NCTIA 2005 Annual Convention Taking Charge of your Telco's Future...

NCTIA 2005 Annual Convention Taking Charge of your Telco’s Future… Manny Staurulakis John Staurulakis, Inc. August 23, 2005

A Need for Change
It is almost certain that traditional regulated revenue streams will be diminished over time due to regulatory changes, competition, and technology. Regardless, incumbent communications providers can remain viable and successful. In order to do so, ILECs need to diversify their revenue streams, control their expenses, and become market focused.

Market Focused
Market focused means:
learning what your customers want
creating services to meet customer expectations
putting together attractive plans to meet their needs

Commitment
With a dedicated plan, it is possible to significantly shift revenues from highly regulated based sources to more competitive/ commodity based sources.

Regulatory Issues

State Regulation Trends
A number of states are providing ILECs with the opportunity to seek alternative forms of regulation or deregulation
Impact on rural exemption
Impact on future universal service funding

The U.S. Supreme Court ruled in the so-called “Brand X” case that the FCC acted properly in declaring cable modem offerings as “information services” not subject to common carrier regulation under Title II of the Communications Act. The FCC provided similar relief to facilities-based wireline broadband Internet access service providers on August 5, 2005. Brand X

ICC FNPRM - Notable Quotes
“ The record confirms the need to replace the existing patchwork of ICC rules with a unified approach”
“ With respect to rate-of-return LECs in particular, we recognize that an approach that retains some ICC payments from IXCs for switched access services may be appropriate”

Intercarrier Compensation
FCC released a FNPRM in the Matter of Developing a Unified Intercarrier Compensation regime on March 3, 2005
Comments were filed May 23rd
Reply comments filed July 20th

COBAK Impact/Line Per NTCA Ex Parte Impact Per Access Line Per Month Interstate State Total Common Line Elimination - $ (4.93) $ (4.93) $ Local Switching Elimination (3.48) $ (4.90) $ (8.38) $ Originating Local Transport Elimination (1.34) $ (1.50) $ (2.84) $ Elimination of Net Settlement (1.54) $ (0.39) $ (2.28) $ Payment for Transiting Orig. Transport (0.64) $ (0.55) $ (1.18) $ Optional Calling Plan CCL, LS & Orig Trans. Elim. (0.41) $ (0.41) $ Optional Calling Plan Paymnt for CCL, LS Elim. 0.01 $ 0.01 $ Optional Calling Plan Orig. Transit Payment Inc. - $ - $ Estimated special access reduction (2.49) $ (2.49) $ Total (including special access) (9.50) $ (12.67) $ (22.16) $

JSI Peer Group Data - 2003
148 client company LECs included in database
LECs from 31 states included in database
Largest LEC in database – over 100,000 A.L.
Smallest LEC in database – approx. 200 A.L.
1,476,000 total access lines
$1.5 billion in regulated revenue - 2003
5.3 billion state & interstate access MOU

Summary of Plan Impacts – Per A.L. $13.78 $1.50 0 $15.28 FACTS $21.42 $21.17 $17.85 Shift to a bulk access charge or additional USF 0 0 $1.50 Additional HCLS due to cap removal 0 0 $2.85 Increase in SLC Caps $21.42 $21.17 $22.20 Reduction in switched access rev. FNPRM NARUC ICF Impact per access line, per month

Plan Impacts on JSI Peer Group Revenue Percentages - 2003 100.0% 8.3 46.2 6.6 8.2 30.7% NARUC 100.0% 8.3 44.1 5.5 11.4 30.7% ICF 8.3 8.3 Other Revenues 100.0% 100.0% Total Regulated Revenues 21.9 39.4 Universal Service Revenue &/Or Bulk Access Charge 30.9 13.4 Network Access Revenue 8.2 8.2 EUCL Revenue (SLCs) 30.7% 30.7% Local Service Revenue Original FACTS Revenue Type

Summary of Plan Impacts – SLC Caps
Increase in SLC Caps
ICF
NARUC (optional for non-rural LECs only)
EPG (optional)
Decrease or no change in SLC Caps
ARIC (possible decrease in SLC charges)
Home/ PBT

Plan Impacts – MOU Charges
Retention of MOU charges
ICF retains terminating MOU charge for CRTCs
ARIC retains orig. & term. MOU charges
EPG retains orig. & term. MOU charges for common trunks
NARUC – retains terminating MOU charge
Elimination of MOU charges
ICF – non rural LECs
Home/ PBT eliminates orig. & term. charges for all LECs

Plan Impacts – USF
Increase in federal and/or state USF
ARIC (via creation of SEF)
NARUC (via creation of RACTF)
EPG (via creation of ARC)
ICF (via creation of TNRM for rural carriers)
Restructure of federal and/or state USF mechanisms
Home/PBT (bulk access charge mechanism)

Take it to the Bank
Increased Accountability and Scrutiny for Universal Service Support
Need for ILECs to prepare
Continued FCC examination on scope of program
Increased state examination of purpose and need of universal service

Federal-State Joint Board On Universal Service - Proposals
Several proposals released on August 17, 2005 relating to high-cost support
Proposals & recommendations being made by individual JB members & staff
Comments due September 16, 2005
Reply comments due October 3, 2005

Four Recommendations/Proposals
The State Allocation Mechanism (SAM)– Ray Baum
Three Stage Package for Universal Service Reform – Billy Jack Gregg
A Holistically Integrated Package – Robert Nelson
Universal Service Endpoint Reform Plan (USERP) - Joel Shifman, Peter Bluhm & Jeff Pursley

State Allocation Mechanism (SAM)
Plan would begin in June 2009 (4 year transition)
FCC to allocate high cost USF & lifeline/linkup funds to accounts for each State maintained by USAC
Each State would determine distribution of funds to ETCs
USAC to remain as fund administrator
States would be allowed to support additional universal service efforts via increments to federal funding mechanism

SAM – Cont’d
Allocation of federal USF to States determined via:
Forward-looking or embedded cost models
A rate affordability benchmark
The intercarrier compensation reform plan adopted by the FCC
Number of consumers in the State eligible for Lifeline and Linkup support

Three Stage Package
Stage 1 – five parts (short term plan: 3 – 5 years)
Combine Study Areas within a state
Large rural carriers (>100,000 lines) would have support determined via FCC’s High Cost Model but not subject to state averaging of costs
For rural LECs, per line support frozen upon competitive entry
Support based on each ETC’s own costs
Rate comparability review extended to rural carriers

Three Stage Package – Cont’d
Stage 2 – Mid-Term Plan
Support to be based on total costs of rural carriers
Federal support based on a comparison of embedded costs of rural carriers to available revenues
Amount of federal support received would be based on a percentage of excess costs (not 100%)

Three Stage Package – Cont’d
Stage 3 – Long-Term Plan
Unified system of support to high-cost areas to be developed. Differences in carrier status, technologies, etc., would be eliminated
Federal support would be allocated to states in the form of block grants
Amount of block grants would be adjusted annually for changes in the GDP-CPI index

Holistically Integrated Package
Reflects portions of other proposals submitted:
Allocation of federal USF to states via block grants
Eliminates rural vs. non-rural carrier distinction: all carriers serving rural areas eligible for support
Combination of study areas within a state
Existing support mechanisms to be combined
Change in contribution methodology through use of connections, bandwidth or numbers

USERP
Addresses changes in support to ILECs and CETCs
States commissions would determine allocations to wireline ILECs within the state
Costs used to determine amounts of funding and allocation to states would be based on embedded or “accounting” costs
Costs would be non-jurisdictional
Existing state averaging policy would be adopted
Affordability index equal to 125% of the national average urban cost would be established

USERP – Cont’d
Wireless CETCs
Support no longer based on support received by incumbent ILEC ( except for wireline CETCs)
Creation of a separate “Portability Fund” available only to wireless carriers and capped at $1 billion/year
Portability Fund to last 5 years and then sunset
State commissions would allocated funds to wireless carriers using a competitive grant method

Regulatory Conclusions
Monitor Federal Activity
Be Proactive
Vocalize Positions
Work with Associations
Strategically Plan for the Future
Take full advantage of existing settlement mechanisms
Firm up Cap X Plans
Have Flexible Long Range Plans

Technology Trends

Where Are We Headed?
All Communications is moving towards IP – Voice and Video migrating toward data structure
Once all services are on the same platform, new applications can link all the media
The network will evolve and become a platform to support applications developed by multiple sources
Similar to a PC with several different software applications

IP Impact on Technology
IP provides a stable well know protocol which is inexpensive with proven performance
IP is an enabler for packet technologies and is embedded in electronic equipment
Outside Plant technologies
Switching
Transport
Video
Keep in mind that IP is a technology that can be implemented just like any other technology in the network without impacting settlements

IP Technology
Telecommunications architecture is migrating to the IP model.
Intelligence continues to become distributed
Circuit Switching migrating to Packet Switching
SONET structure moving Ethernet structure
Software control becoming available to end users via standard data interfaces
LECs must analyze both the technology and their market to offer as many services as possible while keeping it affordable based on revenues generated.

Broadband

Broadband is the first step to the future of communications/entertainment

The New Basic Service
Broadband service tomorrow will be the equivalent of local service today. It should be considered our basic service which will provide our subscribers access to feature rich advanced services.

Broadband Today
Rural markets are often underserved
Coverage is excellent
Prevailing retail rates are too high
Margins are perceived as being anemic
JSI believes
Broadband margins improve dramatically with increased penetration
Rural Broadband penetration equal to Urban penetration is realistic and achievable

Broadband Growth
It is projected that the US home broadband audience will double from approximately 55 million in 2004 to approximately 108 million by 2009

Services

ILEC VoIP
ILECs need to view VoIP as an evolutionary technology service. In the near term, we need to use VoIP to lower operating costs and be prepared to meet a competitive challenge. In the future, VoIP will be our platform as the technological and regulatory environments change.

VoIP Technology vs. Service
Technology
Lower cost equipment
Packet Voice
Efficient, shared transport
Service
Pressure to further lower prices
Web-based account management
Advanced calling features
Arbitrage
Loss of Revenue
Elimination of access charges and taxes
Per minute access savings: 1¢ - 5 ¢
Tax / Surcharge savings: 10% - 20%
Some carriers don’t assess access charges for VoIP calls
VOIP can be used in three ways:

Video Services Business Strategies Financial Assessment

Telco Move into Video
It is less of a question of whether or not we should start providing a video signal. It is more of a question of when and how to do it.

Technological Advancements
Advances in video technologies are increasing at a rapid pace. Video compression, head-end applications over the Internet, set top boxes, MPEG encoders are all areas seeing positive changes in terms of their application to ILEC’s.

IPTV
By capitalizing on technologies such as IP video and xDSL, Internet management, middleware applications, etc., ILEC’s can offer cable TV type services, high-speed Internet access, voice services, and other attractive services over existing copper and fiber facilities

Options to offer Video
Purchase existing CATV provider
Offer Satellite based services as reseller
Over-build service area with HFC/FTTH
Leverage existing copper/fiber facilities (IPTV)

Decision to Overbuild
Technology
Timing
Cost

Copper as Triple Play
Is Copper Enough?
DSL data rates are increasing
Video compression allows more video channels to be delivered on DSL
Copper loop distance is the big gamble:
Will Video and Data compression techniques keep pace with bandwidth demand of Gaming applications and HDTV?
Advantages
Video over DSL (IPTV) leverages existing investment
Implementation is faster than a complete overbuild

HFC
Video is migrating from Analog to Digital
Digital Programs make up approx. 50% of the available channels
As more programs become available in digital format, HFC capacity for video will increase
Video is migrating to IP
New Providers will implement IP Video
Traditional CATV has not yet embraced full transfer to IP video
Internet and VoIP technology is very compatible with HFC RF architecture
Drives new service revenues & margins
Low cost to add customers
Can expand bandwidth available for voice/data

Fiber to the Home
Can be more economical for very rural areas because ILEC only purchases electronics for customers that buy service.
Fiber is a very future proof technology
Not susceptible to water damage
Capacity is only dependent on electronics
No electronic interference
Both LECs with copper plant and CATV companies with HFC plant are evolving their plant to have fiber closer to the home.

Rural IPTV VoD / PPV Market Opportunity
VoD/ PPV are needed to augment broadband and video margins
Rural subscribers do buy VoD/ PPV services — once they’ve tried them
Expensive front end server costs can be defrayed by pooling resources amongst companies

Video Market Summary
There is increasing demand for entertainment services
CATV adding new services with
Digital Channels
Video On Demand
Digital Video Recording
Gaming
Bundling with the triple play services is becoming a reality for CATV companies.
Who will offer the triple play first?

Entertainment

Just How BIG is “Gaming”?
Young people -- those under 30 -- see games as a mainstream entertainment medium just like we think of TV, music or movies
$8 Billion and growing industry
Game introductions often gross more than movies!
49% of kids own games (i.e. Xbox, PlayStation)
Kids spend 1 – 2 hours playing per day!

Online Music / Video Market
The distribution system for the $35B global recorded music market is shifting to the Internet
Who owns an iPod or MP3 player?
20% of Americans under 30
14% of users between 30 and 48
15% of Internet users
23% of users with broadband at home
31% of users with broadband at home AND work
Source: Pew Internet & American Life Project, 2005

Broadband Entertainment Service Observations
Aim Higher! Expect More!
Rural markets are untapped
Profitability is driven by new services (as proven by the cable companies…)
Business opportunities abound and rural markets are ripe for rolling out broadband enabled entertainment services!
New services provide “ground-floor” business opportunities
Create and market bundles to encourage usage of value added services

Bundling

Why Bundle Services?
Subscribers buy bundles
Value
Simplicity
LECs benefit from bundles
Bundles increase “revenue per subscriber”
Can be used to protect access lines and reduce churn
Marketing Is A BIG Reason Why Bundles Are So Effective

Financial Impact
Customers with bundles of local, LD, data, and wireless generate an expected lifetime revenue of $25,508 versus $10,251 for those without bundles
The prime reason is that the value of the churn reduction exceeds the bundle discount
Churn is reduced by two thirds
Cable companies are proof that bundling works!

What does our future hold?

Can We succeed?
Pros
Advanced networks
Existing customer base/relationship
Strong resources
Rural nature
Continued regulatory support
Cons
Not market driven
Need for additional expertise
Decision paralysis

Viability of Local Market
While change will occur, ILECs are well positioned to be successful in the future
There will be continued availability of federal and state support for carriers
Control of the last mile and the broadband connection is key

Outlook
While there are uncertain times ahead, the ILEC sector is still an attractive market. There continues to be a high interest in this space by investors who see the markets as somewhat protected with good growth potential. While there will be some losers, we believe the bulk of the industry will survive and survive well

Customers are the Key
In the end as long as we have a reasonable customer base we will be able to sell a profitable mix of services to them. In saying this, it is important to note that we will need to modify our operating structure as we go. As much as we hate the concept, we need to convert our platform to one of a commodity provider.

Keys to Success
Build a superior network, but not at all costs
Only spend what we have to spend
We can no longer be the “end all, be all”
Partner
The ultimate service platform needs to be based on what the customer wants and what we can afford to provide them

Any Questions? Contact Information: Manny Staurulakis [email_address] 301-459-7590 www.jsitel.com

NCTIA 2005 Annual Convention Taking Charge of your Telco's Future...

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NCTIA 2005 Annual Convention Taking Charge of your Telco’s Future... Presentation Transcript