents; PROVIDED that (i) each such participation shall be in an amount of not less than $1,000,000, (ii) any such sale or participation shall not affect the rights and duties of the selling Bank hereunder to the Company and (iii) the only rights granted to the participant pursuant to such participation arrangements with respect to waivers, amendments or modifications of the Loan Documents shall be the rights to approve waivers, amendments or modifications that would reduce the principal of or the interest rate on any Loans, extend the term or increase the amount of the Commitment of such Bank as it relates to such participant, reduce the amount of any commitment fees or letter of credit fees to which such participant is entitled or extend any regularly scheduled payment date for principal or interest. 54 -54- 10.6. DISCLOSURE. The Company agrees that in addition to disclosures made in accordance with standard and customary banking practices any Bank may disclose information obtained by such Bank pursuant to this Agreement to assignees or participants and potential assignees or participants hereunder; PROVIDED that such assignees or participants or potential assignees or participants shall agree (i) to treat in confidence such information unless such information otherwise becomes public knowledge, (ii) not to disclose such information to a third party, except as required by law or legal process and (iii) not to make use of such information for purposes of transactions unrelated to such contemplated assignment or participation. 10.7. ASSIGNEE OR PARTICIPANT AFFILIATED WITH THE COMPANY. If any assignee Bank is an Affiliate of the Company, then any such assignee Bank shall have no right to vote as a Bank hereunder or under any of the other Loan Documents for purposes of granting consents or waivers or for purposes of agreeing to amendments or other modifications to any of the Loan Documents or for purposes of making requests to the Agent pursuant to Section 8.2, and the determination of the Majority Banks shall for all purposes of this Agreement and the other Loan Documents be made without regard to such assignee Bank's interest in any of the Loans. If any Bank sells a participating interest in any of the Loans or reimbursement obligations with respect to Letters of Credit to a participant, and such participant is the Company or an Affiliate of the Company, then such transferor Bank shall promptly notify the Agent of the sale of such participation. A transferor Bank shall have no right to vote as a Bank hereunder or under any of the other Loan Documents for purposes of granting consents or waivers or for purposes of agreeing to amendments or modifications to any of the Loan Documents or for purposes of making requests to the Agent pursuant to Section 8.2 to the extent that such participation is beneficially owned by the Company or any Affiliate of the Company, and the determination of the Majority Banks shall for all purposes of this Agreement and the other Loan Documents be made without regard to the interest of such transferor Bank in the Loans to the extent of such participation. 10.8. MISCELLANEOUS ASSIGNMENT PROVISIONS. If any assignee Bank is not incorporated under the laws of the United States of America or any state thereof, it shall, prior to the date on which any interest or fees are payable hereunder or under any of the other Loan Documents for its account, deliver to the Company and the Agent certification as to its exemption from deduction or withholding of any United States federal income taxes. Anything contained in this Section 10 to the contrary notwithstanding, any Bank may at any time pledge all or any portion of its interest and rights under this Agreement (including all or any portion of its Notes) to any of the twelve Federal Reserve Banks organized under Section 4 of the Federal Reserve Act, 12 U.S.C. Section 341. No such pledge or the enforcement thereof shall release the pledgor Bank from its obligations hereunder or under any of the other Loan Documents. 55 -55- SECTION XI ---------- MISCELLANEOUS ------------- 11.1. NOTICES. Unless otherwise specified herein, all notices hereunder to any party hereto shall be in writing and shall be deemed to have been given when delivered by hand, when properly deposited in the mails postage prepaid, when sent by telex, answerback received, or electronic facsimile transmission, or when delivered to the telegraph company or overnight courier, addressed to such party at its address indicated below: If to the Company, at PictureTel Corporation 100 Minuteman Road Andover, Massachusetts 01810 Facsimile: (508) 292-3300 Attention: Lloyd S. Dow Director of Finance, Tax and Treasury Services If to a Bank, at the address set forth for such Bank on SCHEDULE 1 hereto. If to the Agent, at BankBoston, N.A. 100 Federal Street Boston, Massachusetts Facsimile: (617) 434-0819 Attention: Lynn R. Schade, Vice President or at any other address specified by such party in writing. 11.2. EXPENSES. The Company will pay on demand all expenses of the Agent in connection with the preparation, waiver or amendment of this Agreement and the other Loan Documents, or the administration, default or collection of the Loans or other Obligations and all expenses of the Agent and each of the Banks in connection with the exercise, preservation or enforcement of any of its rights, remedies or options thereunder, including, without limitation, fees of outside legal counsel or the allocated costs of in-house legal counsel, accounting, consulting, brokerage or other similar professional fees or expenses, and any fees or expenses associated with any travel or other costs relating to any appraisals or examinations conducted in connection with the Obligations or any collateral therefor, and the 56 -56- amount of all such expenses shall, until paid, bear interest at the rate applicable to principal hereunder (including any default rate). 11.3. SET-OFF. Regardless of the adequacy of any collateral or other means of obtaining repayment of the Obligations, any deposits, balances or other sums credited by or due from the head office of any Bank or any of its branch offices to the Company may, at any time and from time to time after the occurrence of an Event of Default hereunder, without notice to the Company or compliance with any other condition precedent now or hereafter imposed by statute, rule of law, or otherwise (all of which are hereby expressly waived) be set off, appropriated, and applied by the Bank against any and all obligations of the Company to the Banks or any of its affiliates in such manner as the head office of the Banks or any of its branch offices in their sole discretion may determine, and the Company hereby grants the Bank a continuing security interest in such deposits, balances or other sums for the payment and performance of all such obligations. Each of the Banks agrees with each other Bank that (i) if an amount to be set off is to be applied to Indebtedness of the Company to such Bank, other than Indebtedness evidenced by the Notes held by such Bank or constituting Reimbursement Obligations owed to such Bank, such amount shall be applied ratably to such other Indebtedness and to the Indebtedness evidenced by all such Notes held by such Bank or constituting Reimbursement Obligations owed to such Bank, and (ii) if such Bank shall receive from the Company, whether by voluntary payment, exercise of the right of setoff, counterclaim, cross action, enforcement of the claim evidenced by the Notes held by, or constituting Reimbursement Obligations owed to, such Bank by proceedings against the Company at law or in equity or by proof thereof in bankruptcy, reorganization, liquidation, receivership or similar proceedings, or otherwise, and shall retain and apply to the payment of the Note or Notes held by, or Reimbursement Obligations owed to, such Bank any amount in excess of its ratable portion of the payments received by all of the Banks with respect to the Notes held by, and Reimbursement Obligations owed to, all of the Banks, such Bank will make such disposition and arrangements with the other Banks with respect to such excess, either by way of distribution, PRO TANTO assignment of claims, subrogation or otherwise as shall result in each Bank receiving in respect of the Notes held by it or Reimbursement obligations owed it, its proportionate payment as contemplated by this Agreement; PROVIDED that if all or any part of such excess payment is thereafter recovered from such Bank, such disposition and arrangements shall be rescinded and the amount restored to the extent of such recovery, but without interest. 11.4. TERM OF AGREEMENT. This Agreement shall continue in force and effect so long as the Agent or any Bank has any commitment to make Loans or issue Letters of Credit hereunder or any Loan, Letter of Credit or any other Obligation shall be outstanding. 11.5. NO WAIVERS. No failure or delay by the Agent or any Bank in exercising any right, power or privilege hereunder or under the other Loan 57 -57- Documents shall operate as a waiver thereof; nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein and in the other Loan Documents provided are cumulative and not exclusive of any rights or remedies otherwise provided by agreement or law. 11.6. GOVERNING LAW. This Agreement and other Loan Documents shall be deemed to be contracts made under seal and shall be construed in accordance with and governed by the laws of The Commonwealth of Massachusetts (without giving effect to any conflicts of laws provisions contained therein). 11.7. CONSENTS, AMENDMENTS, WAIVERS, ETC. Any consent or approval required or permitted by this Agreement to be given by all of the Banks may be given, and any term of this Agreement, the other Loan Documents or any other instrument related hereto or mentioned herein may be amended, and the performance or observance by the Company or any of its Subsidiaries of any terms of this Agreement, the other Loan Documents or such other instrument or the continuance of any Default or Event of Default may be waived (either generally or in a particular instance and either retroactively or prospectively) with, but only with, the written consent of the Company and the written consent of the Majority Banks. Notwithstanding the foregoing, the rate of interest on the Notes, the term of the Notes, the amount of the Commitments of the Banks, and the amount of commitment fee or Letter of Credit Fees hereunder may not be changed without the written consent of the Company and the written consent of all of the Banks; the definition of Majority Banks may not be amended without the written consent of all of the Banks; the Company Guaranties may not be released, any date for payment of the Obligations may not be postponed and the Obligations may not be reduced or forgiven without the written consent of all of the Banks; and the amount of the agent's fee or any Letter of Credit Fees payable for the Agent's account and Section 9 may not be amended without the written consent of the Agent. No waiver shall extend to or affect any obligation not expressly waived or impair any right consequent thereon. No course of dealing or delay or omission on the part of the Agent or any Bank in exercising any right shall operate as a waiver thereof or otherwise be prejudicial thereto. No notice to or demand upon the Company shall entitle the Company to other or further notice or demand in similar or other circumstances. 11.8. BINDING EFFECT OF AGREEMENT. This Agreement and the other Loan Documents shall be binding upon and inure to the benefit of the Company, each Borrowing Subsidiary and the Banks and their respective successors and assigns; PROVIDED that neither the Company nor any Borrowing Subsidiary may assign or transfer its rights or obligations hereunder or under the other Loan Documents. 58 -58- 11.9. COUNTERPARTS. This Agreement may be signed in any number of counterparts with the same effect as if the signatures hereto and thereto were upon the same instrument. 11.10. PARTIAL INVALIDITY. The invalidity or unenforceability of any one or more phrases, clauses or sections of this Agreement shall not affect the validity or enforceability of the remaining portions of it. 11.11. CAPTIONS. The captions and headings of the various sections and subsections of this Agreement are provided for convenience only and shall not be construed to modify the meaning of such sections or subsections. 11.12. WAIVER OF JURY TRIAL. THE AGENT, THE BANKS AND THE COMPANY AGREE THAT NONE OF THEM NOR ANY ASSIGNEE OR SUCCESSOR SHALL (A) SEEK A JURY TRIAL IN ANY LAWSUIT, PROCEEDING, COUNTERCLAIM OR ANY OTHER ACTION BASED UPON, OR ARISING OUT OF, THIS AGREEMENT, ANY OTHER LOAN DOCUMENT, ANY COLLATERAL OR THE DEALINGS OR THE RELATIONSHIP BETWEEN OR AMONG ANY OF THEM, OR (B) SEEK TO CONSOLIDATE ANY SUCH ACTION WITH ANY OTHER ACTION IN WHICH A JURY TRIAL CANNOT BE OR HAS NOT BEEN WAIVED. THE PROVISIONS OF THIS PARAGRAPH HAVE BEEN FULLY DISCUSSED BY THE AGENTS, THE BANKS AND THE COMPANY, AND THESE PROVISIONS SHALL BE SUBJECT TO NO EXCEPTIONS. NEITHER THE BANK NOR THE COMPANY HAS AGREED WITH OR REPRESENTED TO THE OTHER THAT THE PROVISIONS OF THIS PARAGRAPH WILL NOT BE FULLY ENFORCED IN ALL INSTANCES. 11.13. ENTIRE AGREEMENT. This Agreement and the other Loan Documents constitute the final agreement of the parties hereto and supersede any prior agreement or understanding, written or oral, with respect to the matters contained herein and therein. This Agreement replaces the Prior Credit Agreement, as amended, between the Company and the Bank and all loans and letters of credit outstanding thereunder or otherwise designated by the Agent shall be deemed to be outstanding hereunder on the date of this Agreement. From and after the date of this Agreement such Prior Credit Agreement shall have no further force or effect. 59 -59- IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized officers as of the day and year first above written. PICTURETEL CORPORATION By /s/ Authorized Signatory ------------------------------------- Title: BANKBOSTON, N.A., Individually and as Agent By /s/ Vice President ------------------------------------- Title: Vice President MELLON BANK, N.A. By: /s/ Authorized Signatory ------------------------------------- Title: ---------------------------------- THE CHASE MANHATTAN BANK By: /s/ Authorized Signatory ------------------------------------- Title: ---------------------------------- EX-23.3 8 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 EXHIBIT 23.3 CONSENT OF INDEPENDENT ACCOUNTANTS The Board of Directors PictureTel Corporation: We hereby consent to the inclusion in the Prospectus constituting part of this Registration Statement on Form S-4 of our report, which includes an explanatory paragraph regarding the restatement of the financial statements for the year ended December 31, 1996, dated February 25, 1998, on our audits of the consolidated financial statements of PictureTel Corporation as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, which appears in such Prospectus. We also consent to the application of such report to the Financial Statement Schedule for the three years ended December 31, 1997 listed under Item 14(a) of PictureTel Corporation's Annual Report on Form 10-K for the year ended December 31, 1997 when such schedule is read in conjunction with the financial statements referred to in our report. The audits referred to in such report also included this Financial Statement Schedule. We also consent to the reference to our firm under the caption "Experts." /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Boston, Massachusetts September 21, 1998 EX-23.4 9 CONSENT OF ERNST & YOUNG 1 EXHIBIT 23.4 CONSENT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated March 19, 1998, included in the Information Statement/Prospectus constituting part of this Registration Statement (Form S-4 No. 333-00000) of PictureTel Corporation for the registration of 1,331,914 shares of its common stock. /s/ Ernst & Young LLP San Jose, California September 21, 1998 EX-27.1 10 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 1 39,593 20,463 104,944 (1,966) 45,584 221,733 71,007 (45,776) 300,613 78,603 0 0 0 357 208,384 300,613 363,799 363,799 178,782 178,782 0 0 1,063 31,101 9,242 21,859 0 0 0 21,859 0.64 0.57
EX-27.2 11 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 63,333 38,918 146,573 (3,336) 51,538 309,269 109,612 (61,865) 386,254 107,206 0 0 0 376 264,470 264,846 490,225 490,225 251,049 251,049 0 0 1,050 48,095 15,923 32,172 0 0 0 32,172 0.89 0.81
EX-27.3 12 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 49,859 32,152 115,044 (6,315) 44,901 258,059 149,465 (80,362) 355,051 105,086 0 0 0 380 227,585 355,051 466,425 466,425 275,911 275,911 0 0 1,821 (55,490) (16,092) (39,398) 0 0 0 (39,398) (1.04) (1.04)
EX-27.4 13 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PICTURETEL CORPORATION'S BALANCE SHEET AND INCOME STATEMENT FOR THE PERIOD ENDED JUNE 28, 1998. 1,000 U.S. DOLLARS 6-MOS DEC-31-1998 JAN-01-1998 JUN-28-1998 1 33,638 52,545 101,910 (5,956) 36,651 244,135 147,228 (88,504) 336,808 94,618 0 0 0 383 221,076 336,808 205,628 205,628 119,468 119,468 0 0 1,208 (13,021) (4,167) (8,854) 0 0 0 (8,854) (0.23) (0.23)
EX-99 14 FORM OF WRITTEN CONSENT 1 EXHIBIT 99 STARLIGHT NETWORKS INCORPORATED Written Consent The undersigned shareholder of Starlight Networks Incorporated ("Starlight") hereby consents to the proposals set forth below in the manner indicated. VOTING INSTRUCTION--ALL SHAREHOLDERS SHOULD VOTE ON ITEMS 1 AND 2. WHERE A SEPARATE VOTE OF ANY PARTICULAR CLASS OR CLASSES OF STOCK OF STARLIGHT IS REQUIRED, THIS CONSENT SHALL BE TREATED AS A CLASS VOTE. PLEASE RETURN YOUR COMPLETED PROXY TO: WILSON SONSINI GOODRICH & ROSATI, P.C.; ATTENTION RONALD A. BAKER (FACSIMILE: 650-493-6811) A POSTAGE-PAID RETURN ENVELOPE HAS BEEN INCLUDED FOR YOUR CONVENIENCE. TO ALL STARLIGHT SHAREHOLDERS, PLEASE MARK VOTES, AS IN THIS EXAMPLE [X] 1. To approve and adopt the Agreement and Plan of Merger (the "Plan of Merger") by and among the PictureTel Corporation, PictureTel Technology Corporation, SNI Acquisition Corporation, and Starlight Networks, Incorporated ("Starlight") dated as of August 14, 1998 and to approve the merger (the "Merger") of SNI Acquisition Corporation, an indirect wholly owned subsidiary of PictureTel Corporation, with and into Starlight pursuant to which Starlight would become an indirect wholly owned subsidiary of PictureTel Corporation, which approval and adoption of the Plan of Merger and Merger shall also serve as approval and adoption of (i) the Escrow Agreement by and between PictureTel Corporation, James E. Long, as the Stockholder Representative, and State Street Bank & Trust Company and (ii) the appointment and indemnification of James E. Long as the Stockholder Representative pursuant to the terms of such Escrow Agreement. [ ] FOR [ ] AGAINST 2. To approve and adopt the Starlight 1998 Bonus Retention Plan and each payment of a Section 280G Amount as defined and described in the Information Statement/Prospectus. [ ] FOR [ ] AGAINST THE SHARES REPRESENTED BY THIS CONSENT WILL BE TREATED AS DIRECTED OR, IF NO DIRECTION IS GIVEN AND THIS CONSENT IS PROPERLY SIGNED AND DELIVERED TO STARLIGHT, WILL BE TREATED AS CONSENTING "IN FAVOR" OF THE PROPOSALS IN ITEMS 1 AND 2, AS APPLICABLE. 2 [ ] MARK HERE FOR ADDRESS CHANGE AND NOTE BELOW _______________________________________________ _______________________________________________ _______________________________________________ If signing as attorney, executor, trustee or guardian, please give your full title as such. If shares are held jointly, each owner should sign. Dated: October , 1998 ________________________________ ________________________________ (Please Type or Print Name) (Please Type or Print Name) ________________________________ ________________________________ (Signature) (Signature) 2 -----END PRIVACY-ENHANCED MESSAGE-----