-----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, FH0NUO/hdoKakBp2uzLmYnMqqxRkBnUjlSdp8ycxyY9Whcy4+JbETz8IFRxgBeoJ 5Tt32Jlcs/+9HO+j1FhYfA== 0000930661-98-000348.txt : 19980218 0000930661-98-000348.hdr.sgml : 19980218 ACCESSION NUMBER: 0000930661-98-000348 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19980217 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: OPTEL INC CENTRAL INDEX KEY: 0001036712 STANDARD INDUSTRIAL CLASSIFICATION: CABLE & OTHER PAY TELEVISION SERVICES [4841] IRS NUMBER: 95445524 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 333-24881 FILM NUMBER: 98540633 BUSINESS ADDRESS: STREET 1: 1111 W MOCKINGBIRD LANE CITY: DALLAS STATE: TX ZIP: 75247 BUSINESS PHONE: 2146343800 MAIL ADDRESS: STREET 1: 1114 W MOCKINGBIRD LANE CITY: DALLAS STATE: TX ZIP: 75247 10-K405/A 1 FORM 10-K405/A UNITED STATES SECURITIES AND EXCHANGE COMMISISION Washington, D.C. 20549 _____________________________ FORM 10-K/A (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended August 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from..................to.................. 333-24881 (Commission file number) ____________________________ OPTEL, INC. (Exact name of Registrant as specified in its charter) _____________________________ Delaware OpTel, Inc. 95 - 4495524 1111 W. MOCKINGBIRD LANE DALLAS, TEXAS 75247 (214) 634-3800 (State or other (Name, address, (I.R.S. Employer jurisdiction of including Zip code Identification No.) incorporation or of principal executive offices) organization) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes...X.. No....... Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements contained by reference in Part lll of this Form 10-K or any amendment to this Form 10-K. Yes...X.. No....... COMMON STOCK AS OF OCTOBER 30, 1997 Common Stock Authorized Issued and Outstanding Class A common stock, $.01 par 8,000,000 - VALUE Class B common stock, $.01 par 6,000,000 2,353,498 value Class C common stock, $.01 par 300,000 225,000 value DOCUMENTS INCORPORATED BY REFERENCE None - -------------------------------------------------------------------------------- Item 1 of the Annual Report on Form 10-K for the year ended August 31, 1997 of OpTel, Inc. (the "Company") is hereby amended to read as follows: PART I ITEM 1: BUSINESS OVERVIEW OpTel, Inc, together with its subsidaries, ("OpTel" or "the Company") is the largest provider of private cable television services to residents of multiple dwelling unit developments ("MDUs") in the United States and is expanding the telecommunications services it offers to MDU residents. The Company provides cable television and, where currently offered, telecommunications services to MDU residents principally under long-term contracts ("Rights of Entry") with owners of MDUs. The Company's Rights of Entry are generally for a term of ten to fifteen years (five years for Rights of Entry with condominium associations). The weighted average unexpired term of the Company's cable television Rights of Entry was approximately eight years as of August 31, 1997. The Company currently provides cable television services in the metropolitan areas of Houston, Dallas- Fort Worth, San Diego, Phoenix, Chicago, Denver, San Francisco, Los Angeles, Miami-Ft. Lauderdale, Tampa and Austin. The Company also provides telecommunications services in Houston, Dallas-Fort Worth, Austin, Chicago, Denver and Miami-Ft. Lauderdale. As of August 31, 1997, the Company had 132,556 cable television subscribers and 6,825 telecommunications subscribers with 8,190 telephone lines. For regulatory purposes, the Company is considered to be a private cable television operator in most of the markets it serves. Private cable television operators deliver services to consumers without hard-wire crossings of public rights of way. Consequently, private cable television operators are not required to obtain cable television franchises and are subject to significantly less regulatory oversight than are traditional franchise cable television operators. As a result, they have significant latitude in terms of system coverage, pricing and customized delivery of services to selected properties. The Company has no universal service obligations and generally does not incur capital costs to build its networks until it has entered into Rights of Entry from which it reasonably expects to build an appropriate customer base. In certain other markets, such as Houston, the Company delivers cable television services pursuant to franchises the terms of which are significantly more relaxed than traditional cable television franchises. The Company offers a full range of multichannel video programming (including basic and premium services) which the Company believes is competitive in both content and pricing with the programming packages offered by its major competitors. The Company currently provides its telecommunications services as a shared tenant services ("STS") operator through private branch exchange ("PBX") switches. The Company offers customers access to services comparable in scope and price to those provided by the incumbent local exchange carrier ("LEC") and long distance carrier. The Company's telecommunications strategy includes replacing its PBX switches with networked central office switches. The Company invests in networks because it believes that networks provide the optimal mechanism for delivering bundled cable television and telecommunications services. The Company's networks use technologies that are capable of bi- directional transmission. The Company provides its video programming to MDUs through 18-Gigahertz microwave ("18GHz"), 12-Gigahertz microwave ("12 GHz") where appropriate and fiber optic networks and non-networked satellite master antenna television ("SMATV") systems. As of August 31, 1997, approximately 165,000 of the 254,032 units passed for cable television are served by the Company's networks. These networks generally provide up to 72 channels of video programming. The Company's networks will also facilitate delivery of voice signal from each MDU to the central office switches to be deployed or leased by the Company in its markets. 1 The Company intends to license additional spectrum, which it currently anticipates principally will be in the 23-Gigahertz ("23GHz") band, which it will use to provide bi-directional voice transmission. The Company intends to convert substantially all of its SMATV systems to 18GHz, 12GHz (principally in Denver) or fiber optic networks by the end of fiscal 1999 and PBX switches to central office switches by the end of fiscal 2002. The Company believes that there are several benefits to converting its SMATV systems to cable networks and PBX switches to central office switches. These include lower per unit maintenance costs, increased system reliability through better monitoring and redundancy, greater channel capacity, the opportunity to bundle services, integration of video, voice and data and improved operating margins. OpTel was incorporated in the State of Delaware in July 1994, as the successor to a Delaware corporation that was founded in April 1993. The Company's principal offices are located at 1111 W. Mockingbird Lane, Dallas, Texas 75247, and its telephone number is (214) 634-3800. RECENT DEVELOPMENTS - CONSUMMATION OF PHONOSCOPE ACQUISITION; LAUNCH OF HOUSTON CENTRAL OFFICE SWITCH; CHANGE IN MINORITY SHAREHOLDER; BANK FINANCING COMMITMENT On October 27, 1997 the Company acquired the Phonoscope residential cable television and associated fiber optic network in the greater Houston metropolitan area for $36.5 million. Phonoscope provides its services over a fiber optic and coaxial cable distribution system. The Company will use its existing franchise with the City of Houston to serve Phonoscope subscribers within the City of Houston, and has received or will seek assignment of the appropriate municipal franchises to service MDUs in other municipalities. The acquired Phonoscope Rights of Entry or subscriber agreements cover approximately 60,000 units (principally at MDUs, but including certain single family units within the footprint of its network) and approximately 34,000 subscribers and the weighted average unexpired term of the acquired Rights of Entry was approximately 5 years. Phonoscope's network and the Company's existing Houston network are in close proximity with each other, but do not overlap in any material respect. The Company intends to expand the acquired fiber optic network and, over time, interconnect the acquired network with the Company's existing Houston network. The Company recently commenced operating a central office telephone switch in Houston through which it provides local and long distance services as a Competitive Local Exchange Carrier ("CLEC"). The Company intends to migrate its properties currently served through PBX switches in Houston to the central office switch over the coming months. In August 1997 Capital Communications CDPQ Inc ("CDPQ"), a direct subsidiary of Caisse de depot et Placement du Quebec ("Caisse"), a Quebec financial institution and shareholder of the Company's majority shareholder, Le Groupe Videotron Ltee ("GVL") purchased the minority interest in the Company from Vanguard Communications LLP ("Vanguard"). Vanguard also transferred to CDPQ an existing option to purchase additional shares in the Company which CDPQ promptly exercised. As of August 31, 1997 GVL held, indirectly, 74.6% of the common equity of the Company, 16.7% was held by CDPQ and 8.7% by various purchasers of the Company's Senior Discount Notes due 2005, or their transferees. In October 1997, the Company received a commitment from a bank to provide a $150 million senior secured credit facility (the "Senior Facility") which will be used to provide capital to fund future development. The Senior Facility will consist of a term loan and a revolving credit commitment both of which will bear interest at interest rates customary for this type of transaction and the credit position of the Company. The Senior Facility will be secured by a first fixed and floating lien on substantially all of the assets of the Company. Availability under the Senior Facility will be subject to the Company meeting certain performance criteria. Management expects that funds will become available under the Senior Facility in December 1997. The commitment to close the Senior Facility is subject to conditions and terminates December 15, 1997, if not closed. 2 INDUSTRY The private cable television industry has undergone significant changes and consolidation in recent years as a result of changes in cable television and telecommunications laws and regulations. Until February 1991, the primary technology available to private cable television operators was SMATV, whereby the operator received and processed satellite signals directly at an MDU or other private property with an on-site headend facility consisting of receivers, processors and modulators, and distributed the programming to individual units through an internal hard-wire system in the building. SMATV operators spread the relatively high fixed costs of operations (headend equipment, management, customer service, billing, installation and maintenance) over a small subscriber base (frequently the residents of a single MDU). This high cost structure reduced the incentives for SMATV operators to invest in technology and overhead, resulting in inferior channel capacity (usually 33 to 45 channels) and a lesser resource commitment to customer service, which produced lower penetration rates. In February 1991, regulatory changes made 18GHz technology, which had been in use for more than 25 years in commercial and military applications, available for use by private cable television operators for the point-to-point delivery of video programming services. The present structure of the U.S. telecommunications market resulted largely from the break-up of the "Bell System" in 1984 which created two distinct telecommunications industries: local exchange and interexchange or "long distance". The long distance industry was immediately opened to direct competition; however, until recently, the local exchange industry has been virtually closed to competition. Efforts to open the local exchange market to competition began in the late 1980's on a state by state basis when competitive access providers ("CAPs") began offering dedicated private line transmission and access services which account for less than 10% of the local exchange market. In the summer of 1995, several states began opening their markets to local exchange competition. In February 1996, the Telecommunications Act was signed into law. The Telecommunications Act provides a framework by which all states must allow competition for local exchange services. Specifically, the Telecommunications Act (i) requires the incumbent LEC to (a) allow competitors to interconnect to the LEC's network at any technically feasible point and (b) allow competitors access to components of the LECs network selectively and (ii) establishes a framework for reciprocal compensation between the LEC and a CLEC for use of each other's network. MARKETS MDUs comprise a wide variety of high density residential complexes, including high- and low-rise apartment buildings, condominiums, cooperatives, townhouses and mobile home communities. According to 1990 U.S. Census Bureau data, there are more than 13.2 million MDU units in MDUs with greater than 10 MDU units in the United States, of which approximately 4.0 million are within the Company's existing geographic markets. The Company estimates that approximately 2.5 million of the MDU units within its existing markets are within MDUs which meet the Company's preference for MDUs of 150 or more units. Industry sources estimate that in 1995 the total revenues for cable television in the United States were $25 billion and total revenues from telecommunications services in the United States were $168 billion, of which approximately $96 billion represented revenues from local exchange services. The Company selected its current markets based upon their growth characteristics, competitive conditions, MDU concentrations, topographical and climatic conditions, favorable demographics and, to a lesser extent, favorable regulatory environments. 3 OpTel operated in the following geographic markets as of August 31, 1997:
Units passed for Units passed for cable Cable television telecommunications Telecommunications lines LOCATION (1) subscribers (1) - -------------------------------------------------------------------------------------------------------------------- Houston 77,387 31,356 5,270 1,985 Dallas/Fort Worth 34,933 17,787 6,296 2,070 Southern California (Los Angeles, San Diego) 32,842 20,139 768 199 Phoenix 24,047 9,374 - - Chicago 28,796 17,006 110 23 Denver 15,178 7,997 1,069 358 San Francisco 23,016 16,069 - - Miami 14,305 10,969 338 105 Other markets (Austin & Tampa) 3,528 1,860 2,721 3,450 - -------------------------------------------------------------------------------------------------------------------- Total 254,032 132,556 16,572 8,190
(1) Units passed represents the number of units with respect to which the Company has connected and activated its cable television and telecommunication systems, respectively. The Company's strategy has been to enter markets either through the acquisition of a private cable television operator serving the target market or by entering into Rights of Entry with a major MDU owner in the market. The Company has entered substantially all of its markets through acquisitions. Upon acquisition of an operator, the Company historically has begun the process of upgrading the acquired systems by converting MDUs from SMATV technology to the Company's 18GHz or, in Houston, fiber optic networks, adding additional programming and improving customer service. In addition, the Company has been able to achieve cost efficiencies by consolidating acquired operations into its existing organization. As acquired operations generally have not offered telecommunications services, the Company is in the process of adding such services to its acquired systems. HOUSTON The Company entered the Houston market in January 1995 through an acquisition. The Houston market includes the Company's operations in Bryan/College Station. The Company has a cable franchise for the Houston market and utilizes a fiber optic/coaxial cable network to service approximately 83% of its units passed for cable television with the remainder serviced via SMATV systems. The Company installed its first central office switch in the Houston market in October 1997. DALLAS-FORT WORTH The Company entered the Dallas-Fort Worth market in September 1994 by entering into Rights of Entry with a significant property owner. Since that date the Company has increased its market share by acquisition and by entering into additional Rights of Entry. The Company's corporate headquarters and centralized customer call center for all of its markets is located in Dallas- Fort Worth. The Company intends to install a central office switch in the Dallas-Fort Worth market in the early part of calendar year 1998. CHICAGO The Company entered the Chicago market in August 1995 through the acquisition of a private cable operator whose properties were mainly in Chicago's suburbs. The Company intends to commence full scale marketing of a competitive local exchange carrier ("CLEC") telecommunications service in the Chicago market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from a CLEC. In March 1997, the Company consummated an acquisition of a small private cable operator in the downtown Chicago market. 4 PHOENIX The Company entered the Phoenix market in December 1994 through an acquisition. Since that date the Company has increased its market share by entering into additional Rights of Entry. The Company intends to commence full scale marketing of CLEC based telecommunications service in the Phoenix market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from third party providers. SAN DIEGO/LOS ANGELES The Company entered the San Diego market in December 1994 through an acquisition. The San Diego market includes parts of Orange County, San Bernadino County, Riverside County and North County. Since that date, the Company has increased its market share by entering into additional Rights of Entry. The Company entered the Los Angeles market in May 1994 by entering into certain Rights of Entry. Since that date the Company has increased its market share by entering into additional Rights of Entry. The Company operates its systems in San Diego and Los Angeles under one General Manager and intends to share switching capacity between the two cities. The Company intends to commence full scale marketing of a CLEC based telecommunications service in the Southern California market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from third party providers. SAN FRANCISCO The Company entered the San Francisco market in August 1996 through an acquisition and completed another acquisition in November 1996. In the San Francisco market, the Company currently services all of its units passed for cable television via SMATV systems but intends to convert substantially all of these SMATV systems to 18GHz networks by the end of fiscal 1999. The Company intends to commence full scale marketing of a CLEC based telecommunications service in the San Francisco market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from third party providers. DENVER The Company entered the Denver market in July 1995 through an acquisition. Since that date the Company has increased its market share by entering into additional Rights of Entry. The Company intends to use 12GHz networks in Denver for future growth because of recent restrictions imposed on 18GHz use in that market to protect national defense facilities. The Company intends to commence full scale marketing of a CLEC based telecommunications service in the Denver market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from third party providers. MIAMI - FORT LAUDERDALE The Company entered the Miami-Fort Lauderdale market in June 1995 through an acquisition. Since that date the Company has increased its market share by entering into additional Rights of Entry. The Company intends to commence full scale marketing of a CLEC based telecommunications service in the Miami-Fort Lauderdale market by the end of fiscal 1999 using its own telecommunication switch, or sooner if suitable switching capacity can be leased from third party providers. TAMPA The Company entered the Tampa market in August 1996 through an acquisition. The Company currently services all of its units passed for cable television in the Tampa market via either SMATV or coaxial cable systems. The Company intends to dispose of its operations in Tampa during the course of fiscal 1998, either through a sale of the system or by exchanging these properties for private cable networks in its other existing markets. 5 AUSTIN The Company entered the Austin market in July 1994 by entering into certain Rights of Entry. Since that date the Company has increased its market share by entering into additional Rights of Entry. The Company currently services all of its units passed for cable television in the Austin market via SMATV systems. The Company intends to explore disposing of its operations in Austin during the course of fiscal 1998, either through a sale of the system or by exchanging these properties for private cable networks in its other existing markets. STRATEGY The Company intends to grow its business and increase its market concentration by attracting MDUs currently served by other providers, providing services to newly-constructed MDUs and, as appropriate, acquiring existing private cable operators and entering new markets. A critical aspect of the Company's growth strategy is the development of strategic relationships with owners of portfolios of MDUs. These relationships encourage the MDU owner to promote and sell the Company's cable television and telecommunications services to MDU residents. Many Rights of Entry provide incentives to the MDU owner, principally long- term revenue sharing, and, in certain cases, payment of "key money" on Rights of Entry execution. In addition, the Company believes that its ability to deliver special services tailored to MDU owners and residents enhances the MDU owners marketing of unit rentals and sales. The Company's goal is to distinguish itself from its competitors by becoming a leading provider of a comprehensive set of both cable television and telecommunications services to MDUs. The Company's customer marketing strategy is to offer a complete package of cable television and telecommunications services backed by a high level of customer service. The Company believes that, given comparable level of product offerings, MDU residents prefer the simplicity and pricing benefits of dealing with one supplier for all of their cable television and telecommunications services. The Company also believes that prompt response to service requests and customer inquiries is important to MDU residents. The Company affords customers the opportunity to subscribe for Company services at the time the unit lease is signed and believes that this added convenience is important to its marketing efforts. The Company also plans to supplement its cable television and telecommunications services by providing customers with access to additional services, including Internet access, intrusion alarm, utility monitoring, and PCS, cellular and paging services. The Company is expanding the telecommunications component of its business both by increasing the number of MDUs to which it provides telecommunications services and by expanding the number of services offered. As part of its ongoing telecommunications roll out and coincident with the conversion of its SMATV systems to networks, the Company intends to replace its PBX switches located at MDUs with networked central office switches. The Company deployed its first central office switch in the Houston market in October 1997 and intends to install central office switches in substantially all of its markets by the end of fiscal 2002. SALES, MARKETING AND CUSTOMER SERVICE Consistent with its business strategy, the Company's marketing goals are to (i) increase market share in existing markets by entering into additional Rights of Entry, (ii) increase penetration at each MDU served by the Company, (iii) add telephone services to existing cable-only properties and (iv) market additional services, such as premium cable services, Pay-Per-View, Internet access, intrusion alarm, utility monitoring and PCS, cellular and paging services, to its subscribers. The Company focuses its marketing efforts on large MDUs located in clusters within its markets and then attempts to obtain Rights of Entry for additional MDUs within the coverage of its existing networks. 6 The Company tailors its marketing efforts to two different constituencies: (i) owners of MDUs who may enter into Rights of Entry and (ii) actual and potential cable television and telecommunications subscribers at MDUs for which the Company has entered into Rights of Entry. Each constituency is served by separate sales and marketing teams that promote the Company's advantages over its competitors in the marketplace. The Company is committed to providing excellent customer service to MDU owners and subscribers in the home, in the field and on the telephone. The Company believes the most effective means of attracting and retaining MDU owners and subscribers is by providing high quality subscriber service, including: (i) 24- hour-a-day, seven-day-a-week subscriber telephone support; (ii) direct lines to facilitate rapid response to calls initiated by MDU owners and managers; (iii) computerized tracking of all incoming calls to minimize waiting times; (iv) service calls generally made the same day the subscriber indicates a service problem; (v) flexible, seven-day-a-week installation and service appointments; (vi) follow-up calls and on-site inspections to verify subscriber satisfaction; and (vii) 80% of installations completed within 3 business days of receiving the initial installation request, often within 24 hours. The Company also uses focus groups and subscriber surveys to monitor subscriber satisfaction. NETWORKS CABLE TELEVISION ARCHITECTURE An integral part of the Company's strategy is to link properties to master headends through microwave and fiber optic networks, to the maximum extent practicable. In substantially all markets except Houston, the Company transports video programming to MDUs in one of two ways: (i) by transmitting video programming from a master earth station and headend to the MDU using point-to- point microwave conveyance, generally in the 18GHz frequency range; or (ii) by receiving video programming at a self-contained SMATV headend located at the MDU. In Houston, video programming reaches a majority of the MDUs served by the Company through a fiber optic network that the Company operates pursuant to a franchise from the City of Houston. In certain limited geographic areas, video programming reaches MDUs through a combination of coaxial cable and microwave transmission. 18GHz microwave conveyance requires the operator to install small microwave dishes at each MDU. These dishes receive video programming from a centrally located master headend which must be within the line of sight of the receiving dish. The FCC licenses paths between two points at specific frequency ranges. The video programming may, within limits, be retransmitted at repeater sites. To insure a high quality picture, the Company generally limits the number of repeater sites. For the same reason, the Company generally limits the radius of each microwave link to between three and eight miles, depending on topographic and climatic conditions. The Company intends to convert substantially all of its SMATV systems to 18GHz, 12GHz (principally in Denver) or fiber optic networks by the end of fiscal 1999. As of August 31, 1997, the Company had 35 18GHz networks and one fiber optic network in service in 11 metropolitan areas and, on average, 54% of the units passed by the Company were served by such networks. Within the MDUs it serves the Company distributes video programming via conventional coaxial cable. In markets where it offers Pay-Per-View channels, the Company uses a combination of traps (electronic filtering devices) and addressable decoder-converter boxes. Where it does not offer Pay-Per-View, the Company uses traps. 7 The Company has recently completed field testing interdiction devices and has begun deploying them in several of its current systems. Interdiction devices will permit the Company to activate and deactivate services or specific channels by remote command from its central office. When implemented, these devices will afford quicker activation and disconnection, eliminate or significantly reduce the need for traps and for decoder-converter boxes in the home, eliminate or significantly reduce service calls and provide better picture quality. The Company believes that these devices will also result in better collection experience, higher levels of penetration and premium service buy-in and greater customer satisfaction. TELECOMMUNICATIONS ARCHITECTURE In metropolitan areas where the Company currently offers telecommunications services, the Company uses conventional twisted copper wire pairs to distribute telephone services within an MDU. A PBX switch is installed at the MDU and local traffic from the MDU is transported via leased trunk lines to the LEC central office. From the LEC's central office, local calls are routed through the LEC's network. Long distance traffic is routed via leased trunk lines from the PBX switch to the Company's chosen long distance carrier (currently AT&T). The regulations under which the Company's PBX-based services are provided generally prohibit the aggregation of local telephone traffic between noncontiguous MDUs, and in certain states there are limits or prohibitions on resale of intrastate long distance and local service at a profit. These restrictions adversely effect the profitability of the Company's STS operations. The Company intends to seek certification as a CLEC in each of the states in which it operates. As a CLEC, the Company will be relieved of these limits and prohibitions. The Company has already been granted CLEC certification in Texas, Florida, Illinois and California and has applications pending in Arizona and Colorado. The Company believes CLEC certification will be available in a timely manner in these markets. However, if certification were not granted the Company would be restricted to providing STS services in that market. The Company plans to interconnect MDUs to an owned or leased central office switch using its owned fiber optic network and microwave networks and the network facilities of other service providers. The Company intends to interconnect its central office switch to several long distance carriers' points-of-presence and to the public switched telephone network via the LEC's network. The implementation of the Company's telecommunications roll out plans will depend in some measure on the speed and manner in which states implement (i) the liberalized competition provisions of the Telecommunications Act and (ii) the establishment of the interconnection and tariff requirements that the Telecommunications Act imposes on the incumbent LEC. The Company intends to contract for other ancillary elements of service from the incumbent LEC in each market or from other available carriers. These ancillary services include (i) operator service, (ii) directory listings, (iii) emergency 911 service, and (iv) conveyance where the Company does not have a network. The Company intends to modify its existing networks (currently used to provide video programming) to accommodate two-way digital telecommunications traffic so as to connect the MDUs to its planned central office switches in each of its markets. The Company intends to use its existing network configuration if feasible and to supplement its microwave plant if necessary, including through the use of other available radio spectrum for telecommunications services. However, other than in Dallas, the Company has not yet commenced frequency coordination and there can be no assurance that the Company will be able to obtain licenses for these frequencies on the paths it desires. It is also possible that the Company will augment its microwave networks in many markets with fiber optic links between microwave hubs and from hubs to its central switch locations. Particular network architecture in any market will be dependent on, among other factors, bandwith requirements and equipment costs, which are not yet determinable. 8 The Company will use its networks to aggregate MDU long distance and local traffic at its or its selected partners' telecommunications switch. From there, traffic will be delivered to the point of presence of the connecting carrier either through the Company's microwave or fiber networks, or where appropriate, other available means of transport, including those of the interconnecting carriers. SERVICES CABLE TELEVISION SERVICES OpTel offers its subscribers a full range of popular cable television programming at competitive prices. The Company's 18GHz networks are capable of delivering up to 72 uncompressed analog channels of programming at each MDU. In addition, the programming selections available at an MDU can be tailored to the demographics of each MDU and, unlike franchise cable television operators which may be required to carry all local broadcast channels and public access channels, the Company can utilize all of its available channels to provide popular entertainment, news and information programming. The Company offers various programming packages to its cable television subscribers. The Company's basic programming package offered to MDUs served by its 18GHz and fiber optic networks typically includes 60-72 channels and is generally priced below the rate charged by the incumbent franchise cable television operator for a comparable package. The Company's 12GHz networks are expected to have similar characteristics. The Company also offers premium television services. These often feature uninterrupted, full-length motion pictures, sporting events, concerts and other entertainment programming. Premium services are offered individually or in discounted packages with basic or other services. Certain of the Company's systems are capable of offering movies, sporting events, concerts and other special events on a Pay-Per-View basis. The Company purchases copyrighted programming from program suppliers, pursuant to private, negotiated multi-year license agreements. The average term of such contracts is four years and such contracts are typically renewed upon expiration. Generally, the Company pays its programming suppliers a fixed monthly fee per subscriber, subject to volume discounts and reduced rates for MDUs where the Company's services are supplied to all units on a bulk basis. The programming fees average 31% of basic cable revenue and between 60% and 70% of premium and pay per view revenue. The Company is not subject to any material minimum subscriber requirements under its programming license agreements. The video programming broadcast on local television broadcast stations is subject to compulsory copyright license requirements from the copyright owners. The Company is required to obtain retransmission consents from off-air broadcasters but has had little difficulty in obtaining retransmission consent agreements. Non-broadcast programming, often referred to as cable programming, is not subject to the compulsory copyright license. However, federal regulations prohibit (i) cable television operators, satellite cable programming vendors in which a cable television operator has an attributable interest, and satellite broadcast programming vendors from charging unfair, unreasonable or discriminatory prices for programming and (ii) most exclusive dealing arrangements whereby cable systems have procured programming that is unavailable to their competition. The prohibition on exclusive distribution arrangements is scheduled to expire on October 5, 2002, unless the FCC finds, during a proceeding to be conducted in 2001, that the prohibition continues to be necessary. 9 An integral part of the Company's strategy is to link properties to master headends through microwave and fiber optic networks, to the maximum extent practicable. In substantially all markets except Houston, the Company transports video programming to MDUs in one of two ways: (i) by transmitting video programming from a master earth station and headend to the MDU using point-to-point microwave conveyance, generally in the 18GHz frequency range; or (ii) by receiving video programming at a self-contained SMATV headend located at the MDU. In Houston, video programming reaches a majority of the MDUs served by the Company through a fiber optic network that the Company operates pursuant to a franchise from the City of Houston. In certain limited geographic areas, video programming reaches MDUs through a combination of coaxial cable and microwave transmission. 18GHz and 12GHz microwave conveyance requires the operator to install microwave dishes at each MDU. These dishes receive video programming from a centrally located master headend which must be within the line of sight of the receiving dish. The FCC licenses paths between two points at specific frequency ranges. The video programming may, within limits, be retransmitted at repeater sites. To insure a high quality picture, the Company generally limits the number of repeater sites. For the same reason, the Company generally limits the radius of each microwave link to between three and eight miles, depending on the topographic and climatic conditions of the market. The Company intends to convert substantially all of its SMATV systems to 18GHz, 12GHz (principally in Denver) or fiber optic networks by the end of 1999. As of August 31, 1997, the Company operated 18GHz networks in each of its 9 major metropolitan areas except Houston which is served by a fiber-optic network and San Francisco which is served by SMATV systems and is currently in the process of being converted to an 18GHz networks. On average, 60% of the units passed by the Company are currently served by networks (approximately 67% pro forma for the Phonoscope acquisition). OpTel's network design is digital capable and many of its components are hybrid digital-analog. This will facilitate upgrading to digital compression when economical and required by the marketplace. The use of networks facilitates the upgrade to digital because networked systems have fewer headends to upgrade than SMATV systems where it would not be economically viable to update headends serving individual properties. The Company's cable contracts include MDUs which subscribe on a "retail" basis, where each resident of an MDU can independently opt to be a cable subscriber and is separately billed, and MDUs which are under "bulk" contracts, in which the property owner buys cable services from OpTel for 100% of the apartments in the complex and includes basic cable in the services offered to building residents. Residents of MDUs served under bulk contracts contract separately with OpTel for premium services. Currently, approximately two-thirds of OpTel's contracts are retail contracts. While bulk contracts have lower revenues per customer than retail arrangements and generally have a lower gross margin, the increase in penetration helps to offset this and certain program providers grant discounts for bulk subscribers. In addition, bulk contracts have lower servicing costs (billing, bad debt) than retail contracts. The Company will sign bulk contracts where required but generally anticipates that bulk contracts will decrease as a proportion of the total contract base over the next few years as a greater proportion of new contracts are being signed for the provision of retail service. An increase in the number of retail contracts as a proportion of the total contract base is expected to contribute to an increase in revenue per customer. TELECOMMUNICATIONS SERVICES The Company currently provides telephone service under two regulatory frameworks. In Houston, Dallas, Miami, Chicago, San Diego and Denver, it operates as an STS provider. To date, OpTel has restrained the growth of STS telephony because of the marginal economics of that business. In Houston, it also operates as a CLEC. The Company intends to convert to CLEC operation in all of its markets over the next two to three years. 10 OpTel's telephone contracts provide that OpTel will be the exclusive provider of local telephone services to MDU residents, subject to the legal rights of the incumbent local exchange carrier ("ILEC") and other providers to offer service. Pursuant to the telephone ROE contracts, the building owners receive revenue sharing payments and may receive an initial payment. In return building owners are required to promote OpTel's service and refrain from promoting other telecommunications providers' service to MDU residents. While the telephone product currently provides only minor revenue streams for OpTel, Management believes it represents an attractive and potentially lucrative business opportunity for several reasons. First, OpTel has already achieved penetration (in terms of lines) of approximately 48% in those properties which it currently offers telephone services as an STS provider. Even allowing for the distortion of the Austin market where telephone penetration is very high, this figure is above 34%. This penetration level has been achieved with virtually no marketing effort. Secondly, OpTel will be serving as an MDU residential-oriented CLEC, and should benefit from the recognized demand for CLEC services in the residential sector. Management knows of no other CLEC with as directed a residential strategy as OpTel. Thirdly, the revenue sharing structure, together with the "one stop shopping" aspects of cable and telephony ROE contracts, should create incentives for property owners to promote the telephone product. In metropolitan areas where the Company currently offers telecommunications services, the Company uses conventional twisted copper wire pairs to distribute telephone services within an MDU. Under the STS model, a PBX switch is installed at the MDU and local traffic from the MDU is transported using the ILEC's commercial transport either to the ILEC central office switch or to the central office switch of an long distance operator ("IXC"). From the ILEC's central office, local calls and long distance calls are routed through the ILEC's network or using the IXC's long distance network if the PBX is also interconnected with the IXC's switch. Where there is no such direct interconnection, long distance traffic is routed from the ILEC's switch to the Company's chosen long distance carrier (currently AT&T). Using its own central office switches the Company believes it will have much greater control over quality of its product offering and interconnect relationships (and hence price). As a result, the Company intends to seek certification as a CLEC in each of the states in which it operates and currently has CLEC status in Texas, California, Florida and Illinois. The Company is currently in the process of converting to the CLEC telephone model of operation. This involves interconnecting MDUs to an owned central office switch or leased capacity on the central office switch of another CLEC using OpTel's own fiber optic network and microwave networks and the network facilities of other service providers. Local traffic is then routed from the OpTel switch to the ILEC switch using dedicated transport. OpTel intends to interconnect its central office switch to several long distance carriers' points-of-presence and to the public switched telephone network via the ILEC's network. The switch in Houston is now fully operational and direct interconnection with a preferred long distance provider is expected to be completed in the near future. OpTel plans to contract for other ancillary services from the ILEC and other service providers. These services include operator service, directory listings and emergency 911 service and, in certain markets, transport. 11 The Company intends to modify portions of the existing networks, currently used to provide video programming, to accommodate two-way digital telecommunications traffic. The Company expects to use 23GHz as its principal frequency to carry telecommunications traffic. The Company believes that using 23GHz will enable it to utilize proven equipment manufactured by several vendors. The Company will transmit and receive 23 GHz signals generally using certain modifications to its existing 18GHz dishes and has achieved satisfactory results in technology field trials. The Company will use its networks to aggregate MDU long distance and local traffic at its telecommunication switch. In certain markets the Company is currently exploring the possibility of initially leasing telecommunication switch capacity from other CLECs in order to speed up the roll out of telephone services. From these switches, traffic will be delivered to the point of presence of the connecting carrier either through the Company's microwave or fiber networks, or where appropriate, other available means of transport, including those of interconnecting carriers. Competition The multichannel television and telecommunications industries are highly competitive. The Company presently competes with companies that specialize in the provision of multichannel television or telecommunication services and, increasingly, with companies that offer bundled multichannel television and telecommunications services. Many of these competitors are larger companies with greater access to capital, technology and other competitive resources. The Company's private cable television service competes with traditional franchise cable television operators as well as wireless cable television operators, other private cable television operators, direct broadcast satellite ("DBS") operators, stand-alone satellite service providers and, to a lesser extent, off- air broadcasters. The Company's telecommunications services compete with other STS providers, LECs, CLECs and CAPs and will compete with long distance telephone companies and franchise cable television operators as they begin to enter the local telephone business. The Company's long distance service competes with established interexchange carriers and resellers. In addition, recent telecommunications offerings, including PCS, and future offerings may increase competition in the telecommunications industry. Recent and future legislative, regulatory and technological developments will likely result in additional competition, as telecommunications companies enter the cable television market and as franchise cable television operators and interexchange carriers begin to enter the local telephone market. Similarly, mergers, joint ventures and alliances among franchise, wireless or private cable television operators and Regional Bell Operating Companies ("RBOCs") may result in providers capable of offering bundled cable television and telecommunications services in direct competition with the Company. The Company competes with multichannel television operators and telecommunications service providers to obtain Rights of Entry. In most markets serviced by the Company, franchise cable television operators now offer revenue sharing and access fee arrangements to MDU owners. There can be no assurance that these payments will not increase in the future as competition increases for access to the higher quality MDUs. Another basis of competition is the breadth of programming and range of services offered. Although the Company as a matter of course investigates new sources of programming and technologies that may increase its range of services, other larger and more diversified competitors may attract the targeted MDUs based on their increased menu of services. Consequently, the Company may be compelled to reduce its prices and improve its range of services under its existing Rights of Entry which generally require the Company to remain competitive with the market in general. At present, the Company believes that its existing Rights of Entry give it a competitive advantage within its present markets; however, these advantages may deteriorate with changes in regulations, the types of competitors and with technological advances. There can be no assurance that the Company will be able to compete successfully with existing competitors or new entrants in the market for such services. Competition may also be enhanced by technological developments that allow competitors of the Company to bypass property owners altogether and market their services directly to the tenants of MDUs. Although the Company's Rights of Entry prohibit tenants from installing receiving equipment on the exterior of the building, these provisions are not always enforced. The Rights of Entry do not prevent a resident from 12 using cellular telephone service, for example, offered by another provider. While the Company believes that the exclusivity provisions of its Rights of Entry provide it with competitive advantages, such advantages may be significantly diminished by technological and other developments beyond the control of the Company. Such developments may impact the Company's strategies and may require it to expend funds beyond the levels currently contemplated. Certain of the Company's current and potential competitors are described below. Traditional Franchise Cable Systems. The Company's major competition for Rights of Entry in each market comes from the traditional franchise cable television operator. The Company competes with such operators by (i) focusing exclusively on MDUs, (ii) sharing profits with MDU owners, (iii) offering customized programming, and (iv) charging lower rates to subscribers. Multipoint Multichannel Distribution Systems. MMDS systems are similar to the Company's 18GHz networks in that they use microwave transmitting and receiving equipment. MMDS differs from 18GHz and 12GHz in that (i) it "broadcasts" its video programming direct to individual subscribers and generally not to an MDU's receiver and (ii) its systems transmit in an omni-directional manner, while 18GHz systems are point-to-point. As a result, MMDS wireless cable can provide service to all households within a wireless operator's "line-of-sight." The 2.5GHz spectrum utilized by MMDS wireless cable was initially allocated by the FCC to applicants other than MMDS operators within a given market, with 20 of the available channels generally allocated to educational institutions. As a result, MMDS wireless operators have had difficulty acquiring or leasing the critical mass of channels required to offer a diverse programming lineup. Moreover, absent digital compression technology, channel capacity is limited to 33 analog channels. Local Multipoint Distribution Service. The FCC has recently issued rules reallocating the 28GHz band to create a new video programming delivery service referred to as local multipoint distribution service ("LMDS"). The FCC also has issued a license for the New York City market for one operator that is developing a system to utilize the 28GHz frequency for pay television. As currently proposed, LMDS would provide a single licensee up to 1000 MHz of spectrum for the distribution of programming in each prescribed geographic area. LMDS systems, like MMDS, will use point-to-multipoint microwave distribution for wireless cable services. Unlike MMDS, however, LMDS systems, using the proposed allocation in the 28 GHz band will be able to provide channel capacity equal or greater to that of most cable systems, including the Company's. In addition, LMDS systems that would allow subscriber-to-hub transmissions to facilitate the provision of interactive services and telecommunications have been proposed. SMATV Systems. The largest number of private cable companies are operators of SMATV systems. Like the Company, these systems offer a multichannel television service pursuant to rights of entry with MDU owners. Where the Company has introduced or will introduce 18GHz or, principally in Denver, 12GHz systems, the Company competes with SMATV systems on the basis of (i) larger channel offerings (typically SMATV offers 33 to 45 channels), (ii) the quality of its video programming delivery, (iii) customer service, and (iv) the perceived high price of SMATV relative to the programming package provided. The Company may acquire additional SMATV operations with a view to converting them, where feasible, to 18GHz technology, adding channels and upgrading customer and field service. Direct Broadcast Satellite. DBS systems involve the transmission of encoded video programming direct from a satellite to the home user without any intermediate processing or retransmission by a terrestrial operator. Although prices have been decreasing, DBS service typically requires the purchase of equipment and installation fees which are a significant cost to the subscriber. In addition, subscribers generally pay a monthly programming fee to receive DBS service. Some of these fees are lower than those charged by the Company before consideration of the equipment costs. However, the Company believes that it can effectively compete with DBS systems in the MDU marketplace for the following reasons. First, DBS line-of-sight problems are significant (unless an entire MDU is connected to the service) because a DBS antenna must be pointed in the proper direction to receive video programming from the satellite. In 13 addition, most MDU owners prohibit the placement of individual antennas on their property by MDU residents. Perhaps more importantly, other than in so-called "white areas" of the country (generally rural locations without either cable television service or good reception of over-the-air broadcast programming), DBS operators are presently not permitted to retransmit network or local broadcasting programming. Certain DBS operators have announced "MDU programs" which generally consist of either (i) paying commissions to a local satellite dish dealer who has, at its own expense, overbuilt an MDU or (ii) billing MDU owners for the service on a bulk basis. The Company's Rights of Entry currently prohibit an MDU owner from allowing a DBS system to be installed at the MDU. OpTel does not view DBS as a major threat as, because of the frequencies that they use, they are generally not amenable to MDU installation in properties of over 100 units. However, OpTel would consider offering this service, using its own technology, to supplement its channel lineup if there was overwhelming demand for the product and it was a commercially viable source of programming. Telephone Companies. The Telecommunications Act repealed the telecommunications-cable television cross-ownership restriction, which prohibited telecommunications companies from providing video programming directly to subscribers in their telecommunications service areas. Several of the RBOCs have acquired MMDS or other private cable television operators in an effort to begin providing cable television services and several other LECs have indicated their intent to enter the cable television market. Similarly, the Telecommunications Act will in all likelihood result in a significant increase in the number of companies, including CLECs, long distance carriers and wireless telephone operators, offering local telephone service. Many of the Company's telecommunications services compete directly with services offered by the ILECs which currently dominate their local telecommunications markets. These companies all have long-standing relationships with their subscribers and have financial, personnel and technical resources substantially greater than the Company. The Company expects to compete in this market by (i) establishing strategic relationships with MDU owners so as to allow the Company to market effectively to MDU residents, (ii) providing value added, enhanced services to MDU residents, (iii) bundling its telecommunications and cable television services, (iv) providing a high level of customer service and responsiveness, and (v) competitively pricing its products. Wireless Telecommunications. The Company's telecommunications services will also compete with current and future wireless telecommunications offerings, including those of cellular and PCS providers. Wireless telecommunications can be sold to MDU residents without violating the Company's Rights of Entry since wireless telecommunications do not require the use of the Company's network or the MDUs internal wiring. The Company intends to offer all or certain of these services, on a resale basis, directly to its subscribers and to bundle wireless communications with the Company's other offerings. Video Stores. Retail stores rent video cassette recorders ("VCRs") and/or video tapes, and are a major participant in the entertainment video program delivery industry. Videocassette rentals do not compete with cable television operators' news, information, education and public affairs programming. Although management does not believe that video rentals and sales have a material competitive impact on the basic services provided by franchise, private or wireless cable systems, the availability of movies and other programming on videocassette has a competitive impact on the penetration rates for the Company's premium channels and Pay-Per-View programming. The Pay-Per-View window (i.e., the time period after which a theatrical film is released in the Pay-Per- View market) is generally later than the corresponding home video window. Management believes that until this Pay-Per-View window is shortened to coincide with or precede the home video window, any rise in Pay-Per-View penetration rates would be unlikely to come for studio produced feature films. Rather, it would more likely come from sporting events, concerts and cable-exclusive movies not released through theaters. 14 Off-Air Local Broadcasts. Off-air local broadcasts (e.g., ABC, NBC, CBS, Fox and PBS affiliates and independent local stations) provide a free programming alternative to the public. This programming generally offers MDU residents less variety and does not include the specialized entertainment and news programming available only on cable television. Customers who choose it over cable television usually do so on the basis of cost. The Company currently retransmits off-air local broadcasts to its private cable television subscribers, but its ability to do so in the future is generally dependent upon receipt of retransmission consents. REGULATION The multichannel television and telecommunication industries are subject to extensive regulation at the federal, state and local levels. The following summary does not purport to describe all present and proposed federal, state and local regulations and legislation relating to the multichannel television and telecommunications industry. Legislative and regulatory proposals under consideration from time to time by Congress and various federal agencies, as well as state and local franchise requirements, have in the past, and may in the future, materially affect the Company and the multichannel television and telecommunications industries. Additionally, many aspects of regulation at the federal, state and local levels currently are subject to judicial review or are the subject of administrative or legislative proposals to modify, repeal or adopt new laws and administrative regulations and policies. Neither the outcome of these proceedings nor their impact on the Company can be predicted at this time. The Company believes that it is in compliance in all material respects with all federal, state and local regulations applicable to it. In some instances, the Company has acquired businesses that do not comply with all regulations applicable to them and it undertakes to remediate such matters as soon as practicable and in a manner that does not materially adversely impact it. TELECOMMUNICATIONS ACT OF 1996 On February 8, 1996, the President signed into law the Telecommunications Act of 1996, (the "Telecommunications Act") which amended the Communications Act of 1934 (the "Communications Act"). The Telecommunications Act has altered, and will continue to alter, federal, state and local laws and regulations regarding telecommunications providers and services. The law is intended, in part, to promote substantial competition in the marketplace for local telephone service and in the delivery of video and other services. Although the Company believes that certain provisions of the Telecommunications Act will help the Company compete with ILECs, it is premature to predict the effect of the Telecommunications Act on the multichannel television and telecommunications industries in general or the Company in particular. In large part, the impact of the Telecommunications Act will depend upon the outcome of various FCC rule making proceedings to interpret and implement the Telecommunications Act, including the FCC's First Report and Order regarding the interconnection obligations of telecommunications carriers and litigation concerning the FCC's implementation of the Telecommunications Act. 15 REGULATION OF CABLE TELEVISION Certain of the Company's networks are, for regulatory purposes, deemed to be "Cable Systems". To constitute a Cable System, a multichannel television system must use hard-wire or fiber optic cable that makes a tangible physical crossing or use of a public right-of-way. As a result, all Cable Systems are required to obtain a local franchise and are subject to state and local regulation as well as federal Cable System regulation. The Company's 18GHz networks, its 12GHz networks to be developed, and SMATV systems are not considered Cable Systems and thus are not subject to local franchising requirements and are free from most Cable System regulation. The Company's Houston, Texas system, a portion of its Fort Worth, Texas system and certain other small systems are regulated as Cable Systems. However, the Company's Houston, Fort Worth and other small franchise cable television systems are exempt from federal rate regulation and the universal service obligation, even though they are Cable Systems, because they are subject to "effective competition" as discussed in greater detail below. Set forth below is a discussion of the principal laws and regulations governing the Company's private and franchise cable television operations. Federal Cable System Regulation ------------------------------- The Communications Act, as amended, governs the regulation of Cable Systems. The regulations imposed on Cable Systems include requirements to (i) obtain a local franchise (which may require the franchisee to pay franchise fees to local governments of up to 5% of yearly gross revenues), (ii) delete certain programs from cablecasts, (iii) comply with certain customer service standards, (iv) retransmit certain broadcast television programming, (v) in most circumstances, conform subscriber service and equipment rates to applicable federal regulations, (vi) comply with FCC equal employment opportunity ("EEO") rules and policies, (vii) make available channels for leased-access programmers at rates that are to be calculated on a formula established by the FCC, and (viii) offer customer service to all buildings passed by its network. In addition, rates for basic cable service on Cable Systems not subject to "effective competition" are regulated by local franchising authorities. Rates for upper tier or "cable programming services" on such systems are regulated by the FCC. The Telecommunications Act eliminates cable programming service tier rate regulation effective March 31, 1999, for all Cable System operators. The Company's networks that are Cable Systems are subject to these requirements, which impose regulatory costs and reduce the speed and flexibility with which the Company and its Cable System competitors can respond to competitive challenges from other video distribution technologies. The Company's Cable Systems, however, are exempt from rate regulation because they are, the Company believes, subject to "effective competition." Prior to the enactment of the Telecommunications Act, Cable Systems were deemed to be subject to "effective competition" if either: (1) fewer than 30% of the households in the franchise area subscribe to the service of the Cable System; (2) the area is served by at least two unaffiliated multichannel television operators, both of which are able to provide service to at least 50% of the households in the franchise area, and the number of households actually subscribing to all but the largest multichannel television operator exceeds 15%; or (3) the local franchising authority itself offers multichannel television to at least 50% of the households in the franchise area. The Telecommunications Act expanded the definition of "effective competition" to include situations in which a LEC or its affiliate offers multichannel television directly to subscribers by any means (other than direct-to-home satellite services) in the franchise area. It is expected that this change will provide franchise cable television operators with increased pricing flexibility as LECs begin to provide multichannel television services. No assurance can be given that the Company does not, or will not in the future, constitute "effective competition" to any franchise cable television operator with which it competes. 16 Copyright Licensing. Cable Systems and private cable television systems are entitled to federal compulsory copyright licensing privileges. In order to obtain a compulsory copyright, such systems must make semi-annual payments to a copyright royalty pool administered by the Library of Congress. A compulsory copyright provides a blanket license to retransmit the programming carried on television broadcast stations. Non-broadcast programming, often referred to as cable channel programming, is not subject to the compulsory copyright license. The Company purchases this copyrighted programming from program suppliers (e.g., ESPN), which in turn obtain rights to the programming directly from the program copyright owner pursuant to a private negotiated agreement. Bills have been introduced in Congress over the past several years that would eliminate or modify the cable compulsory license. The need to negotiate with the copyright owners for each program carried on each broadcast station in the channel lineup could increase the cost of carrying broadcast signals or could impair the Company's ability to obtain programming. Must-Carry and Retransmission Consent. The Communications Act grants local television stations the right to elect to either force local Cable Systems to "carry" the television station free of charge (a "must carry" right) or to prohibit Cable Systems and private cable television systems from carrying the local television station (a "retransmission consent" right). Under the must- carry rules, a Cable System, subject to certain restrictions, generally must carry, upon request by the station and depending on the number of usable activated channels on the system, all commercial television stations with adequate signals that are licensed to the same market as the Cable System. Under the retransmission consent rules, Cable Systems and private cable television systems are precluded from carrying commercial broadcast stations that choose not to exercise their must-carry rights, all "distant" commercial broadcast stations (except for "superstations", i.e., commercial satellite-delivered independent stations such as WTBS), commercial radio stations and certain low- powered television stations, without obtaining those stations' explicit written consent for the retransmission of their programming. Retransmission consent agreements do not obviate a copyright license for the programming carried on the broadcaster's signal. However, Cable Systems and private cable television systems may obtain a compulsory copyright license for broadcast programming as described above. To date, the "must carry/retransmission consent" regulations have not had a significant impact on either the operations or profitability of the Company. The Company has had little difficulty obtaining retransmission consent agreements with local broadcasters. Nonetheless, there can be no assurance that broadcasters, in some circumstances, will not withhold retransmission consent, require excessive compensation for that consent or impose onerous conditions thereon. Recent changes in federal law and regulation will likely affect the conduct of the Company's private and franchise cable television business. Changes in the Definition of a "Cable System." Formerly, to avoid being classified as a Cable System, private cable television systems were limited to linking with hard wire only commonly owned or managed MDUs without crossing a public right-of-way. The Telecommunications Act amended the definition of Cable System such that systems which make no use of public streets or public rights- of-way no longer are deemed to be Cable Systems, regardless of the type or ownership of properties served by the system. Thus, for example, the Company's private cable television systems now may serve mobile home parks and private communities without a local franchise and free of most federal Cable System regulations. 17 Elimination of the Telco-Cable Cross-Ownership Restriction. The Telecommunications Act repealed the LEC cable television cross-ownership restriction, which prohibited LECs from providing multichannel television directly to subscribers in their telephone service areas. This change may increase the level of competition in the multichannel television market. LECs now have several options for entering and competing in the multichannel television marketplace. LECs now may: (i) provide video programming to subscribers through radio communications under Title III of the Communications Act; (ii) provide transmission of video programming on a common carrier basis under Title II of the Communications Act (i.e., provide a common carrier video platform); (iii) provide video programming as a Cable System under Title VI of the Communications Act (franchise cable); or (iv) provide video programming by means of an "open video system." Open video systems are not required to comply with the full panoply of federal Cable System regulation, but they are subject to certain additional programming selection limitations. It is unclear at this time the extent to which any of these market entry options will be used by LECs. Rate Relief for Small Cable Operators. The Telecommunications Act deregulated the rates charged for cable programming services in any Cable System operated by a "small cable operator" that serves 50,000 or fewer subscribers. The law defines a "small cable operator" as one which, in the aggregate, serves fewer than one percent of all subscribers in the United States and which is not affiliated with any entity with gross annual revenues in excess of $250 million. This provision may provide increased pricing flexibility for certain of the Company's competitors who qualify as "small cable operators." The Uniform Rate Requirement. Prior to enactment of the Telecommunications Act, the Communications Act generally provided that Cable Systems were required to have a rate structure for the provision of cable service that was uniform throughout its geographic area. The Telecommunications Act provides that this requirement is applicable only where "effective competition" is absent. Further the Telecommunications Act exempts from the uniform rate requirement non- predatory bulk discounts offered to MDUs. Consequently, the franchise cable television operators with which the Company competes now have increased pricing flexibility with respect to MDU bulk discounts. Program Access. The program access provisions of the Communications Act were intended to eliminate unfair competitive practices and facilitate competition by providing competitive access to certain defined categories of programming. Generally, these restrictions are applicable to Cable System operators, satellite cable programming vendors in which a Cable System operator has an attributable interest and satellite broadcast programming vendors. The programming access provisions prohibit these entities from charging unfair, unreasonable or discriminatory prices for programming. Further, the programming access provisions prohibit most exclusive dealing arrangements pursuant to which Cable Systems obtain the exclusive right to distribute the subject programming within their franchise areas. Such exclusive distribution arrangements have been found to inhibit the ability of new entrants to compete in the multichannel television market. The prohibition on exclusive contracts, however, is scheduled to expire on October 5, 2002 unless the FCC determines, during a proceeding that is to be conducted in 2001, that the prohibition continues to be necessary to promote competition in the multichannel television market. The Telecommunications Act amended the program access provisions by adding that the provisions shall also apply to common carriers and their affiliates. Thus, telecommunications companies entering the market will find it more difficult to limit their competitors' access to programming. 18 Subscriber Access. The FCC has initiated a review of the rights of various multichannel television service providers to obtain access to MDUs and other private property. The FCC has indicated that it seeks to ensure a level competitive playing field in the emerging multichannel television market. One possibility raised by the FCC is the establishment of a federal mandatory access requirement or a limit on the duration of exclusive service agreements between MDU owners and video programming providers. In another proceeding, the FCC is contemplating an order preempting state, local and private restrictions on over- the-air reception antennas placed on rental properties or properties not within the exclusive control of the viewer. Although it is open to question whether the FCC has statutory and constitutional authority to compel mandatory access, restrict exclusive agreements or preempt private restrictions on antennas located on property owned or controlled by others, there can be no assurance that it will not attempt to do so. Either such action would tend to undermine the exclusivity provisions of the Company's Rights of Entry with MDU owners. State and Local Cable System Regulation --------------------------------------- Because Cable Systems use public rights-of-way, they are subject to state and local regulation, typically imposed through the franchising process. State and/or local officials often are involved in the franchisee selection, system design and construction, safety, consumer relations, billing, and community- related programming and services among other matters. Cable Systems generally are operated pursuant to nonexclusive franchises, permits, or licenses granted by a municipality or other state or local government entity. Franchises generally are granted for fixed terms and in many cases are terminable if the franchise operator fails to comply with material provisions of the franchise. Franchising authorities are immune from monetary damage awards arising out of regulation of Cable Systems or decisions made on franchise grants, renewals, transfers and amendments. Cable franchises typically contain provisions governing fees to be paid to the franchising authority, length of the franchise term, renewal, sale or transfer of the franchise, territory of the franchise, design and technical performance of the system, use and occupancy of public rights-of-way and types of cable services provided. Although federal law contains certain procedural safeguards to protect incumbent Cable Systems from arbitrary denials of franchise renewal, the renewal of a cable franchise cannot be assured unless the franchisee has met certain statutory standards. Moreover, even if a franchise is renewed, a franchising authority may impose new requirements, such as the upgrading of facilities and equipment or higher franchise fees. At least two states, Massachusetts and Connecticut, have adopted legislation subjecting Cable Systems to regulation by a centralized state government agency. There can be no assurance that other states will not similarly adopt state level regulation. The Company's Houston cable television franchise and its other limited cable television franchises are subject to state and local franchise laws. Moreover, although 18GHz and 12GHz private cable systems are not subject to local franchise laws, state and local property tax and environmental laws are applicable to the Company's business. For example, the Company has to comply with local zoning laws and applicable covenants, conditions and restrictions when installing its antennae and other microwave equipment. In addition, a number of states have enacted mandatory access laws. Although such laws differ in some respects from state to state, state mandatory access laws generally require that, in exchange for just compensation (typically set by statute or regulation to be as low as $1.00), the owners of rental apartments (and, in some instances, the owners of condominiums and manufactured housing parks) must allow the local franchise cable television operator to have access to the property to install its equipment and provide cable service to residents of the MDU. Such state mandatory access laws effectively eliminate the ability of the property owner to enter into an exclusive Rights of Entry agreement with a provider of cable or other video programming services. To the best of the Company's knowledge, states that have enacted cable mandatory access statutes in some form are: Connecticut, Delaware, Illinois, Kansas, Maine, Minnesota, 19 Nevada, New Jersey, New York, Pennsylvania, Rhode Island and Wisconsin. The District of Columbia and the cities of Scottsdale and Glendale, Arizona, and Lewisville, Texas also have adopted municipal ordinances requiring mandatory access. However, the Company believes that the enforceability of such ordinances is doubtful under existing judicial precedent. Florida currently has a mandatory access statute for condominiums, but the validity of that statute has been called into question because an identical provision of Florida law that applied to rental properties has been held to be unconstitutional. Virginia has an anti- compensation statute that forbids an owner of an MDU from accepting compensation from whomever the owner permits to provide cable or other video programming services to the property. Such a statute severely limits the ability of a cable or other video programming provider to enter into an exclusive Right of Entry agreement with an owner of an MDU because an owner usually is induced to enter an exclusive agreement through financial incentives. These statutes have been and are being challenged on constitutional grounds in various states. The Company does not operate in any mandatory access state other than Florida (with respect to condominiums) and Illinois. The Company has recently entered into Rights of Entry in Nevada which is also a mandatory access state. When operating in Illinois, the Company generally enters into bulk sales agreements with MDU owners, whereby the MDU owner agrees to purchase cable television, at a discount, for each unit in the MDU and provides the service to the MDU resident as one of the amenities included in their rent. 18GHz and Private Cable Regulation ---------------------------------- In February of 1991, the FCC made 18GHz frequencies available for the point- to-point delivery of multichannel television. The FCC exercises jurisdiction over 18GHz microwave and other transport technologies using the radio frequency spectrum pursuant to Title III of the Communications Act, which vests authority in the FCC to regulate radio transmissions and to issue licenses for radio stations. The scope, content, and meaning of existing laws, rules and regulations governing 18GHz technology are subject to legislative, judicial and administrative changes. Recently, at the request of national defense agencies, the FCC restricted use of 18GHz in the greater Denver and Washington, D.C. areas. The Company has received assurances from the FCC that it believes will permit it to use 12GHz, which is otherwise not available to private cable operators, in substitution for 18GHz in its Denver market. The Company believes that 12GHz is an acceptable substitution for 18 GHz and that the required change of frequency will not materially adversely affect the Company's network plans in Denver. However, there can be no assurance that future legislative or regulatory actions will not adversely affect the Company's ability to deliver video or telecommunications programming or the cost thereof. The Company's 18GHz networks must comply with the FCC's licensing procedures and rules governing a licensee's operations. Application to use 18GHz microwave "paths" and frequencies is made to the FCC and is subject to certain technical requirements and eligibility qualifications. After 18GHz paths are licensed to an applicant, the facilities must be constructed and fully operational within 18 months of the grant. The facilities must be built in strict accordance with the terms of the granted application. Most of the Company's licenses are valid for a period of five years from the grant date, however, new licenses are valid for ten years from the date of grant, after which the licensee must apply to the FCC for license renewal. License renewal is not an automatic right, although it is routinely granted if the licensee is in substantial compliance with the FCC rules. Licensing procedures include (i) obtaining an engineering report confirming that the proposed path does not interfere with existing paths and (ii) filing FCC Form 402 which includes a statement of eligibility and use, a system diagram and a statement regarding compliance with the frequency coordination requirement. The entire licensing procedure requires approximately 120 days. 20 The Company does not "own" the paths and frequencies granted by the FCC. Rather, the Company is merely licensed or permitted to "use" the frequencies. Moreover, the rights granted to the Company to use 18GHz frequencies are not to the complete exclusion of other potential licensees. First, the Company's rights only extend to the 18GHz paths identified in its application as connecting the various points in its video distribution system. Other 18GHz microwave users are permitted to file applications and serve the same buildings as the Company (in so far as the 18GHz licensing is concerned), but they may not interfere with an incumbent user's licensed microwave paths. Second, the Company has no right to the airspace over which the programming is transmitted. Obstructions could be constructed in the line-of-sight of the microwave paths, precluding connection of the satellite earth station with the various reception points to be served. The 18GHz band also is authorized for use by other kinds of users, including non-video, point-to-point microwave, mobile communications and satellite down- link transmissions. Although sharing these frequencies is technically feasible, it is possible that the Company will be unable to obtain licenses for these frequencies on the paths it desires, or that it will be able to use only a portion of the frequencies at certain locations because of pre-existing users. Although private cable television operators are not subject to the full range of regulation applicable to Cable Systems, they are subject to the following federal regulations. First, private cable television operators are entitled to the compulsory copyright license described above. Second, private cable television operators benefit from the federal laws and regulations that require certain programming providers to make cable programming available to all multichannel video programming distributors on fair, reasonable and nondiscriminatory terms. Third, as noted above, private cable television operators are required to obtain retransmission consent from local broadcasters in order to retransmit their signals. Finally, private cable television systems are required to comply with the FCC's EEO rules and policies. The FCC's EEO rules and policies require multichannel television operators to establish and disseminate an EEO program that includes the use of recruiting sources that serve minorities and women, and to evaluate its hiring and promotion practices in comparison to the local labor pool. In addition, the FCC requires systems with six or more full time employees to file an annual EEO report detailing the system's EEO performance. Because they are subject to minimal federal regulation, 18GHz private cable television operators have significantly more competitive flexibility than do the franchised Cable Systems with which they compete. 18GHz private cable television operators have fewer programming restrictions, greater pricing freedom, and they are not required to serve any customer whom they do not choose to serve. In addition, with the exception of local zoning laws and regulations, state and local authorities generally have no jurisdiction over private cable television operators. The Company believes that these advantages help to make its private cable television systems competitive with larger franchised Cable Systems. 23GHz Microwave Regulation -------------------------- The Company anticipates that in the future it will use 23GHz microwave frequencies, which are available for both private or common carrier communications, to provide bi-directional telecommunications services. The application and licensing procedures for authorizations to use the 23GHz frequencies are substantially the same as those applicable at 18GHz. Although the Company expects that 23GHz frequencies will be available on its current paths and to meet its future needs, the Company has not commenced frequency coordination and there can be no assurance that the Company will be able to obtain licenses for these frequencies on the paths it desires. 12 GHz Microwave Regulation --------------------------- Recently the FCC, at the request of national defense agencies, restricted the use of 18GHz frequencies in the greater Denver and Washington, D.C. areas. As a result, the Company has received assurances from the FCC that it will be permitted, subject to licensing procedures, to use 12GHz as a medium to deliver multi-channel video programming and telecommunications services in Denver. The application and licensing procedures for authorization to use 12 GHz frequencies are substantially the same as those applicable at 18GHz. The Company has commenced frequency coordinations for 12GHz paths, however, there can be no assurance that such frequency will be available for the Company's future needs in Denver. 21 TELECOMMUNICATIONS REGULATION The telecommunications services provided by the Company are subject to regulation by federal, state and local government agencies. As the Company implements its telecommunications strategy, which includes replacing many of its current PBX switches with networked central office switches, the Company will increasingly become regulated as a CLEC. The FCC has jurisdiction over interstate services, and state regulatory commissions exercise jurisdiction over intrastate services. Additionally, local authorities may regulate limited aspects of the Company's business, such as the use of public rights-of-way. The following subsections summarize the local, state and federal regulations that pertain to the Company's current and projected telecommunications services. Shared Tenant Services ---------------------- The Company currently offers telecommunications services as an STS operator to subscribers in Houston, Dallas-Ft. Worth, Austin, Denver and Miami-Ft. Lauderdale. The Company offers STS services to residents of MDUs using conventional twisted copper wire pairs to distribute telephone services within an MDU. A PBX switch is installed at the MDU and traffic from the MDU is transported via leased trunk lines to the LEC central office. From the LEC's central office, local calls are routed through the LEC's network and long distance traffic is routed to the Company's chosen long distance carrier (currently AT&T). By providing MDU tenants with interconnection in this manner, the STS provider (rather than the tenant) subscribes to local exchange service from the telecommunications company, then "resells" service to the MDU tenant. The resale of STS is subject to the terms and conditions in the tariffs of the telecommunications company whose services it resells and to regulation by the states in which the Company resells such services. Historically, virtually all such telecommunications company tariffs flatly prohibited resale of local exchange service. However, in recent years several state legislatures and Public Utility Commissions ("PUCs") determined that resale of local exchange service is in the public interest and have directed telecommunications companies within their jurisdictions to allow for resale of local exchange service, opening the way for STS operations. Moreover, the Telecommunications Act requires such resale pursuant to interconnection agreements with the incumbent LEC. In some states, PUCs have issued detailed regulations governing the provision of STS and other resale services. In other jurisdictions where no formal requirements have been adopted, most telecommunications companies have nonetheless modified their tariffs to provide for resale of local exchange services. The precise terms and conditions under which such resale services may be provided varies from state to state, and from LEC to LEC, and may include significant restrictions and limitations. These include: (i) a requirement to be certified by the state PUC; (ii) restrictions with respect to the location and ownership of MDUs to which STS service may be provided and the crossing of public rights-of-way by STS operator facilities; (iii) regulations allowing telecommunications companies to apply different local service rate structures (e.g., measured use vs. flat rate) to STS providers and other subscribers, in some cases lessening or even eliminating efficiencies which might otherwise be realized through the use of the LECs' trunking facilities; (iv) regulations providing for LEC access or rights-of-way to directly service individual customers within an MDU; and (v) in certain states, limits or prohibitions on resale of intrastate long distance and local service at a profit. Of the six states in which the Company operates, none has adopted regulations governing the provision of STS services. The California PUC has, however, adopted informal STS "guidelines." In addition, Florida requires providers of STS services to be certified to resell local exchange services. The Company has applied for such certification. Other than the California "guidelines" and Florida's certification requirement, the Company may provide STS services in each of these six states, subject only to individual telecommunications company tariff provisions. The tariffs of all major LECs serving these jurisdictions provide for resale of local exchange service pursuant to varying terms and conditions. Provision of STS service in these states in the future will be subject to any regulations that ultimately may be adopted by state authorities, and to changes in telephone company tariffs. 22 Competitive Local Exchange Carrier Regulation --------------------------------------------- Recent and impending changes in federal law and regulation likely will affect the conduct of the Company's telecommunication service business. The FCC historically has left the regulation of the intrastate aspects of local exchange service to the states. It has, however, exercised its jurisdiction over interstate matters and jurisdictionally mixed matters respecting local telephone service. The Telecommunications Act expands the FCC's authority to regulate local exchange service and there can be no assurance that the FCC will not exercise this authority aggressively. State regulation of local exchange service traditionally has favored the ILECs (principally the RBOCs and GTE). The state laws have, with the exception of STS, generally prohibited competition in the local exchange. The Telecommunications Act expressly preempts such prohibitions. The Telecommunication Act declares that no state or local laws or regulations may prohibit or have the effect of prohibiting the ability of any entity to provide any interstate or intrastate telecommunications service. States may, however, impose "competitively neutral" requirements regarding universal service, public safety and welfare, service quality and consumer protection. Local authorities may also require reasonable, competitively neutral compensation for use of the public rights-of-way. The Company currently offers telecommunications services in Houston as a CLEC, but has not yet converted many of its telephone properties from STS to CLEC services. The Company anticipates that it will, in the future, increasingly compete in other telecommunications markets as a CLEC. For purposes of the Telecommunications Act, CLECs and ILECs are subject to the same basic set of requirements. However, certain additional obligations are imposed on ILECs, but not on CLECs. Although the Company does not believe that the regulatory burdens applicable to CLECs will have a material effect on its business, no assurance can be given at this time regarding the extent or impact of such regulation. The Telecommunications Act requires all carriers, both CLECs and ILECs, to interconnect, resell their services, provide number portability, provide dialing parity, afford access to their poles, ducts, conduits and rights-of-way, and to establish reciprocal compensation for the transport and termination of other LECs' telephone traffic. All providers of telecommunications services are also subject to the Act's requirements that they contribute to state and federal universal service funds. ILECs are subject to certain additional requirements, such as a duty to negotiate interconnection agreements in good faith, to unbundle elements of their networks, to provide non-discriminatory interconnection with their networks, to comply with specific resale obligations, to provide notice of changes to their networks and to allow collocation of other carriers' equipment on their premises. The Company is not, however, considered an ILEC in any state, and is instead only subject to the obligations imposed on CLECs. The FCC and various state PUCs are in the process of defining the precise contours of the requirements that will govern local exchange service in the future. Although the Telecommunications Act sets forth certain standards, it also authorizes the states to adopt additional regulations provided that such regulations do not conflict with the federal standards. It is unclear at this time how the states will respond to the new federal legislation, and what additional regulations they may adopt. Moreover, the United States Court of Appeals for the Eighth Circuit overturned portions of the FCC's First Report and Order that had set forth pricing methodologies for unbundling, resale and interconnection, and that had also set forth certain technical requirements, such as obligations relating to quality of service and combination of unbundled network elements. The FCC has stated that it intends to seek review of this decision in the Supreme Court, but has not yet done so. It is not possible for the Company to predict the outcome of these or any other proceedings relating to the Telecommunications Act. Nonetheless, at this time it is clear that an increasing number of service providers will be seeking to compete as CLECs in the local exchange markets and that state and federal regulations will, to some extent, allow for such market entry. Although 23 jurisdictional lines of authority and basic implementation issues are being determined by the FCC and the federal courts in accordance with the statutory provisions outlined above, several states already have begun the process of opening the local exchange market to competition. Most states require companies seeking to compete in intrastate telecommunications services to be certified to provide such services. These certifications generally require a showing that the carrier has the financial, managerial and technical resources to offer the proposed services consistent with the public interest. State regulation of telecommunications services may impose upon the Company additional regulatory burdens, including quality of service obligations and universal service contributions. Long Distance Resale Regulation ------------------------------- Non-dominant interexchange carriers, such as the Company, are subject to limited federal regulation. Nonetheless, carriers are required by statute to offer their services under rates, terms and conditions that are just, reasonable and not unreasonably discriminatory, and to file tariffs for their international and interexchange services. The Telecommunications Act grants the FCC explicit authority to forbear from regulating any telecommunications service provider if the agency determines that it would be in the public interest to do so. Pursuant to this authority, the FCC previously determined that it would forbear from requiring that non-dominant interexchange carriers file tariffs for their domestic services. The U.S. Court of Appeals for the District of Columbia Circuit, however, has stayed that decision pending court review. As a non-dominant carrier, the Company is permitted to make tariff filings on a single day's notice and without cost support to justify specific rates. The FCC generally does not exercise direct oversight over cost justification and the level of charges for service of non-dominant carriers, although it has the statutory power to do so. The FCC has jurisdiction to act upon complaints brought by third parties, or on the FCC's own motion, against a carrier for failure to comply with its statutory obligations. Foreign Ownership Restrictions ------------------------------ Section 310(b) of the Communications Act prohibits foreign controlled companies from holding common carrier radio licenses. To allow the Company to provide common carrier telecommunications services using its networks, in the event that the Company decides it desires to provide such services, the Company has assigned substantially all of its frequency licenses (the "Assigned Licenses") to Transmission Holdings, Inc ("THI"), an entity controlled by United States citizens. To establish the terms of the Company's continued and unencumbered use of the Assigned Licenses, the Company has entered into a license and services agreement pursuant to which THI has agreed to provide to the Company all the transmission capacity it requires or may in the future require and the Company has granted THI a non-exclusive license to use all of the Company's facilities and related equipment, such as microwave transmitting and receiving equipment, required to provide transmission capacity. The Company has also obtained an option to acquire the assets or equity of THI, subject to FCC approval. ITEM 2: PROPERTIES The Company's national call center and its executive, administrative and sales offices are located in Dallas, Texas. The premises lease has a ten year term expiring November 30, 2005, and, as of August 31, 1997, requires monthly rental payments of approximately $50,000. The Company, by exercising an option, can lease additional space at its current location at comparable rates. The Company leases additional space in the cities in which it operates for its regional offices and warehouse operations. In October 1997, the Company purchased a building proximate to its executive offices in Dallas, Texas. The Company intends to relocate certain administrative functions and to install a central office switch at the building. 24 The Company owns substantially all of the cable television and telecommunications equipment essential to its operations. The Company's major fixed assets are cable television headends, microwave transmitters and receivers, SMATV receivers, PBX switches and coaxial fiber optic cable. Such properties do not lend themselves to description by character and location of principal units. Substantially all of this equipment (other than fiber optic cable laid under public rights of way) resides on or under the MDUs served by the Company or in leased facilities in various locations throughout the metropolitan areas served by the Company. ITEM 3: LEGAL PROCEEDINGS Except as set forth below, the Company is not a party to any pending material legal proceedings except for those arising in the ordinary course of business. The Company does not believe that these will have a material adverse impact on the Company's financial condition or results of operations. The Company is engaged in an administrative proceeding before the United States Patent and Trademark Office ("PTO") relative to registration of the "OpTel" trademark. The PTO found the Company's application to be allowable; however, a proceeding in the PTO was commenced by Octel Communications Corp. ("Octel Communications") on November 7, 1995 seeking to prevent the Company from registering the "OpTel" trademark on the grounds that the Company's trademark is confusingly similar to the mark used by Octel Communications in a related field and claiming that the Company's application has procedural deficiencies. The PTO proceeding is related solely to the Company's right to register the mark and does not have a direct bearing on the Company's continued use of the OpTel trademark. The PTO proceeding is in its relatively early stages and the Company is vigorously pursuing its right to register the OpTel trademark. However, there can be no assurance as to the outcome of the PTO proceeding. In addition, there can be no assurance that Octel Communications or another third party will not commence an infringement action against the Company under applicable federal or state law. Although the Company does not believe that its use of the name "OpTel" infringes on the trademark rights of any other person, there can be no assurance as to the outcome of any future infringement action or that any such outcome would not materially adversely affect the Company. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 4A: EXECUTIVE OFFICERS OF REGISTRANT The following table sets forth certain information regarding the directors and executive officers of the Company at August 31, 1997: BOARD OF DIRECTORS
POSITION Age -------- --- Claude Chagnon Chairman of the Board and Director 42 Louis Brunel Director; President and CEO 56 Christian Chagnon Director 41 Pierre Fortier Director 42 Alain Michel Vice Chairman of the Board and Director 48
25 EXECUTIVE OFFICERS
POSITION Age Previous Experience -------- --- ------------------- Louis Brunel President, CEO and Director 56 GVL, VHP Bertrand Blanchette CFO 40 GVL, VHP John Czapko VP, Sales 56 Metrocel Cellular Telephone Stephen Dube VP, Marketing and Corporate 41 GVL; Laurentian Development Financial Inc. Michael E. Katzenstein VP, Legal Affairs and General 38 Kronish, Lieb, Counsel Weiner and Hellman LLP William Shepherd VP, New Business and Product 44 Great Lakes Development Telecommunications Thomas Watson VP, Engineering & Information 41 GTE Telephone Services Lynn Zera VP, Human Resources 50 Keystone Consulting
Claude Chagnon has served as a Director since August 1996. Since October 1996, he has been the President and Chief Operating Officer of GVL. From January 1994 to October 1996, Mr. Chagnon was Vice Chairman of GVL. Prior to 1994, Mr. Chagnon has held various positions at GVL and its subsidiaries including, from May 1988 to January 1994, President of Videotron Ltee, a Canadian cable television company and wholly-owned subsidiary of GVL. Mr. Chagnon also serves as a Director of GVL, Tele-Metropole Inc., a Canadian broadcaster and subsidiary of GVL. Louis Brunel has served as a Director since March 1995 and as President and Chief Executive Officer since April 1996. Since 1988, Mr. Brunel has held various positions at GVL and its subsidiaries, including, immediately prior to joining OpTel, Vice-Chairman and Chief Executive Officer of Videotron Holdings Plc ("VHP"), a recently divested UK based cable and telephone subsidiary of GVL. While at VHP, Mr. Brunel was the chief architect of VHP's cable television/telecommunications business. From 1988 to 1990, he served as Vice President-Corporate Development of GVL. In addition, he served as President of Videotron International Ltee ("VIL"), from September 1994 through December 1996. Christian Chagnon has served as a Director since March 1997 and has been Senior Vice President, Strategic Planning and Technology of GVL since September 1993. Prior to August 1994, Mr. Chagnon was also President of Videotron Services Informatiques Lte. Mr. Chagnon also serves as a Director of GVL. Pierre Fortier has served as a director of OpTel since November 1997. Mr. Fortier was appointed a director of OpTel, as CDPQ's nominee, pursuant to a Stockholders Agreement dated as of August 15, 1997, between VPC, the Company and CDPQ. Since August 1997, Mr. Fortier has served as a vice president of CDPQ. From 1990 to August 1997, Mr. Fortier served as a Vice President of Capital d'American, a subsidiary of Caisse, and from 1990 until November 1995 as a Vice President of Special Projects at Caisse. Alain Michel has served as a director of OpTel since April 1997. Since July 1992, Mr. Michel has held various management positions at GVL, most recently, since July 1994, he has been GVL's Senior Vice President and Chief Financial Officer. Mr. Michel is also a director of NB Capital, Inc. a publicly traded Delaware real estate investment trust and Groupe Goyette Inc., a Canadian public company which provides transportation and storage services. Bertrand Blanchette was appointed Chief Financial Officer in September 1996. From September 1995 to December 1996, Mr. Blanchette served as Chief Financial Officer of VHP. From June 1994 to December 1995, he was Vice President Control of GVL. From October 1986 to June 1994, Mr. Blanchette was Vice President Finance of Heroux, Inc., a public manufacturer of airplane parts. John Czapko was appointed Vice President Sales in March 1997. From September 1993 to February 1997, Mr. Czapko was Director of Indirect Distribution of Metrocel Cellular Telephone Company ("Metrocel"). From June 1991 to September 1993, he was Director of Direct Distribution of Metrocel. Prior to that, Mr. Czapko was Director of Spectrum Management of Primeco Personal Communications where he helped develop and launch their new wireless PCS networks. 26 Stephen Dube served as Vice President Acquisitions and Strategic Planning for OpTel from July 1995 to May 1997 and since that date as Vice President Marketing and Corporate Development for OpTel. From July 1995 to March 1997, Mr. Dube served as a Director of OpTel. From January 1992 to April 1995, Mr. Dube was Senior Vice President of Laurentian Financial Inc., a financial services company. From June 1986 to January 1992, he was Vice President of Alexis Nihon Group, a real estate and venture capital company. Michael E. Katzenstein was appointed Vice President Legal Affairs, General Counsel and Secretary in November 1995. Prior to joining OpTel, Mr. Katzenstein was a partner (and, prior to January 1993, an associate) at Kronish, Lieb, Weiner and Hellman LLP. Mr. Katzenstein received his J.D. from Boston University School of Law in 1985. William Shepherd has been Vice President New Business and Product Development since June 1996. From September 1994 to December 1995 Mr. Shepherd was Vice President, Sales and marketing of Great Lakes Telecommunications Corporation ("Great Lakes") and from December 1995 until February 1996 was Chief Operating Officer of that Company. From January 1992 to September 1994 Mr. Shepherd was President of Continental Communications Corporation, a provider of communications consulting and international transmission resale. Thomas Watson was appointed Vice President Information Services in September 1996. In August 1997 he also assumed the role of Vice President of Engineering. From January 1992 to September 1996, Mr. Watson held various positions at GTE Telephone Operations, an ILEC, including, Group Product Manager, Group Manager Engineering and Senior Program Manager. From June 1990 to January 1992, he was Group Engineer Manager for GTE Government Systems Corporation, a software developer. Lynn Zera was appointed Vice President Human Resources in November 1995. From July 1994 to October 1995 Ms. Zera was Executive Director of Keystone Consulting. From July 1993 to July 1994, she was Executive Director of Human Resources of Intellicall, Inc., a telecommunications company. From March 1978 to January 1993, she held various management and marketing positions with Oryx Energy, a company involved with the production and exploration of oil and gas. 27 Part IV Item 14 of the Annual Report Form 10-K for the year ended August 31, 1997 of OpTel, Inc. (the "Company") is hereby amended to include the following exhibits: ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K 3 Exhibits NUMBER EXHIBIT ------ ------- 10.28 Stockholders Agreement dated as of August 15, 1997 by and among VPC Corporation and Capital Communications CDPQ Inc. and the Registrant. 21.1 List of subsidiaries of the registrant. 28 3. Exhibits -------- 3.1 Restated Certificate of Incorporation of the Registrant, together with all amendments thereto.* 3.2 Bylaws of the Registrant.* 3.3 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant.** 4.1 Indenture, dated as of February 14, 1997, between the Registrant and U.S. Trust Company of Texas, N.A., as Trustee.* 4.2 Form of Senior Note (included in Exhibit 4.1).* 4.3 Escrow Agreement, dated as of February 14, 1997, between the Registrant and U.S. Trust Company of Texas, N.A., as Trustee and as Escrow Agent. 4.4 Registration Agreement, dated as of February 14, 1997, between the Registrant, Salomon Brothers Inc. and Merrill Lynch, Pierce, Fenner & Smith.* 4.5 Common Stock Registration Rights Agreement, dated as of February 14, 1997, between the Registrant, VPC, GVL, Salomon Brothers Inc. and Merrill Lynch, Pierce, Fenner & Smith.* 4.6 Registration Rights Agreement, dated as of August 15, 1997, between the Registrant and Capital Communications CDPQ Inc.** 4.7 Warrant Agreement, dated as of July 11, 1997, between the Registrant and Rory O. Cole.** 10.1 Stockholders' Agreement, dated as of December 22, 1994, between VPC, Vanguard Communications, L.P. ("Vanguard"), Vanguard Communications, Inc. ("General Partner") and the Registrant.* 10.2 Registration Rights Agreement, dated as of December 22, 1994, between the Registrant and Vanguard.* 10.3 Settlement Agreement, dated as of August 1, 1996, between Vanguard, the General Partner, Pacific Capital Group, Inc. ("Pacific"), VPC, the Registrant and GVL.* 10.4 Amendment, dated as of February 17, 1997, between Vanguard, the General Partner, Pacific, VPC, GVL and the Registrant.* 10.5 Form of Convertible Note (included as Exhibit B to the Amendment referenced as Exhibit 10.4 hereto) and a list of the issue dates and principal amounts of all outstanding Convertible Notes (included as Schedule 1 to the Amendment referenced as Exhibit 10.4 hereto).* 10.6 Warrant, dated as of December 29, 1994, between International Richey Pacific Capital Corporation and Vanguard.* 10.7 Lease Agreement dated July 25, 1995 between Space Center Dallas, Inc. and the Registrant.* 10.8 First Amendment to Lease Agreement dated August 8, 1996 between Space Center Dallas, Inc. and the Registrant.* 10.9 Restated Incentive Stock Plan of the Registrant.* 10.10 Annual Bonus Plan of the Registrant.* 10.11 Medium Term Performance Plan of the Registrant.* 10.12 Employment Agreement between Louis Brunel and the Registrant dated November 15, 1996.* 10.13 Employment Agreement between Rory Cole and the Registrant dated January 3, 1997.* 10.14 Employment Agreement between Michael Katzenstein and the Registrant dated September 18, 1995.* 29 3. Exhibits (continued) ------------------- 10.15 Separation and Consulting Agreement, dated as of September 1, 1996, between the Registrant and James A. Kofalt.* 10.16 Warrant Agreement, dated as of September 1, 1997, between the Registrant and James A. Kofalt.* 10.17 Assignment Agreement, dated as of February 14, 1997, among TVMAX Telecommunications, Inc. ("TVMAX"), Sunshine Television Entertainment, Inc., Richey Pacific Cablevision, Inc., IRPC Arizona, Inc. and Transmissions Holdings, Inc. ("THI").* 10.18 Equipment License and Services Agreement, dated as of February 14, 1997, between TVMAX and THI.* 10.19 Form of Shareholders Option Agreement, dated as of February 14, 1997, between TVMAX and each of the shareholders of THI, together with a list of the shareholders of THI.* 10.20 Option Agreement, dated as of February 14, 1997, between TVMAX and THI.* 10.21 City of Houston, Texas, Ordinance No. 97-285 dated March 19, 1997, granting TVMAX Communications (Texas), Inc. a temporary permit to operate a Telecommunications Network.* 10.22 City of Houston, Texas, Ordinance No. 89-338 dated March 29, 1989 granting to PrimeTime Cable Partners I, Ltd. the right to operate for 15 years a Community Antenna Television System, and subsequent ordinances consenting to assignment of rights to Eaglevision and to TVMAX Communications (Texas), Inc.* 10.23 City of Houston, Texas, Ordinance No. 97-1088 dated September 3 1997, extending the TVMAX Communications (Texas), Inc. temporary permit to operate a Telecommunications Network (originally granted under Ordinance 97-285).** 10.24 Purchase Agreement, dated as of July 23, 1997 among the Registrant, Phonoscope, Ltd., Phonoscope Management L.C., Lee Cook, Alton Cook and Lee Cook Family Trust.** 10.25 Amendment Number 001 to the Videotron/Lucent Agreement, dated August 28, 1997, among Videotron Telecom Ltee and Lucent Technologies Canada Inc. and TVMAX Telecommunications Inc and Lucent Technologies Inc.** 10.26 Summary of Terms and Conditions of Senior Secured Facilities between Registrant and Goldman Sachs Credit Partners L.P.** 10.27 Interconnection Agreement under Sections 251 and 252 of the Telecommunications Act of 1996 by and between Southwestern Bell Telephone Company and OpTel (Texas) Telecom, Inc.** 10.28 Stockholders Agreement dated as of August 15, 1997 by and among VPC Corporation and Capital Communications CDPQ Inc. and the Registrant.*** 11. Computation of Per Share Earnings.** 21.1 List of subsidaries of the Registrant.*** * Filed as an exhibit to the Registrant's registration statement on Form S-4 filed with Securities and Exchange Commission on April 10, 1997. ** Filed as an exhibit to the Registrant's annual statement on Form 10K filed with Securities and Exchange Commission on November 23, 1997. ***Filed as an exhibit to the Registrant's annual statement on Form 10K/A filed with Securities and Exchange Commission on February 10, 1998. (b) Reports on Form 8-K - ---- ------------------- A report on Form 8-K related to an event on August 14 has been filed during the last quarter of the period covered by this report. 30 2. Financial Statements Schedules. The following financial statements schedule of the Company for the period xx and the years ended August 31, 1996 and 1997 is included in this Form 10-K on page S-1 SCHEDULE NO. DESCRIPTION PAGE NO ----------- ----------- ------- Schedule II Valuation and Qualifying Accounts S-1 All other financial statement schedules have been omitted because they are inapplicable or the required information is included or incorporated by reference elsewhere herein. 3. Exhibits. The Company will furnish to any eligible stockholder, upon written request of such stockholder, a copy of an exhibit listed below upon payment of a reasonable fee equal to the Company's expenses in furnishing such exhibit. 31 PURSUANT TO THE REQUIREMENTS OF RULE 12b 15 PROMULGATED UNDER THE SECURITIES AND EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS DULY CAUSED THIS AMENDMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. OPTEL, INC. (REGISTRANT) February 17, 1998 BY: /s/ Bertrand Blanchette --------------------------------------- Bertrand Blanchette Chief Financial Officer 32 EX-10.28 2 STOCKHOLDERS AGREEMENT EXHIBIT 10.28 EXECUTION COPY STOCKHOLDERS AGREEMENT (THIS "AGREEMENT") DATED AS OF AUGUST 15, 1997. BY AND AMONG: VPC CORPORATION, a Delaware corporation ("VPC"); AND: CAPITAL COMMUNICATIONS CDPQ INC., a Quebec company ("CDPQ"); AND: OPTEL, INC., a Delaware corporation (the "Corporation"). WHEREAS, as of the date hereof and after Vanguard's exercise in full of the Vanguard Option, VPC owns of record and beneficially (i) 1,923,977 shares of Class B Stock which represents approximately 74.62% of the issued and outstanding shares of Common Stock and approximately 81.75% of the issued and outstanding shares of Voting Common Stock and (ii) Convertible Notes having an outstanding balance (including principal and accrued interest) of approximately $128,145,213 as of July 31, 1997 (the "Convertible Notes Outstanding Balance"); WHEREAS, as of June 27, 1997, Vanguard and CDPQ entered into a Stock Purchase Agreement (the "Stock Purchase Agreement"), pursuant to which CDPQ is purchasing all of Vanguard's equity interest in the Corporation which consists of 429,521 shares of Class B Stock and represents approximately 16.66% of the issued and outstanding shares of Common Stock and approximately 18.25% of the issued and outstanding shares of Voting Common Stock; WHEREAS, it is a condition precedent to CDPQ's consummation of the transactions contemplated by the Stock Purchase Agreement that each of the parties hereto enter into this Agreement; and In consideration of the foregoing recitals, the mutual agreements contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. CONSTRUCTION. 1.1 Definitions. As used herein: 1.1.1 "Affiliate" has the meaning set forth in Rule 12b-2 of the regulations promulgated under the Securities Exchange Act of 1934, as amended. 1.1.2 "Alternative Strategic Investment" means (i) a one time issuance (the "alternative original issuance") by the Corporation to a single alternative strategic investor (i.e., any issuance of securities by the Corporation to any other alternative strategic investor shall not qualify as an "Alternative Strategic Investment" hereunder) which is not an Affiliate of VPC or Videotron of shares of Common Stock at a price which is not less than $82.18 per share (which is the price per share paid by CDPQ pursuant to the Stock Purchase Agreement), such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof and (ii) a subsequent issuance, which meets the requirements of the alternative original issuance, if such subsequent issuance is pursuant to obligations incurred by, or the exercise of options, warrants or rights issued or granted to the alternative strategic investor at the time of the alternative original issuance. For purposes of this Agreement, a "single alternative strategic investor" shall be the operator of a business (or a group of such operators acting as a consortium) which is not a single strategic investor for purposes of Section 1.1.25 and shall not be a financial institution or a passive investor. 1.1.3 "Board" means the Board of Directors of the Corporation. 1.1.4 "CDPQ Shares" means all Stockholder Shares held directly or indirectly by CDPQ. 1.1.5 "Class A Stock" means the Class A Common Stock, par value $.01 per share, of the Corporation. 1.1.6 "Class B Stock" means the Class B Common Stock, par value $.01 per share, of the Corporation. 1.1.7 "Class C Stock" means the Class C Common Stock, par value $.01 per share, of the Corporation. 1.1.8 "Cole Warrant" means an option or warrant to be issued to Rory Cole, a former officer of the Corporation, to purchase not more than 9406.36 shares of Class A Stock at an exercise price of $74.42 per share, subject to adjustment. 1.1.9 "Common Stock" means the Class A Stock, the Class B Stock the Class C Stock or other common stock of the Corporation. -2- 1.1.10 "Convertible Notes" means the Corporation's 15% convertible subordinated promissory notes issued or to be issued to VPC and all notes issued directly or indirectly in replacement of, substitution for or as interest on any such note in whole or in part. For purposes of this Agreement, whenever a calculation of the Common Stock or other common equity of the Corporation on a fully diluted basis is required, the Convertible Notes shall be deemed to be convertible into a number of shares of Common Stock or other common equity, as the case may be, using the assumption set forth in the definition of "Stockholder Shares" hereunder. 1.1.11 "Corporation Shares" means all issued and outstanding shares of capital stock of the Corporation (including the Common Stock and any preferred stock) and all rights to acquire any capital stock of the Corporation (including the rights contained in the Convertible Notes). 1.1.12 "Director" means any member of the Board or a Sub Board, as the context requires. 1.1.13 "Hecht Warrant" means the Warrant Agreement dated as of July 3, 1997 granted by the Corporation to Gordon Hecht pursuant to which Gordon Hecht has the right to purchase up to 728.86 share of Class A Stock at an exercise price of $85.75 per share, subject to adjustment. 1.1.14 "Indenture" means the Indenture dated as of February 14, 1997 between the Corporation and U.S. Trust Company of Texas, N.A., as trustee and as escrow agent as such Indenture is in effect on the date hereof. 1.1.15 "IPO Date" means the first date on which the Corporation receives the net proceeds of a Public Offering. 1.1.16 "Kofalt Warrant" means the Warrant Agreement dated as of September 1, 1996 granted by the Corporation to James A. Kofalt pursuant to which James A. Kofalt has the right to purchase up to 24,992 shares of Class A Stock at an exercise price of $53.55 per share, subject to adjustment. 1.1.17 "Person" means an individual, a partnership, a corporation, an association, a joint stock company, a trust, a joint venture, a limited liability company, an unincorporated organization, or a governmental entity (or any department, agency, or political subdivision thereof). 1.1.18 "Public Offering" means any sale of shares of Voting Common Stock to the public pursuant to an offering registered under the Securities Act, if immediately thereafter such Voting Common Stock is listed on a national securities exchange or quoted on the NASDAQ National Market System. 1.1.19 "Repayment Date" has the meaning set forth in Exhibit A. --------- -3- 1.1.20 "SEC" means the Securities and Exchange Commission. 1.1.21 "Securities Act" means the Securities Act of 1933, as amended. 1.1.22 "Stockholder" means any of the Stockholders. 1.1.23 "Stockholder Shares" means (i) any Common Stock held, directly or indirectly, by the Stockholders, including without limitation any Common Stock issued or issuable upon conversion of the Convertible Notes (assuming a conversion price of $83.38), whether or not the Convertible Notes are at the time convertible in accordance with their terms, and (ii) any equity securities issued or issuable directly or indirectly with respect to the securities referred to in clause (i) above by way of any stock split, reverse stock split, stock dividend or other subdivision or combination. 1.1.24 "Stockholders" mean collectively VPC and CDPQ. 1.1.25 "Strategic Investment" means (i) a one time issuance (the "original issuance") by the Corporation to a single strategic investor (i.e., any issuance of securities by the Corporation to any other strategic investor shall not qualify as a "Strategic Investment" hereunder) which is not an Affiliate of VPC or Videotron of shares of Common Stock at a price which is not less than $82.18 per share (which is the price per share paid by CDPQ pursuant to the Stock Purchase Agreement), such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof and (ii) a subsequent issuance, which meets the requirements of the original issuance, if such subsequent issuance is pursuant to obligations incurred by, or the exercise of options, warrants or rights issued or granted to the strategic investor at the time of the original issuance. For purposes of this Agreement, a "single strategic investor" shall mean (a) any company (or a group of such companies acting as a consortium) which is engaged principally in a Cable/Telecommunications Business (as defined in the Indenture as in effect on the date hereof) and which has a rating from Moody's of Baa3 (or the equivalent thereof) or higher or from S&P of BBB- (or the equivalent thereof) or higher or (b) any controlled Affiliate of such company or consortium referred to in the preceding clause (a). 1.1.26 "Subsidiary" means, with respect to any Person, any corporation, limited liability company, partnership, association or other business entity of which (i) if a corporation, association or other business entity, a majority of the total voting power of securities entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by that Person or one or more of the other Subsidiaries of that Person or a combination thereof, or (ii) if a limited liability company or partnership, a majority of the partnership or other similar ownership interest thereof is at the time owned -4- or controlled, directly or indirectly, by any Person or one or more Subsidiaries of that Person or a combination thereof. For purposes hereof, a Person or Persons shall be deemed to have a majority ownership interest in a limited liability company or partnership if such Person or Persons shall control any managing member or general partner of such limited liability company or partnership. 1.1.27 "Transfer" as to any security means any sale, exchange, assignment, the creation of any option or right to purchase, security interest or other encumbrance, and any other disposition of any kind, whether voluntary or involuntary, affecting title to, possession of or voting rights in respect of such security, or any interest therein. 1.1.28 "Vanguard" means Vanguard Communications, L.P., a California limited partnership. 1.1.29 "Vanguard Option" means the Option dated August 1, 1996 granted by the Corporation to Vanguard. 1.1.30 "Videotron" means Le Groupe Videotron Ltee, a Quebec corporation that is the indirect ultimate parent of VPC. 1.1.31 "VPC Shares" means all Stockholder Shares held directly or indirectly by VPC. 1.1.32 "Voting Common Stock" means the Class A Stock and the Class B Stock. 1.1.33 "Voting Ratio" means, as to a Stockholder at the time of determination, the percentage obtained by dividing the number of votes to which such Stockholder and its Affiliates are entitled with respect to the number of shares of Voting Common Stock held by such Stockholder and its Affiliates on a fully-diluted basis at such time by the aggregate number of votes to which all holders of Voting Common Stock are entitled with respect to all of the shares of Voting Common Stock held by all such holders of Voting Common Stock on a fully-diluted basis, in each case, assuming all holders of then outstanding warrants, options and convertible securities of the Corporation which are in the money had converted such convertible securities or exercised such warrants or options immediately prior to such time. For purposes of this Section 1.1.33, the Convertible Notes shall be deemed at all times to be "in the money". 1.2 Interpretation. When the context in which words are used in this Agreement indicates that such is the intent, singular words include the plural and vice versa. References herein to Sections, Exhibits or Schedules are to the appropriate sections, exhibits or schedules of this Agreement unless otherwise expressly so stated. The words "herein", "hereof", and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Section, Exhibit, Schedule or -5- other subdivision. All Schedules and Exhibits attached hereto are incorporated herein by reference and are deemed a part hereof. 2. DIRECTORS 2.1 Voting for Directors. The Corporation agrees to take all required actions and each Stockholder agrees to vote all Corporation Shares now or hereafter owned by it, at any regular or special meeting of stockholders called for the purpose of, or shall otherwise consent to, the election to the Board of the Person or Persons designated pursuant to Section 2.2 ("Designee" or the "Designees") and to take all other required or requested actions so that at all times the provisions of Section 2.2 are complied with. 2.2 Designees 2.2.1 For so long as CDPQ's Voting Ratio is at least 5%, CDPQ shall be entitled to designate a number of Designees which shall result in such Designees representation on the Board being at least as great as CDPQ's Voting Ratio, but in no event shall CDPQ have less than one (1) Designee. VPC shall be entitled to designate a number of Designees which shall result in such Designees representation on the Board being as close as possible (after CDPQ designates its Designees) to VPC's Voting Ratio. 2.2.2 The right granted to CDPQ under Section 2.2.1 is in temporary substitute of all rights to designate Directors with respect to the Corporation and its Subsidiaries that are held by Caisse de depot et placement du Quebec ("Caisse") under the Consolidated Agreement (the "Consolidated Agreement") dated as of May 10, 1995 among Caisse, Andre Chagnon and Sojecci Ltee. By separate agreement being executed concurrently herewith, such rights under the Consolidated Agreement have been suspended for so long as the right of CDPQ under Section 2.2.1 remains in effect. 2.2.3 The composition of the board of directors or similar governing board of each of the Corporation's Subsidiaries (a "Sub Board") shall be subject to determination in the same manner as that of the Board. 2.2.4 Any committees of the Board or a Sub Board shall be created only upon the approval of a majority of the Directors, and the number of Directors which have been designated by CDPQ on any such committee shall be proportionately equivalent to the number of such Directors on the Board or Sub Board, as the case may be, which have been designated by CDPQ; provided, that so -------- long as CDPQ's Voting Ratio is at least 5%, CDPQ shall be entitled to name at least one Designee to every committee of the Board and any Sub Board. 2.3 Substitution. If any Designee designated by either Stockholder shall be unable or unwilling to serve on the Board or any Sub Board or any committee thereof, or shall -6- resign or be removed therefrom, the Stockholder which designated such Designee shall be entitled (if such Stockholder would then be entitled to designate such Designee pursuant to Section 2.2.1) to designate a replacement who then shall be a Designee for purposes of this Agreement. 2.4 Removal. Each Stockholder at the written request of the other Stockholder shall vote all Corporation Shares now or hereafter owned by it, at any regular or special meeting of stockholders called for the purpose of, or shall otherwise consent to, the removal from the Board, any Sub Board or any committee thereof, of any Designee designated by the other Stockholder, whether such removal is with or without cause. 2.5 Meetings and Actions of the Board and each Sub Board 2.5.1 Meetings of the Board and each Sub Board shall be held in accordance with the applicable corporation's bylaws. 2.5.2 A simple majority of the Board shall constitute a quorum for the transaction of any business at a meeting of the Board; provided that proper prior notice of such meeting has been delivered to or waived in writing by each member of the Board (or any member who has not received such notice or executed such a waiver is present at such meeting). A simple majority of a Sub Board shall constitute a quorum for the transaction of any business at a meeting of such Sub Board; provided that proper prior notice of such meeting has been delivered to or waived in writing by each member of such Sub Board (or any member who has not received such notice or executed such a waiver is present at such meeting). 2.5.3 The affirmative vote of a simple majority of the directors present at a meeting at which a quorum is present, or a unanimous written consent without a meeting, shall be sufficient to effect Board or Sub Board action with respect to any matter. 2.5.4 The Board shall meet at least quarterly. 2.5.5 The Stockholders shall take or cause to be taken any and all actions which may be necessary or desirable and proper to carry out the provisions of this Section 2.5. 2.6 Decisions Requiring Prior Stockholder Approval 2.6.1 Actions and decisions concerning the conduct of the business and internal affairs of the Corporation and its Subsidiaries regarding any of the matters mentioned in Exhibit A hereto --------- shall not be undertaken or decided, as the case may be, unless the subject to be dealt with has been specifically disclosed in reasonable detail in a notice previously sent by, the Corporation to CDPQ, and only to the extent that such action or decision is approved by CDPQ in writing. In the event that the Corporation gives notice of any proposed such -7- action or decision in accordance with the preceding sentence and such notice expressly requests CDPQ's written approval thereof, then if CDPQ fails, within twenty (20) days after CDPQ's receipt of such notice, to give written notice to the Corporation stating that CDPQ does not approve such action or decision or stating the extent to which CDPQ does not approve such action or decision, CDPQ shall be deemed to have given its written approval of such action or decision. 2.6.2 If the Corporation consummates a Public Offering or if CDPQ and its Affiliates cease to own any Corporation Shares, Section 2.6.1 shall become null and void. 2.6.3 By separate agreement being executed concurrently herewith, Caisse has agreed that the right granted to CDPQ in Section 2.6.1 amends and supersedes the rights of Caisse contained in Section 3 of the Consolidated Agreement insofar as such rights of Caisse concern the Corporation and any Subsidiary thereof. 2.6.4 The Stockholders shall take or cause to be taken any and all actions which may be necessary or desirable and proper to carry out the provisions of this Section 2.6. 2.7 Covenants by VPC. 2.7.1 VPC hereby covenants that it will use its reasonable best efforts to cause the Corporation not to enter into any Affiliate Transactions (as such term is defined in the Indenture as of the date hereof whether or not such Indenture remains in effect) except in accordance with and as permitted by the Indenture. 2.7.2 VPC hereby covenants that it will and that it will cause the Corporation to notify CDPQ at least five (5) business days prior to the grant by either VPC or the Corporation to any other holder of Corporation Shares (whether such shares are issued before or after the date hereof including any issuance of Corporation Shares pursuant to a Strategic Investment or an Alternative Strategic Investment) of any rights or privileges which are of the type granted to CDPQ pursuant to Sections 6.1, 6.2 and 10, as they may be amended from time to time (the "CDPQ Rights"), and such notice shall include a reasonable description of the rights or privileges to be granted to such other holder (the "Proposed Rights"). If, within 30 days after CDPQ's receipt of such notice, CDPQ determines, in its sole discretion acting reasonably, that any of the Proposed Rights are more advantageous to such other holder than the CDPQ Rights then held by CDPQ and so notifies VPC, then VPC hereby covenants that it will and it will cause the Corporation to amend the CDPQ Rights then held by CDPQ to conform to the Proposed Rights either (i) contemporaneously with the actual grant of the Proposed Rights to such other holder or (ii) as soon as reasonably possible after the actual grant of the -8- Proposed Rights to such other holder, provided that such amendment shall be deemed to be effective as of the time of such actual grant of the Proposed Rights to such other holder. The CDPQ Rights in force at any time under any of Sections 6.1, 6.2 and 10 shall cease to be CDPQ Rights and shall not be subject to modification pursuant to this Section 2.7.2 from and after such time, if ever, as the provisions of Section 6.1, 6.2 or 10 cease to be effective or shall be terminated in accordance with the provisions hereof. 2.7.3 VPC acknowledges that it no longer has any right to receive an annual $350,000 management fee from the Corporation or any of its Subsidiaries pursuant to any agreement or arrangement in force at or prior to the date hereof. Except as listed on Exhibit B-1 hereto, none of VPC, Videotron or any of their ----------- respective Affiliates (collectively, the "VPC Affiliates") provides any services to or has any other contractual relationship (whether written or oral) (the "Related Party Services") with the Corporation or any of its Subsidiaries. After the date hereof, except pursuant to approval of the Board and in compliance with Section 2.7.1, the VPC Affiliates shall not provide any services to the Corporation or any of its Subsidiaries for a fee or enter into any other contractual relationship (whether oral or written) with the Corporation or any of its Subsidiaries other than the Related Party Services, and the VPC Affiliates shall only provide the Related Party Services to the Corporation and its Subsidiaries pursuant to the terms described on Exhibit B-2 hereto. ----------- 2.7.4 If at any time VPC makes use of any of the Corporation's and its Subsidiaries' tax losses or credits (whether by carry-over, carry-back or otherwise) (collectively "Tax Items") for any fiscal year ending subsequent to the fiscal year ending August 31, 1997, VPC hereby agrees to fully compensate the Corporation, at the end of any such fiscal year, as provided in Exhibit C. --------- 2.7.5 Neither VPC nor any of its Affiliates shall at any time convert any of the Convertible Notes for a conversion price less than $82.18 for each share of Common Stock (such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof). 2.8 Representations and Warranties by VPC. VPC represents and warrants to CDPQ that (i) neither VPC nor any of its Affiliates is bound by any contractual provision (other than the provisions of this Agreement, the Consolidated Agreement and financial covenants and similar financial restrictions contained in instruments governing indebtedness for borrowed money and provisions of agreements entered into by the Corporation and its Subsidiaries in the ordinary course of business) in favor of any other Person which restricts the ability of the Corporation and its Subsidiaries to freely engage in the business of acquiring, developing and operating cable television systems and telecommunications services in the United States (a "Restrictive Covenant") and (ii) in particular, and without limitation of clause (i), neither the Corporation nor any of its Subsidiaries is bound by any provision in the -9- nature of a Restrictive Covenant with VPC or any of VPC's Affiliates or Subsidiaries that are not also Subsidiaries of the Corporation or which is enforceable by or for the benefit of VPC or any of VPC's Affiliates or Subsidiaries that are not also Subsidiaries of the Corporation. CDPQ acknowledges that an Affiliate of VPC holds an interest in Wireless Holdings Inc. and Videotron (Bay Area) Inc. and VPC holds an interest in County Cable Corp. 2.9 Supervoting and Preemptive Rights. If in connection with (i) a Public Offering, (ii) the first to occur of a Strategic Investment or an Alternative Strategic Investment, or (iii) an amalgamation or merger of the Corporation, VPC determines that it would be in the Corporation's best interests that the supervoting rights of the Series B Stock be terminated or that the preemptive rights granted pursuant to Sections 8.1 through 8.3 be waived with respect to such transaction, CDPQ shall promptly cooperate with VPC in taking all actions necessary to terminate such supervoting rights and/or waive such preemptive rights, provided that CDPQ and VPC are treated in the same manner (including the receipt of any consideration) by such termination or waiver (except for differences based solely on the magnitude of CDPQ's and VPC's relative ownership interests in the Corporation). In particular and without limitation of the foregoing, VPC and CDPQ each agrees that it will waive all such preemptive rights with respect to a Strategic Investment and will promptly execute an appropriate acknowledgment of such waiver as may be required or appropriate in connection with a Strategic Investment. 2.10 Early Conversion of Convertible Notes. CDPQ hereby consents to and agrees that, on one occasion at or prior to March 31, 1998, VPC may convert the minimum portion of the Convertible Notes necessary so that VPC will be entitled to include the Corporation and its Subsidiaries in VPC's consolidated income tax return for U.S. Federal Income Tax reporting purposes from the time of such conversion, as determined on the assumption that, without duplication, all outstanding options, warrants and other rights (other than those held by VPC or CDPQ) to acquire Common Stock from the Corporation or issuable pursuant to the Corporation's Incentive Stock Option Plan as in effect on the date hereof (which Plan has not been amended between February 7, 1997 and the date hereof) were then exercised, provided that such conversion -------- complies with the requirements of the Indenture and the conversion price is not less than the greater of (i) $82.18 per share of Common Stock (such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof) or (ii) the price per share of Common Stock received by the Corporation in connection with any Strategic Investment or Alternative Strategic Investment which has been agreed to prior to such conversion (such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date of such agreement). -10- 3. AVAILABILITY OF FINANCIAL STATEMENTS UNDER CERTAIN CIRCUMSTANCES 3.1 During the period beginning on the date hereof and ending on the IPO Date, the Corporation shall deliver to each Stockholder the following information: 3.1.1 Within 45 days after the last day of each fiscal quarter, unaudited consolidated quarterly financial statements of the Corporation, including a consolidated balance sheet and consolidated statements of income and cash flow, and, to the extent they are regularly prepared, the individual unaudited quarterly financial statements of each of its Subsidiaries, including a balance sheet and statements of income and cash flow; 3.1.2 Within 120 days after the last day of the Corporation's fiscal year, audited consolidated financial statements of the Corporation, including a consolidated balance sheet and consolidated statements of income and cash flow; to the extent they are regularly prepared, the individual audited financial statements of each of its Subsidiaries, including a balance sheet and statements of income and cash flow; and the report, if any, on such financial statements by the independent auditors engaged by the Corporation to audit such financial statements; and 3.1.3 Within a reasonable period of time, a copy of any document sent (i) to any Director, in his capacity as a Director, and (ii) to any member of a committee of the Board or any Sub Board, in his capacity as a member of such committee, subject, however, to applicable requirements of confidentiality and provided that the Corporation shall not be required to provide any such copy if it is advised by its counsel that doing so would waive the attorney-client privilege or any other applicable legal right or privilege. 3.2 All financial statements delivered pursuant to Section 3.1 shall be prepared in accordance with generally accepted accounting principles consistently applied, and shall fairly present the financial condition, assets, liabilities, results of operations and cash flow of the Corporation and its consolidated Subsidiaries, subject in the case of quarterly statements to the omission of certain footnotes and year end adjustments. 4. CONSTITUENT DOCUMENTS AND LIABILITY INSURANCE The Stockholders shall take or cause to be taken all necessary actions to cause the certificate of incorporation and bylaws of the Corporation to contain the most favorable provisions in respect of indemnification and director exculpation permitted under the Delaware General Corporation Law. CDPQ acknowledges and agrees that such certificate of incorporation and bylaws of the Corporation as in force on the date hereof comply with the foregoing requirement. The Stockholders shall take or cause to be taken all necessary actions to cause the applicable organizational documents of each Subsidiary of the Corporation for which any Designee is designated by CDPQ to contain the most favorable provisions in respect of indemnification and director (or any similar position) exculpation permitted under the laws of the jurisdiction of its incorporation or other creation. The Stockholders shall be entitled -11- at all times to rely on the advice of legal counsel in satisfying their obligations with respect to the foregoing requirements. The Corporation shall maintain and shall maintain on behalf of its Subsidiaries customary officers and directors liability insurance coverage. CDPQ acknowledges and agrees that the provision of such coverage through policies maintained by Videotron as in force on the date hereof is sufficient for such purpose. 5. TRANSFERABILITY OF STOCKHOLDER SHARES 5.1 Transfer in Violation of this Agreement. Any Transfer or attempted Transfer of any Stockholder Shares in violation of any provision of this Agreement shall be null and void, and the Corporation shall not record such Transfer on its books or treat any purported transferee of such Stockholder Shares as the owner of such shares for any purpose. 5.2 Transfer of Stockholder Shares. 5.2.1 Stockholder Shares are transferable only pursuant to (i) public offerings registered under the Securities Act, (ii) Section 9 and 10, (iii) subject to the provisions of Section 6, transactions under Rule 144 or Rule 144A (or any similar rule or rules then in effect) of the SEC if such rule is available, (iv) subject to Sections 5.2.2, 6 and 7, any other legally available means of Transfer to any Person that is not an Affiliate of the transferor, (v) subject to Section 5.3, Transfers by CDPQ to any of its Affiliates, and (vi) subject to Section 5.4, Transfers by VPC to any of its wholly-owned Subsidiaries or to any wholly-owned Subsidiary of Videotron. 5.2.2 In connection with the proposed Transfer of any Stockholder Shares described in clause (iv) of Section 5.2.1, the holder thereof shall deliver written notice to the Corporation describing in reasonable detail the proposed Transfer, together with an opinion of counsel reasonably acceptable to the Corporation to the effect that such proposed Transfer of Stockholder Shares may be effected without registration of such Stockholder Shares under the Securities Act. In addition, if the holder of the Stockholder Shares delivers to the Corporation an opinion of counsel reasonably acceptable to the Corporation that no subsequent Transfer of such Stockholder Shares shall require registration under the Securities Act, the Corporation shall promptly upon such proposed Transfer deliver new certificates for such Stockholder Shares which do not bear the securities legend set forth in Section 11. If the Corporation is required to deliver new certificates for such Stockholder Shares bearing such legend, the holder thereof shall not consummate a Transfer of the same until the prospective transferee has confirmed to the Corporation in writing its agreement to be bound by the conditions contained in this Section 5.2.2 and Section 11. 5.2.3 Upon the request of a holder of Stockholder Shares, the Corporation shall promptly supply to such Person or its prospective transferees all information regarding the Corporation required to be delivered by an issuer pursuant to paragraph (d)(4)(i) of Rule 144A of the SEC in connection with a Transfer -12- pursuant to Rule 144A (or comparable information under any similar rule or rules then in effect) of the SEC. 5.2.4 Upon the request of any holder of Stockholder Shares, the Corporation shall remove the legend set forth in Section 11 from the certificates for such holder's Stockholder Shares; provided, that such Stockholder Shares are, in the opinion of counsel reasonably satisfactory to the Corporation, eligible for sale pursuant to Rule 144(k) (or any similar rule or rules then in effect) of the SEC. 5.3 Transfer to CDPQ Affiliates. Prior to CDPQ's Transfer of any Stockholder Shares to any of its Affiliates (other than the Corporation) pursuant to a Transfer permitted under clause (v) of Section 5.2.1, CDPQ shall cause such Affiliate to execute a joinder to this Agreement and shall deliver such executed joinder to the Secretary of the Corporation. Thereafter, for purposes of this Agreement, the term "CDPQ" shall be deemed to include CDPQ and such Affiliate. 5.4 Transfer to VPC Affiliates. Prior to VPC's Transfer of any Stockholder Shares to any of its Affiliates (other than the Corporation) pursuant to a Transfer permitted under clause (vi) of Section 5.2.1, VPC shall cause such Affiliate to execute a joinder to this Agreement and shall deliver such executed joinder to the Secretary of the Corporation. Thereafter, for purposes of this Agreement, the term "VPC" shall be deemed to include VPC and such Affiliate. 6. RESTRICTIONS ON TRANSFERABILITY OF STOCKHOLDER SHARES 6.1 Tag Along Rights. 6.1.1 Subject to the Threshold (as defined below), at least 15 days prior to any Transfer by VPC (other than a Transfer permitted by clause (i) or (vi) of Section 5.2.1 or a Transfer pursuant to Rule 144 of the SEC) of any VPC Shares then held by VPC, VPC shall deliver a written notice (the "Sale Notice") to CDPQ, specifying in reasonable detail the identity of the prospective transferee(s) and the terms and conditions of the Transfer. CDPQ may elect to participate in the contemplated Transfer by delivering written notice to VPC within 10 days after CDPQ's receipt of the Sale Notice. If CDPQ has elected to participate in such Transfer, each of VPC and CDPQ shall be entitled to sell in the contemplated Transfer, at the same price (if VPC is selling Convertible Notes, CDPQ shall receive the highest implicit value attributable to the VPC Shares contained in such Convertible Notes) and on the same terms, a number of VPC Shares and CDPQ Shares equal to the product of (i) the quotient determined by dividing the number of VPC Shares and CDPQ Shares held by VPC or CDPQ, as the case may be, by the aggregate number of Stockholder Shares at the time held by VPC and CDPQ and (ii) the aggregate number of Stockholder Shares to be sold in the contemplated Transfer. This Section 6.1.1 shall not apply to a Transfer of VPC Shares by VPC to the extent the sum of the number of VPC Shares to be Transferred and the aggregate number of all VPC Shares previously Transferred (other than as permitted by clause (i) or (vi) of Section 5.2.1 or -13- pursuant to Rule 144 of the SEC) does not exceed 10% of the total of all VPC Shares now held by VPC or subsequently acquired by it (including all shares and other equity securities issued, Transferred, paid, or distributed in respect of VPC Shares, or otherwise acquired by VPC, whether by way of purchase, split, combination, or distribution made otherwise than in cash with respect to the Stockholder Shares, provided such shares or other equity securities are not acquired by VPC in violation of this Agreement) (the "Threshold"). This Section 6.1.1 shall not apply to a Transfer to which Section 6.1.2 applies. 6.1.2 At least 15 days prior to any Transfer (or series of related Transfers) by VPC (other than a Transfer permitted by clause (i) or (vi) of Section 5.2.1 or a Transfer pursuant to Rule 144 of the SEC) (a) prior to the IPO Date, of at least 50% of the VPC Shares then held by VPC (representing in the aggregate at least 10% of the Common Stock on a fully diluted basis assuming all holders of then outstanding warrants, options, and convertible securities of the Corporation which are in the money had converted such convertible securities or exercised such warrants or options immediately prior to such Transfer), (c) prior to the IPO Date, of a number of VPC Shares which when added to the number of VPC Shares previously Transferred would cause the aggregate number of VPC Shares Transferred after the date hereof to exceed 50% of the largest number of VPC Shares held by VPC between the date hereof and the date of such Transfer or Transfers, as appropriately adjusted for any stock split, reverse stock split, stock dividend or other division or combination of Common Stock after the date hereof, or (c) on or after the IP0 Date, of a number of VPC Shares which represents a majority of VPC's Voting Ratio immediately prior to such Transfer or Transfers. VPC shall deliver a written notice (the "Fifty Percent Sale Notice") to CDPQ, specifying in reasonable detail the identity of the prospective transferee(s) and the terms and conditions of the Transfer or Transfers. CDPQ may elect to participate in the contemplated Transfer or Transfers by delivering written notice to VPC within 10 days after CDPQ's receipt of the Fifty Percent Sale Notice. If CDPQ has elected to participate in the contemplated Transfer or Transfers, CDPQ shall be entitled to sell in such Transfer or Transfers, at the same price (if VPC is selling Convertible Notes, CDPQ shall receive the highest implicit value attributable to the VPC Shares contained in such Convertible Notes) and on the same terms as VPC, up to all of the CDPQ Shares then held by CDPQ. For purposes of this Section 6.1.2, the Convertible Notes shall be deemed at all times to be "in the money". 6.2 First Offer Rights. At least 30 days prior to any Transfer (other than a Transfer permitted by clause (i), (ii), (v) or (vi) of Section 5.2.1) of Corporation Shares or Convertible Notes by either CDPQ or VPC, the Stockholder proposing to make such Transfer (the "Offering Stockholder") shall deliver a written notice (the "Transfer Notice") to the other Stockholder (the "Offered Stockholder"), specifying in reasonable detail the number of Corporation Shares and, if applicable, the principal amount of Convertible Notes proposed to be transferred, the proposed purchase -14- price (which shall be payable solely in cash) (the "Proposed Purchase Price") and the other terms and conditions of the Transfer. The Offered Stockholder may elect to purchase all (but not less than all) of the Corporation Shares and Convertible Notes to be Transferred, upon the same terms and conditions as those set forth in the Transfer Notice, by delivering a written notice of such election to the Offering Stockholder within 30 days after the Transfer Notice has been received by the Offered Stockholder. If the Offered Stockholder has not elected within such 30-day period (the "Offer Period") to purchase all of the Corporation Shares and Convertible Notes to be Transferred, then, provided the Offering Shareholder has also complied with the provisions of Section 6.1, if applicable, and no transferee is an Affiliate of the Offering Stockholder, the Offering Stockholder may, during the 120-day period immediately following the expiration of the Offer Period (the "Third Party Offer Period"), Transfer the Corporation Shares and Convertible Notes specified in the Transfer Notice at an aggregate price which is not less than 90% of the Proposed Purchase Price and on other terms which are not more favorable to the transferee(s) than specified in the Transfer Notice. Corporation Shares and Convertible Notes not Transferred within the Third Party Offer Period as permitted by the foregoing provisions may not be Transferred thereafter except upon further compliance with the provisions of this Section 6.2 as if a Transfer Notice had never been given with respect thereto. 6.3 Termination of Restrictions. The provisions of Section 6.2 shall terminate upon the IPO Date. 7. DRAG-ALONG RIGHTS 7.1 Prior to the IPO Date, if VPC elects to sell VPC Shares representing (or Videotron elects to sell shares of the capital stock of VPC indirectly representing) a majority of the votes of the Voting Common Stock on a fully diluted basis for cash and/or readily marketable securities (provided that (i) any such marketable securities are listed on a recognized national securities exchange or quoted on NASDAQ National Market System and are issued by a corporation whose market capitalization is at least U.S. $1 billion and (ii) the amount of such marketable securities that would be issuable to CDPQ in connection with such sale would represent not more than 5% of the public float of such corporation), then VPC (or Videotron, as the case may be) shall have the right to require CDPQ to join in such sale by selling all (but not less than all) of its CDPQ Shares on the same terms and at the same price as the sale to be effected by VPC (or on the same terms and at the same price as the sale to be effected by Videotron with respect to its indirect ownership of the Corporation Shares only), provided that CDPQ shall not be obligated to join in any such sale unless CDPQ shall receive a payment in cash or readily marketable securities (as described above) of at least $82.18 per CDPQ Share (such number to be appropriately adjusted for any stock split, reverse stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof) at the closing of such sale. Such right of VPC (or Videotron, as the case may be) may be exercised by the delivery by VPC (or Videotron, as the case may be) to CDPQ, at least fifteen (15) days prior to the consummation of the proposed sale, of notice of the proposed -15- sale setting forth a description of the terms of such sale in reasonable detail and stating that VPC (or Videotron, as the case may be) requires the CDPQ Shares be included in such sale. Such a sale is referred to herein as a "Disposition". 7.2 In connection with a Disposition, CDPQ will, if requested by the purchasers, execute, deliver and perform agreements with the purchasers relating to such Disposition containing terms and conditions that are the same in all material respects as those contained in the comparable agreements to be executed, delivered and performed by VPC (or Videotron, as the case may be), subject only to the limitations that (i) VPC and its Affiliates will not be obligated to make representations or warranties regarding CDPQ or any of its Affiliates and (ii) CDPQ will not be obligated to make representations or warranties regarding VPC or any of its Affiliates including the Corporation and its Subsidiaries, or (except as expressly provided herein) to assume or otherwise become liable in any way for any obligations requiring performance or containing any restrictions during any period after the consummation of such Disposition, or to indemnify any party or third party beneficiary to the applicable agreements in connection with such Disposition (excluding indemnities with respect to matters regarding CDPQ exclusively) except that CDPQ will be obligated to indemnify the applicable purchasers on a pro rata basis (based on the then --- ---- Corporation's stockholders' respective ownership of the outstanding Common Stock as of such Disposition assuming the conversion in full of all then outstanding Convertible Notes) with respect to representations and warranties as to the Corporation or any of its Subsidiaries made by VPC in connection with such Disposition in the same manner as VPC will be obligated to indemnify such applicable purchasers, provided, however, -------- ------- that the effect of all such indemnities provided by CDPQ in connection with such Disposition (excluding indemnities with respect to matters regarding CDPQ exclusively) will not reduce the net payment received by CDPQ in cash or readily marketable securities (as described in Section 7.1) for the sale of all CDPQ Shares to an amount less than $74 per share (such number to be appropriately adjusted for any stock split, stock dividend or other subdivision or combination of Common Stock after the date hereof), and provided, further, that CDPQ shall in no event be -------- ------- required to become jointly and severally liable with VPC or any other Person for any indemnities, liabilities or obligations arising out of such Disposition. 8. PREEMPTIVE RIGHTS 8.1 Subject to Sections 2.9 and 8.4, if at any time the Corporation wishes to issue and sell any equity securities (whether preferred stock or common stock) or any options, warrants or other rights to acquire equity securities or any notes or other securities convertible into equity securities (all such equity securities and other rights and securities, collectively, the "Equity Equivalents") to any Person or Persons, the Corporation shall promptly deliver a notice of intention to issue and sell (the "Corporation's Notice of Intention to Sell") to each Stockholder setting forth a description of the Equity Equivalents to be issued and the proposed purchase price and terms of sale. Upon receipt of the Corporation's Notice of Intention to Sell, each Stockholder shall have the right to elect to purchase, at the price and on the terms -16- stated in the Corporation's Notice of Intention to Sell, a number of the Equity Equivalents equal to the product of (i) such Stockholder's proportionate ownership (expressed as a fraction) of the aggregate Common Stock and rights to acquire Common Stock (calculated on a fully-diluted basis assuming all holders of then outstanding warrants, options and convertible securities of the Corporation which are in the money had converted such convertible securities or exercised such warrants or options immediately prior to the taking of the record of the holders of Common Stock for the purpose of determining whether they are entitled to receive such offer) held by all Stockholders multiplied by (ii) the number of Equity Equivalents to be issued. Such election shall be made by the electing Stockholder by written notice to the Corporation within five (5) business days after receipt by such Stockholder of the Corporation's Notice of Intention to Sell (the "Acceptance Period for Equity Equivalents"). For purposes of this Section 8.1, the Convertible Notes shall be deemed at all times to be "in the money". 8.2 If effective elections to purchase shall not be received pursuant to Section 8.1 in respect of all the Equity Equivalents to be issued and sold, then the Corporation may, at its election, during a period of one hundred and twenty (120) days following the expiration of the Acceptance Period for Equity Equivalents, issue and sell the remaining Equity Equivalents to another Person or Persons at a price and upon terms not more favorable to such Person than those stated in the Corporation's Notice of Intention to Sell; provided, however, that -------- ------- failure by a Stockholder to exercise its right to purchase with respect to the issuance and sale of Equity Equivalents pursuant to one Corporation's Notice of Intention to Sell shall not affect its right to acquire Equity Equivalents pursuant to any subsequent issuance and sale for which a separate Corporation's Notice of Intention to Sell would be required hereunder. In the event the Corporation has not sold the Equity Equivalents covered by a Corporation's Notice of Intention to Sell, or entered into a binding agreement to sell the Equity Equivalents, within such one hundred and twenty (120) day period, the Corporation shall not thereafter issue or sell such Equity Equivalents without again first offering such securities to each Stockholder in the manner provided in Section 8.1. 8.3 If a Stockholder gives the Corporation notice pursuant to Section 8.1 that such Stockholder desires to purchase Equity Equivalents offered by the Corporation, payment therefor shall be made by wire transfer of immediately available funds, against delivery of the securities at the executive offices of the Corporation within ten (10) days after the giving of such notice, or, if later, not later than the closing date fixed by the Corporation for the sale of all such Equity Equivalents. 8.4 The preemptive rights contained in Sections 8.1 through 8.3 shall not apply to (i) the issuance of shares of Common Stock as a stock dividend or upon any subdivision, stock split or combination of the outstanding shares of Common Stock or in exchange for outstanding shares of Common Stock pursuant to any conversion right or obligation contained in the Corporation's Certificate of Incorporation (e.g., the conversion of Class B Stock or Class C Stock into Class A Stock); (ii) the issuance of Convertible Notes as cumulative interest payments on the Convertible Notes Outstanding Balance in accordance with the terms of the Convertible Notes (and any -17- other applicable governing documents) as in effect on the date hereof; (iii) provided VPC and its Affiliates comply with the provisions of Section 2.7.5, the issuance of Common Stock upon the conversion of Convertible Notes; (iv) the grant of options, warrants or rights to subscribe for shares of Common Stock, and the issuance of shares of Common Stock upon the exercise of such options, warrants or rights to subscribe for shares of Common Stock (including such options, warrants or rights issued prior to the date hereof), to officers, directors and employees of the Corporation or any of its Subsidiaries pursuant to the Corporation's Incentive Stock Option Plan or pursuant to any other plan or arrangement for the grant of options and other rights to acquire Common Stock to such officers, directors and employees adopted by the Corporation with the approval of the Board; (v) the issuance of Common Stock upon the exercise of the Kofalt Warrant, the Cole Warrant or the Hecht Warrant; (vi) the issuance of Equity Equivalents pursuant to an offering registered under the Securities Act; (vii) the issuance of Common Stock or options or warrants exercisable for Common Stock or securities convertible or exchangeable for Common Stock (collectively, "Common Stock Equivalents") for other than cash, provided that any such issuance shall give rise to the rights provided to CDPQ under Section 8.5; (viii) provided a Strategic Investment has not been consummated, the issuance of Common Stock Equivalents pursuant to an Alternative Strategic Investment, provided that any such issuance shall give rise to the rights provided to CDPQ under Section 8.5; and (ix) and the issuance of Common Stock Equivalents to CDPQ pursuant to Section 8.5. 8.5 Subject to Section 2.9, if at any time the Corporation issues and sells any Common Stock Equivalents (a) pursuant to an Alternative Strategic Investment or (b) for other than cash to any Person (other than to VPC or any of its Affiliates) (any such issuance, an "Alternative Issuance"), then, within five (5) business days after such Alternative Issuance, the Corporation shall deliver a notice of issuance and sale (the "Corporation's Notice of Issuance") to CDPQ setting forth a description and the amount of and the number of shares of Common Stock represented by the Common Stock Equivalents issued, a description of the consideration received by the Corporation for the issuance of such Common Stock Equivalents (as well as an estimate of the fair market value of any non-cash consideration) and a description of the other material terms of the issuance and sale. Upon receipt of the Corporation's Notice of Issuance, CDPQ shall have the right to elect to purchase from the Corporation an amount or number of the Common Stock Equivalents which would restore CDPQ to its proportionate ownership of Common Stock (calculated on a fully diluted basis) immediately prior to such Alternative Issuance for a cash purchase price equal to the then fair market value of the Common Stock Equivalents to be purchased by CDPQ (which fair market value will be based upon and will be no more than the implicit fair market value of the consideration received by the Corporation for such Common Stock Equivalents in such Alternative Issuance). Such election shall be made by CDPQ by written notice to the Corporation within five (5) business days after receipt by CDPQ of the Corporation's Notice of Issuance. If CDPQ gives the Corporation notice pursuant to this Section 8.5 that CDPQ desires to purchase the Common Stock Equivalents offered by the Corporation, payment therefor shall be made by wire transfer of immediately available funds, against -18- delivery of the securities at the executive offices of the Corporation within ten (10) days after the giving of such notice. 8.6 The Corporation represents and warrants to each Stockholder, and each Stockholder represents and warrants to the Corporation, that, except as provided herein, the Person making such representation and warranty is not a party to any agreement or other arrangement under which any other Person has a preemptive right or right of first refusal to acquire Corporation Shares or other Equity Equivalents from the Person making such representation and warranty. 9. PUT ARRANGEMENT 9.1 Unless the IPO Date shall have occurred on or prior to the fifth anniversary of the date hereof, at any time during the Put Exercise Period (as defined below), CDPQ shall have the right and option to require VPC to purchase all, but not less than all, of the Corporation Shares held by CDPQ (the "Put") at the Put Price (as defined below); provided, however, that CDPQ shall not exercise the Put (and any prior -------- ------- exercise of the Put shall be suspended, if not previously consummated) during one 90 day period beginning on the date CDPQ receives a letter from a reputable underwriter stating that such underwriter has undertaken to consummate a Public Offering. The "Put Exercise Period" shall be the period beginning on the fifth anniversary of the date hereof and ending on the first to occur of (i) the tenth anniversary of the date hereof and (ii) the IPO Date. 9.2 The Put shall be exercisable by delivery to VPC during the Put Exercise Period of written notice of such exercise specifying the number of shares to be purchased (the "Put Notice"). Upon the delivery of the Put Notice, VPC and CDPQ shall be firmly bound to consummate the purchase and sale of shares in accordance with the Put Notice and the terms hereof and shall, in good faith, promptly determine the Put Price as provided hereunder. Subject to the provisions hereof, within ten (10) days after the determination of the Put Price, VPC shall purchase and CDPQ shall sell all of the Corporation Shares held by CDPQ at a mutually agreeable time and place (the "Put Closing"). 9.3 At the Put Closing, CDPQ shall deliver to VPC certificates representing the Corporation Shares to be purchased by VPC, and VPC shall deliver to CDPQ the Put Price, by wire transfer of immediately available funds to an account designated by CDPQ. CDPQ agrees that, at the request of Videotron effected by delivery of written notice to CDPQ at least ten (10) days prior to the Put Closing, CDPQ shall apply all (or such part as Videotron shall have specified in such notice) of the Put Price, immediately upon receipt by CDPQ, to the purchase from Videotron of freely tradeable shares (such shares shall have, without limitation, no restrictions on resale) of Videotron duly listed on the Toronto Stock Exchange and/or the Montreal Stock Exchange (or any other Exchange acceptable to CDPQ), at a purchase price per share equal to the weighted average closing sale price of shares of the same class as the shares of Videotron to be delivered to CDPQ during the twenty (20) most recent -19- trading days, as of the day prior to the Put Closing, on the Exchange with the largest trading volume of such shares during such period. 9.4 The "Put Price" shall be the Market Value of the Corporation Shares to be purchased by VPC pursuant to a Put Notice (such shares, the "Purchase Shares"). Promptly after the giving of a Put Notice, VPC and CDPQ shall each designate an investment bank to be engaged by them to determine such Market Value; provided that if VPC or CDPQ does not -------- designate an investment bank within 30 days after the giving of a Put Notice, the other party shall select and engage two separate investment banks to make such determinations. The expenses of all investment banks engaged pursuant to this Section 9.4 shall be borne equally by VPC and CDPQ. The "Market Value" of the Purchase Shares for purposes of determining the Put Price shall be the fair market value of the Purchase Shares as of the date of the delivery of the Put Notice to VPC as determined by (i) first determining the all-cash price that an informed and willing buyer would pay to an informed and willing seller, neither being under any compulsion to buy or sell, in an arms-length transaction arranged in an orderly manner over a reasonable period of time under then prevailing market conditions, to purchase all of the outstanding Common Stock of the Corporation as a going concern (the "Company Value"), (ii) then multiplying the result (as adjusted to reflect the assumed exercise of rights to acquire Corporation Shares pursuant to outstanding options, warrants and convertible securities of the Corporation to the extent such rights are in-the-money) by the percentage of the Common Stock of the Corporation represented by the Purchase Shares, determined on a fully diluted basis but without regard to the dilutive effects of out-of- the-money rights to acquire Corporation Shares pursuant to outstanding options, warrants and convertible securities of the Corporation, and (iii) then making adjustments, if appropriate, based on differences (such as voting rights) among the various classes of Common Stock. In the event that Company Value as determined by either of the two investment banks is not greater than 120% of Company Value as determined by the other investment bank, the Put Price will be the average of the two amounts determined by the investment banks to be the Market Value. In the event Company Value as determined by one of the investment banks is greater than 120% of Company Value as determined by the other investment bank, the two investment banks shall promptly engage a third investment bank to choose one of the two Market Values determined by them (without modification) within 30 days of its engagement, and the Market Value chosen by such third investment bank shall be the Put Price. The determination of the Put Price in accordance with this Section 9.4 shall be binding and conclusive. For purposes of this Section 9.4, the Convertible Notes shall be deemed at all times to be "in the money". 10. CHANGE IN CONTROL 10.1 If at any time prior to the IPO Date any transaction is proposed whereby Videotron would cease to own, directly or indirectly, Corporation Shares representing at least a majority of the outstanding Common Stock on a fully-diluted basis assuming the holders of then outstanding warrants, options and convertible securities of the Corporation which are in the money had converted such convertible securities or -20- exercised such warrants or options immediately prior to such transaction, Videotron shall deliver or cause to be delivered to CDPQ a notice of such proposal at least thirty (30) days prior to entering into any agreement or other arrangement (the "CC Agreement") pursuant to which such transaction would be effected. CDPQ shall have the right and option for a period of fifteen (15) days after receipt of such notice to require VPC to purchase all or any part of CDPQ's Corporation Shares, contemporaneously with and as a condition to the consummation of the transactions contemplated by the CC Agreement, at a price to be determined in the same manner as the Put Price in Section 9.4; provided, that each investment banker designated to -------- determine a Market Value and a Company Value shall give appropriate consideration to the terms of the proposed transaction and any previous transactions pursuant to which Videotron directly or indirectly disposed of Corporation Shares in determining such Market Value and such Company Value. For purposes of this Section 10.1, the Convertible Notes shall be deemed at all times to be "in the money". 11. LEGENDS Each certificate or note representing directly or indirectly Stockholder Shares now or hereafter registered in the name of any Stockholder shall be endorsed with a legend substantially as follows: "THE SECURITY REPRESENTED BY THIS INSTRUMENT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ARE SUBJECT TO THE RESTRICTIONS CONTAINED IN A STOCKHOLDERS AGREEMENT DATED AS OF AUGUST 15, 1997, AMONG THE CORPORATION, VPC CORPORATION AND CAPITAL COMMUNICATIONS CDPQ INC., A COPY OF WHICH IS ON FILE IN THE OFFICES OF THE CORPORATION AND WILL BE FURNISHED TO THE HOLDER OF THIS INSTRUMENT UPON WRITTEN REQUEST AND WITHOUT CHARGE. OWNERSHIP, VOTING AND TRANSFER OF SUCH SECURITY ARE SUBJECT TO THE TERMS OF SUCH AGREEMENT. THE HOLDER OF THIS INSTRUMENT, BY ACCEPTANCE HEREOF, AGREES TO BE BOUND BY ALL THE TERMS OF SUCH AGREEMENT, AS THE SAME IS IN EFFECT FROM TIME TO TIME. NO VOTE, SALE, ASSIGNMENT, ENCUMBRANCE, PLEDGE, TRANSFER OR OTHER HYPOTHECATION OR DISPOSITION OF SUCH SECURITY MAY BE MADE EXCEPT IN COMPLIANCE WITH SUCH AGREEMENT." The Stockholders agree to present all certificates and notes evidencing directly or indirectly Stockholder Shares as of the date hereof so that the Corporation may imprint the foregoing legend on such certificates or notes. The legend set forth above shall be removed from the certificates or notes, as the case may be, evidencing any securities which cease directly or indirectly to be Stockholder Shares. -21- 12. TERM AND TERMINATION 12.1 Term. This Agreement is effective as of the date hereof and shall continue in force until either VPC and its permitted transferees who have executed a joinder to this Agreement and their respective permitted assigns no longer own any VPC Shares or CDPQ and its permitted transferees who have executed a joinder to this Agreement and their respective permitted assigns no longer own any CDPQ Shares. 12.2 Effect of Termination. Termination of this Agreement pursuant to Section 12.1 or otherwise shall not affect or impair any rights or obligations that arise prior to or at the time of the termination of this Agreement, or which may arise by reason of an event causing the termination of this Agreement, and all such rights and obligations, including the rights and obligations under any provision of this Agreement, which by their terms are to survive termination, shall also survive. The rights and remedies provided in this Agreement and in such other agreements shall be cumulative and not exclusive and shall be in addition to any other remedies which the Stockholders may have under this Agreement or otherwise. 13. MISCELLANEOUS 13.1 Entire Agreement. This Agreement supersedes all prior oral and written agreements between the parties with respect to the subject matter hereof, and this Agreement and the other documents and agreements between the parties which are referred to herein or executed contemporaneously herewith set forth the entire agreement among the parties with respect to the transactions contemplated hereby. 13.2 Amendment. This Agreement may not be modified, amended or terminated, nor may any provision hereof be waived, except by an instrument in writing executed by or on behalf of each party or, in the case of any such waiver, by the party or parties entitled to the benefit of the provision to be waived. 13.3 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective permitted assigns. Neither this Agreement nor any rights or obligations hereunder shall be assignable or otherwise transferrable by any party, voluntarily or by operation of law, without the prior written consent of the other parties hereto, and any assignment or transfer without such consent shall be null and void. 13.4 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original and all of which taken together shall constitute a single agreement. 13.5 Further Assurances. Each party shall, at any time and from time to time after the date hereof, do, execute, acknowledge and deliver, or cause to be done, executed, acknowledged and delivered, all such further acts, deeds, assignments, transfers, conveyances, powers of attorney, receipts, acknowledgments, acceptances and -22- assurances as may be reasonably required to procure for any party, its successors and assigns, its rights as set forth herein. 13.6 Severability. If any provision of this Agreement is held to be invalid, unlawful or incapable of being enforced by reason of rule of law or public policy, all other conditions and provisions of this Agreement which can be given effect without such invalid, unlawful or unenforceable provisions shall, nevertheless, remain in full force and effect. 13.7 Notices. All notices, consents, instructions and other communications required or permitted under this Stockholders Agreement (collectively, "Notice") shall be effective only if given in writing and shall be considered to have been duly given and received when (i) delivered by hand, (ii) sent by telecopier (with receipt confirmed), provided that a copy is mailed (on the same date) by certified or registered mail, return receipt requested, postage prepaid, or (iii) delivered to the addressee, if sent by Express Mail, Federal Express or other reputable express delivery service (receipt requested), or by first class certified or registered mail, return receipt requested, postage prepaid. Notice shall be sent in each case to the appropriate addresses or telecopier numbers set forth below (or to such other addresses and telecopier numbers as a party may from time to time designate as to itself by notice similarly given to the other parties in accordance herewith, which shall not be deemed given until received by the addressee). Notice shall be given: 13.7.1 If to VPC: VPC CORPORATION 46th Floor 1114 Avenue of the Americas New York, New York 10036-7798 Attention: Russell S. Berman Esq. Telecopier: (212) 479-6275 copy to: Le Groupe Videotron Ltee 300 Viger Avenue East Montreal, Quebec H2X3W4 Attention: Senior Vice President--Legal Affairs and Secretary Telecopier: (514) 985-8515 13.7.2 If to the Corporation: OPTEL, INC. 1111 W. Mockingbird Lane Dallas, Texas 75247 Attention: General Counsel Telecopier: (214) 634-3889 -23- 13.7.3 If to CDPQ: CAPITAL COMMUNICATIONS CDPQ INC. 1981 McGill College Avenue 9th Floor Montreal, Quebec H3A 3C7 Attention: President, Lynn McDonald and Robert Cote, Esq. Telecopier: (514) 847-2493 and (514)281-5212 copies to: KIRKLAND & ELLIS 153 East 53rd Street New York, New York 10022 Attention: Luc A. Despins, Esq. Telecopier: (212) 446-4900 and --- MARTINEAU WALKER Stock Exchange Tower Suite 3400 P.O. Box 242 800 Place Victoria Montreal, Quebec H4Z 1E9 Attention: Bernard Bussieres, Esq. Telecopier: (514) 397-7600 13.7.4 If to Videotron: Le Groupe Videotron Ltee 300 Viger Avenue East Montreal, Quebec H2X3W4 Attention: Senior Vice President--Legal Affairs and Secretary Telecopier: (514) 985-8515 13.8 Governing Law; Consent to Exclusive Jurisdiction THIS STOCKHOLDERS AGREEMENT IS BEING DELIVERED AND IS INTENDED TO BE PERFORMED IN THE STATE OF NEW YORK, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, AND THE RIGHTS OF THE PARTIES SHALL BE GOVERNED BY, THE LAW OF SUCH STATE APPLICABLE TO CONTRACTS ENTERED INTO AND TO BE -24- PERFORMED WHOLLY WITHIN SUCH STATE. ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO ANY MATTER ARISING UNDER OR IN CONNECTION WITH THIS STOCKHOLDERS AGREEMENT OR THE SUBJECT MATTER HEREOF THAT IS PERMITTED UNDER SECTION 13.9 OR 13.10 MAY BE BROUGHT EXCLUSIVELY IN THE COURTS OF THE STATE OF NEW YORK OR OF THE UNITED STATES OF AMERICA FOR THE SOUTHERN DISTRICT OF NEW YORK, AND, BY EXECUTION AND DELIVERY OF THIS STOCKHOLDERS AGREEMENT, VPC, THE CORPORATION AND CDPQ HEREBY ACCEPT FOR THEMSELVES AND IN RESPECT OF THEIR PROPERTY, GENERALLY AND UNCONDITIONALLY, THE EXCLUSIVE JURISDICTION OF THE AFORESAID COURTS. EACH OF VPC, THE CORPORATION, AND CDPQ HEREBY WAIVES, AND AGREES NOT TO ASSERT, AS A DEFENSE IN ANY ACTION, SUIT OR PROCEEDING PROVIDED FOR IN THIS SECTION 13.8 THAT IT IS NOT SUBJECT THERETO OR THAT SUCH ACTION, SUIT OR PROCEEDING MAY NOT BE BROUGHT OR IS NOT MAINTAINABLE IN SAID COURTS OR THAT THIS STOCKHOLDERS AGREEMENT MAY NOT BE ENFORCED IN OR BY SAID COURTS OR THAT ITS PROPERTY IS EXEMPT OR IMMUNE FROM EXECUTION, THAT THE SUIT, ACTION OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM, THAT THE VENUE OF THE SUIT, ACTION OR PROCEEDING IS IMPROPER OR (PROVIDED THAT PROCESS SHALL BE SERVED IN ANY MANNER REFERRED TO IN THE FOLLOWING SENTENCE) THAT SERVICE OR PROCESS UPON SUCH PARTY IS INEFFECTIVE. EACH OF CDPQ, THE CORPORATION AND VPC AGREES THAT SERVICE OF PROCESS IN ANY SUCH ACTION, SUIT OR PROCEEDING MAY BE MADE UPON IT IN ANY MANNER PERMITTED BY THE LAWS OF THE STATE OF NEW YORK OR THE FEDERAL LAWS OF THE UNITED STATES OR AS FOLLOWS: (I) BY PERSONAL SERVICE OR BY CERTIFIED OR REGISTERED MAIL TO THE PARTY'S DESIGNATED AGENT FOR SUCH SERVICE IN SUCH STATE, OR (II) BY CERTIFIED OR REGISTERED MAIL TO THE PARTY FOR WHICH INTENDED AT ITS ADDRESS SET FORTH HEREIN. SERVICE OF PROCESS IN ANY MANNER REFERRED TO IN THE PRECEDING SENTENCE SHALL BE DEEMED, IN EVERY RESPECT, EFFECTIVE SERVICE OF PROCESS UPON SUCH PARTY. 13.9 Binding Arbitration 13.9.1 Subject to the rights granted in Section 13.9.2 and 13.10, any controversy, claim or dispute arising out of or relating to this Agreement or the breach, termination, enforceability or validity thereof, including without limitation the determination of the scope or applicability of this Agreement to arbitrate, shall be determined exclusively by binding arbitration in New York City before three arbitrators. The arbitration shall be governed by the American Arbitration Association ("AAA") under its Commercial Arbitration Rules and its Supplementary Procedures for large, Complex Disputes, provided that Persons eligible to be selected as arbitrators shall be limited to attorneys-at-law who (a) are on the AAA's Large, Complex Case Panel or a -25- Center for Public Resources ("CPR") Panel of Distinguished Neutrals, or who have professional credentials similar to the attorneys listed on such AAA and CPR Panels, and (b) who practiced law for at least 15 years as an attorney in New York specializing in either general commercial litigation or general corporate and commercial matters. 13.9.2 No provision of, nor the exercise of any rights under, Section 13.9.1 shall limit the right of any party to request and obtain from a court having jurisdiction before, during or after the pendency of any arbitration, provisional or ancillary remedies and relief including, but not limited to, injunctive or mandatory relief or the appointment of a receiver. The institution and maintenance of an action or judicial proceeding for, or pursuit of, provisional or ancillary remedies shall not constitute a waiver of the right of any party hereto, even if such party is the plaintiff, to submit the dispute to arbitration if such party would otherwise have such right. 13.9.3 In any such arbitration proceeding, the arbitrator shall not have the power or authority to award punitive damages to any party. Judgment upon the award rendered may be entered in any court having jurisdiction (which shall not be restricted by Section 13.8). 13.9.4 Each of the parties (other than the Corporation in any instance where it is joined in the proceeding as a nominal party) shall, subject to the award of the arbitrators, pay an equal share of the arbitrators' fees. The arbitrators shall have the power to award recovery of all costs and fees (including attorneys' fees, administrative fees, arbitrators' fees, and court costs) to the prevailing party. 13.10 Equitable Relief. Since the Corporation or a Stockholder may sustain irreparable harm in the event there is a breach of the covenants provided in this Agreement, in addition to any other rights or remedies which the Corporation or any Stockholder may have under this Agreement or otherwise, the Corporation or a Stockholder shall be entitled to obtain specific performance or injunctive relief against the breaching or defaulting party hereto in any court of competent jurisdiction for the purposes of restraining such breaching or defaulting party from any actual or threatened breach of such covenants or to compel such breaching or defaulting party to perform such covenants, without the necessity of proving irreparable injury or the inadequacy of remedies at law or posting bond or other security. 13.11 Consequential Damages. In no event shall any party be liable to the other for any consequential, punitive or speculative damages (including but not limited to damages for lost profits) arising from performance or breach of this Agreement. 13.12 Currency. Unless expressly set forth to the contrary, all references to currency contained in this Agreement are to United States dollars. -26- 13.13 Conflicting Agreements. Each Stockholder represents that such Stockholder has not granted and is not a party to any proxy, voting trust or other agreement which is inconsistent with or conflicts with the provisions of this Agreement, and no holder of Stockholder Shares shall grant any proxy or become party to any voting trust or other agreement which is inconsistent with or conflicts with the provisions of this Agreement. 13.14 Confidentiality. Each Stockholder acknowledges that, in connection with its relationship with the Corporation, the officers, directors, agents and/or employees of such Stockholder and Caisse will have access to trade secrets and other confidential information (including marketing data and strategic planning information) pertaining to the business of the Corporation and its Subsidiaries. For purposes of this Section 13.14, confidential information shall not include any information which is now known by or readily available to the general public or which hereafter becomes known by or readily available to the general public other than as a result of any breach of this Section 13.14. Accordingly, each Stockholder agrees that so long as it shall continue to own any Corporation Shares and for a period of 12 months after it ceases to own any Corporation Shares it will neither disclose nor use any of such trade secrets or confidential information, and will use its best efforts to prevent any of its officers, directors, agents or employees from doing so, except in each case for the benefit of the Corporation and its Subsidiaries; provided, however, that nothing herein shall be construed to prevent -------- ------- any Stockholder or Caisse from disclosing information pursuant to court or governmental order or subpoena or in any action or proceeding between parties hereto or from disclosing any information as required by applicable law or regulation (including all applicable disclosure requirements). Notwithstanding the foregoing: (a) CDPQ and Caisse and the officers, directors, agents and employees of each of them, may engage or invest in, own and/or manage, independently or with others, any business activity of any type or description, including without limitation those that might be in direct or indirect competition with the Corporation or any of its Subsidiaries; (b) neither the Corporation nor any of its Subsidiaries shall have any right in or to any of such other ventures or activities or to the income or proceeds derived therefrom; (c) neither CDPQ nor Caisse nor the officers, directors, agents or employees of any of them shall be obligated to present any investment opportunity or prospective economic advantage to the Corporation or any of its Subsidiaries, even if the opportunity is of the character that, if presented to the Corporation or any of its Subsidiaries, could be taken advantage of by the Corporation or any of its Subsidiaries; and (d) CDPQ and Caisse and the officers, directors, agents and employees of each of them shall have the right to hold any investment opportunity or prospective economic advantage for their own account or to recommend such opportunity to Persons other than the Corporation or any of its Subsidiaries; provided that this sentence shall not in any way -------- relieve any Designee designated by CDPQ of his or her fiduciary responsibilities in his or her capacity as a member of the Board or any Sub Board (including responsibilities with respect to the doctrine of corporate opportunity). -27- IN WITNESS WHEREOF the parties hereto have executed this Stockholders Agreement as of the date first written above. OPTEL, INC. CAPITAL COMMUNICATIONS CDPQ INC. By: /s/ LOUIS BRUNEL By: /s/ PIERRE FONTIER ---------------------------------- ------------------------------------ Name: Louis Brunel Name: Title: President and CEO Title: By: /s/ MICHAEL E. KETTERSTEIN By: /s/ LYNN C. McDONALD ---------------------------------- ------------------------------------ Name: Michael E. Ketterstein Name: Title: VP and General Counsel Title: VPC CORPORATION By: /s/ SUZANNE RENAULT ---------------------------------- Name: Suzanne Renault Title: Vice President Legal Affairs and Secretary Le Groupe Videotron Ltee hereby agrees to be bound by Sections 9 and 10 and hereby agrees that it is jointly and severally liable with VPC Corporation for all of VPC Corporation's obligations under Sections 9 and 10. LE GROUPE VIDEOTRON LTEE By: /s/ CLAUDE CHAGNON ---------------------------------- Name: Claude Chagnon Title: President and Chief Operating Officer By: /s/ SUZANNE RENAULT ---------------------------------- Name: Suzanne Renault Title: Senior Vice President Legal Affairs and Secretary EXHIBIT A --------- (a) Any modification, amendment or deletion to the certificate of incorporation or bylaws (or any similar organizational documents) of the Corporation or any Subsidiary thereof. (b) Any subdivision, consolidation, conversion, reclassification or modification of any kind to the authorized or outstanding capital stock of the Corporation or any Subsidiary thereof. (c) Except for the contemplated acquisition of Phonoscope and other acquisitions which in the aggregate do not exceed US$ 25,000,000, the acquisition by the Corporation or any Subsidiary thereof of shares, partnership interests, indebtedness or other securities of any Person which is not the Corporation or a Subsidiary of the Corporation or of all or substantially all of the assets or any business thereof for consideration in excess of US$ 10,000,000 in any single such transaction or in excess of US$ 40,000,000 in the aggregate in all such transactions in the same fiscal year. (d) The merger, amalgamation or other business combination (if such combination results in an acquisition or transfer of assets or causes important changes in the affairs of the Corporation or any Subsidiary thereof) between the Corporation or any Subsidiary thereof and any other Person which is not the Corporation or a Subsidiary of the Corporation if the consideration in such transaction is in excess of US$ 10,000,000 or if the consideration in all such transactions in the same fiscal year is in excess of US$ 40,000,000 in the aggregate. (e) The disposal of or transfer of any shares the Corporation may directly or indirectly hold in the capital stock of any other company, or all or substantially all the assets of the Corporation or of any Subsidiary thereof or of a business thereof if for a consideration in excess of US$ 10,000,000 in any transaction or in excess of US$ 40,000,000 in the aggregate in all such transactions in the same fiscal year. (f) From the date hereof until the date all obligations for borrowed money under the Indenture have been repaid by the Corporation and its Subsidiaries (the "Repayment Date"), the incurrence by the Corporation or a Restricted Subsidiary (as defined in the Indenture) of any indebtedness which is not permitted to be incurred under the Indenture. (g) After the Repayment Date, the granting by the Corporation or any Subsidiary thereof of loans (excluding loans made to their employees as authorized under the Indenture) or guarantees, the guaranteeing of any debt or obligation of a third party, or any borrowing except for Permitted Indebtedness (as defined in the Indenture) if; in either case, after giving pro forma effect to such occurrence (including the application of the net proceeds therefrom), the ratio of (x) Total Consolidated Indebtedness (as of the date of occurrence) to (y) Annualized Pro Forma Consolidated Operating Cash Flow (based upon the two most recent fiscal quarters for which consolidated financial statements of the Corporation are available preceding the date of such occurrence) would be more than (i) 8.0 to 1.0 if such occurrence is prior to August 31, 2000 or (ii) 7.0 to 1.0 if such occurrence is on or after August 3l, 2000 and prior to August 31, 2002 or (iii) 6.0 to 1.0 if such occurrence is on or after August 31, 2002. EXHIBITS B-1 and B-2 to Stockholders Agreement dated as of August 15, 1997 The following services are provided by VPC and its Affiliates to the Corporation and/or its Subsidiaries as of the date of the Agreement: 1. Strategic Planning Services: Personal services rendered by senior corporate management of Videotron in providing consultation and guidance to the Corporation's management regarding long-term corporate goals and strategies. Compensation for these services is calculated based on an assumed 72 person days per year, at cost (without allowance for profit), and is estimated at US$80,000 per year. 2. Board Participation: Reimbursement of expenses of VPC designees to the Board for attendance at Board and committee meetings. This covers most travel and lodging costs for strategic planning services. 3. Treasury Functions: Videotron's director and vice president of treasury communicate with the Corporation on an almost daily basis regarding financing matters. Videotron's chief financial officer is involved in this work for coordination and direction. Compensation for these services is based on an assumed 125 person days per year, at cost (without allowance for profit), and is estimated at US$85,000 per year. 4. Internal Audit: conducted three times in each year by Videotron's accounting staff. The estimated cost is US$92,000 per year (without allowance for profit), including an estimated US$30,000 for travel and lodging expense. 5. Additional Services: as and when requested by the Corporation, charged to recover costs for personnel engaged and materials used (without allowance for profit), calculated on the basis of a daily rate, up to an aggregate amount of US$50,000 per year. EXHIBIT C to Stockholders Agreement dated as of August 15, 1997 Compensation Formula for Use by VPC for Consolidated Federal Income Tax Reporting Purposes of Tax Losses Generated by the Corporation ------------------------------------------------------------- Compensation is required to reflect the economic difference to the Corporation between the Base Case and the Consolidated Case, where: (i) the Base Case is the assumed result of continued independent tax reporting by VPC and the Corporation, the conversion to Common Stock of all outstanding Convertible Notes (and accrued interest) on August 31, 1998, and the presumed use of tax losses by the Corporation commencing in 2001 based on the Corporation's former business plan (as reflected in the attached Schedule C-1), and (ii) the Consolidated Case results from VPC's actual conversion of a portion of the Convertible Notes on a date prior to March 31, 1998, with the effects that (x) the Corporation's interest deductions are reduced from the date of conversion until August 31, 1998 and (y) VPC includes the Corporation in VPC's consolidated tax return for one or more fiscal years and actually uses a portion or all of the Corporation's tax losses as of the last day of one or more of such years to reduce VPC's U.S. income taxes. In this case, the Corporation benefits from a current reduction in interest expense but is deprived of the value of the future tax use of its losses and a portion of the interest expense deduction for interest on the Convertible Notes as included in the Base Case. The amount of compensation due to the Corporation for each fiscal year in which tax losses of the Corporation are used by VPC and its consolidated subsidiaries is the excess, if any, of (a) the present value at the end of such fiscal year of the Corporation's presumed use of the Adjusted Losses to reduce its federal income tax liability in a future fiscal year at a tax rate of 35%, using an annual discount factor of 15% with respect to presumed future uses (it being agreed that the timing of the presumed future use of Adjusted Losses by the Corporation will be determined by reference to the Base Case in all instances, assuming that the Adjusted Losses will be used by the Corporation after all carryforwards are exhausted), over (b) the Corporation's interest savings, if ---- any, for that fiscal year (as compared to the Base Case) due to the early conversion of the Convertible Notes (it being acknowledged that the Corporation would not have any such interest savings for any fiscal year ending after August 31, 1998). For this purpose, the term "Adjusted Losses" means, with respect to --------------- each fiscal year, (x) the aggregate amount, if any, of the Corporation's losses for such fiscal year and any carryforward losses from prior years, but only to the extent such losses and carryforward losses are actually used by VPC to reduce its consolidated federal income tax liability attributable to VPC and its consolidated subsidiaries (excluding the Corporation) for that fiscal year, plus, (y) with respect to fiscal years ending on or before August 31, 1998, if - ---- any such losses or carryforward losses are so used in any such fiscal year, any additional interest expense that would have been accrued by the Corporation in that fiscal year if there had been no early conversion of the Convertible Notes (that is, if the Convertible Notes had been converted on August 31, 1998 rather than on the date of the actual early conversion). All compensation payments owed by VPC to the Corporation in respect of any fiscal year will be paid within 30 days after the filing of VPC's consolidated federal income tax return for that fiscal year, subject to increase or decrease based upon any subsequent adjustment of VPC's consolidated income tax return. In no event will the Corporation be required to pay compensation to VPC pursuant to this arrangement, but the Corporation will be obligated to repay promptly to VPC without interest any excess amount received by the Corporation as determined following any such adjustment and VPC will be obligated to pay promptly to the Corporation without interest any additional compensation owing to the Corporation as determined following any such adjustment. The calculation of compensation payable by VPC to the Corporation pursuant to this arrangement is demonstrated on the attached Schedule C-1, which would be modified in an actual case to reflect the actual date of conversion and the actual utilization by VPC of Adjusted Losses.
VPC 6/1/97 Estimated Cost of Use of OpTel Tax Losses In Millions (U.S.$) OpTel Stand Alone Tax Status ---------------------------- Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Total (5) Net Income Before Tax (6) (41.1) (56.5) (30.0) (6.0) 28.4 68.3 119.8 184.7 237.7 312.7 820.0 First Year Interest Charge (1.1) (1.8) Other Restriction of VPC Interest 0.0 (already taken into account above) 0.0 --------------------------------------------------------------------------------------------- Net Income (loss) B/4 NOL (4) (41.1) (57.3) (30.0) (6.0) 28.4 68.3 119.8 184.7 237.7 312.7 818.2 NOL Carryforward (8) (28.0) (28.0) (89.1) (126.4) (156.4) (162.4) (134.0) (64.7) 0.0 0.0 0.0 --------------------------------------------------------------------------------------------------- Net Income (Loss) (28.0) (69.1) (126.4) (158.4) (162.4) (134.0) (64.7) (85.1) 184.7 237.7 312.7 Tax Rate (3), (7) 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% S --------------------------------------------------------------------------------------------- C Tax 0.0 0.0 0.0 0.0 0.0 0.0 18.3 64.6 83.2 109.4 270.8 H E NPV of Tax at 8/98 104.8 D Discount Rate 15% U L OpTel and VPC Consolidated E -------------------------- OpTel Taxable Income (per above) (5) (57.0) (30.0) (8.0) 28.4 89.3 119.0 184.7 237.7 312.7 868.0 C First Year Interest Charge (1.1) (1.8) 1 NOL Carryforward from 8/97 (5) (59.1) (109.0) (139.0) (145.8) (117.5) 46.2 0.0 0.0 0.0 VPC Income (2) (5) 14.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 14.7 --------------------------------------------------------------------------------------------- Consolidated Taxable Income 0.0 (109.9) (139.9) (145.9) (117.5) (48.2) 71.8 154.7 237.7 312.7 245.3 Tax Rate (3), (7) 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% --------------------------------------------------------------------------------------------- Tax 0.0 0.0 0.0 0.0 0.0 0.0 25.1 64.6 83.2 109.4 282.0 NPV of Tax at 8/98 104.0 Discount Rate 15% Difference ---------- NPV of Incremental Tax (1) 2.9 Unaccounted Tax Cost 5.8 =========
Footnotes and Assumptions: ------------------------- 1 Assumes that OpTel would otherwise be able to use its tax losses, but only at a future time, so the economic cost in OpTel is the NPV of the additional taxes it will bear in the future. 2 Assumes an VPC expense and only income is note from Optel ($110 million principal less conversion of 12 million to such time 15% interest rate). On 9/1/98 convert remaining notes. 3 Considers only US Federal Income taxes; state taxes ignored. 4 Assumes no material book-tax difference in OpTel's Income, or that any material depreciation differences will reverse by the time the NOLs are estimated. 5 Model does not take into account VPC's separate 8/97 Income, since the tax sharing of that amount has already been taken into account in the prior shareholder settlement. 6 Per projections provided by Claude Bernier on 4/23/97. 7 This model ignores the affect of alternative minimum tax, which is believed to be immaterial. 8 The August, 1998 tax returns are not yet finished, thus the NOL carryforward amounts are estimates. EX-21.1 3 LIST OF SUBSIDIARIES OF REGISTRANT LIST OF SUBSIDIARIES OF REGISTRANT EXHIBIT 21.1
State of incorporation Names under which or Formation business is conducted IRPC - Arizona, Inc. AZ OpTel IRPC Texas - Ventana, Inc. TX OpTel IRPC Texas, Inc. TX OpTel OpTel (Arizona) Telecom, Inc. DE OpTel (California) Telecom, Inc. DE OpTel (Colorado) Telecom, Inc. DE OpTel (Florida) Telecom, Inc. DE OpTel (Illinois) Telecom, Inc. DE OpTel (Texas) Telecom, Inc. DE Richey Pacific Cable Vision, Inc. CA OpTel Sunshine Television Entertainment, Inc. FL OpTel TA V GP Holdings Corp. DE Tara Communication Systems, Inc. IL TVMAX Communications (Texas), Inc. DE OpTel TVMAX Telecommunications, Inc. DE OpTel OpTel (Illinois), L.P. CO Richey Pacific Cable Partners V, L.P. CA Richey Pacific Cable Partners VI, L.P. CA Richey Pacific Cable Partners VII, L.P. CA
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