List of Capped Companies Plummets from 283 to 106 in QRA 2.0

It appears as though the Wireline Competition Bureau has paid attention to the hundreds of filings, letters, and ex parte meetings from the rural independent telecom industry over the last few months, because the new version of quantile regression analysis (QRA) released on April 25, 2012 actually makes more than a few minor changes closely based on RLEC input and recommendations. The “Benchmarks Order” was released late in the day along with a separate Second Order on Reconsideration addressing CAF Phase I and VoIP ICC and a new website for CAF resources on FCC.gov. Overall, the FCC made some profound changes to QRA—changes that the RLEC industry will likely applaud, and changes that may prevent several hundred companies from facing financial distress before the end of the year.

Going back to the USF/ICC Transformation Order, the FCC approved regression analysis as a methodology for limiting high-cost support. The FCC felt that some RLECs were simply receiving too much money from the fund, and “these carriers generally faced no overall limits on their expenditures.” In the Order, the FCC proposed a specific quantile regression analysis methodology in Appendix H, and put it up for comment in the FNPRM. RLECs were overwhelmingly against the proposed methodology (you can read about this more here, here, here, and here). RLECs unleashed a storm of fury and frantically tried to figure out how the proposed caps would impact their investment and capital over the next few years, only to find that it was literally impossible to predict anything beyond 2012.

The RLEC industry provided countless examples of why the original QRA was arbitrary and capricious, why the FCC’s underlying data was wrong, and why the methodology failed to meet the standards of predictable and sufficient support. Furthermore, RLECs took their concerns to Congress, and dozens of Senators and Representatives responded by pressuring the FCC to revise the methodology. In the last two weeks, over two dozen companies have filed letters of intent to file waivers if the FCC adopts the original methodology. And one last thing—government economists who reviewed the methodology a couple months ago also suggested a variety of changes, arguing that the FCC basically got it wrong.

JSICA will dig deeper into QRA 2.0 and the Benchmarks Order over the coming weeks; meanwhile we offer an overview of the changes. The FCC explains that it made the changes “in response to the comments from two peer reviews and interested parties and based on further analysis by the Bureau. These changes significantly improve the methodology while redistributing funding to a greater number of carriers to support continued broadband investment.” Notable changes include:

• 106 carriers are capped, instead of the previous 283.
• For the capped carriers, the reduction in HCLS will be phased in between July 1, 2012 and January 1, 2014.
• The “savings” from capping the 106 companies will amount to about $65m, in contrast to the previously estimated $109m. $55m will be redistributed to the uncapped carriers for broadband investment.
• QRA is now used to generate a capex limit and an opex limit for each company, rather than to generate limits for 11 separate Study Area Cost per Loop algorithm lines. As the FCC notes in the Order, this is “the most significant change in the methodology,” and the decision “reflects a balancing of considerations.” The FCC also notes, “Using fewer regressions limits the Commission’s ability to identify outliers, but enables carriers to account for the needs of individual networks and recognizes the fact that carriers may have higher costs in one category that may be offset by lower costs in others.” This is indeed an important realization and compromise.  
• The FCC changes the definitions of capex and opex. It now defines capex “as the plant-related costs in step twenty-five, which includes return on capital and depreciation, and [defines] opex as the remaining components that are added in step twenty-five to calculate total costs.” It is important to note that the FCC now accounts for depreciation in the capex definition.
• The FCC made significant changes to the selection of independent variables used in QRA by adding a variety of robust and descriptive variables and proxies. A full list of the variables is available in Appendix A of the Order, but some of the notable additions include road miles, road crossings, climate, soil difficulty and bedrock depth. The FCC also includes special variables for Tribal areas, Alaska, the Midwest, and the Northeast.
• The FCC acknowledged the widespread criticism of the TeleAtlas study area boundary data, but declined to modify the study area boundaries in the new methodology. However, the FCC will “provide a streamlined, expedited waiver process for carriers affected by the benchmarks to correct any errors in their study area boundaries.” Additionally, the FCC will solicit data from RLECs about study area boundaries and update the regression methodology in 2014 based on this data. The FCC will also generously waive the $8k waiver fee for carriers seeking a study area boundary waiver.
• The new methodology includes an independent variable that captures the age of the plant—this is important, because it will help differentiate carriers that have invested recently from carriers that have not invested recently. The FCC explains, “Adding this variable raises the cost limit for carriers that have invested recently.”

Some aspects of QRA were not changed, and the FCC rejects several arguments presented by the RLEC industry about QRA. First, the FCC is keeping the ninetieth percentile threshold for now. RLECs previously argued that the FCC should increase the threshold because the caps themselves were overly-inclusive. Under the new methodology, significantly fewer companies are capped which the FCC believes justifies the ninetieth percentile threshold: “We conclude that using the ninetieth percentile as part of the revised methodology appropriately balances the Commission’s twin goals of providing better incentives for carriers to invest prudently and operate more efficiently.”

Second, the FCC rejected the notion that QRA constitutes retroactive ratemaking because “it cannot fairly be said that the application of these benchmarks will take away or impair a vested right, create a new obligation, impose a new duty, or attach a new disability in respect to the carriers’ previous expenditures.” The FCC also notes that it is now phasing in the caps over 18 months, which “provides a greater opportunity for carriers to make any necessary adjustments.” Lastly, the FCC rejects the notion that QRA is a slap in the face of the USF principles of predictability and sufficiency—on the contrary, the FCC believes “if anything, support will now be more predictable for most carriers because the new rule discourages companies from exhausting the fund by over-spending relative to their peers.” Additionally, “the very purpose of the benchmarks is to ensure that carriers as a whole receive a sufficient (but not excessive) amount of HCLS.”

QRA 2.0 is drastically, profoundly, tremendously different from the initial methodology proposed in the USF/ICC Transformation Order. There are sure to be at least a couple “devils in the details,” but for the most part it appears as though the FCC really did listen to and accept the arguments made by the RLEC industry in response to QRA 1.0. In addition to developing a more robust and realistic methodology, the FCC is inserting a reasonable transition period whereby RLECs can prepare for the caps in a gradual manner. What do you think about QRA 2.0—what do you like and dislike the most? Will the changes have a positive impact on RLEC broadband investment over the next 18 months?

RLECs' Extended Family Calls on FCC to Promote Rural Economic Growth

On April 24, 2012, a group of professional service and vendor firms wrote a letter to FCC Chairman Julius Genachowski, explaining that the USF/ICC Transformation Order conflicts with the goals of the American Recovery and Reinvestment Act of 2009 (ARRA), and “will ultimately undermine job creation and retention gains envisioned by ARRA.” The signatories of the letter include representatives from the following firms that support the rural telecom industry: CHR Solutions, Consortia Consulting, HunTel Engineering, Kadrmas Lee & Jackson, Ladd Engineering, Mapcom Systems, Monte R. Lee Engineering, National Information Solutions Cooperative, Palmetto Engineering & Consulting, RVW, Inc., and TCA.

These parties have a vested interest in USF/ICC Reform, just as we do at JSI Capital Advisors. According to the letter, “Collectively, we employ more than 2,000 people and generate annual revenues exceeding $265m in both rural and urban areas. Our firms provide network construction and maintenance, engineering and environmental services, software and systems development, and accounting and financial services.” They continue, “We are precisely the type of firms that create and retain jobs as intended by the ARRA.”

Despite their success in serving the rural telecom industry, the signatories of the letter now face significant challenges along with the companies they serve—that’s because RLECs don’t operate in a vacuum, regardless of what the FCC may or may not believe. If regulatory uncertainty causes RLECs to scale back investment, it is likely that professional services and equipment vendors will take a direct hit, too. The letter explains, “We are seeing economic activity in this sector slow, and in many cases stall altogether, largely as a result of changes and lingering regulatory uncertainty arising out of recent Commission action…The already-adopted reductions, combined with proposed future cutback, are undermining market confidence in continued rural broadband investment.”

The letter further explains how the funding cuts imposed by USF/ICC reform run contrary to the White House Administration’s goals in ARRA: “the cuts…are causing our clients and their investors to either scale downward or eliminate entirely new deployment initiatives, and consequently, the material inputs they require from us. In sum, the Commission measures are discouraging economic growth, limiting broadband investment, and stalling job creation.” The parties call these impacts of USF/ICC reform “anti-stimulus” and then they call on the FCC to “temper swiftly those adverse measures already adopted, and defer action on pending items until the impact of new requirements is evaluated and absorbed.”

From the perspective of vendors and professional service firms who primarily serve the RLEC industry, it may be easy to see the glass as half-empty with a giant crack in the bottom. However, new opportunities may arise from the USF/ICC debacle if patience perseveres. There is certainly an impending need for professional service firms to help navigate their clients through the new regulations, prepare filings at the federal and state level, guide strategic planning efforts, and ensure compliance with the new requirements.

Equipment vendors—software, hardware, fiber, etc.—may find opportunities where RLECs are looking to upgrade to more efficient operations—after all, this is one of the primary intentions of the Order. The FCC encourages RLECs to consolidate softswitching operations and look for other scale efficiencies (hint: the FCC wants RLECs to consolidate in general)—but this is an opportunity for equipment vendors. I may be teetering on a shaky limb here, but if quantile regression analysis is modified based on input from the rural industry and ulitmately works the way the FCC intends (without the accompanying “parade of horribles” anticipated by RLECs), companies may look for new ways to operate more efficiently, which could mean new investment in various categories of central office equipment and network infrastructure. Other RLECs will seek opportunities for new revenue streams through edging out their networks, participating in CAF and Mobility Fund auctions, offering new broadband-enabled video services, and expanding into other unregulated markets like data storage and home security. The FCC is also pushing the transition from PSTN to IP, which presents myriad opportunities for engineers, consultants, and equipment vendors. In all of these scenarious, there are bountiful opportunities for vendors and professional service firms who are willing to be patient while their RLEC customers and clients modify strategic plans in light of the regulatory changes.

If USF/ICC reform works as it is intended, boosts the goals of the ARRA, and promotes investment across the rural telecom sector, then rural Americans will benefit from universal broadband and economic growth. The professional service firms and vendors who signed the letter described above comment that they “trust the Commission did not intend” for the results that the RLEC industry is currently bracing for—vast cutbacks in investment, abandoned broadband projects, possible financial insolvency in the most severe cases. Several other commenters in waiver and ex parte filings have also said that they trust that the FCC did not outright intend to cause great harm to the rural telecom industry.

So—do you trust that the FCC did not intend to bring down mass destruction on the RLEC industry and its extended family of vendors and professional service firms, or do you just not trust the FCC at all? Share your thoughts on JSICA’s LinkedIn USF Forum.

Arizona RLEC Pans FCC for Obstructing Precise Predictions of USF Reform Impact

Only a week ago, FCC Wireline Competition Bureau deputy chief Carol Mattey told a group of telecom lawyers and lobbyists attending the Catholic University Communications Symposium, “A Telecommunications Agenda for 2012 and Beyond,” that only four waiver requests of the USF rules had been filed. Only four—so the FCC must have done something right…right? 8 days later, the number of “letters of intent” to file waivers has grown from 2 to 10, and another RLEC has filed a full-blown waiver request.

Arizona-based Accipiter Communications, Inc. filed its waiver on April 18, 2012. Accipiter is seeking a temporary waiver of the $250 per line per month cap and the quantile regression analysis (QRA) caps for at least 6 months after the FCC releases its final decision on QRA methodology.  Last week, JSICA discussed how the few brave and bold early waiver filers appeared to have a particular “hook,” or an extremely extenuating circumstance driving the need to file a waiver. Big Bend has its networks used by national security agencies, and Windy City Cellular operates in what may be the most inhospitable weather and terrain in the country.

Accipiter’s geography and customer base don’t appear to stand out quite so severely, but the company (which is relatively new, incorporated in 1995) is in the midst of expanding, and by Accipiter’s admission, “is growing rapidly.” As such, it has made significant investments in recent years and expects its expenses to stabilize in the near future as it continues to add broadband and telephone subscribers.  However, if the FCC denies its waiver request, Accipiter fears that “The Commission’s new regime could cause Accipiter to fail, default on its loans and cease serving its subscribers, some of whom have no service alternative.”

The meat of Accipiter’s waiver request lies in its critique of QRA and the FCC’s inability to release a final decision on the precise QRA methodology. Accipiter argues that not only are parts of the Order “based upon methodologies and assumptions which are in some cases plainly erroneous and in other cases fail to address the real cost drivers for a carrier such as Accipiter;” but “The Commission has compounded this problem by failing to provide sufficient information regarding its methodology…meaning that Accipiter cannot predict with certainty the scope of the financial impact that the Report and Order will cause.” Despite not being able to accurately predict the impacts of the Order, Accipiter has concluded that it “must seek a waiver now out of an abundance of caution.”

While most of Accipiter’s subscriber and study area data is redacted, the company depicts its service area as sparsely populated, covering 1,010 square miles with a population of about 4,600. The company provides voice, DSL and some FTTH reaching speeds of 60/5 Mbps. The terrain is a mix of desert, canyons, mountains, and rocks; and the service area includes a large lake “which draws thousands of residential visitors per year.” Accipiter explained how the company originally incorporated largely to serve rural customers that former US West would not serve unless the customer paid tens of thousands of dollars.

Currently, Accipiter’s main competitor is Cox, which focuses its attention on the populated subdivisions in Accipiter’s service area. Cox covers 6.5 square miles, and “does not undertake to serve the remaining 1003.5 square miles of Accipiter service territory.” Accipiter nonetheless has struggled in its competitive battles with Cox, as developers have entered into “preferred provider” arrangements with Cox. Accipiter explains, “Plainly, one intent of these preferred provider agreements was to create a market environment which strangles competition for telecommunications services.” Meanwhile, wireless options exist but Accipiter claims that wireless service is spotty or non-existent in the rural areas. Furthermore, Accipiter provides transport service to the cell towers in the area, and “without Accipiter’s network, these cell sites would lose connectivity to the PSTN.”

Accipiter argues that a failure to grant the requested temporary waiver would be arbitrary and capricious; against the public interest; and in violation of the Administrative Procedure Act and due process. Accipiter explains that the FCC doesn’t seem to recognize that growing companies will eventually require less support as they add more customers, as the caps will abruptly clip support that is needed to recover investments that have already been made. Accipiter made its investments consistent with previous FCC rules and standards for receiving RUS loans, and “Delaying the implementation of the cap by just a few years would substantially reduce or eliminate the effect of the cap on Accipiter.”

Accipiter brings up one very important argument about QRA—that it was created “in pursuit of a flawed objective.” The QRA methodology was intended to weed out extremely high-cost carriers that are likely engaged in waste, fraud and abuse…but in reality, the methodology makes no differentiation between waste, fraud, and abuse and circumstances like geography that would make a carrier a high-cost outlier even if its costs are reasonable given its situation. Digging further into the many flaws of QRA, Accipiter explains that the FCC’s model “appears to be incapable of predicting the correct study area data for Accipiter.” The model puts Accipiter’s study area at 30.5 square miles, but it is actually 1010 square miles. Adding insult to FCC-created injury, the FCC apparently refused to provide Accipiter with a list of census blocks used in the model. Accipiter then took it upon itself to “replicate the FCC’s data through a time-intensive and costly trial and error process but Accipiter has no way of confirming that the result reached is the same as that relied upon by the Commission.” Accipiter believes this ordeal to be a violation of due process.

Accipiter is essentially saying that the FCC used the wrong data for QRA, then refused to share this incorrect data with the company upon request, and left it up to the company to bear the cost of figuring out its own regression analysis impact without any certainty. Accipiter’s waivers highlight everything that is wrong with QRA, especially the fact that companies are now in a regulatory limbo awaiting the final decision on the methodology. At which point, companies will likely have to undertake the process of analyzing the impacts for the second time in less than a year. How will this all impact network investment in 2012?