News of the Week

Wave 16 for FY 2014 will be released on Wednesday, August 27th. Funding for FY 2014 is available for Priority 1 services only. As of this wave, and for the second funding year in a row, Priority 2 funding is being denied at all discount levels. Cumulative funding for FY 2014 is $1.75 billion.

Wave 63 for FY 2013 will be released on Thursday, August 28th. Funding for FY 2013 is available for Priority 1 services only. Priority 2 funding is being denied at all discount levels. Cumulative funding for FY 2013 is $2.09 billion.

Wave 91 for FY 2012 will be released on Friday, August 29th. Funding for FY 2012 is available for Priority 1 services as well as for Priority 2 services at the 90% discount level. Cumulative funding for FY 2012 is $2.87 billion.

A major point of contention among the FCC Commissioners, as they debated the modernization of the E-rate program, was the need to increase the annual funding cap. As released, the E-rate modernization Order (FCC 14-99) maintains the current funding level. But the Order also contains a Further Notice of Proposed Rulemaking (“FNPRM”) that, in part, requests comments on the need for an increase in the future.

With no new funding for now, the financial outlook for E-rate applicants as a whole remains the same. To oversimplify, with the same dollars available each year, USAC will be able to award the same level of discounts. On average, applicants remain whole.

But for individual applicants, the “average” is misleading. While the pie remains the same size, it will be sliced in a completely different manner. This will create financial winners and losers among both the applicant and service provider communities.

Two fundamental changes need to be understood, namely:

1. By focusing on broadband, and targeting substantial new funding on internal Wi-Fi systems, funding is being eliminated or phased down for a number of “legacy” services; and
2. Numerous changes in discount rate calculations will raise discount rates for some applicants, and lower them for others.

Category 1 and Category 2 Changes:

Through FY 2014, all available funding was funneled first to Priority 1 services. To the extent funding in a given year was left over, that funding was used for Priority 2. But lately, there has been a problem. There was not enough money left over in FY 2013 or FY 2014 to fund Priority 2 services, even at the 90% discount level.

The major E-rate 2.0 funding change targeted for FY 2015 will be to provide $1 billion to support internal Wi-Fi systems, now known as Category 2 services. In order to do this, however, Category 1 (previously designated Priority 1) funding will have to be reduced. The E-rate modernization Order does this by eliminating the eligibility of certain non-broadband services (paging, email, webhosting, etc.), and phasing out all voice services (local and long distance phone, cellular voice, VoIP, etc.) by reducing applicant discount rates by 20 percentage points per year.

For many applicants, the Category 1 changes will mean a reduction in E-rate discounts in FY 2015 and ensuing years. Whether such applicants win or lose funding under E-rate 2.0 is critically dependent upon how much Category 2 funding they can garner to offset their Category 1 losses.

Category 2 funding, at least in the short-term, is difficult to project for all but the highest discount applicants. The original FCC concept was that Category 2 funding should be available to all applicants, regardless of discount level, over a five year period. The FCC calculated that $1 billion per year would be sufficient to fund all applicants to a pre-discount budgeted maximum of $150 per student (or $2.30 per square foot for libraries).

The final Order, however, established the budget allocation methodology only for FY 2015 and FY 2016. Beyond FY 2016, the FCC must act to continue the budgetary process, enact a new allocation process, or default back to the pre-FY 2015 process.

Our best guess for FY 2015 is that Category 2 funding will be available for the highest discount (85%) applicants, and that some funding might be available for 80% applicants. If 80% funding has to be allocated, it will be done by funding those applicants with the highest percentage of student eligibility first (e.g., 74%, 73%, 72%, etc.). The situation should be somewhat better for FY 2016, but will probably still not be good enough to provide funding for all applicants.

Our win/lose conclusion, at least for the next couple of years, is:

1. High discount applicants stand to be net winners, gaining more Category 2 funding than they lose in Category 1 funding.
2. Lower discount applicants will most likely be net losers, losing Category 1 funding for legacy services, while being unable to initially access offsetting Category 2 funding.

Discount Rate Changes:

Given whatever funding is available to applicants, a secondary factor in the win/lose equation is the discount rate applied to that funding. The E-rate modernization Order makes a number of changes in the way discount rates are calculated, some of which could either raise or lower a given applicant’s discount rate. In particular, as of FY 2015:

1. A district’s overall discount rate will be based on their total student NSLP eligibility rather than on the student-weighted average of the discount rates of the district’s individual schools. This means that the district will have a “matrix” discount rate (40%, 50%, etc.) rather than what was often some intermediate discount percentage. This is how library discount rates have long been calculated. For many districts, this will mean a higher or lower discount rate. As a rough estimate of the impact, a district’s new discount rate will be equal to its current discount rate, rounded up or down to the closest matrix rate. For example, a district currently having an average rate of 54% is likely to have a 50% discount in FY 2015, whereas a district with a current average of 56% is likely to have a 60% discount next year. One currently at 55% could go either way.
2. The new district discount rate must be used for all funding requests, both Category 1 and Category 2. No longer will a district be able to apply for internal connections just for individual schools with higher discount rates. If all applicants are ultimately funded for Category 2 services, this may all average out. But in the early years, this change will adversely affect some districts’ ability to get any Category 2 funding for specific schools.
3. Income surveys will still be permitted as an alternative discount mechanism, but only to identify specific student eligibility. No longer will applicants be allowed to extrapolate student eligibility percentages from partial survey returns. Applicants that have historically used income surveys can expect to see lower discount rates.
4. Student eligibility for schools using the Community Eligibility Provision (“CEP”) option to provide free meals to all their students will henceforth use the 1.6x multiplier on the number of students identified by direct certification. Heretofore, the FCC had not recognized the 1.6x multiplier established by USDA for setting free meal reimbursements. For individual schools, our analysis indicates that this change will have very little impact on discount rates. Use of the 1.6x multiplier tends to raise student eligibility percentages, but most such schools already had high student eligibility percentages and already qualified for the highest discount rate. For a school district with one or more CEP schools, however, the increased count of eligible students determined via the 1.6x multiplier may indeed increase the district’s combined discount rate.
5. The maximum discount rate for Category 2 is reduced from 90% to 85%. Applicants qualifying for the highest discount rate will thus lose 5% on Category 2 services. No other discount bands are affected by this change.
6. The definition of “rural” has been changed to reflect census track data. This may positively affect a few applicants moving from urban to rural in the middle ranges of the discount matrix, and adversely affect those moving from rural to urban.

The bottom line of these E-rate modernization changes, as far as applicants are concerned, is that there will be winners and losers. Numerically, particularly in the early years, there will probably be more losers than winners. Individual applicants may want to “run the numbers” to see where they are likely to come out in FY 2015 and FY 2016.

For service providers, the win/lose picture is clearer, namely:

1. Since there has been no Priority 2 funding for the past two years, and there should be roughly $1 billion in funding available for Category 2 going forward, providers of eligible Wi-Fi services win.
2. Providers (including web hosting companies) of previously eligible Priority 1 services, now ineligible as of FY 2015, lose.
3. Providers of Category 1 voice services, whose eligibility is being phased down, gradually lose.
4. Providers of Category 1 broadband services are largely unaffected.

We would not be surprised to hear some howls from the losing service providers, perhaps in the form of petitions for reconsideration.