UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2021
or
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☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-35134
LEVEL 3 PARENT, LLC
(Exact name of registrant as specified in its charter)
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Delaware | | 47-0210602 |
(State of Incorporation) | | (I.R.S. Employer Identification No.) |
1025 Eldorado Blvd., | | |
Broomfield, | CO | | 80021-8869 |
(Address of principal executive offices) | | (Zip Code) |
(720) 888-1000
(Registrant’s telephone number,
including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class | | Trading Symbol(s) | | Name of Each Exchange on Which Registered |
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THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF LUMEN TECHNOLOGIES, INC., MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE PURSUANT TO GENERAL INSTRUCTION H(2).
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer | ☐ | | Accelerated filer | ☐ |
Non-accelerated filer | ☒ | | Smaller reporting company | ☐ |
| | | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. | ☐ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
All of the limited liability company interest in the registrant is held by an affiliate of the registrant. NaN of the interest is publicly traded.
TABLE OF CONTENTS
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* All references to "Notes" in this quarterly report refer to these Notes to Consolidated Financial Statements. |
Unless the context requires otherwise, references in this report to "Level 3," “we,” “us,” "its," the "Company" and "our" refer to Level 3 Parent, LLC and its predecessor Level 3 Communications, Inc., and their respective consolidated subsidiaries.
Special Note Regarding Controlling Member
On September 14, 2020, our controlling member, CenturyLink, Inc. commenced operating under the brand name "Lumen" and on January 22, 2021, officially changed its legal name to "Lumen Technologies, Inc.". As a result, CenturyLink, Inc. is now “Lumen Technologies, Inc.”, and sometimes referred to herein as "Lumen Technologies" or “Lumen”.
Special Note Regarding Forward-Looking Statements
This report and other documents filed by us under the federal securities law include, and future oral or written statements or press releases by us and our management may include, forward-looking statements about our business, financial condition, operating results or prospects. These "forward-looking" statements are defined by, and are subject to the "safe harbor" protections under, the federal securities laws. These statements include, among others:
•statements regarding how the health and economic challenges raised by the COVID-19 pandemic may impact our business, operations, cash flows or financial position;
•forecasts of our anticipated future results of operations, cash flows or financial position;
•statements concerning the anticipated impact of our transactions, investments, product development, and other initiatives, including synergies or costs associated with these initiatives;
•statements about our liquidity, profitability, profit margins, tax position, tax assets, tax rates, asset values, contingent liabilities, growth opportunities, growth rates, acquisition and divestiture opportunities, business prospects, regulatory and competitive outlook, market share, product capabilities, investment and expenditure plans, business strategies, distribution and securities repurchase plans, leverage, capital allocation plans, financing alternatives and sources, and pricing plans; and
•other similar statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts, many of which are highlighted by words such as “may,” “will,” “would,” “could,” “should,” “plan,” “believes,” “expects,” “anticipates,” “estimates,” “projects,” “intends,” “likely,” “seeks,” “hopes,” or variations or similar expressions with respect to the future.
These forward-looking statements are based upon our judgment and assumptions as of the date such statements are made concerning future developments and events, many of which are beyond our control. These forward-looking statements, and the assumptions upon which they are based, (i) are not guarantees of future results, (ii) are inherently speculative and (iii) are subject to a number of risks and uncertainties. Actual events and results may differ materially from those anticipated, estimated, projected or implied by us in those statements if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect. All of our forward-looking statements are qualified in their entirety by reference to our discussion of factors that could cause our actual results to differ materially from those anticipated, estimated, projected or implied by us in those forward-looking statements. Factors that could affect actual results include but are not limited to:
•uncertainties regarding the impact that COVID-19 health and economic disruptions will continue to have on our business, operations, cash flows and corporate initiatives;
•the effects of competition from a wide variety of competitive providers, including decreased demand for our more mature service offerings and increased pricing pressures;
•the effects of new, emerging or competing technologies, including those that could make our products less desirable or obsolete;
•our ability to attain our key operating imperatives, including simplifying and consolidating our network, simplifying and automating our service support systems, strengthening our relationships with customers and attaining projected cost savings;
•our ability to safeguard our network, and to avoid the adverse impact of possible security breaches, service outages, system failures, or similar events impacting our network or the availability and quality of our services;
•the effects of ongoing changes in the regulation of the communications industry, including the outcome of legislative, regulatory or judicial proceedings relating to content liability standards, intercarrier compensation, broadband deployment, data protection, privacy and net neutrality;
•our ability to effectively retain and hire key personnel;
•possible changes in the demand for our products and services, including increased demand for high-speed data transmission services;
•our ability to successfully maintain the quality and profitability of our existing product and service offerings and to introduce profitable new offerings on a timely and cost-effective basis;
•our ability to generate cash flows sufficient to fund our financial commitments and objectives, including our capital expenditures, operating costs, debt repayments and distributions;
•our ability to successfully and timely implement our operating plans and corporate strategies, including our deleveraging strategy;
•changes in our operating plans, corporate strategies and capital allocation plans, whether based upon COVID-19 disruptions, changes in our cash flows, cash requirements, financial performance, financial position, market conditions or otherwise;
•the impact of any future material acquisitions or divestitures that we may engage in;
•the negative impact of increases in the costs of Lumen’s pension, health, post-employment or other benefits, including those caused by changes in markets, interest rates, mortality rates, demographics or regulations;
•the potential negative impact of customer complaints, government investigations, security breaches or service outages impacting us or our industry;
•adverse changes in our access to credit markets on favorable terms, whether caused by changes in our financial position, lower credit ratings, unstable markets or otherwise;
•our ability to meet the terms and conditions of our debt obligations and covenants, including our ability to make transfers of cash in compliance therewith;
•our ability to maintain favorable relations with our security holders, key business partners, suppliers, vendors, landlords and financial institutions;
•Lumen's ability to meet evolving environmental, social and governance ("ESG") expectations and benchmarks, and effectively communicate its ESG strategies;
•our ability to collect our receivables from, or continue to do business with, financially-troubled customers, including, but not limited to, those adversely impacted by the economic dislocations caused by the COVID-19 pandemic;
•Lumen's ability to use its net operating loss carryforwards in the amounts projected;
•any adverse developments in legal or regulatory proceedings involving us or our affiliates, including Lumen Technologies;
•changes in tax, pension, healthcare or other laws or regulations, or in general government funding levels, including those arising from pending proposals of the Biden Administration to increase infrastructure spending and federal income tax rates;
•the effects of changes in accounting policies, practices or assumptions, including changes that could potentially require additional future impairment charges;
•the effects of adverse weather, terrorism, epidemics, pandemics, rioting, societal unrest, or other natural or man-made disasters or disturbances;
•the potential adverse effects if our internal controls over financial reporting have weaknesses or deficiencies, or otherwise fail to operate as intended;
•the effects of more general factors such as changes in interest rates, in exchange rates, in operating costs, in public policy, in the views of financial analysts, or in general market, labor, economic or geo-political conditions; and
•other risks referenced in the "Risk Factors" section or other portions of this report or other of our filings with the U.S. Securities and Exchange Commission (the "SEC").
Additional factors or risks that we currently deem immaterial, that are not presently known to us or that arise in the future could also cause our actual results to differ materially from our expected results. Given these uncertainties, investors are cautioned not to unduly rely upon our forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly update or revise any forward-looking statements for any reason, whether as a result of new information, future events or developments, changed circumstances, or otherwise. Furthermore, any information about our intentions contained in any of our forward-looking statements reflects our intentions as of the date of such forward-looking statement, and is based upon, among other things, existing regulatory, technological, industry, competitive, economic and market conditions, and our assumptions as of such date. We may change our intentions, strategies or plans (including our distribution or other capital allocation plans) at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEVEL 3 PARENT, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
OPERATING REVENUE | | | |
Operating revenue | $ | 1,934 | | | 1,932 | |
Operating revenue - affiliates | 55 | | | 48 | |
Total operating revenue | 1,989 | | | 1,980 | |
OPERATING EXPENSES | | | |
Cost of services and products (exclusive of depreciation and amortization) | 878 | | | 876 | |
Selling, general and administrative | 294 | | | 310 | |
Operating expenses - affiliates | 107 | | | 93 | |
Depreciation and amortization | 437 | | | 416 | |
Total operating expenses | 1,716 | | | 1,695 | |
OPERATING INCOME | 273 | | | 285 | |
OTHER (EXPENSE) INCOME | | | |
Interest income - affiliate | 18 | | | 13 | |
Interest expense | (93) | | | (106) | |
Other income (expense), net | 4 | | | (34) | |
Total other expense, net | (71) | | | (127) | |
INCOME BEFORE INCOME TAXES | 202 | | | 158 | |
Income tax expense | 51 | | | 45 | |
NET INCOME | $ | 151 | | | 113 | |
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
NET INCOME | $ | 151 | | | 113 | |
OTHER COMPREHENSIVE LOSS | | | |
Foreign currency translation adjustments, net of $7 and $23 tax | (88) | | | (228) | |
Other comprehensive loss, net of tax | (88) | | | (228) | |
COMPREHENSIVE INCOME (LOSS) | $ | 63 | | | (115) | |
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
CONSOLIDATED BALANCE SHEETS
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| March 31, 2021 (unaudited) | | December 31, 2020 |
| (Dollars in millions) |
ASSETS | | | |
CURRENT ASSETS | | | |
Cash and cash equivalents | $ | 234 | | | 190 | |
Accounts receivable, less allowance of $44 and $45 | 673 | | | 683 | |
Note receivable - affiliate | 1,468 | | | 1,468 | |
Other | 354 | | | 297 | |
Total current assets | 2,729 | | | 2,638 | |
Property, plant and equipment, net of accumulated depreciation of $3,018 and $2,818 | 10,477 | | | 10,518 | |
GOODWILL AND OTHER ASSETS | | | |
Goodwill | 7,389 | | | 7,405 | |
Other intangible assets, net | 6,413 | | | 6,605 | |
Other, net | 1,458 | | | 1,410 | |
Total goodwill and other assets | 15,260 | | | 15,420 | |
TOTAL ASSETS | $ | 28,466 | | | 28,576 | |
LIABILITIES AND MEMBER'S EQUITY | | | |
CURRENT LIABILITIES | | | |
Current maturities of long-term debt | $ | 29 | | | 14 | |
Accounts payable | 500 | | | 495 | |
Accounts payable - affiliates | 694 | | | 869 | |
Accrued expenses and other liabilities | | | |
Salaries and benefits | 155 | | | 220 | |
Income and other taxes | 106 | | | 111 | |
Current operating lease liabilities | 265 | | | 241 | |
Other | 134 | | | 159 | |
Current portion of deferred revenue | 325 | | | 315 | |
Total current liabilities | 2,208 | | | 2,424 | |
LONG-TERM DEBT | 10,339 | | | 10,373 | |
DEFERRED REVENUE AND OTHER LIABILITIES | | | |
Deferred revenue | 1,401 | | | 1,396 | |
Operating lease liabilities | 973 | | | 903 | |
Other | 577 | | | 575 | |
Total deferred revenue and other liabilities | 2,951 | | | 2,874 | |
COMMITMENTS AND CONTINGENCIES (Note 7) | 0 | | 0 |
MEMBER'S EQUITY | | | |
Member's equity | 13,290 | | | 13,139 | |
Accumulated other comprehensive loss | (322) | | | (234) | |
Total member's equity | 12,968 | | | 12,905 | |
TOTAL LIABILITIES AND MEMBER'S EQUITY | $ | 28,466 | | | 28,576 | |
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
OPERATING ACTIVITIES | | | |
Net income | $ | 151 | | | 113 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 437 | | | 416 | |
Deferred income taxes | 42 | | | 38 | |
Changes in current assets and liabilities: | | | |
Accounts receivable | 1 | | | (80) | |
Accounts payable | (1) | | | 22 | |
Other assets and liabilities, net | (159) | | | (188) | |
Other assets and liabilities, affiliate | (161) | | | 105 | |
Changes in other noncurrent assets and liabilities, net | 37 | | | (10) | |
Other, net | (19) | | | (21) | |
Net cash provided by operating activities | 328 | | | 395 | |
INVESTING ACTIVITIES | | | |
Capital expenditures | (297) | | | (349) | |
Payments of notes receivable - affiliates | 0 | | | 122 | |
Proceeds from sale of property, plant and equipment and other assets | 25 | | | 33 | |
Net cash used in investing activities | (272) | | | (194) | |
FINANCING ACTIVITIES | | | |
Net proceeds from issuance of long-term debt | 891 | | | 0 | |
Distributions | 0 | | | (275) | |
Payments of long-term debt | (904) | | | (4) | |
Other | (2) | | | 0 | |
Net cash used in financing activities | (15) | | | (279) | |
Net increase (decrease) in cash, cash equivalents and restricted cash | 41 | | | (78) | |
Cash, cash equivalents and restricted cash at beginning of period | 205 | | | 338 | |
Cash, cash equivalents and restricted cash at end of period | $ | 246 | | | 260 | |
Supplemental cash flow information: | | | |
Income taxes paid, net | $ | (7) | | | (5) | |
Interest paid (net of capitalized interest of $4 and $6) | $ | (126) | | | (115) | |
| | | |
Cash, cash equivalents and restricted cash: | | | |
Cash and cash equivalents | $ | 234 | | | 239 | |
Restricted cash included in Other current assets | 2 | | | 3 | |
Restricted cash included in Other, net noncurrent assets | 10 | | | 18 | |
Total | $ | 246 | | | 260 | |
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
CONSOLIDATED STATEMENTS OF MEMBER'S EQUITY
(UNAUDITED)
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
MEMBER'S EQUITY | | | |
Balance at beginning of period | $ | 13,139 | | | 13,724 | |
Cumulative effect of adoption of ASU 2016-13, Measurement of Credit Losses, net of $2 tax | — | | | (3) | |
Net income | 151 | | | 113 | |
Distributions | 0 | | | (318) | |
Other | 0 | | | 8 | |
Balance at end of period | 13,290 | | | 13,524 | |
ACCUMULATED OTHER COMPREHENSIVE LOSS | | | |
Balance at beginning of period | (234) | | | (179) | |
Other comprehensive loss | (88) | | | (228) | |
Balance at end of period | (322) | | | (407) | |
TOTAL MEMBER'S EQUITY | $ | 12,968 | | | 13,117 | |
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
Notes To Consolidated Financial Statements
(UNAUDITED)
Unless the context requires otherwise, references in this report to "Level 3," “we,” “us,” "its," the “Company” and “our”, refer to Level 3 Parent, LLC and its predecessor, Level 3 Communications, Inc. and their respective subsidiaries. References to "Lumen Technologies" or "Lumen" refer to our ultimate parent company, Lumen Technologies, Inc. and its consolidated subsidiaries including Qwest Corporation, referred to as "Qwest".
(1) Background
General
We are an international facilities-based technology communications provider (that is, a provider that owns or leases a substantial portion of the property, plant and equipment necessary to provide our services) of a broad range of integrated communications services. We created our communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.
Basis of Presentation
Our consolidated balance sheet as of December 31, 2020, which was derived from our audited consolidated financial statements, and our unaudited interim consolidated financial statements provided herein have been prepared in accordance with the instructions for Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to rules and regulations of the SEC. However, in our opinion, the disclosures made therein are adequate to make the information presented not misleading. We believe that these consolidated financial statements include all normal recurring adjustments necessary to fairly present the results for the interim periods. The consolidated results of operations and cash flows for the first three months of the year are not necessarily indicative of the consolidated results of operations and cash flows that might be expected for the entire year. These consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020.
The accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries in which we have a controlling interest. Intercompany amounts and transactions with our consolidated subsidiaries have been eliminated. Transactions with our non-consolidated affiliates (Lumen Technologies and its other subsidiaries, referred to herein as affiliates) have not been eliminated. Due to exchange restrictions and other conditions, effective at the end of the third quarter of 2015 we deconsolidated our Venezuelan subsidiary and began accounting for our investment in our Venezuelan subsidiary using the cost method of accounting. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the first quarter of 2021.
We reclassified certain prior period amounts to conform to the current period presentation, including our revenue by product and service categories. See Note 3—Revenue Recognition for additional information. These changes had no impact on total operating revenue, total operating expenses or net income for any period.
Operating lease assets are included in other, net under goodwill and other assets on our consolidated balance sheets.
Segments
Our operations are integrated into and reported as part of Lumen Technologies. Lumen's chief operating decision maker ("CODM") is our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the SEC. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we have 1 reportable segment.
Summary of Significant Accounting Policies
The significant accounting policy below is in addition to the significant accounting policies described in Note 1 — Background and Summary of Significant Accounting Policies to the consolidated financial statements and accompanying notes in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2020.
Operating Lease Income
We lease various dark fiber, office facilities, colocation facilities, switching facilities, other network sites and service equipment to third parties under operating leases. Lease and sublease income are included in operating revenue in our consolidated statements of operations.
For the three months ended March 31, 2021 and 2020, our gross rental income was $197 million and $176 million, respectively, which represents approximately 10% and 9%, respectively, of our operating revenue for the three months ended March 31, 2021 and 2020.
Recently Adopted Accounting Pronouncements
Debt
On January 1, 2021, we adopted ASU 2020-09, "Debt (Topic 470) Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762" ("ASU 2020-09"). This ASU amends and supersedes various SEC paragraphs to reflect SEC Release No. 33-10762, which includes amendments to the financial disclosure requirements applicable to registered debt offerings that include credit enhancements, such as subsidiary guarantees. The adoption of ASU 2020-09 did not have a material impact to our consolidated financial statements.
Investments
On January 1, 2021, we adopted ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815)" ("ASU 2020-01"). This ASU, among other things, clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323, Investments - Equity Method and Joint Ventures, for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. As of March 31, 2021, we determined there was no application or discontinuation of the equity method during the reporting periods. The adoption of ASU 2020-01 did not have an impact to our consolidated financial statements.
Income taxes
On January 1, 2021, we adopted ASU 2019-12, "Simplifying the Accounting for Income Taxes (Topic 740)" ("ASU 2019-12"). This ASU removes certain exceptions for investments, intra-period allocations and interim calculations, and adds guidance to reduce complexity in accounting for income taxes. The adoption of ASU 2019-12 did not have a material impact to our consolidated financial statements.
Measurement of Credit Losses on Financial Instruments
We adopted ASU 2016-13, "Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13") on January 1, 2020 and recognized a cumulative adjustment to our accumulated deficit as of the date of adoption of $3 million, net of tax effect of $2 million. Please refer to Note 4—Credit Losses on Financial Instruments for more information.
Recently Issued Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting" ("ASU 2020-04"), designed to ease the burden of accounting for contract modifications related to the global market-wide reference rate transition period. Subject to certain criteria, ASU 2020-04 provides qualifying entities the option to apply expedients and exceptions to contract modifications and hedging accounting relationships made until December 31, 2022. These amendments are
effective immediately and may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2022. ASU 2020-04 provides optional guidance for a limited time to ease the potential burden in accounting for reference rate reform. As of March 31, 2021, we are evaluating the existing contracts and the impact on consolidated financial statements.
(2) Goodwill, Customer Relationships and Other Intangible Assets
Goodwill, customer relationships and other intangible assets consisted of the following:
| | | | | | | | | | | |
| March 31, 2021 | | December 31, 2020 |
| (Dollars in millions) |
Goodwill | $ | 7,389 | | | 7,405 | |
Customer relationships, less accumulated amortization of $2,417 and $2,246 | $ | 5,972 | | | 6,156 | |
Capitalized software, less accumulated amortization of $280 and $256 | 400 | | | 401 | |
Trade names, less accumulated amortization of $89 and $83 | 41 | | | 48 | |
Total other intangible assets, net | $ | 6,413 | | | 6,605 | |
Our goodwill was derived from Lumen's acquisition of us where the purchase price exceeded the fair value of the net assets acquired.
We assess our goodwill for impairment annually, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate there may be impairment. We are required to write down the value of goodwill only when our assessment determines the carrying value of equity of our reporting unit exceeds its fair value. Our annual impairment assessment date for goodwill is October 31, at which date we assess goodwill at our reporting unit. In reviewing the criteria for reporting units, we have determined that we are 1 reporting unit.
The following table shows the rollforward of goodwill from December 31, 2020 through March 31, 2021:
| | | | | |
| (Dollars in millions) |
As of December 31, 2020 | $ | 7,405 | |
Effect of foreign currency exchange rate changes | (16) | |
As of March 31, 2021 | $ | 7,389 | |
_______________________________________________________________________________
(1)Goodwill at March 31, 2021 and December 31, 2020 is net of accumulated impairment loss of $3.7 billion.
Total amortization expense for intangible assets for the three months ended March 31, 2021 and 2020, was $211 million and $208 million, respectively. As of March 31, 2021, the gross carrying amount of goodwill, customer relationships, indefinite-life and other intangible assets was $16.6 billion.
We estimate that total amortization expense for intangible assets for the years ending December 31, 2021 through 2025 will be as follows:
| | | | | |
| (Dollars in millions) |
2021 (remaining nine months) | $ | 634 | |
2022 | 783 | |
2023 | 755 | |
2024 | 744 | |
2025 | 680 | |
(3) Revenue Recognition
Beginning in the first quarter of 2021, we categorized our products, services and revenue among the following 5 categories:
•Compute and Application Services, which include our Edge Cloud services, IT solutions, Unified Communications and Collaboration ("UC&C"), data center, content delivery network ("CDN") and Managed Security services;
•IP and Data Services, which include Ethernet, IP, and VPN data networks, including software-defined wide area networks ("SD WAN") based services, Dynamic Connections and Hyper WAN;
•Fiber Infrastructure Services, which include dark fiber, optical services and equipment;
•Voice and Other, which includes Time Division Multiplexing ("TDM") voice, private line and other legacy services; and
•Affiliate Services, which include telecommunication services provided to our affiliates that we also provide to our external customers.
From time to time, we may change the categorization of our products and services.
Disaggregated Revenue by Service Offering
The following tables provide disaggregation of revenue from contracts with customers based on service offering for the three months ended March 31, 2021. It also shows the amount of revenue that is not subject to ASC 606, but is instead governed by other accounting standards.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2021 | | Three Months Ended March 31, 2020 |
| Total Revenue | Adjustments for Non-ASC 606 Revenue (1) | Total Revenue from Contracts with Customers | | Total Revenue | Adjustments for Non-ASC 606 Revenue (1) | Total Revenue from Contracts with Customers |
| (Dollars in millions) |
Compute and Application Services | $ | 280 | | (127) | | 153 | | | 275 | | (125) | | 150 | |
IP and Data Services | 881 | | 0 | | 881 | | | 881 | | 0 | | 881 | |
Fiber Infrastructure Services | 397 | | (53) | | 344 | | | 369 | | (50) | | 319 | |
Voice and Other | 376 | | (2) | | 374 | | | 407 | | (2) | | 405 | |
Affiliate Services | 55 | | (55) | | 0 | | | 48 | | (48) | | 0 | |
Total revenue | $ | 1,989 | | (237) | | 1,752 | | | 1,980 | | (225) | | 1,755 | |
_____________________________________________________________________
(1) Includes lease revenue which is not within the scope of ASC 606.
Customer Receivables and Contract Balances
The following table provides balances of customer receivables, contract assets and contract liabilities as of March 31, 2021 and December 31, 2020:
| | | | | | | | | | | |
| March 31, 2021 | | December 31, 2020 |
| (Dollars in millions) |
Customer receivables (1) | $ | 671 | | | 683 | |
Contract assets | 37 | | | 38 | |
Contract liabilities | 323 | | | 385 | |
_____________________________________________________________________
(1)Gross customer receivables of $715 million and $728 million, net of allowance for credit losses of $44 million and $45 million, at March 31, 2021 and December 31, 2020, respectively.
Contract liabilities are consideration we have received from our customers in advance of providing the goods or services promised in the future. We defer recognizing this consideration until we have satisfied the related performance obligation to the customer. Contract liabilities include recurring services billed one month in advance and installation and maintenance charges that are deferred and recognized over the actual or expected contract term, which typically ranges from one to five years depending on the service. Contract liabilities are included within deferred revenue in our consolidated balance sheets. During the three months ended March 31, 2021 and 2020, we recognized $93 million and $99 million, respectively, of revenue that was included in contract liabilities as of January 1, 2021 and January 1, 2020, respectively.
Performance Obligations
As of March 31, 2021, our estimated revenue expected to be recognized in the future related to performance obligations associated with existing customer contracts that are partially or wholly unsatisfied is approximately $3.7 billion. We expect to recognize approximately 90% of this revenue through 2023, with the balance recognized thereafter.
These amounts exclude (i) the value of unsatisfied performance obligations for contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed (for example, uncommitted usage or non-recurring charges associated with professional or technical services to be completed), and (ii) contracts that are classified as leasing arrangements that are not subject to ASC 606.
Contract Costs
The following tables provide changes in our contract acquisition costs and fulfillment costs for:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
| Acquisition Costs | | Fulfillment Costs | | Acquisition Costs | | Fulfillment Costs |
Beginning of period balance | $ | 78 | | | 122 | | | 79 | | | 121 | |
Costs incurred | 14 | | | 23 | | | 23 | | | 23 | |
Amortization | (17) | | | (22) | | | (16) | | | (22) | |
End of period balance | $ | 75 | | | 123 | | | 86 | | | 122 | |
Acquisition costs include commission fees paid to employees as a result of obtaining contracts. Fulfillment costs include third party and internal costs associated with the provision, installation and activation of telecommunications services to customers, including labor and materials consumed for these activities.
Deferred acquisition and fulfillment costs are amortized based on the transfer of services on a straight-line basis over the average expected contract term of approximately 30 months for our business customers. Amortized fulfillment costs are included in cost of services and products, and amortized acquisition costs are included in selling, general and administrative expenses in our consolidated statements of operations. The amount of these deferred costs that are anticipated to be amortized in the next 12 months are included in other current assets on our consolidated balance sheets. The amount of deferred costs expected to be amortized beyond 12 months is included in other non-current assets on our consolidated balance sheets. Deferred acquisition and fulfillment costs are assessed for impairment on an annual basis.
(4) Credit Losses on Financial Instruments
In accordance with ASC 326, "Financial Instruments - Credit Losses" ("ASC 326"), we aggregate financial assets with similar risk characteristics to align our expected credit losses with the credit quality or deterioration over the life of the asset. We monitor certain risk characteristics within our aggregated financial assets and revise their composition accordingly, to the extent internal and external risk factors change each reporting period. Financial assets that do not share risk characteristics with other financial assets are evaluated separately. Our financial assets measured at amortized cost primarily consist of accounts receivable.
In developing our accounts receivable portfolio, we pooled certain assets with similar credit risk characteristics based on the nature of our customers, their industry, policies used to grant credit terms, and their historical and expected credit loss patterns.
Prior to the adoption of the new credit loss standard, the allowance for doubtful accounts receivable reflected our best estimate of probable losses inherent in our receivable portfolio determined based on historical experience, specific allowances for known troubled accounts, and other currently available evidence.
We implemented the new standard effective January 1, 2020, using a loss rate method to estimate our allowance for credit losses. Our determination of the current expected credit loss rate begins with our use of historical loss experience as a percentage of accounts receivable. We measure our historical loss period based on the average days to recognize accounts receivable as credit losses. When asset specific characteristics and current conditions change from those in the historical period, due to changes in our credit and collections strategy, or credit loss and recovery policies, we perform a qualitative and quantitative assessment to update our current loss rate, which as noted below has increased due to an increase in historic loss experience and weakening economic forecasts. We use regression analysis to develop an expected loss rate using historical experience and economic data over a forecast period. We measure our forecast period based on the average days to collect payment on billed accounts receivable. The historical, current, and expected credit loss rates are combined and applied to period end accounts receivable, which results in our allowance for credit losses.
If there is a deterioration of a customer's financial condition or if future default rates in general differ from currently anticipated default rates (including changes caused by COVID-19), we may need to adjust the allowance for credit losses, which would affect earnings in the period that adjustments are made.
The assessment of the correlation between historical observed default rates, current conditions and forecasted economic conditions requires judgment. Alternative interpretations of these factors could have resulted in different conclusions regarding the allowance for credit losses. The amount of credit loss is sensitive to changes in circumstances and forecasted economic conditions. Our historical credit loss experience, current conditions and forecast of economic conditions may also not be representative of the customers' actual default experience in the future.
The following table presents the activity of our allowance for credit losses for our accounts receivable portfolio:
| | | | | | | | | |
| (Dollars in millions) | | | | |
Beginning balance at December 31, 2020 | $ | 45 | | | | | |
Provision for expected losses | 2 | | | | | |
Write-offs charged against the allowance | (5) | | | | | |
Recoveries collected | 2 | | | | | |
Ending balance at March 31, 2021 | $ | 44 | | | | | |
For the three months ended March 31, 2021, we decreased our allowance for credit losses for our accounts receivable portfolio as a result of normal business activity.
(5) Long-Term Debt
The following chart reflects our consolidated long-term debt, including finance leases, unamortized discounts and premiums, net and unamortized debt issuance costs, but excluding intercompany debt:
| | | | | | | | | | | | | | | | | | | | | | | |
| Interest Rates (1) | | Maturities (1) | | March 31, 2021 | | December 31, 2020 |
| | | | | (Dollars in millions) |
Level 3 Financing, Inc. | | | | | | | |
Senior Secured Debt: (2) | | | | | | | |
Senior notes | 3.400% - 3.875% | | 2027 - 2029 | | $ | 1,500 | | | 1,500 | |
Tranche B 2027 Term Loan (3) | LIBOR + 1.750% | | 2027 | | 3,111 | | | 3,111 | |
Senior Notes and other debt: | | | | | | | |
Senior notes (4) | 3.625% - 5.375% | | 2025 - 2029 | | 5,515 | | | 5,515 | |
Finance leases | Various | | Various | | 265 | | | 255 | |
Unamortized premiums, net | | | | | 40 | | | 60 | |
Unamortized debt issuance costs | | | | | (63) | | | (54) | |
Total long-term debt | | | | | 10,368 | | | 10,387 | |
Less current maturities | | | | | (29) | | | (14) | |
Long-term debt, excluding current maturities | | | | | $ | 10,339 | | | 10,373 | |
______________________________________________________________________
(1)As of March 31, 2021.
(2)See Note 6—Long-Term Debt in our Annual Report on Form 10-K for the year ended December 31, 2020 for a description of certain parent or subsidiary guarantees and liens securing this debt.
(3)The Tranche B 2027 Term Loan had an interest rate of 1.859% at March 31, 2021 and 1.897% at December 31, 2020.
(4)This debt is, or is expected to be, fully and unconditionally guaranteed by certain affiliates of Level 3 Financing, Inc., including Level 3 Parent, LLC and Level 3 Communications, LLC.
New Issuances
On January 13, 2021, Level 3 Financing, Inc. issued $900 million aggregate principal amounts of its 3.750% Sustainability-Linked Senior Notes due 2029 (the "Sustainability-Linked Notes"). The net proceeds, together with cash on hand, were used to redeem certain of its outstanding senior note indebtedness. See "—Redemption of Senior Notes" below. The Sustainability-Linked Notes are (i) guaranteed by Level 3 Parent, LLC and (ii) expected to be guaranteed by Level 3 Communications, LLC, upon the receipt of all requisite material governmental authorizations.
Redemption of Senior Notes
On February 12, 2021, Level 3 Financing, Inc. redeemed all $900 million aggregate principal amount of its outstanding 5.375% Senior Notes due 2024. This transaction resulted in a gain of $16 million.
Long-Term Debt Maturities
Set forth below is the aggregate principal amount of our long-term debt as of March 31, 2021 (excluding unamortized premiums, net, and unamortized debt issuance costs), maturing during the following years:
| | | | | |
| (Dollars in millions) |
2021 (remaining nine months) | $ | 26 | |
2022 | 14 | |
2023 | 15 | |
2024 | 16 | |
2025 | 817 | |
2026 and thereafter | 9,503 | |
Total long-term debt | $ | 10,391 | |
Covenants
The term loan and senior notes of Level 3 Financing, Inc. contain extensive affirmative and negative covenants. Such covenants include, among other things and subject to certain significant exceptions, restrictions on their ability to declare or pay dividends, repay certain other indebtedness, create liens, incur additional indebtedness, make investments, engage in transactions with their affiliates including Lumen Technologies and its other subsidiaries, dispose of assets and merge or consolidate with any other person. Also, in connection with a "change of control" of Level 3 Parent, LLC, or Level 3 Financing, Inc., Level 3 Financing will be required to offer to repurchase or repay certain of its long-term debt at a price of 101% of the principal amount of debt repurchased or repaid, plus accrued and unpaid interest.
Certain of Lumen's and our debt instruments contain cross-payment default or cross-acceleration provisions.
Compliance
As of March 31, 2021, we believe we were in compliance with the financial covenants contained in our debt agreements in all material respects.
(6) Fair Value of Financial Instruments
Our financial instruments consist of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, note receivable-affiliate and long-term debt, excluding finance lease and other obligations. Due to their short-term nature, the carrying amounts of our cash and cash equivalents, restricted cash, accounts receivable, note receivable-affiliate and accounts payable approximate their fair values.
The three input levels in the hierarchy of fair value measurements are defined by the FASB are generally as follows:
| | | | | | | | |
Input Level | | Description of Input |
Level 1 | | Observable inputs such as quoted market prices in active markets. |
Level 2 | | Inputs other than quoted prices in active markets that are either directly or indirectly observable. |
Level 3 | | Unobservable inputs in which little or no market data exists. |
The following table presents the carrying amounts and estimated fair values of our long-term debt, excluding finance leases, as well as the input level used to determine the fair values indicated below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2021 | | December 31, 2020 |
| Input Level | | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
| | | (Dollars in millions) |
Liabilities-Long-term debt, excluding finance leases | 2 | | $ | 10,103 | | | 10,212 | | | 10,132 | | | 10,340 | |
(7) Commitments, Contingencies and Other Items
We are subject to various claims, legal proceedings and other contingent liabilities, including the matters described below, which individually or in the aggregate could materially affect our financial condition, future results of operations or cash flows. As a matter of course, we are prepared to both litigate these matters to judgment as needed, as well as to evaluate and consider reasonable settlement opportunities.
Irrespective of its merits, litigation may be both lengthy and disruptive to our operations and could cause significant expenditure and diversion of management attention. We review our litigation accrual liabilities on a quarterly basis, but in accordance with applicable accounting guidelines only establish accrual liabilities when losses are deemed probable and reasonably estimable and only revise previously-established accrual liabilities when warranted by changes in circumstances, in each case based on then-available information. As such, as of any given date we could have exposure to losses under proceedings as to which no liability has been accrued or as to which the accrued liability is inadequate. Amounts accrued for our litigation and non-income tax contingencies at March 31, 2021 aggregated to approximately $58 million and are included in other current liabilities and other liabilities in our consolidated balance sheet as of such date. The establishment of an accrual does not mean that actual funds have been set aside to satisfy a given contingency. Thus, the resolution of a particular contingency for the amount accrued could have no effect on our results of operations but nonetheless could have an adverse effect on our cash flows.
Peruvian Tax Litigation
In 2005, the Peruvian tax authorities ("SUNAT") issued tax assessments against 1 of our Peruvian subsidiaries asserting $26 million, of additional income tax withholding and value-added taxes ("VAT"), penalties and interest for calendar years 2001 and 2002 on the basis that the Peruvian subsidiary incorrectly documented its importations. After taking into account the developments described below, as well as the accrued interest and foreign exchange effects, we believe the total amount of our exposure is $1 million at March 31, 2021.
We challenged the assessments via administrative and then judicial review processes. In October 2011, the highest administrative review tribunal (the Tribunal) decided the central issue underlying the 2002 assessments in SUNAT's favor. We appealed the Tribunal's decision to the first judicial level, which decided the central issue in favor of Level 3. SUNAT and we filed cross-appeals with the court of appeal. In May 2017, the court of appeal issued a decision reversing the first judicial level. In June 2017, we filed an appeal of the decision to the Supreme Court of Justice, the final judicial level. Oral argument was held before the Supreme Court of Justice in October 2018. A decision on this case is pending.
In October 2013, the Tribunal decided the central issue underlying the 2001 assessments in SUNAT’s favor. We appealed that decision to the first judicial level in Peru, which decided the central issue in favor of SUNAT. In June 2017, we filed an appeal with the court of appeal. In November 2017, the court of appeals issued a decision affirming the first judicial level and we filed an appeal of the decision to the Supreme Court of Justice. Oral argument was held before the Supreme Court of Justice in June 2019. A decision on this case is pending.
Brazilian Tax Claims
The São Paulo and Rio de Janeiro state tax authorities have issued tax assessments against our Brazilian subsidiaries for the Tax on Distribution of Goods and Services (“ICMS”), mainly with respect to revenue from leasing certain assets and revenue from the provision of Internet access services by treating such activities as the provision of communications services, to which the ICMS tax applies. We filed objections to these assessments in both states, arguing, among other things that neither the lease of assets nor the provision of Internet access qualifies as “communication services” subject to ICMS.
We have appealed to the respective state judicial courts the decisions by the respective state administrative courts that rejected our objections to these assessments. In cases in which state lower courts ruled partially in our favor finding that the lease assets are not subject to ICMS, the State appealed those rulings. In other cases, the assessment was affirmed at the first administrative level and we have appealed to the second administrative level. Other assessments are still pending state judicial decisions.
We are vigorously contesting all such assessments in both states and view the assessment of ICMS on revenue from equipment leasing and Internet access to be without merit. These assessments, if upheld, could result in a loss of $12 million to as high as $49 million as of March 31, 2021, in excess of the reserved accruals established for these matters.
Qui Tam Action
We were notified in late 2017 of a qui tam action pending against Level 3 Communications, Inc. and others in the U.S. District Court for the Eastern District of Virginia, captioned United States of America ex rel., Stephen Bishop v. Level 3 Communications, Inc. et al. The original qui tam complaint and an amended complaint were filed under seal on November 26, 2013 and June 16, 2014, respectively. The court unsealed the complaints on October 26, 2017.
The amended complaint alleges that we, principally through 2 former employees, submitted false claims and made false statements to the government in connection with 2 government contracts. The relator seeks damages in this lawsuit of approximately $50 million, subject to trebling, plus statutory penalties, pre-and-post judgment interest, and attorney’s fees. The case is currently stayed.
We are evaluating our defenses to the claims. If, contrary to our expectations, the plaintiff obtains an award of the approximate magnitude he has claimed, the award would significantly exceed the reserve we have accrued for the matter. Such an outcome could have a material adverse effect on our results of operations in the period in which a liability is recognized and on our cash flows for the period in which any damages are paid.
Several people, including 2 former Level 3 employees, were indicted in the U.S. District Court for the Eastern District of Virginia on October 3, 2017, and charged with, among other things, accepting kickbacks from a subcontractor, who was also indicted, for work to be performed under a prime government contract. Of the 2 former employees, 1 entered into a plea agreement, and the other is deceased. We are fully cooperating in the government’s investigations in this matter.
Other Proceedings, Disputes and Contingencies
From time to time, we are involved in other proceedings incidental to our business, including patent infringement allegations, regulatory hearings relating primarily to our rates or services, actions relating to employee claims, various tax issues, environmental law issues, grievance hearings before labor regulatory agencies and miscellaneous third-party tort actions.
We are currently defending several patent infringement lawsuits asserted against us by non-practicing entities, many of which are seeking substantial recoveries. These cases have progressed to various stages and 1 or more may go to trial during 2021 if they are not otherwise resolved. Where applicable, we are seeking full or partial indemnification from our vendors and suppliers. As with all litigation, we are vigorously defending these actions and, as a matter of course, are prepared to litigate these matters to judgment, as well as to evaluate and consider all reasonable settlement opportunities.
We are subject to various foreign, federal, state and local environmental protection and health and safety laws. From time to time, we are subject to judicial and administrative proceedings brought by various governmental authorities under these laws. Several such proceedings are currently pending, but none individually is reasonably expected to exceed $300,000 in fines and penalties.
The outcome of these other proceedings described under this heading is not predictable. However, based on current circumstances, we do not believe that the ultimate resolution of these other proceedings, after considering available defenses and any insurance coverage or indemnification rights, will have a material adverse effect on us.
The matters listed above in this Note do not reflect all of our contingencies. For additional information on our contingencies, see Note 16—Commitments, Contingencies and Other Items to the financial statements included in Item 8 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2020. The ultimate outcome of the above-described matters may differ materially from the outcomes anticipated, estimated, projected or implied by us in certain of our statements appearing above in this Note, and proceedings currently viewed as immaterial by us may ultimately materially impact us.
(8) Accumulated Other Comprehensive Loss
The table below summarizes changes in accumulated other comprehensive loss recorded on our consolidated balance sheets by component for the three months ended March 31, 2021:
| | | | | | | | | | | | | | | | | |
| Pension Plans | | Foreign Currency Translation Adjustment and Other | | Total |
| (Dollars in millions) |
Balance at December 31, 2020 | $ | (13) | | | (221) | | | (234) | |
Other comprehensive loss, net of tax | 0 | | | (88) | | | (88) | |
Net other comprehensive loss | 0 | | | (88) | | | (88) | |
Balance at March 31, 2021 | $ | (13) | | | (309) | | | (322) | |
The table below summarizes changes in accumulated other comprehensive loss recorded on our consolidated balance sheets by component for the three months ended March 31, 2020:
| | | | | | | | | | | | | | | | | |
| Pension Plans | | Foreign Currency Translation Adjustment and Other | | Total |
| (Dollars in millions) |
Balance at December 31, 2019 | $ | 2 | | | (181) | | | (179) | |
Other comprehensive loss, net of tax | 0 | | | (228) | | | (228) | |
Net other comprehensive loss | 0 | | | (228) | | | (228) | |
Balance at March 31, 2020 | $ | 2 | | | (409) | | | (407) | |
During the three month periods ended March 31, 2021 and 2020, there were no reclassifications out of accumulated other comprehensive income (loss) in our statements of operations.
(9) Other Financial Information
Other Current Assets
The following table presents details of other current assets reflected in our consolidated balance sheets:
| | | | | | | | | | | |
| March 31, 2021 | | December 31, 2020 |
| (Dollars in millions) |
Prepaid expenses | $ | 165 | | | 106 | |
Contract fulfillment costs | 61 | | | 63 | |
Contract acquisition costs | 45 | | | 47 | |
Contract assets | 33 | | | 34 | |
Other | 50 | | | 47 | |
Total other current assets | $ | 354 | | | 297 | |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context requires otherwise, references in this report to “Level 3 Communications, Inc.,” "Level 3," “we,” “us,” "its," the “Company” and “our” refer to Level 3 Parent, LLC and its consolidated subsidiaries.
All references to "Notes" in this Item 2 of Part I refer to the Notes to Consolidated Financial Statements included in Item 1 of Part I of this report.
Certain statements in this report constitute forward-looking statements. See "Special Note Regarding Forward-Looking Statements" appearing at the beginning of this report and "Risk Factors" referenced in Item 1A of Part II of this report or other of our filings with the SEC for a discussion of certain factors that could cause our actual results to differ from our anticipated results or otherwise impact our business, financial condition, results of operations, liquidity or prospects.
Overview
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") included herein should be read in conjunction with MD&A and the other information included in our Annual Report on Form 10-K for the year ended December 31, 2020, and with the consolidated financial statements and related notes in Item 1 of Part I of this report. The results of operations and cash flows for the first three months of the year are not necessarily indicative of the results of operations and cash flows that might be expected for the entire year.
We are an international facilities-based technology and communications company engaged in providing a broad array of integrated communication services to our business customers. We created our communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.
Impact of COVID-19 Pandemic
In response to the safety and economic challenges arising out of the COVID-19 pandemic and in a continued attempt to mitigate the negative impact on our stakeholders, we have taken a variety of steps to ensure the availability of our network infrastructure, to promote the safety of our employees and customers, to enable us to continue to adapt and provide our products and services worldwide to our customers, and to strengthen our communities. In addition to other actions described in our earlier reports, these steps included:
•establishing protocols for the safety of our on-site technicians and customers, including our “Safe Connections” program;
•adopting a rigorous employee work-from-home policy and substantially restricting non-essential business travel;
•continuously monitoring our network to enhance its ability to respond to changes in usage patterns;
•donating products or services in several of our communities to enhance their abilities to provide necessary support services; and
•taking steps to maintain our internal controls and the security of our systems and data in a remote work environment.
As the pandemic continues and vaccination rates increase, we expect to revise our responses or take additional steps to adjust to changed circumstances.
Social distancing, business and school closures, travel restrictions, and other actions taken in response to the pandemic have impacted us, our customers and our business since March 2020. In conjunction with our plans to continue to reduce costs, we expect to continue our real estate rationalization efforts and incur additional costs in 2021. Additionally, as discussed further elsewhere herein, we have tracked pandemic impacts, including: (i) increases in certain revenue streams and decreases in others (including late fee revenue), (ii) increases in allowances for credit losses through the end of 2020, (iii) increases in overtime expenses and (iv) delays in our cost transformation initiatives. Thus far, these changes have not materially impacted our financial performance or financial position, and, barring any unforeseen changes in conditions, we do not expect these changes to materially impact us during 2021. The impact of the pandemic during 2021 will materially depend on additional steps that we may take in response to the pandemic and various events outside of our control, including the pace of vaccinations worldwide, the length and severity of the health crisis and economic dislocations, actions taken by central banks,
governmental agencies or legislative bodies, and the impact of those events on our employees, suppliers and customers. For additional information, see the risk factor disclosures referenced in Item 1A of Part II of this report.
Beginning in the first quarter of 2021, we categorized our products, services and revenue among the following five categories:
•Compute and Application Services, which include our Edge Cloud services, IT solutions, Unified Communications and Collaboration ("UC&C"), data center, content delivery network ("CDN") and Managed Security services;
•IP and Data Services, which include Ethernet, IP, and VPN data networks, including software-defined wide area networks ("SD WAN") based services, Dynamic Connections and Hyper WAN;
•Fiber Infrastructure Services, which include dark fiber, optical services and equipment;
•Voice and Other, which includes Time Division Multiplexing ("TDM") voice, private line and other legacy services; and
•Affiliate Services, which include telecommunication services provided to our affiliates that we also provide to our external customers.
From time to time, we may change the categorization of our products and services.
Results of Operations
The following table summarizes the results of our consolidated operations for the three months ended March 31, 2021 and March 31, 2020:
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2021 | | 2020 |
| (Dollars in millions) |
Operating revenue | $ | 1,989 | | | 1,980 | |
Operating expenses | 1,716 | | | 1,695 | |
Operating income | 273 | | | 285 | |
Other expense, net | (71) | | | (127) | |
Income before income taxes | 202 | | | 158 | |
Income tax expense | 51 | | | 45 | |
Net income | $ | 151 | | | 113 | |
For a discussion of certain trends that impact our business, see the MD&A discussion of trends impacting Lumen’s non-mass market business included in Lumen’s reports filed with the SEC, including its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2021.
Operating Revenue
The following tables summarize our consolidated operating revenue recorded under our five above-described revenue categories:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2021 | | 2020 | | % Change |
| (Dollars in millions) | |
Compute and Application Services | $ | 280 | | | 275 | | | 2 | % |
IP and Data Services | 881 | | | 881 | | | — | % |
Fiber Infrastructure Services | 397 | | | 369 | | | 8 | % |
Voice and Other | 376 | | | 407 | | | (8) | % |
Affiliate Services | 55 | | | 48 | | | 15 | % |
Total operating revenue | $ | 1,989 | | | 1,980 | | | — | % |
Our total operating revenue increased by $9 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to increases in IP and wavelength services, which were partially offset by VPN data network and voice services.
Operating Expenses
The following tables summarize our consolidated operating expenses:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2021 | | 2020 | | % Change |
| (Dollars in millions) | |
Cost of services and products (exclusive of depreciation and amortization) | $ | 878 | | | 876 | | | — | % |
Selling, general and administrative | 294 | | | 310 | | | (5) | % |
Operating expenses - affiliates | 107 | | | 93 | | | 15 | % |
Depreciation and amortization | 437 | | | 416 | | | 5 | % |
Total operating expenses | $ | 1,716 | | | 1,695 | | | 1 | % |
Cost of Services and Products (Exclusive of depreciation and amortization)
Cost of services and products (exclusive of depreciation and amortization) increased by $2 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to increases in facility costs from an increase in installations, which were partially offset by lower employee-related expenses, customer premises equipment expenses from lower sales, and direct taxes and fees.
Selling, General and Administrative
Selling, general and administrative decreased by $16 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to the transfer of certain employees to affiliates, employee-related benefits, marketing and advertising expenses and bad debt expenses, which were partially offset by higher salaries and wages from higher headcount, professional fees, and property and other taxes.
Operating Expenses - Affiliates
Operating expenses - affiliates increased by $14 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020, primarily due to an increase in the level of services provided to us by our affiliates for leased circuits and IRU leases. The increase is also due to transferring certain employees to other affiliates, which results in expenses being allocated back to us through operating expenses - affiliates rather than included in selling, general and administrative expenses. These increases were partially offset by lower overall employee related expenses allocated from our affiliates.
Depreciation and Amortization
The following tables provide detail regarding depreciation and amortization expense:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2021 | | 2020 | | % Change |
| (Dollars in millions) | |
Depreciation | $ | 226 | | | 208 | | | 9 | % |
Amortization | 211 | | | 208 | | | 1 | % |
Total depreciation and amortization | $ | 437 | | | 416 | | | 5 | % |
Depreciation expense increased by $18 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to higher depreciation expense of $15 million associated with net growth in depreciable assets.
Amortization expense increased by $3 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to higher amortization expense associated with net growth in amortizable assets.
Other Consolidated Results
The following tables summarize other expense, net and income tax expense:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2021 | | 2020 | | % Change |
| (Dollars in millions) | |
Interest income - affiliate | $ | 18 | | | 13 | | | 38 | % |
Interest expense | (93) | | | (106) | | | (12) | % |
Other income (expense), net | 4 | | | (34) | | | (112) | % |
Total other expense, net | $ | (71) | | | (127) | | | (44) | % |
Income tax expense | $ | 51 | | | 45 | | | 13 | % |
Interest Income - Affiliate
Interest income - affiliate increased by $5 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to an increase in the average interest rate associated with our note receivable - affiliate balance.
Interest Expense
Interest expense decreased by $13 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to a decrease in the average interest rate from 4.35% to 3.61%.
Other Income (Expense), Net
The following table summarizes our total other income (expense), net:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | % Change |
| 2021 | | 2020 | |
| (Dollars in millions) | |
Gain on extinguishment of debt | $ | 16 | | | — | | | nm |
Foreign currency loss | (11) | | | (26) | | | (58) | % |
Interest income | — | | | 1 | | | nm |
Other | (1) | | | (9) | | | (89) | % |
Total other income (expense), net | $ | 4 | | | (34) | | | (112) | % |
_______________________________________________________________________________
nm Percentages greater than 200% and comparisons between positive and negative values or to/from zero values are considered not meaningful.
Income Tax Expense
For the three months ended March 31, 2021 and 2020, our effective income tax rate was 25.2% and 28.5%, respectively. The decrease in the effective tax rate for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily related to a favorable impact from U.S. tax law changes regarding Global Intangible Low Taxed Income regulations.
Liquidity and Capital Resources
Overview
As of March 31, 2021, we held cash and cash equivalents of $234 million, of which $81 million were held in foreign bank accounts for funding our foreign operations. Due to various factors, our access to foreign cash is generally more restricted than our access to domestic cash.
Debt and Other Financing Arrangements
As of March 31, 2021 and December 31, 2020, our long-term debt (including current maturities and finance leases) totaled $10.4 billion. See Note 5—Long-Term Debt.
Subject to market conditions, from time to time we expect to continue to issue term debt or senior notes to refinance our maturing debt. The availability, interest rate and other terms of any new borrowings will be impacted by the ratings assigned us by the three major credit rating agencies, among other factors. As of the date of this report, the credit ratings for the senior secured and unsecured debt of Level 3 Financing, Inc. were as follows:
| | | | | | | | | | | | | | | | | | | | |
Borrower | | Moody's Investor Services, Inc. | | Standard & Poor's | | Fitch Ratings |
Level 3 Financing, Inc. | | | | | | |
Unsecured | | Ba3 | | BB | | BB |
Secured | | Ba1 | | BBB- | | BBB- |
Our credit ratings are reviewed and adjusted from time to time by the rating agencies. Any future downgrades of the senior unsecured or secured debt ratings of Level 3 Financing, Inc. could impact our access to debt capital or further raise our borrowing costs. See "Risk Factors—Financial Risks" in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2020.
See Note 5—Long-Term Debt for additional information about our long-term debt.
Letters of Credit
It is customary for us to use various financial instruments in the normal course of business. These instruments include letters of credit. Letters of credit are conditional commitments issued on our behalf in accordance with specified terms and conditions. As of March 31, 2021 and December 31, 2020, we had outstanding letters of credit or other similar obligations, of approximately $15 million and $18 million, respectively, of which $10 million and $11 million, respectively, were collateralized by restricted cash. We do not believe exposure to loss related to our letters of credit is material.
Future Contractual Obligations
For information regarding our estimated future contractual obligations, see the MD&A discussion included in Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2020.
Historical Information
The following table summarizes our consolidated cash flow activities:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| 2021 | | 2020 | | $ Change |
| (Dollars in millions) |
Net cash provided by operating activities | $ | 328 | | | 395 | | | (67) | |
Net cash used in investing activities | $ | (272) | | | (194) | | | 78 | |
Net cash used in financing activities | $ | (15) | | | (279) | | | (264) | |
Operating Activities
Net cash provided by operating activities decreased by $67 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020, primarily due to a decrease in the contribution from working capital, which was partially offset by an increase in net income adjusted for non-cash items. Cash provided by operating activities is subject to variability period over period as a result of timing, including the collection of receivables and payments of interest, accounts payable, and bonuses.
Investing Activities
Net cash used in investing activities increased by $78 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to a decrease in receipt of affiliate notes receivable payments and a decrease in proceeds from the sale of property, plant and equipment, which was partially offset by a decrease in capital expenditures.
Financing Activities
Net cash used in financing activities decreased by $264 million for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 primarily due to an increase in net proceeds from issuance of long-term debt and a decrease in distributions, which was partially offset by an increase in payments of long-term debt.
Other Matters
We are subject to various legal proceedings and other contingent liabilities that individually or in the aggregate could materially affect our financial condition, future results of operations or cash flows. See Note 7—Commitments, Contingencies and Other Items for additional information.
Lumen Technologies is involved in several legal proceedings to which we are not a party that, if resolved against it, could have a material adverse effect on its business and financial condition. As a wholly owned subsidiary of Lumen Technologies, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in Lumen's quarterly and annual reports filed with the SEC. Because we are not a party to any of the matters, we have not accrued any liabilities for these matters.
Summarized Financial Information
Level 3 Financing, Inc., our wholly owned subsidiary, has registered two series of currently outstanding Senior Notes that are fully and unconditionally and jointly and severally guaranteed on an unsubordinated unsecured basis by Level 3 Parent, LLC and Level 3 Communications, LLC. Level 3 Financing, Inc., Level 3 Parent, LLC and Level 3 Communications, LLC are collectively referred to as the “Obligor Group.”
In conjunction with the registration of those Level 3 Financing, Inc. Senior Notes under the Securities Act of 1933, we have presented below the accompanying summarized financial information pursuant to SEC Regulation S-X Rule 13-01 "Guarantors and issuers of guaranteed securities registered or being registered."
The summarized financial information set forth below excludes subsidiaries that are not within the Obligor Group and presents transactions between the Obligor Group and the subsidiaries that do not guarantee the Senior Notes (the “Non-Guarantor Subsidiaries”). Investment in and equity in earnings of subsidiaries have been excluded from the summarized financial information.
The following tables present summarized financial information specified in Rule 1-02(bb)(1) of Regulation S-X for the three months ended March 31, 2021:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2021 |
| Level 3 Parent, LLC | | Level 3 Financing, Inc. | | Level 3 Communications, LLC |
| (Dollars in millions) |
Operating revenue | $ | — | | | — | | | 1,024 | |
Operating revenue-affiliates | — | | | — | | | 54 | |
Operating expenses | (25) | | | — | | | 986 | |
Operating expenses-affiliates | — | | | — | | | 84 | |
Operating income (loss) | 25 | | | — | | | 8 | |
Net income (loss) | 1,087 | | | 66 | | | (1,175) | |
The following tables present summarized financial information reflected in our consolidated balance sheet as of March 31, 2021 and December 31, 2020, respectively:
| | | | | | | | | | | | | | | | | |
| March 31, 2021 |
| Level 3 Parent, LLC | | Level 3 Financing, Inc. | | Level 3 Communications, LLC |
| (Dollars in millions) |
Advances to affiliates | $ | 21,050 | | | 30,048 | | | — | |
Note receivable-affiliate | 1,468 | | | — | | | — | |
Other current assets | 34 | | | — | | | 479 | |
Operating lease assets - affiliates | — | | | — | | | 614 | |
Other noncurrent assets | 271 | | | 1,613 | | | 8,796 | |
Accounts payable-affiliates | 78 | | | 21 | | | 597 | |
Current operating lease liabilities-affiliates | — | | | — | | | 135 | |
Due to affiliates | — | | | — | | | 56,533 | |
Other current liabilities | 2 | | | 67 | | | 741 | |
Non-current operating lease liabilities-affiliates | — | | | — | | | 486 | |
Other noncurrent liabilities | 84 | | | 10,104 | | | 2,635 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2020 |
| Level 3 Parent, LLC | | Level 3 Financing, Inc. | | Level 3 Communications, LLC |
| (Dollars in millions) |
Advances to affiliates | $ | 19,985 | | | 30,062 | | | — | |
Note receivable-affiliate | 1,468 | | | — | | | — | |
Other current assets | 18 | | | — | | | 432 | |
Operating lease assets - affiliates | — | | | — | | | 472 | |
Other noncurrent assets | 271 | | | 1,595 | | | 8,811 | |
Accounts payable-affiliates | 85 | | | 21 | | | 773 | |
Current operating lease liabilities-affiliates | — | | | — | | | 107 | |
Due to affiliates | — | | | — | | | 55,114 | |
Other current liabilities | 1 | | | 101 | | | 774 | |
Non-current operating lease liabilities-affiliates | — | | | — | | | 377 | |
Other noncurrent liabilities | 83 | | | 10,131 | | | 2,636 | |
Market Risk
At March 31, 2021, we were exposed to market risk from changes in interest rates on our variable rate long-term debt obligations. We seek to maintain a favorable mix of fixed and variable rate debt in an effort to limit interest costs and cash flow volatility resulting from changes in rates.
As of March 31, 2021, we had approximately $10.1 billion (excluding unamortized premiums, net unamortized debt issuance costs and finance leases) of long-term debt outstanding, 69% of which bears interest at fixed rates and is therefore not exposed to interest rate risk. We also held $3.1 billion of floating rate debt exposed to changes in the LIBOR. A hypothetical increase of 100 basis points in LIBOR relative to this debt would decrease our annual pre-tax earnings by $31 million.
By operating internationally, we are exposed to the risk of fluctuations in the foreign currencies used by our international subsidiaries, including the British Pound, the Euro, the Brazilian Real and the Argentinian Peso. Although the percentages of our consolidated revenue and costs that are denominated in these currencies are immaterial, our consolidated results of operations could be adversely impacted by volatility in exchange rates or an increase in the number of foreign currency transactions.
Certain shortcomings are inherent in the method of analysis presented in the computation of exposures to market risks. Actual values may differ materially from those presented above if market conditions vary from the assumptions used in the analyses performed. These analyses only incorporate the risk exposures that existed at March 31, 2021.
Other Information
Lumen's and our website is www.lumen.com. We routinely post important investor information in the "Investor Relations" section of our website at ir.lumen.com. The information contained on, or that may be accessed through, our website is not part of this quarterly report. You may obtain free electronic copies of annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K filed by us or our ultimate controlling member Lumen Technologies, Inc., and all amendments to those reports, in the "Investor Relations" section of our website (ir.lumen.com) under the heading "SEC Filings." These reports are available on our website as soon as reasonably practicable after they are electronically filed with the SEC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Omitted pursuant to General Instruction H(2).
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or furnish under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. These include controls and procedures designed to ensure this information is accumulated and communicated to our senior management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management, with the participation of our Chief Executive Officer, Jeff K. Storey, and our Executive Vice President and Chief Financial Officer, Indraneel Dev, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2021. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded our disclosure controls and procedures were effective, as of March 31, 2021, in providing reasonable assurance the information required to be disclosed by us in this report was accumulated and communicated in the manner provided above.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the first quarter of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations of Internal Controls
The effectiveness of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events and the inability to eliminate misconduct completely. As a result, there can be no assurance that our disclosure controls and procedures will detect all errors or fraud. By their nature, our or any system of disclosure controls and procedures can provide only reasonable assurance regarding management's control objectives.
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information contained in Note 7—Commitments, Contingencies and Other Items, included in Item 1 of Part I of this quarterly report on Form 10-Q is incorporated herein by reference. The ultimate outcome of the matters described in Note 7 may differ materially from the outcomes anticipated, estimated, projected or implied by us in certain of our statements appearing in such Note, and proceedings currently viewed as immaterial by us may ultimately materially impact us. For more information, see “Risk Factors—Legal and Regulatory Risks—Our pending legal proceedings could have a material adverse impact on us” in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2020.
ITEM 1A. RISK FACTORS
Our operations and financial results are subject to various risks and uncertainties, which could adversely affect our business, financial condition or future results. We urge you to carefully consider (i) the other information set forth in this report and (ii) the risk factors discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020.
ITEM 5. OTHER INFORMATION
As we continue to evaluate our disclosure obligations under Section 13(r) of the Exchange Act in connection with the matter outlined below, the following disclosure is being made under Section 13(r) of the Exchange Act out of an abundance of caution:
We are required to engage on a regular basis with the Russian Federal Security Service (“FSB”) in the FSB’s official capacity of regulating our use of technology in Russia in connection with providing commercial services therein through our local subsidiary. On March 2, 2021, the U.S. Secretary of State designated the FSB as a party subject to the provisions of U.S. Executive Order No. 13382 issued in 2005. There are no gross revenues or net profits directly associated with any such dealings by us with the FSB and all such dealings are explicitly authorized by General License 1B issued by the U.S. Department of the Treasury’s Office of Foreign Assets Control. We plan to continue these activities as required to continue to provide commercial services in Russia.
ITEM 6. EXHIBITS
Exhibits identified in parentheses below are on file with the SEC and are incorporated herein by reference. All other exhibits are provided as part of this electronic submission.
| | | | | |
22.1* | |
31.1* | |
31.2* | |
32.1* | |
32.2* | |
101* | The following materials from the Quarterly Report on Form 10-Q of Level 3 Parent, LLC for the quarter ended March 31, 2021, formatted in Inline XBRL (eXtensible Business Reporting Language); (i) Consolidated Statements of Operations, (ii) Consolidated Statements of Comprehensive Income (Loss), (iii) Consolidated Balance Sheets, (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Member's Equity and (vi) Notes to Consolidated Financial Statements. |
104* | Cover page formatted as Inline XBRL and contained in Exhibit 101. |
_______________________________________________________________________________
* Exhibit filed herewith.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on May 5, 2021.
| | | | | | | | |
| LEVEL 3 PARENT, LLC |
| By: | /s/ Eric J. Mortensen |
| Eric J. Mortensen Senior Vice President - Controller (Principal Accounting Officer) |