Universal Service Fund Survey of Current Issues A Brief History And Survey of Current Issues * 5 Doug Kitch, CPA Alexicon, Inc. Principal October 17, 2016

Agenda History, 1934 – 1996 What is Universal Service? Recent Changes – USF in the Broadband World Why Does USF Matter? Challenges for Small Companies Tribal Implications

USF History, 1934-1996 The 1934 Telecommunications Act created and tasked the FCC with “regulating interstate and foreign commerce in communication by wire and radio so as to make available, so far as possible, to all the people of the United States a rapid, efficient, Nation-wide, and world-wide wire and radio communication service with adequate facilities at reasonable charges.” The Act did not specifically mention “universal service” nor did it provide guidance as to how the FCC was supposed to accomplish and fund this goal. Mechanisms included implicit subsidies (i.e., via cost allocation rules and access charges); and, in 1988, the Universal Service Fund (USF—now known as the high cost loop support, or HCLS, program)

USF Background, 1996-2011 The 1996 Act, for the first time, added the words “universal service” to the United States Code, set forth detailed guidelines that the FCC and states are to consider in efforts to preserve and advance universal service, and requires regulators to make existing and future mechanisms “explicit.” Quality services to be available at just, reasonable, and affordable rates All regions of the nation should have access to advanced telecommunications and information services Consumers throughout the nation, including low-income consumers and those in rural, insular, and high cost areas, should have access to telecommunications services that are reasonably comparable to those offered in urban areas at rates that are reasonably comparable to those charged in urban areas Both states and the federal government should develop specific, predictable, and sufficient support mechanisms to preserve and advance universal service

Definition – What is Universal Service? The most important regulatory consideration was to make local telephone service available to all Americans at a reasonable cost. This morphed into similar services being available at reasonably comparable rates Now, universal access to broadband is the national goal, which involves changing definitions of “broadband” For example, speeds of 10/1 mbps (downstream/upstream) is the new universal service funding standard (25/3 is the metric for determining if all Americans have access)

National Broadband Plan The American Recovery and Reinvestment Act (ARRA) of 2009 required the FCC to issue a National Broadband Plan (NBP). The FCC’s NBP (March 2010), among other things, called for: Reforming current universal service mechanisms to support deployment of broadband and voice in high-cost areas… “Many Tribal communities face significant obstacles to the deployment of broadband infrastructure, including high buildout costs, limited financial resources that deter investment by commercial providers and a shortage of technically trained members who can undertake deployment and adoption planning. Current funding programs administered by NTIA and RUS do not specifically target funding for projects on Tribal lands and are insufficient to address all of these challenges. Tribes need substantially greater financial support than is presently available to them, and accelerating Tribal broadband deployment will require increased funding.”

Recent Activity - Overview In response to the NBP, the FCC released the USF Transformation Order in November 2011 Preserves and advances universal availability of voice service Adds broadband to the list of universal services to be supported Established the Connect America Fund (CAF) Total budget - $4.5b ($2b for RoR programs) Began statistics-based cost recovery constraints (QRA, scrapped by Chairman Wheeler) Adopted cap on support $3,000/line/yr ($250/mo) Adopted rate floor Local rates must be at a minimum level or carrier loses support Adopted model-based support for price cap carriers (Connect America Cost Model) Adopted broadband public interest obligations (speed, latency, capacity) Speeds initially set at 4/1 mbps, now 10/1 mbps Reformed intercarrier compensation regimes Eliminate Local Switching Support; adopted CAF ICC Provides specific support for Mobile voice and broadband $50m one time “shot in the arm” for Tribal carriers “Up to” $100m/yr ongoing, annual funding (out of $500m total; will be done after CAF Phase II) Adopts new accountability requirements (i.e. further compliance, record retention, Tribal engagement, etc)

Recent Activity – Overview On March 30, 2016, the FCC adopted the RoR USF Reform Order. Two paths for all RoR carriers: Model-based path Revised legacy/cost-based mechanism Based on Alternative Connect America Model (ACAM) Began with price cap model, modified for RoR; based on “greenfield build” Provides fixed amount of support for 10 years Decisions due November 1 Legacy Path Replaces ICLS with CAF BLS (broadband loop support),which provides support for standalone broadband service Retains HCLS Adopts operating and capital expense limitations Broadband Buildout Obligations for both paths Restrictions on support in areas with unsubsidized competition Interstate authorized rate-of-return transition to 9.75% over six years

RoR USF Reform Order - Specifics Model-based (ACAM) Path Theory – provides support based on the most efficient, forward-looking network Model developed with certain engineering assumptions Inputs based on various industry data used Census block-driven Support module calculates and distributes support Term of support – 10 years Carriers with >90% 10/1 buildout not eligible Certain census blocks are not eligible for support Low relative costs ($52.50 per location threshold) Those covered by unsubsidized competition Where incumbent provides 10/1 using fiber or cable Deployment obligations depends on current speed, household density, and ACAM funding Deployment obligations to be met over 10 years Support transition for carriers electing ACAM path but with higher current support

RoR USF Reform Order - Specifics Revised Legacy Mechanism Path ICLS renamed CAF BLS CAF BLS designed to support standalone broadband costs Currently included in interstate special access costs Assumes carriers will recover $42/mo from end users for broadband only lines Operating expense limits Regression based on operating cost per housing unit Applies to all opex accounts (except depreciation and income taxes) used in determining HCLS and CAF BLS 1st year – 50% of total reduction Effective 1/1/2017 Capital Investment Allowance Based on inflation adjusted loop plant Adjusted for current broadband deployment Effective 1/1/2017 for CAF BLS and 2019 for HCLS Buildout obligations To be met over five years No support for census blocks with unsubsidized competition $2 billion budget retained FCC adopted budget control mechanism What about “CAF Reserves”?

RoR USF Reform Order: By the Percentages 5%: approximate percent of funding reductions due to budget control mechanism 9.75%: the level the rate of return will drop to over 6 years 25%: Tribal Broadband Factor for additional funding 50%: phase in of operating expense cap reductions beginning January 2017 80%: threshold which if broadband deployment/availability is less than this, a percent of CAF BLS funding must be used on deployment 85%: Competitor must serve this percent and certify on form 477 to disallow funding for unsubsidized competition in a given census block 85%: percent of Tribal population in rural areas without access to speeds of 25/3 90%: carriers with broadband availability above this threshold not eligible for ACAM funding 95%: required number of locations to be deployed to by end of year 10 years under ACAM

Why Does Universal Service Matter? Original goal – universal voice service – has largely been met Overall, over 96% of the population has access to basic voice service While there are still pockets of the population without affordable, basic service, between wireline and wireless service, the voice service problem has been solved Theory – the nation-wide network becomes more valuable as more of the population gains access Other programs contribute to success Lifeline Schools and Libraries (E-rate) Rural Health Care State programs Arguably, universal broadband service is even more important Access to global markets Long distance education Long distance medicine Connection to wider world The challenge has been and will continue to be to close the digital divide (comparable access in rural and urban areas)

Challenges for Small Companies Closing the digital divide FCC defines “broadband” as service (NOT for funding purposes) providing at least 25/3 mbps FCC 2015 Broadband Progress Report Americans Without Access to 25/3 Speeds

Challenges for Small Companies High cost areas Sparse populations Lower incomes Difficult terrain Lack of economies of scale Increasing cost of regulation Reporting burden

Implications for Tribal Areas “Tribal governments, and by extension, Tribally-owned and operated carriers, play a vital role in serving the needs and interests of their local communities, often in remote, low-income, and underserved regions of the country. Tribally-owned and operated carriers serve cyclically impoverished communities with a historical lack of critical infrastructure. Reservation-based economies lack fundamental similarities to non-reservation economies and are among the most impoverished economies in the country. Tribal Nations also cannot collateralize trust land assets, and as a result, have more limited abilities to access credit and capital.” -FCC’s November 2011 Transformation Order NTTA proposal – Tribal Broadband Factor Tribally-owned carriers FCC recognition of unique situations: Adopted Tribal Engagement rules Tribal Bidding Credits Tribal Coefficient NBP & Transformation Order all littered with examples Considered Tribal carrier-only RoR Tribal Mobility Funds

USF Reforms and Service in Tribal Areas Recent USF Reform Activity Support for standalone broadband should benefit customers in Tribal areas On the negative side: Operating Expense Cap Capital Investment Allowance Continuation of corporate operations expense cap Now four transitions of capping: HCLS; CAF BLS; Budget Control; Opex/Regression caps No recognition of higher costs in Tribal areas Reduced rate of return / not providing for higher RoR for Tribally-owned carriers

Tribal Operating Expenses NTTA and its members advocated for special recognition of additional operating costs on Tribal lands: Time and expense related to gaining rights of way access and easements from the BIA Service to allotted lands Obtaining cultural clearances Compliance with unique Tribal environmental policies Tribal 911 system challenges, including the lack of a master street address guide (MSAG) Hiring policies requiring the employment of Tribal members that increase workforce recruitment and training costs Compliance with Tribal council reporting and audits Costs necessary to protect and advance Tribal sovereignty and self- determination

Tribal Broadband Factor Additional 25% support for use in broadband deployment Applies to HCLS and CAF BLS Not applicable for ACAM takers Available to all RoR carriers serving Tribal areas Estimate – 112 carriers would qualify (have at least one housing unit in a Tribal census block) Support available over a ten-year term Participation is voluntary

Consideration for Tribal Areas/”Getting in the Game” The Case for Tribally-owned carriers Focus is on serving reservation areas and closing the digital divide Trust of the population Sensitive to unique Tribal issues Two paths Purchase ILEC lines Act as competitive carrier ILEC path Negotiations Financing Navigating maze of state and federal regulations Operations Experience and FCC waiver analysis from previous successful Tribal carriers Competitive Path Technology Choice Winning customers Regulatory and legal challenges Hybrid Path Warm Springs Telecom FCC petition pending

Summary Universal service has changed significantly From voice over a single network to broadband over multiple platforms Support for Universal Service has evolved Implicit subsidies to recovering actual, higher than average costs, to cost models Challenges in the broadband world remain the same Ensuring universal deployment Enhancing affordability Increasing education

Questions? Doug Kitch, CPA dkitch@alexicon.net (719)531-6342