Acquisition of Level 3

On November 1, 2017, CenturyLink acquired Level 3 through successive merger transactions, including a merger of Level 3 with and into a merger subsidiary, which survived such merger as our indirect wholly-owned subsidiary under the name of Level 3 Parent, LLC. We entered into this acquisition to, among other things, realize certain strategic benefits, including enhanced financial and operational scale, market diversification and an enhanced combined network. As a result of the acquisition, Level 3 shareholders received $26.50 per share in cash and 1.4286 shares of CenturyLink common stock, with cash paid in lieu of fractional shares, for each outstanding share of Level 3 common stock they owned at closing, subject to certain limited exceptions. We issued this consideration with respect to all of the outstanding common stock of Level 3, with the exception of shares held by the dissenting common shareholders. Upon closing, CenturyLink shareholders owned approximately 51% and former Level 3 shareholders owned approximately 49% of the combined company.

In addition, each outstanding Level 3 restricted stock unit award granted prior to April 1, 2014 or granted to an outside director of Level 3 was converted into the right to receive $26.50 in cash and 1.4286 shares of CenturyLink common stock (and cash in lieu of fractional shares) with respect to each Level 3 share covered by such award (the "Converted RSU Awards"). Each outstanding Level 3 restricted stock unit award granted on or after April 1, 2014 (other than those granted to outside directors of Level 3) was converted into a CenturyLink restricted stock unit award using a conversion ratio of 2.8386 to 1 as determined in accordance with a formula set forth in the merger agreement (“the Continuing RSU Awards”).

As of March 31, 2018, our preliminary estimated amount of aggregate consideration of $19.612 billion is based on:


•	the 517.3 million shares of CenturyLink’s common stock (including those issued in connection with the Converted RSU Awards) issued to consummate the acquisition and the closing stock price of CenturyLink common stock at October 31, 2017 of $18.99;


•	the cash consideration of $26.50 per share on the 362.2 million common shares of Level 3 issued and outstanding as of October 31, 2017, and the cash consideration of $1 million paid on the Converted RSUs awards;


•	the estimated value of $131 million for the Continuing RSU Awards, which represents the pre-combination portion of Level 3’s share-based compensation awards replaced by CenturyLink share based awards; and


•	the approximately $58.0 million of cash paid to settle claims of former holders of dissenting shares.

At closing, CenturyLink assumed Level 3's long-term debt of approximately $10.6 billion.

The aggregate cash payments paid on or about the closing date were funded with the proceeds of $7.945 billion of term loans and $400 million of funds borrowed under our new revolving credit facility together with other available funds, which included $1.825 billion borrowed from Level 3 Parent, LLC. For additional information regarding CenturyLink’s financing of the Level 3 acquisition see Note 5—Long-Term Debt and Credit Facilities.

We have recognized the assets and liabilities of Level 3 based on CenturyLink’s preliminary estimates of the fair value of the acquired tangible and intangible assets and assumed liabilities of Level 3 as of November 1, 2017, the consummation date of the acquisition, with the excess aggregate consideration recorded as goodwill. The final determination of the allocation of the aggregate consideration paid by CenturyLink in the combination will be based on the fair value of such assets and liabilities as of the acquisition date with any excess aggregate consideration to be recorded as goodwill. The estimation of such fair values and the estimation of lives of depreciable tangible assets and amortizable intangible assets require significant judgment. As such, we have not completed our valuation analysis and calculations in sufficient detail necessary to arrive at the final estimates of the fair value of Level 3’s assets acquired and liabilities assumed, along with the related allocation to goodwill. The fair values of certain tangible assets, intangible assets, certain liabilities and residual goodwill are the most significant areas not yet finalized and therefore are subject to change. We expect to complete our final fair value determinations prior to the anniversary date of the acquisition. Our final fair value determinations may be significantly different than those reflected in our consolidated financial statements at March 31, 2018.

The U.S. Department of Justice approved the acquisition subject to conditions of a consent decree on October 2, 2017, which requires us to divest (i) certain metro network assets in the markets located in Albuquerque, New Mexico; Boise, Idaho; and Tucson, Arizona and (ii) 24 strands of dark fiber connecting 30 specified city-pairs across the United States in the form of an indefeasible right of use agreement. The metro network assets are classified as assets held for sale on the consolidated balance sheets as of March 31, 2018 and December 31, 2017. For additional information on the status of these divestiture proceedings, see "Subsequent Events" below in this Note 2.

Based solely on our preliminary estimates through March 31, 2018, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $11.141 billion, which we have recognized as goodwill. The goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that we expect to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes.

As of March 31, 2018, the following is our updated assignment of the preliminary estimated aggregate consideration:



	Adjusted November 1, 2017 Balance as of December 31, 2017			Purchase Price Adjustments		Adjusted November 1, 2017 Balance as of March 31, 2018
	(Dollars in millions)
Cash, accounts receivable and other current assets ⁽¹⁾	$	3,317		(3	)	3,314
Property, plant and equipment	9,311			92		9,403
Identifiable intangible assets ⁽²⁾
Customer relationships	8,964			(476	)	8,488
Other	391			(13	)	378
Other noncurrent assets	782			156		938
Current liabilities, excluding current maturities of long-term debt	(1,461		)	—		(1,461	)
Current maturities of long-term debt	(7		)	—		(7	)
Long-term debt	(10,888		)	—		(10,888	)
Deferred revenue and other liabilities	(1,629		)	(65	)	(1,694	)
Goodwill	10,837			304		11,141
Total estimated aggregate consideration	$	19,617		(5	)	19,612

____________________________________________________________________________________________________________


⁽¹⁾	Includes a preliminary estimated fair value of $866 million for accounts receivable, which had a gross contractual value of $884 million on November 1, 2017. The $18 million difference between the gross contractual value and the preliminary estimated fair value assigned represents our best estimate as of November 1, 2017 of contractual cash flows that will not be collected.


⁽²⁾	The preliminary estimate of the weighted-average amortization period for the acquired intangible assets is approximately 12.0 years.

Based upon the changes in the purchase price allocation as of March 31, 2018, our revised estimated amortization expense for intangible assets for the years ending December 31, 2018 through 2022 is as follows:



	(Dollars in millions)
Remainder of 2018	$	1,313
2019	1,677
2020	1,575
2021	1,143
2022	957

On the acquisition date, we assumed Level 3’s contingencies. For more information on our contingencies, see Note 11—Commitments and Contingencies.

Acquisition-Related Expenses

We have incurred acquisition-related expenses related to our acquisition of Level 3. The table below summarizes our acquisition-related expenses, which consist of integration-related expenses, including severance and retention compensation expenses, and transaction-related expenses:



	Three Months Ended March 31,
	2018		2017
	(Dollars in millions)
Transaction-related expenses	$	1	10
Integration-related expenses	70		—
Total acquisition-related expenses	$	71	10

Through March 31, 2018, we had incurred cumulative acquisition-related expenses of $393 million for Level 3. The total amounts of these expenses have been included in our selling, general and administrative expenses beginning in the fourth quarter of 2016.

Level 3 incurred transaction-related expenses of $47 million on the date of acquisition. This amount is not included in our results of operations.

References to Acquired Businesses

In the discussion that follows, we refer to the incremental business activities that we now operate as a result of the Level 3 acquisition as “Legacy Level 3”. References to “Legacy CenturyLink”, when used to compare our consolidated results for the three months ended March 31, 2018 and 2017, mean the business we operated prior to the Level 3 acquisition.

As a result of the acquisition of Level 3's net operating losses ("NOLs"), we expect to significantly reduce our federal cash taxes for the next several years.

Combined Pro Forma Operating Results (Unaudited)

For the three months ended March 31, 2018, CenturyLink's results of operations included operating revenues (net of intercompany eliminations) attributable to Level 3 of $2.062 billion.

The following unaudited pro forma financial information presents the combined results of CenturyLink as if the Level 3 acquisition had been consummated as of January 1, 2017.



	Three Months Ended March 31, 2017
Operating revenues	6,194
Net income	172
Basic earnings per common share	0.16
Diluted earnings per common share	0.16

This pro forma information reflects certain adjustments to previously-reported operating results, consisting primarily but not exclusively of:

•

decreased operating revenues and expenses due to the elimination of deferred revenues associated with installation activities that were preliminarily assigned no value at the acquisition date (excluding certain deferred revenue associated with certain long-term prepaid customer capacity arrangements, which have been included at its current carrying value) and the elimination of transactions among CenturyLink and Level 3 that are now subject to intercompany elimination;


•	increased amortization expense related to identifiable intangible assets, net of decreased depreciation expense to reflect the preliminary fair value of property, plant and equipment;

•

increased interest expense resulting from (i) interest on the new debt to finance the combination and amortization of the related debt discount and debt issuance costs, (ii) the elimination of Level 3’s historical amortization of debt discount and debt issuance costs and (iii) a reduction in interest expense due to the accretion of an adjustment to reflect the increased preliminary fair value of the long-term debt of Level 3 recognized on the acquisition date; and


•	the related income tax effects.

The pro forma information is presented for illustrative purposes only and does not necessarily reflect the actual results of operations had the Level 3 acquisition been consummated at January 1, 2017, nor is it necessarily indicative of future operating results. The pro forma information excludes transaction costs incurred by us and Level 3 during the quarterly periods presented above (which are further described above in this note) and does not reflect integration costs to be incurred by us in future periods. In addition, the pro forma information does not give effect to any potential revenue enhancements, cost synergies or other operating efficiencies that could result from the acquisitions (other than those actually realized in our historical consolidated financial statements after November 1, 2017).

As a result of the acquisition of Level 3's net operating losses ("NOLs"), we expect to significantly reduce our federal cash taxes for the next several years.

Subsequent Events

On May 4, 2018, we sold Level 3 network assets in Boise that we were required to divest as a condition to the merger. These assets were classified as assets held for sale on our March 31, 2018 and December 31, 2017 consolidated balance sheets and no gain or loss was recognized on this transaction.

On January 22, 2018, we entered an agreement to sell certain Level 3 intangible assets for $68 million. We received a deposit of $34 million in the first quarter of 2018 and it is recorded in other current liabilities on our March 31, 2018 consolidated balance sheet. The receipt of this $34 million is reflected in our cash flows from investing activities on our March 31, 2018 statement of cash flows. The remaining $34 million was collected in the second quarter of 2018.