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. Level 3's results of operations have been included in our consolidated results of operations since November 1, 2017.

As of September 30, 2018, our preliminary estimated amount of aggregate consideration was $19.6 billion.

We have recognized the assets and liabilities of Level 3 based on our 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 we paid in the combination is 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. We are reviewing our valuation analysis along with the related allocation to goodwill. We expect to complete our final fair value determinations during the fourth quarter of 2018. We are also reviewing our calculations of the estimates of the fair value of Level 3’s deferred tax assets acquired and liabilities assumed and performing related final controls. Our final fair value determinations may be different than those reflected in our consolidated financial statements at September 30, 2018, however we do not expect that any subsequent modifications to the preliminary purchase price allocation will be material.

The U.S. Department of Justice approved the acquisition subject to conditions of a consent decree on October 2, 2017, which required us to divest (i) certain Level 3 metro network assets in three markets 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. During the second quarter of 2018, we sold network assets in Boise, Idaho and Albuquerque, New Mexico that we were required to divest as a condition of the merger. The proceeds from these sales were included in the proceeds from sale of property, plant and equipment in our consolidated statements of cash flows. No gain or loss was recognized with these transactions. All of the metro network assets were classified as assets held for sale on our consolidated balance sheet as of December 31, 2017. The Tucson, Arizona assets continued to be classified as assets held for sale on our consolidated balance sheet as of September 30, 2018. In October 2018, we sold the Tucson, Arizona assets for their net book value.

Based solely on our preliminary estimates through September 30, 2018, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $11.2 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 September 30, 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 ⁽³⁾		Adjusted November 1, 2017 Balance as of September 30, 2018
	(Dollars in millions)
Cash, accounts receivable and other current assets ⁽¹⁾	$	3,317		(25	)	3,292
Property, plant and equipment	9,311			86		9,397
Identifiable intangible assets ⁽²⁾
Customer relationships	8,964			(476	)	8,488
Other	391			(13	)	378
Other noncurrent assets	782			203		985
Current liabilities, excluding current maturities of long-term debt	(1,461		)	(31	)	(1,492	)
Current maturities of long-term debt	(7		)	—		(7	)
Long-term debt	(10,888		)	—		(10,888	)
Deferred revenue and other liabilities	(1,629		)	(102	)	(1,731	)
Goodwill	10,837			353		11,190
Total estimated aggregate consideration	$	19,617		(5	)	19,612

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⁽¹⁾	Includes accounts receivable, which had a gross contractual value of $884 million on November 1, 2017 and September 30, 2018.


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


⁽³⁾	All purchase price adjustments occurred during the nine months ended September 30, 2018.

On the acquisition date, we assumed Level 3’s contingencies. For more information on our contingencies, see Note 12—Commitments and Contingencies and Other Items.

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 September 30,			Nine Months Ended September 30,
	2018		2017	2018	2017
	(Dollars in millions)
Transaction-related expenses	$	1	6	2	23
Integration-related expenses	43		28	275	40
Total acquisition-related expenses	$	44	34	277	63

Through September 30, 2018, we had incurred cumulative acquisition-related expenses of $600 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 and nine months ended September 30, 2018 and 2017, mean the business we operated prior to the Level 3 acquisition.

Combined Pro Forma Operating Results (Unaudited)

For the three and nine months ended September 30, 2018, our results of operations included operating revenues (net of intercompany eliminations) attributable to Level 3 of $1.984 billion and $6.071 billion, respectively.

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 September 30, 2017		Nine Months Ended September 30, 2017
	(Dollars in millions, except per share amounts)
Operating revenues	$	6,031	18,316
Net income	194		459
Basic earnings per common share	0.18		0.43
Diluted earnings per common share	0.18		0.43

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 transactions among CenturyLink and Level 3 that are now subject to intercompany elimination and the elimination of deferred revenues associated with installation activities that were preliminarily assigned no value at the acquisition date;


•	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 does not reflect:


•	the transaction costs incurred by us and Level 3 during the periods presented above (which are further described above in this note);


•	integration costs incurred by us in future periods; or


•	potential revenue enhancements, cost synergies or other operating efficiencies that could result from the acquisition

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