Edgar Filing: CHESAPEAKE ENERGY CORP

CHK-2014.03.31_10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2014

[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File No. 1-13726

Chesapeake Energy Corporation

(Exact name of registrant as specified in its charter)



Oklahoma		73-1395733
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
6100 North Western Avenue
Oklahoma City, Oklahoma		73118
(Address of principal executive offices)		(Zip Code)

(405) 848-8000

(Registrant’s telephone number, including area code)

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 [X] NO [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). YES [X] 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 the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer [X] Accelerated Filer [ ] Non-accelerated Filer [ ] Smaller Reporting Company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]

As of April 30, 2014, there were 666,211,707 shares of our $0.01 par value common stock outstanding.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2014



	PART I. FINANCIAL INFORMATION
		Page
Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013	1
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2014 and 2013	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013	5
	Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2014 and 2013	7
	Notes to the Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	53
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	69
Item 4.	Controls and Procedures	73
PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	73
Item 1A.	Risk Factors	75
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 3.	Defaults Upon Senior Securities	75
Item 4.	Mine Safety Disclosures	75
Item 5.	Other Information	75
Item 6.	Exhibits	76

PART I. FINANCIAL INFORMATION

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



	March 31, 2014			December 31, 2013
	($ in millions)
CURRENT ASSETS:
Cash and cash equivalents ($1 and $1 attributable to our VIE)	$	1,004		$	837
Restricted cash	75			75
Accounts receivable, net	2,593			2,222
Short-term derivative assets	2			—
Deferred income tax asset	243			223
Other current assets	358			299
Total Current Assets	4,275			3,656
PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full cost accounting:
Proved natural gas and oil properties ($488 and $488 attributable to our VIE)	57,399			56,157
Unproved properties	11,672			12,013
Oilfield services equipment	2,239			2,192
Other property and equipment	3,429			3,203
Total Property and Equipment, at Cost	74,739			73,565
Less: accumulated depreciation, depletion and amortization (($190) and ($168) attributable to our VIE)	(37,844		)	(37,161		)
Property and equipment held for sale, net	627			730
Total Property and Equipment, Net	37,522			37,134
LONG-TERM ASSETS:
Investments	288			477
Long-term derivative assets	11			4
Other long-term assets	509			511
TOTAL ASSETS	$	42,605		$	41,782

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(Unaudited)



	March 31, 2014			December 31, 2013
	($ in millions)
CURRENT LIABILITIES:
Accounts payable	$	1,786		$	1,596
Short-term derivative liabilities ($6 and $5 attributable to our VIE)	417			208
Current maturities of long-term debt, net	316			—
Accrued interest	145			200
Other current liabilities ($19 and $22 attributable to our VIE)	3,294			3,511
Total Current Liabilities	5,958			5,515
LONG-TERM LIABILITIES:
Long-term debt, net	12,653			12,886
Deferred income tax liabilities	3,828			3,407
Long-term derivative liabilities	395			445
Asset retirement obligations	443			405
Other long-term liabilities	851			984
Total Long-Term Liabilities	18,170			18,127
CONTINGENCIES AND COMMITMENTS (Note 4)
EQUITY:
Chesapeake Stockholders’ Equity:
Preferred stock, $0.01 par value, 20,000,000 shares authorized: 7,251,515 shares outstanding	3,062			3,062
Common stock, $0.01 par value, 1,000,000,000 shares authorized: 665,214,625 and 666,192,371 shares issued	7			7
Paid-in capital	12,459			12,446
Retained earnings	1,012			688
Accumulated other comprehensive loss	(153		)	(162		)
Less: treasury stock, at cost; 1,986,178 and 2,002,029 common shares	(46		)	(46		)
Total Chesapeake Stockholders’ Equity	16,341			15,995
Noncontrolling interests	2,136			2,145
Total Equity	18,477			18,140
TOTAL LIABILITIES AND EQUITY	$	42,605		$	41,782

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



	Three Months Ended March 31,
	2014			2013
	($ in millions except per share data)
REVENUES:
Natural gas, oil and NGL	$	1,766		$	1,453
Marketing, gathering and compression	3,015			1,781
Oilfield services	265			190
Total Revenues	5,046			3,424
OPERATING EXPENSES:
Natural gas, oil and NGL production	288			307
Production taxes	50			53
Marketing, gathering and compression	2,980			1,745
Oilfield services	220			155
General and administrative	79			110
Restructuring and other termination costs	(7		)	133
Natural gas, oil and NGL depreciation, depletion and amortization	628			648
Depreciation and amortization of other assets	78			78
Impairments of fixed assets and other	20			27
Net gains on sales of fixed assets	(23		)	(49		)
Total Operating Expenses	4,313			3,207
INCOME FROM OPERATIONS	733			217
OTHER INCOME (EXPENSE):
Interest expense	(39		)	(21		)
Losses on investments	(21		)	(37		)
Net gain on sales of investments	67			—
Other income	6			6
Total Other Income (Expense)	13			(52		)
INCOME BEFORE INCOME TAXES	746			165
INCOME TAX EXPENSE
Current income taxes	3			1
Deferred income taxes	277			62
Total Income Tax Expense	280			63
NET INCOME	466			102
Net income attributable to noncontrolling interests	(41		)	(44		)
NET INCOME ATTRIBUTABLE TO CHESAPEAKE	425			58
Preferred stock dividends	(43		)	(43		)
Earnings allocated to participating securities	(8		)	—
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS	$	374		$	15
EARNINGS PER COMMON SHARE:
Basic	$	0.57		$	0.02
Diluted	$	0.54		$	0.02
CASH DIVIDEND DECLARED PER COMMON SHARE	$	0.0875		$	—
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic	658			651
Diluted	765			651

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)



	Three Months Ended March 31,
	2014			2013
	($ in millions)
NET INCOME	$	466		$	102
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAX:
Unrealized gain (loss) on derivative instruments, net of income tax expense (benefit) of $1 million and ($1) million	3			(1		)
Reclassification of loss on settled derivative instruments, net of income tax expense of $7 million and $7 million	11			12
Unrealized loss on investments, net of income tax benefit of $0 and ($3) million	—			(5		)
Reclassification of (gain) loss on investment, net of income tax expense (benefit) of ($3) million and $4 million	(5		)	6
Other Comprehensive Income	9			12
COMPREHENSIVE INCOME	475			114
COMPREHENSIVE INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS	(41		)	(44		)
COMPREHENSIVE INCOME ATTRIBUTABLE TO CHESAPEAKE	$	434		$	70

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three Months Ended March 31,
	2014			2013
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME	$	466		$	102
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization	706			726
Deferred income tax expense	277			62
Derivative losses, net	363			143
Cash (payments) receipts on derivative settlements, net	(157		)	12
Stock-based compensation	20			32
Net gains on sales of fixed assets	(23		)	(49		)
Impairments of fixed assets and other	12			27
Losses on investments	21			29
Net gain on sales of investments	(67		)	—
Restructuring and other termination costs	(9		)	105
Other	5			(10		)
Changes in assets and liabilities	(323		)	(255		)
Net Cash Provided By Operating Activities	1,291			924
CASH FLOWS FROM INVESTING ACTIVITIES:
Drilling and completion costs	(897		)	(1,579		)
Acquisitions of proved and unproved properties	(187		)	(280		)
Proceeds from divestitures of proved and unproved properties	49			190
Additions to other property and equipment	(437		)	(330		)
Proceeds from sales of other assets	239			201
Additions to investments	(3		)	(3		)
Proceeds from sales of investments	239			—
Decrease in restricted cash	—			55
Other	(2		)	1
Net Cash Used In Investing Activities	(999		)	(1,745		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facilities borrowings	421			3,632
Payments on credit facilities borrowings	(362		)	(2,811		)
Cash paid for common stock dividends	(58		)	(58		)
Cash paid for preferred stock dividends	(43		)	(43		)
Cash paid on financing derivatives	(15		)	(11		)
Cash paid for prepayment of mortgage	—			(55		)
Distributions to noncontrolling interest owners	(53		)	(57		)
Other	(15		)	(30		)
Net Cash Provided By (Used In) Financing Activities	(125		)	567
Net increase (decrease) in cash and cash equivalents	167			(254		)
Cash and cash equivalents, beginning of period	837			287
Cash and cash equivalents, end of period	$	1,004		$	33

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)

(Unaudited)

Supplemental disclosures to the condensed consolidated statements of cash flows are presented below:



	Three Months Ended March 31,
	2014			2013
	($ in millions)
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid, net of capitalized interest	$	75		$	60
Income taxes paid, net of refunds received	$	—		$	—

SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:
Change in accrued drilling and completion costs	$	(168	)	$	(79	)
Change in accrued acquisitions of proved and unproved properties	$	7		$	(3	)
Change in accrued additions to other property and equipment	$	(2	)	$	11

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)



	Three Months Ended March 31,
	2014			2013
	($ in millions)
PREFERRED STOCK:
Balance, beginning and end of period	$	3,062		$	3,062
COMMON STOCK:
Balance, beginning and end of period	7			7
PAID-IN CAPITAL:
Balance, beginning of period	12,446			12,293
Stock-based compensation	5			70
Tax benefit (reduction in tax benefit) from stock-based compensation	3			(10		)
Exercise of stock options	5			2
Balance, end of period	12,459			12,355
RETAINED EARNINGS:
Balance, beginning of period	688			437
Net income attributable to Chesapeake	425			58
Dividends on common stock	(58		)	—
Dividends on preferred stock	(43		)	—
Balance, end of period	1,012			495
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period	(162		)	(182		)
Hedging activity	14			11
Investment activity	(5		)	1
Balance, end of period	(153		)	(170		)
TREASURY STOCK – COMMON:
Balance, beginning of period	(46		)	(48		)
Purchase of 10,156 and 160,145 shares for company benefit plans	—			(3		)
Release of 26,007 and 77,892 shares from company benefit plans	—			2
Balance, end of period	(46		)	(49		)
TOTAL CHESAPEAKE STOCKHOLDERS’ EQUITY	16,341			15,700
NONCONTROLLING INTERESTS:
Balance, beginning of period	2,145			2,327
Net income attributable to noncontrolling interests	41			44
Distributions to noncontrolling interest owners	(50		)	(57		)
Balance, end of period	2,136			2,314
TOTAL EQUITY	$	18,477		$	18,014

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


1.	Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Chesapeake Energy Corporation ("Chesapeake" or the "Company") and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of our direct and indirect wholly owned subsidiaries and entities in which Chesapeake has a controlling financial interest. Intercompany accounts and balances have been eliminated.

This Form 10-Q relates to the three months ended March 31, 2014 (the “Current Quarter”) and the three months ended March 31, 2013 (the “Prior Quarter”). Chesapeake’s annual report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”) includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Form 10-Q. All material adjustments (consisting solely of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods have been reflected. The results for the Current Quarter are not necessarily indicative of the results to be expected for the full year.

Risks and Uncertainties

We recently conducted a company-wide review of our operations, assets and organizational structure to best position the Company to maximize shareholder value as we focus on our strategic priorities of financial discipline and profitable and efficient growth from captured resources. We intend to apply financial discipline through all aspects of our business, and we believe that the successful execution of this strategy will allow us to better balance capital expenditures with cash flow from operations as well as reduce financial leverage and complexity. While furthering our strategic priorities, certain actions that would reduce financial leverage and complexity could negatively impact our future results of operations and/or liquidity. We expect to incur various cash and noncash charges, including but not limited to impairments of fixed assets, lease termination charges, financing extinguishment costs and charges for unused natural gas transportation and gathering capacity.


2.	Earnings Per Share

Basic earnings per share (EPS) is calculated using the weighted average number of common shares outstanding during the period and includes the effect of any participating securities as appropriate. Participating securities consist of unvested restricted stock issued to our employees and non-employee directors that provide dividend rights.

Diluted EPS is calculated assuming issuance of common shares for all potentially dilutive securities, provided the effect is not antidilutive. For the Current Quarter and the Prior Quarter, our contingent convertible senior notes did not have a dilutive effect and therefore were excluded from the calculation of diluted EPS. See Note 3 for further discussion of our contingent convertible senior notes.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

For the Prior Quarter, our cumulative convertible preferred stock and participating securities and associated adjustments to net income, consisting of dividends on such shares, were excluded from the calculation of diluted EPS, as the effect was antidilutive. The impact of our stock options was immaterial in the calculation of diluted EPS for both the Current Quarter and the Prior Quarter. The following table sets forth the net income adjustments and shares of common stock related to our outstanding cumulative convertible preferred stock and participating securities in the Prior Quarter:



	Net Income Adjustments		Shares
	($ in millions)		(in millions)
Three Months Ended March 31, 2013:
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	21	56
5.75% cumulative convertible preferred stock (series A)	$	16	39
5.00% cumulative convertible preferred stock (series 2005B)	$	3	5
4.50% cumulative convertible preferred stock	$	3	6
Participating securities	$	—	—

For the Current Quarter, all outstanding equity securities that were convertible into common stock were included in the calculation of diluted EPS. A reconciliation of basic EPS and diluted EPS for the Current Quarter is as follows:



	Net Income Available to Common Stockholders (Numerator)		Weighted Average Shares (Denominator)	Per Share Amount
	(in millions, except per share data)
Three Months Ended March 31, 2014:
Basic EPS	$	374	658	$	0.57
Effect of Dilutive Securities:
Assumed conversion as of the beginning of the period of preferred shares outstanding during the period:
Common shares assumed issued for 5.75% cumulative convertible preferred stock	21		56
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)	16		39
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)	3		5
Common shares assumed issued for 4.50% cumulative convertible preferred stock	3		6
Outstanding stock options	—		1
Diluted EPS	$	417	765	$	0.54

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


3.	Debt

Our long-term debt consisted of the following as of March 31, 2014 and December 31, 2013:



	March 31, 2014			December 31, 2013
	($ in millions)
Term loan due 2017^(a)	$	2,000		$	2,000
9.5% senior notes due 2015^(b)	1,265			1,265
3.25% senior notes due 2016	500			500
6.25% euro-denominated senior notes due 2017^(c)	473			473
6.5% senior notes due 2017	660			660
6.875% senior notes due 2018^(d)	97			97
7.25% senior notes due 2018	669			669
6.625% senior notes due 2019^(e)	650			650
6.625% senior notes due 2020	1,300			1,300
6.875% senior notes due 2020	500			500
6.125% senior notes due 2021	1,000			1,000
5.375% senior notes due 2021	700			700
5.75% senior notes due 2023	1,100			1,100
2.75% contingent convertible senior notes due 2035^(f)	396			396
2.5% contingent convertible senior notes due 2037^(f)	1,168			1,168
2.25% contingent convertible senior notes due 2038^(f)	347			347
Corporate revolving bank credit facility	—			—
Oilfield services revolving bank credit facility	464			405
Discount on senior notes and term loan^(g)	(333		)	(357		)
Interest rate derivatives^(h)	13			13
Total debt, net	12,969			12,886
Less current maturities of long-term debt, net^(b)	(316		)	—
Total long-term debt, net	$	12,653		$	12,886

___________________________________________


(a)	We repaid the borrowings outstanding under the term loan due 2017 on April 24, 2014 with a portion of the net proceeds from our offering of $3.0 billion in aggregate principal amount of senior notes issued on April 24, 2014. See Note 19 for further discussion of refinancing transactions subsequent to March 31, 2014.

(b)

On April 10, 2014, we commenced a tender offer for the 9.5% Senior Notes due 2015 concurrently with an offering of senior notes. On April 24, 2014, we purchased approximately $946 million aggregate principal amount of notes that were tendered by the early tender date. The tender offer will expire on May 7, 2014, unless extended. See Note 19 for further discussion of refinancing transactions subsequent to March 31, 2014. The remaining $319 million in aggregate principal amount not tendered by the early tender date and the associated $3 million of discount are reflected as a current liability on our March 31, 2014 condensed consolidated balance sheet.


(c)	The principal amount shown is based on the exchange rate of $1.3769 to €1.00 and $1.3743 to €1.00 as of March 31, 2014 and December 31, 2013, respectively. See Note 8 for information on our related foreign currency derivatives.


(d)	On April 10, 2014, we called the 6.875% Senior Notes due 2018 for redemption on May 12, 2014. See Note 19 for discussion of refinancing transactions subsequent to March 31, 2014.


(e)	Issuers are Chesapeake Oilfield Operating, L.L.C. (COO), an indirect wholly owned subsidiary of the Company, and Chesapeake Oilfield Finance, Inc. (COF), a wholly owned subsidiary of COO formed solely to facilitate the

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

offering of the 6.625% Senior Notes due 2019. COF is nominally capitalized and has no operations or revenues. Chesapeake Energy Corporation is the issuer of all other senior notes and the contingent convertible senior notes.

(f)

The holders of our contingent convertible senior notes may require us to repurchase, in cash, all or a portion of their notes at 100% of the principal amount of the notes on any of four dates that are five, ten, fifteen and twenty years before the maturity date. The notes are convertible, at the holder’s option, prior to maturity under certain circumstances into cash and, if applicable, shares of our common stock using a net share settlement process. One such triggering circumstance is when the price of our common stock exceeds a threshold amount during a specified period in a fiscal quarter. Convertibility based on common stock price is measured quarterly. In the first quarter of 2014, the price of our common stock was below the threshold level for each series of the contingent convertible senior notes during the specified period and, as a result, the holders do not have the option to convert their notes into cash and common stock in the second quarter of 2014 under this provision. The notes are also convertible, at the holder’s option, during specified five-day periods if the trading price of the notes is below certain levels determined by reference to the trading price of our common stock. The notes were not convertible under this provision in the Current Quarter or the Prior Quarter. In general, upon conversion of a contingent convertible senior note, the holder will receive cash equal to the principal amount of the note and common stock for the note’s conversion value in excess of such principal amount. Under certain conditions, we will pay contingent interest on the convertible senior notes after they have been outstanding at least ten years. We may redeem the convertible senior notes once they have been outstanding for ten years at a redemption price of 100% of the principal amount of the notes, payable in cash. The optional repurchase dates, the common stock price conversion threshold amounts and the ending date of the first six-month period in which contingent interest may be payable for the contingent convertible senior notes are as follows:



Contingent Convertible Senior Notes	Repurchase Dates	Common Stock Price Conversion Thresholds		Contingent Interest First Payable (if applicable)
2.75% due 2035	November 15, 2015, 2020, 2025, 2030	$	48.09	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$	63.62	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$	106.75	June 14, 2019

(g)

Discount as of March 31, 2014 and December 31, 2013 included $284 million and $303 million, respectively, associated with the equity component of our contingent convertible senior notes. This discount is amortized based on an effective yield method. Discount also included $30 million and $33 million as of March 31, 2014 and December 31, 2013, respectively, associated with our term loan discussed further below.


(h)	See Note 8 for further discussion related to these instruments.

Term Loan

In November 2012, we established an unsecured five-year term loan credit facility in an aggregate principal amount of $2.0 billion for net proceeds of $1.935 billion. The term loan provided that it could be voluntarily repaid before November 9, 2015 at par plus a specified premium and at any time thereafter at par. The maturity date of the term loan was December 2, 2017. On April 24, 2014, the Company used a portion of the net proceeds from its offering of $3.0 billion in aggregate principal amount of senior notes to repay the borrowings under, and terminate, the term loan. See Note 19 for further discussion related to the refinancing transactions subsequent to March 31, 2014.

Chesapeake Senior Notes and Contingent Convertible Senior Notes

The Chesapeake senior notes and the contingent convertible senior notes are unsecured senior obligations of Chesapeake and rank equally in right of payment with all of our other existing and future senior unsecured indebtedness and rank senior in right of payment to all of our future subordinated indebtedness. Chesapeake is a holding company and owns no operating assets and has no significant operations independent of its subsidiaries. Chesapeake’s obligations under the senior notes and the contingent convertible senior notes are jointly and severally, fully and unconditionally guaranteed by certain of our direct and indirect 100% owned subsidiaries. See Note 17 for condensed consolidating financial information regarding our guarantor and non-guarantor subsidiaries.

We may redeem the senior notes, other than the contingent convertible senior notes, at any time at specified make-whole or redemption prices. Our senior notes are governed by indentures containing covenants that may limit

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

our ability and our subsidiaries’ ability to incur certain secured indebtedness, enter into sale/leaseback transactions, and consolidate, merge or transfer assets. The indentures governing the senior notes and the contingent convertible senior notes do not have any financial or restricted payment covenants. The senior notes and contingent convertible senior notes indentures have cross default provisions that apply to other indebtedness the Company or any guarantor subsidiary may have from time to time with an outstanding principal amount of at least $50 million, depending on the indenture.

We are required to account for the liability and equity components of our convertible debt instruments separately and to reflect interest expense at the interest rate of similar nonconvertible debt at the time of issuance. The applicable rates for our 2.75% Contingent Convertible Senior Notes due 2035, our 2.5% Contingent Convertible Senior Notes due 2037 and our 2.25% Contingent Convertible Senior Notes due 2038 are 6.86%, 8.0% and 8.0%, respectively.

In March 2013, the Company brought suit in the U.S. District Court for the Southern District of New York (the “Court”) against The Bank of New York Mellon Trust Company, N.A. (“BNY Mellon”), the indenture trustee for the 2019 Notes. The Company sought a declaration that the notice it issued on March 15, 2013 to redeem all of the 2019 Notes at par (plus accrued interest through the redemption date) was timely and effective pursuant to the special early redemption provision of the supplemental indenture governing the 2019 Notes. BNY Mellon asserted that the March 15, 2013 notice was not effective to redeem the 2019 Notes at par because it was not timely for that purpose and because of the specific phrasing in the notice that provided it would not be effective unless the Court concluded it was timely. The Court conducted a trial on the matter in late April and on May 8, 2013 ruled in the Company’s favor. On May 11, 2013, BNY Mellon filed notice of an appeal of the decision with the United States Court of Appeals for the Second Circuit and the appeal is currently pending.

No scheduled principal payments are required on our senior notes until February 2015. See Note 19 for discussion of senior notes refinancing transactions subsequent to March 31, 2014.

COO Senior Notes

The COO senior notes are the unsecured senior obligations of COO and rank equally in right of payment with all of COO’s other existing and future senior unsecured indebtedness and rank senior in right of payment to all of its future subordinated indebtedness. The COO senior notes are jointly and severally, fully and unconditionally guaranteed by all of COO’s wholly owned subsidiaries, other than de minimis subsidiaries. The notes may be redeemed by COO at any time at specified make-whole or redemption prices and, prior to November 15, 2014, up to 35% of the aggregate principal amount may be redeemed in connection with certain equity offerings. Holders of the COO notes have the right to require COO to repurchase their notes upon a change of control on the terms set forth in the indenture, and COO must offer to repurchase the notes upon certain asset sales. The COO senior notes are subject to covenants that may, among other things, limit the ability of COO and its subsidiaries to make restricted payments, incur indebtedness, issue preferred stock, create liens, and consolidate, merge or transfer assets. The COO senior notes have cross default provisions that apply to other indebtedness COO or any of its guarantor subsidiaries may have from time to time with an outstanding principal amount of $50 million or more.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Bank Credit Facilities

During the Current Quarter, we had the following two revolving bank credit facilities as sources of liquidity:



	Corporate Credit Facility^(a)		Oilfield Services Credit Facility^(b)
	($ in millions)
Facility structure	Senior secured revolving		Senior secured revolving
Maturity date	December 2015		November 2016
Borrowing capacity	$	4,000	$	500
Amount outstanding as of March 31, 2014	$	—	$	464
Letters of credit outstanding as of March 31, 2014	$	23	$	—

___________________________________________


(a)	Co-borrowers are Chesapeake Exploration, L.L.C., Chesapeake Appalachia, L.L.C. and Chesapeake Louisiana, L.P.


(b)	Borrower is COO.

Although the applicable interest rates under our corporate credit facility fluctuate based on our long-term senior unsecured credit ratings, our credit facilities do not contain provisions which would trigger an acceleration of amounts due under the respective facilities or a requirement to post additional collateral in the event of a downgrade of our credit ratings.

Corporate Credit Facility. Our $4.0 billion syndicated revolving bank credit facility is used for general corporate purposes. Borrowings under the facility are secured by proved reserves and bear interest at our option at either (i) the greater of the reference rate of Union Bank, N.A. or the federal funds effective rate plus 0.50%, both of which are subject to a margin that varies from 0.50% to 1.25% per annum according to our senior unsecured long-term debt ratings, or (ii) the Eurodollar rate, which is based on LIBOR, plus a margin that varies from 1.50% to 2.25% per annum according to our senior unsecured long-term debt ratings. The collateral value and borrowing base are determined periodically. The unused portion of the facility is subject to a commitment fee of 0.50% per annum. Interest is payable quarterly or, if LIBOR applies, it may be payable at more frequent intervals.

Our corporate credit facility agreement contains various covenants and restrictive provisions which limit our ability to incur additional indebtedness, make investments or loans and create liens and require us to maintain an indebtedness to total capitalization ratio and an indebtedness to EBITDA ratio, in each case as defined in the agreement. We were in compliance with all covenants under our corporate credit facility agreement as of March 31, 2014.

Our corporate credit facility is fully and unconditionally guaranteed, on a joint and several basis, by Chesapeake and certain of our wholly owned subsidiaries. If we should fail to perform our obligations under the credit facility agreement, the revolving credit commitment could be terminated and any outstanding borrowings under the facility could be declared immediately due and payable. Such acceleration, if involving a principal amount of $50 million or more, would constitute an event of default under our senior note and contingent convertible senior note indentures, which could in turn result in the acceleration of a significant portion of such indebtedness. The credit facility agreement also has cross default provisions that apply to our secured hedging facility, equipment master lease agreements, term loan and other indebtedness of Chesapeake and its restricted subsidiaries with an outstanding principal amount in excess of $125 million. In addition, the facility contains a restriction on our ability to declare and pay cash dividends on our common or preferred stock if an event of default has occurred.

Oilfield Services Credit Facility. Our $500 million syndicated oilfield services revolving bank credit facility is used to fund capital expenditures and for general corporate purposes associated with our oilfield services operations. Borrowings under the oilfield services credit facility are secured by all of the assets of the wholly owned subsidiaries of COO, itself an indirect wholly owned subsidiary of Chesapeake. The facility has initial commitments of $500 million and may be expanded to $900 million at COO’s option, subject to additional bank participation. Borrowings under the credit facility are secured by all of the equity interests and assets of COO and its wholly owned subsidiaries (the restricted subsidiaries for this facility, which are unrestricted subsidiaries under Chesapeake’s senior notes, contingent convertible senior notes, term loan and corporate revolving bank credit facility), and bear interest at our option at either

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

(i) the greater of the reference rate of Bank of America, N.A., the federal funds effective rate plus 0.50%, or one-month LIBOR plus 1.00%, all of which are subject to a margin that varies from 1.00% to 1.75% per annum, or (ii) the Eurodollar rate, which is based on LIBOR plus a margin that varies from 2.00% to 2.75% per annum. The unused portion of the credit facility is subject to a commitment fee that varies from 0.375% to 0.50% per annum. Both margins and commitment fees are determined according to the most recent leverage ratio described below. Interest is payable quarterly or, if LIBOR applies, it may be payable at more frequent intervals.

The oilfield services credit facility agreement contains various covenants and restrictive provisions which limit the ability of COO and its restricted subsidiaries to enter into asset sales, incur additional indebtedness, make investments or loans and create liens. The agreement requires maintenance of a leverage ratio based on the ratio of lease-adjusted indebtedness to earnings before interest, taxes, depreciation, amortization and rent (EBITDAR), a senior secured leverage ratio based on the ratio of secured indebtedness to EBITDA and a fixed charge coverage ratio based on the ratio of EBITDAR to lease-adjusted interest expense, in each case as defined in the agreement. COO was in compliance with all covenants under the agreement as of March 31, 2014. If COO or its restricted subsidiaries should fail to perform their obligations under the agreement, the revolving credit commitment could be terminated and any outstanding borrowings under the facility could be declared immediately due and payable. Such acceleration, if involving a principal amount of $50 million or more, would constitute an event of default under our COO senior note indenture, which could in turn result in the acceleration of the COO senior note indebtedness. The oilfield services credit facility agreement also has cross default provisions that apply to other indebtedness COO and its restricted subsidiaries may have from time to time with an outstanding principal amount in excess of $15 million.

Fair Value of Other Financial Instruments

We estimate the fair value of our exchange-traded debt using quoted market prices (Level 1). The fair value of all other debt, which consists of our credit facilities and our term loan, is estimated using our credit default swap rate (Level 2). Fair value is compared to the carrying value, excluding the impact of interest rate derivatives, in the table below.



	March 31, 2014				December 31, 2013
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
			($ in millions)
Long-term debt (Level 1)	$	10,522	$	11,639	$	10,501	$	11,557
Long-term debt (Level 2)	$	2,434	$	2,432	$	2,372	$	2,369


4.	Contingencies and Commitments

Contingencies

Litigation and Regulatory Proceedings

The Company is involved in a number of litigation and regulatory proceedings (including those described below). Many of these proceedings are in early stages, and many of them seek or may seek damages and penalties, the amount of which is indeterminate. We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. We account for legal defense costs in the period the costs are incurred.

July 2008 Common Stock Offering. On February 25, 2009, a putative class action was filed in the U.S. District Court for the Southern District of New York against the Company and certain of its officers and directors along with certain underwriters of the Company’s July 2008 common stock offering. The plaintiff filed an amended complaint on September 11, 2009 alleging that the registration statement for the offering contained material misstatements and omissions and seeking damages under Sections 11, 12 and 15 of the Securities Act of 1933 of an unspecified amount and rescission. The action was transferred to the U.S. District Court for the Western District of Oklahoma on October 13, 2009. Chesapeake and the officer and director defendants moved for summary judgment on grounds of loss causation and materiality on December 28, 2011, and the motion was granted as to all claims as a matter of law on March 29, 2013. Final judgment in favor of Chesapeake and the officer and director defendants was entered on June 21, 2013, and the plaintiff filed a notice of appeal on July 19, 2013 in the U.S. Court of Appeals for the Tenth Circuit. The appeal has been fully briefed and oral argument is scheduled for May 14, 2014. We are currently unable to assess the probability of loss or estimate a range of potential loss associated with this matter.

A derivative action relating to the July 2008 offering filed in the U.S. District Court for the Western District of Oklahoma on September 6, 2011 is pending. Following the denial on September 28, 2012 of its motion to dismiss and pursuant to court order, nominal defendant Chesapeake filed an answer in the case on October 12, 2012. By stipulation between the parties, the case is stayed pending resolution of the Tenth Circuit appeal.

2012 Securities and Shareholder Litigation. A putative class action was filed in the U.S. District Court for the Western District of Oklahoma on April 26, 2012 against the Company and its former Chief Executive Officer (CEO), Aubrey K. McClendon. On July 20, 2012, the court appointed a lead plaintiff, which filed an amended complaint on October 19, 2012 against the Company, Mr. McClendon and certain other officers. The amended complaint asserted claims under Sections 10(b) (and Rule 10b-5 promulgated thereunder) and 20(a) of the Securities Exchange Act of 1934 based on alleged misrepresentations regarding the Company’s asset monetization strategy, including liabilities associated with its volumetric production payment (VPP) transactions, as well as Mr. McClendon’s personal loans and the Company’s internal controls. On December 6, 2012, the Company and other defendants filed a motion to dismiss the action. On April 10, 2013, the Court granted the motion, and on April 16, 2013, entered judgment against the plaintiff and dismissed the complaint with prejudice. The plaintiff filed a notice of appeal on June 14, 2013 in the U.S. Court of Appeals for the Tenth Circuit. Briefing on the appeal was complete on August 2, 2013, and on November 18, 2013 argument was heard. We are currently unable to assess the probability of loss or estimate a range of potential loss associated with this matter.

A related federal consolidated derivative action and an Oklahoma state court derivative action are stayed pursuant to the parties' stipulation pending resolution of the appeal in the federal securities class action.

On May 8, 2012, a derivative action was filed in the District Court of Oklahoma County, Oklahoma against the Company's directors alleging, among other things, breaches of fiduciary duties and corporate waste related to the Company's officers and directors' use of the Company's fractionally owned corporate jets. On August 21, 2012, the District Court granted the Company's motion to dismiss for lack of derivative standing, and the plaintiff appealed the ruling on December 6, 2012.

2014 Shareholder Litigation. On April 10, 2014, a derivative action was filed in the District Court of Oklahoma County, Oklahoma against current and former directors and officers of the Company alleging, among other things, breach of fiduciary duties, waste of corporate assets, gross mismanagement and unjust enrichment related to the Company’s payment of shareholder dividends since October 2012.

Regulatory Proceedings. On May 2, 2012, Chesapeake and Mr. McClendon received notice from the U.S. Securities and Exchange Commission that its Fort Worth Regional Office had commenced an informal inquiry into, among other things, certain of the matters alleged in the foregoing 2012 securities and shareholder lawsuits. On December 21, 2012, the SEC’s Fort Worth Regional Office advised Chesapeake that its inquiry was continuing as an investigation. The Company provided information and testimony to the SEC pursuant to subpoenas and otherwise in connection with this matter and is also responding to related inquiries from other governmental and regulatory agencies and self-regulatory organizations. On April 8, 2014, the SEC’s Fort Worth Regional Office advised Chesapeake that it had concluded its investigation and, based on the information it had as of that date, did not intend to recommend an enforcement action by the SEC.

The Company has received, from the Antitrust Division of the U.S. Department of Justice (DOJ) and certain state governmental agencies, subpoenas and demands for documents, information and testimony in connection with investigations into possible violations of federal and state laws relating to our purchase and lease of oil and gas rights in various states. Chesapeake has engaged in discussions with the DOJ and state agencies and continues to respond to such subpoenas and demands. On March 5, 2014, the Attorney General of the state of Michigan filed a criminal complaint against Chesapeake in Michigan state court alleging misdemeanor antitrust violations and attempted antitrust violations under state law arising out of the Company’s leasing activities in Michigan during 2010.

Business Operations. Chesapeake is involved in various other lawsuits and disputes incidental to its business operations, including commercial disputes, personal injury claims, royalty claims, property damage claims and contract actions. With regard to contract actions, various mineral or leasehold owners have filed lawsuits against us seeking specific performance to require us to acquire their natural gas and oil interests and pay acreage bonus payments, damages based on breach of contract and/or, in certain cases, punitive damages based on alleged fraud. The Company has successfully defended a number of these cases in various courts, has settled others and believes that it has substantial defenses to the claims made in those pending at the trial court and on appeal. Regarding royalty claims, Chesapeake and other natural gas producers have been named in various lawsuits alleging royalty underpayment. The suits allege that we used below-market prices, made improper deductions, used improper measurement techniques and/or entered into arrangements with affiliates that resulted in underpayment of royalties in connection with the production and sale of natural gas and NGL. The Company is defending against certain pending claims, has resolved a number of claims through negotiated settlements of past and future royalties and has prevailed in various other lawsuits.

Based on management’s current assessment, we are of the opinion that no pending or threatened lawsuit or dispute relating to the Company’s business operations is likely to have a material adverse effect on its consolidated financial position, results of operations or cash flows. The final resolution of such matters could exceed amounts accrued, however, and actual results could differ materially from management’s estimates.

Environmental Proceedings

The nature of the natural gas and oil business carries with it certain environmental risks for Chesapeake and its subsidiaries. Chesapeake has implemented various policies, procedures, training and auditing to reduce and mitigate such environmental risks. Chesapeake conducts periodic reviews, on a company-wide basis, to assess changes in our environmental risk profile. Environmental reserves are established for environmental liabilities for which economic losses are probable and reasonably estimable. We manage our exposure to environmental liabilities in acquisitions by using an evaluation process that seeks to identify pre-existing contamination or compliance concerns and addressing the potential liability. Depending on the extent of an identified environmental concern, Chesapeake may, among other things, exclude a property from the transaction, require the seller to remediate the property to our satisfaction in an acquisition or agree to assume liability for the remediation of the property.

On December 19, 2013, our subsidiary Chesapeake Appalachia, LLC (CALLC) entered into a consent decree with the U.S. Environmental Protection Agency (EPA), the U.S. Department of Justice (DOJ) and the West Virginia Department of Environmental Protection (WVDEP) to resolve alleged violations of the Clean Water Act (CWA) and the West Virginia Water Pollution Control Act at 27 sites in West Virginia. In a complaint filed against CALLC the same day in the U.S. District Court for the Northern District of West Virginia, the EPA and WVDEP alleged that CALLC impounded streams and discharged sand, dirt, rocks and other fill material into streams and wetlands without a federal permit in order to construct well pads, impoundments, road crossings and other facilities related to natural gas extraction. The consent decree was approved and entered by the court on March 11, 2014.

In accordance with the consent decree, CALLC paid a civil penalty of $3.2 million, which was divided evenly between the U.S. and the state of West Virginia. The consent decree settlement also requires that CALLC restore the affected wetlands and streams in accordance with an agreed plan, monitor the restored sites for up to 10 years to assure the success of the restoration, and implement a comprehensive compliance program to ensure future compliance with the CWA and applicable West Virginia law. To offset the impacts to sites, CALLC is required by the consent decree to perform compensatory mitigation, which will likely involve purchasing credits from a wetland mitigation bank located in a local watershed. We believe that compliance with the consent decree will not have a material adverse impact on our business.

In a related case, in December 2012, CALLC pled guilty to three misdemeanor violations of the CWA for unauthorized discharge at one of the sites subject to the consent decree of crushed stone and gravel into a local stream to create a roadway to improve access to a drilling site. CALLC paid a $600,000 penalty and is subject to a two-year probation ending in December 2014. CALLC has fully restored the site, and we believe that CALLC is in compliance with the terms of probation. By operation of law, a CWA conviction triggers “disqualification”, by which the disqualified entity is prohibited from receiving federal contracts or benefits until the EPA certifies that the conditions giving rise to the conviction have been corrected. Disqualification of CALLC has not had, and we do not expect it to have, a material adverse impact on our business.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Commitments

Rig Leases

As of March 31, 2014, we leased 25 rigs under master lease agreements with an aggregate undiscounted future lease commitment of $20 million. The lease commitments are guaranteed by Chesapeake and certain of its subsidiaries. Under the leases, we can exercise an early purchase option or we can purchase the rigs at the expiration of the lease for the fair market value at the time. In addition, in most cases, we have the option to renew a lease for negotiated new terms at the expiration of the lease. Commitments related to rig lease payments are not recorded in the accompanying condensed consolidated balance sheets. During the Current Quarter, we purchased 20 leased rigs from various lessors for an aggregate purchase price of approximately $77 million and paid approximately $8 million in lease termination costs. Through these transactions, we lowered our minimum aggregate undiscounted future rig lease payments by approximately $43 million.

Compressor Leases

As of March 31, 2014, we leased 346 compressors under master lease agreements with an aggregate undiscounted future lease commitment of $63 million. The lease commitments are guaranteed by Chesapeake and certain of its subsidiaries. Under the leases, we can exercise an early purchase option or we can purchase the compressors at the expiration of the lease for the fair market value at the time. In addition, in most cases we have the option to renew a lease for negotiated new terms at the expiration of the lease. Commitments related to compressor lease payments are not recorded in the accompanying condensed consolidated balance sheets. During the Current Quarter, we purchased 1,435 leased compressor units from various lessors for an aggregate purchase price of approximately $271 million, lowering our minimum aggregate undiscounted future compressor lease payments by approximately $196 million.

Gathering, Processing and Transportation Agreements

We have contractual commitments with midstream service companies and pipeline carriers for future gathering, processing and transportation of natural gas and liquids to move certain of our production to market. Working interest owners and royalty interest owners, where appropriate, will be responsible for their proportionate share of these costs. Commitments related to gathering, processing and transportation agreements are not recorded in the accompanying condensed consolidated balance sheets; however, they are reflected as adjustments to natural gas, oil and NGL sales prices used in our proved reserves estimates.

The aggregate undiscounted commitments under our gathering, processing and transportation agreements, excluding any reimbursement from working interest and royalty interest owners or credits for third-party volumes, are presented below.



	March 31, 2014
	($ in millions)
2014	$	1,546
2015	1,830
2016	1,915
2017	1,948
2018	1,749
2019 - 2099	7,746
Total	$	16,734

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Drilling Contracts

Chesapeake has contracts with various drilling contractors to utilize 13 rigs with terms ranging from six months to three years. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of March 31, 2014, the aggregate undiscounted minimum future payments under these drilling rig commitments were approximately $109 million.

Drilling Commitments

In December 2011, as part of our Utica joint venture development agreement with Total S.A. (Total) (see Note 9), we committed to spud no less than 90 cumulative Utica wells by December 31, 2012, 270 cumulative wells by December 31, 2013 and 540 cumulative wells by July 31, 2015. Through March 31, 2014, we had spud 488 cumulative Utica wells and had met our 2012 and 2013 commitments. If we fail to meet the drilling commitment at July 31, 2015 for any reason other than a force majeure event, the drilling carry percentage used to determine our promoted well reimbursement will be reduced from 60% to 45% for the number of wells drilled in the subsequent 12-month period represented by the shortfall versus our drilling commitment. As such, any reduction would only affect the timing of the receipt of the drilling carry but not the total drilling carry to be received.

We have also committed to drill wells in conjunction with our CHK Utica and CHK C-T financial transactions and in conjunction with the formation of the Chesapeake Granite Wash Trust. See Note 6 for discussion of these transactions and commitments.

Property and Equipment Purchase Commitments

Much of the oilfield services and other equipment we purchase requires long production lead times. As a result, we have outstanding orders and commitments for such equipment. As of March 31, 2014, we had $117 million of purchase commitments related to future inventory and capital expenditures for oilfield services and other equipment.

Natural Gas and Liquids Purchase Commitments

We regularly commit to purchase natural gas and liquids from other owners in the properties we operate, including owners associated with our VPP transactions. Production purchased under these arrangements is based on market prices at the time of production, and the purchased natural gas and liquids are resold at market prices. See Note 9 for further discussion of our VPP transactions.

Net Acreage Maintenance Commitments

Under the terms of our joint venture agreements with Statoil, Total and Sinopec (see Note 9), we are required to extend, renew or replace certain expiring joint leasehold, at our cost, to ensure that the net acreage is maintained in certain designated areas. To date, we have satisfied our replacement commitments under the Statoil and Sinopec agreements. We estimate a shortfall of approximately 14,000 net acres pursuant to our net acreage maintenance commitment with Total under the terms of our Barnett Shale joint venture agreement and have accrued $28 million as of March 31, 2014. Total has disputed our estimate of the shortfall, however, and the cash payment we ultimately make to Total could exceed amounts we have accrued.

Affiliate Commitments

Under the terms of our corporate revolving bank credit facility, certain of our subsidiaries, including our oilfield services companies, are not guarantors of the credit facility debt. Transactions between us and our non-guarantor subsidiaries may affect our EBITDA or indebtedness for purposes of our credit facility covenant calculations, but they would have no effect on our consolidated financial statements because the transactions would be eliminated through consolidation. See Note 3 for discussion of our covenant calculations.

In October 2011, we entered into a services agreement with our wholly owned subsidiary, COO, under which we guarantee the utilization of a portion of COO’s drilling rig and hydraulic fracturing fleets during the term of the agreement. Through October 2016, we are subject to non-utilization fees if we do not operate a specific number of COO’s drilling rigs or utilize a specific number of its hydraulic fracturing fleets. We were not subject to any non-utilization fees in the Current Quarter or the Prior Quarter.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Other Commitments

In April 2011, we entered into a master frac service agreement with our equity affiliate, FTS International, Inc. (FTS), which expires on December 31, 2014. Pursuant to this agreement, we are committed to enter into a predetermined number of backstop contracts, providing at least a 10% gross margin to FTS, if utilization of FTS fleets falls below a certain level. To date, we have not been required to enter into any backstop contracts.

In July 2011, we agreed to invest $155 million in preferred equity securities of Sundrop Fuels, Inc., a privately held cellulosic biofuels company based in Longmont, Colorado, $35 million of which was invested in July 2011 and the remainder of which was payable in separate tranches linked to specified funding and operational milestones. We also provided Sundrop with a one-time option to require us to purchase up to $25 million in additional preferred equity securities following the full payment of the initial investment, subject the occurrence of specified milestones. As of March 31, 2014, we had funded our initial $155 million commitment in full and the milestones related to the option had not been met. See Note 10 for further discussion of this investment.

As part of our normal course of business, we enter into various agreements providing, or otherwise arranging, financial or performance assurances to third parties on behalf of our wholly owned guarantor subsidiaries. These agreements may include future payment obligations or commitments regarding operational performance that effectively guarantee our subsidiaries’ future performance.

In connection with divestitures, our purchase and sale agreements generally provide indemnification to the counterparty for liabilities incurred as a result of a breach of a representation or warranty by the indemnifying party or in regards to perfecting title to property. These indemnifications generally have a discrete term and are intended to protect the parties against risks that are difficult to predict or cannot be quantified at the time of the consummation of a particular transaction.

Certain of our natural gas and oil properties are burdened by non-operating interests such as royalty and overriding royalty interests, including overriding royalty interests sold through our VPP transactions. As the holder of the working interest from which such interests have been created, we have the responsibility to bear the cost of developing and producing the reserves attributable to such interests. See Note 9 for further discussion of our VPP transactions.


5.	Other Liabilities

Other current liabilities as of March 31, 2014 and December 31, 2013 are detailed below.



	March 31, 2014		December 31, 2013
	($ in millions)
Revenues and royalties due others	$	1,499	$	1,409
Accrued natural gas, oil and NGL drilling and production costs	285		457
Joint interest prepayments received	530		464
Accrued compensation and benefits	228		320
Other accrued taxes	113		161
Accrued dividends	101		101
Other	538		599
Total other current liabilities	$	3,294	$	3,511

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Other long-term liabilities as of March 31, 2014 and December 31, 2013 are detailed below.



	March 31, 2014		December 31, 2013
	($ in millions)
CHK Utica ORRI conveyance obligation^(a)	$	242	$	250
CHK C-T ORRI conveyance obligation^(b)	146		149
Financing obligations	30		31
Other	433		554
Total other long-term liabilities	$	851	$	984

____________________________________________


(a)	$15 million and $13 million of the total $257 million and $263 million obligations are recorded in other current liabilities as of March 31, 2014 and December 31, 2013, respectively. See Note 6 for further discussion of the transaction.


(b)	$15 million and $12 million of the total $161 million and $161 million obligations are recorded in other current liabilities as of March 31, 2014 and December 31, 2013, respectively. See Note 6 for further discussion of the transaction.


6.	Equity

Common Stock

The following is a summary of the changes in our common shares issued for the three months ended March 31, 2014 and 2013:



	Three Months Ended March 31,
	2014		2013
	(in thousands)
Shares issued as of January 1	666,192		666,468
Restricted stock issuances (net of forfeitures)^(a)	(1,236	)	2,631
Stock option exercises	259		176
Shares issued as of March 31	665,215		669,275

___________________________________________


(a)	In the second quarter of 2013, we began granting restricted stock units (RSUs) in lieu of restricted stock awards (RSAs) to non-employee directors and employees. Shares of common stock underlying RSUs are issued when the units vest, whereas restricted shares of common stock are issued on the grant date of RSAs. We refer to RSAs and RSUs collectively as restricted stock.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Preferred Stock

The following reflects the shares outstanding and liquidation preferences of our cumulative convertible preferred stock for the three months ended March 31, 2014 and 2013:



	5.75%		5.75% (A)		4.50%		5.00% (2005B)
Shares outstanding as of January 1, 2014 and 2013 and March 31, 2014 and 2013 (in thousands)	1,497		1,100		2,559		2,096

Liquidation preference per share	$	1,000	$	1,000	$	100	$	100

Dividends

Dividends declared on our common stock and preferred stock are reflected as adjustments to retained earnings to the extent a surplus of retained earnings will exist after giving effect to the dividends. To the extent retained earnings are insufficient to fund the distributions, such payments constitute a return of contributed capital rather than earnings and are accounted for as a reduction to paid-in capital.

Dividends on our outstanding preferred stock are payable quarterly. We may pay dividends on our 5.00% Cumulative Convertible Preferred Stock (Series 2005B) and our 4.50% Cumulative Convertible Preferred Stock in cash, common stock or a combination thereof, at our option. Dividends on both series of our 5.75% Cumulative Convertible Non-Voting Preferred Stock are payable only in cash.

Accumulated Other Comprehensive Income (Loss)

For the Current Quarter and the Prior Quarter, changes in accumulated other comprehensive income (loss) by component, net of tax, are detailed below.



	Net Gains (Losses) on Cash Flow Hedges			Net Gains (Losses) on Investments			Total
	($ in millions)
Balance, December 31, 2013	$	(167	)	$	5		$	(162	)
Other comprehensive income before reclassifications	3			—			3
Amounts reclassified from accumulated other comprehensive income	11			(5		)	6
Net other comprehensive income	14			(5		)	9
Balance, March 31, 2014	$	(153	)	$	—		$	(153	)



	Net Gains (Losses) on Cash Flow Hedges			Net Gains (Losses) on Investments			Total
	($ in millions)
Balance, December 31, 2012	$	(189	)	$	7		$	(182	)
Other comprehensive income before reclassifications	(1		)	(5		)	(6		)
Amounts reclassified from accumulated other comprehensive income	12			6			18
Net other comprehensive income	11			1			12
Balance, March 31, 2013	$	(178	)	$	8		$	(170	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

For the Current Quarter and the Prior Quarter, amounts reclassified from accumulated other comprehensive income (loss), net of tax, into the condensed consolidated statements of operations are detailed below.



Details About Accumulated Other Comprehensive Income (Loss) Components	Affected Line Item in the Statement Where Net Income is Presented	Three Months Ended March 31,
		2014			2013
		($ in millions)
Net losses on cash flow hedges:
Commodity contracts	Natural gas, oil and NGL revenues	$	11		$	12
Investments:
Impairment of investment	Losses on investments	—			6
Sale of investment	Net gain on sale of investment	(5		)	—
Total reclassifications for the period, net of tax		$	6		$	18

Noncontrolling Interests

Cleveland Tonkawa Financial Transaction. We formed CHK C-T in March 2012 to continue development of a portion of our natural gas and oil assets in our Cleveland and Tonkawa plays. CHK C-T is an unrestricted subsidiary under our corporate credit facility agreement and is not a guarantor of, or otherwise liable for, any of our indebtedness or other liabilities, including indebtedness under our indentures. In exchange for all of the common shares of CHK C-T, we contributed to CHK C-T approximately 245,000 net acres of leasehold and the existing wells within an area of mutual interest in the plays between the top of the Tonkawa and the top of the Big Lime formations covering Ellis and Roger Mills counties in western Oklahoma. In March 2012, in a private placement, third-party investors contributed $1.25 billion in cash to CHK C-T in exchange for (i) 1.25 million preferred shares, and (ii) our obligation to deliver a 3.75% overriding royalty interest (ORRI) in the existing wells and up to 1,000 future net wells to be drilled on the contributed play leasehold. Subject to customary minority interest protections afforded the investors by the terms of the CHK C-T limited liability company agreement (the CHK C-T LLC Agreement), as the holder of all the common shares and the sole managing member of CHK C-T, we maintain voting and managerial control of CHK C-T and therefore include it in our condensed consolidated financial statements. Of the $1.25 billion of investment proceeds, we allocated $225 million to the ORRI obligation and $1.025 billion to the preferred shares based on estimates of fair values. The remaining ORRI obligation is included in other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our condensed consolidated balance sheets. Pursuant to the CHK C-T LLC Agreement, CHK C-T is required to retain an amount of cash equal to the next two quarters of preferred dividend payments and, until December 31, 2013, it was also required to retain an amount of cash equal to its projected operating funding shortfall for the next six months. The amounts retained, approximately $38 million as of March 31, 2014 and December 31, 2013, were reflected as restricted cash on our condensed consolidated balance sheets.

Dividends on the preferred shares are payable on a quarterly basis at a rate of 6% per annum based on $1,000 per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as, any dividend amount is not paid in full for any quarter. As the managing member of CHK C-T, we may, at our sole discretion and election at any time after March 31, 2014, distribute certain excess cash of CHK C-T, as determined in accordance with the CHK C-T LLC Agreement. Any such optional distribution of excess cash is allocated 75% to the preferred shares (which is applied toward redemption of the preferred shares) and 25% to the common shares unless we have not met our drilling commitment at such time, in which case an optional distribution would be allocated 100% to the preferred shares (and applied toward redemption thereof). We may also, at our sole discretion and election, in accordance with the CHK C-T LLC Agreement, cause CHK C-T to redeem all or a portion of the CHK C-T preferred shares for cash. The preferred shares may be redeemed at a valuation equal to the greater of a 9% internal rate of return or a return on investment of 1.35x, in each case inclusive of dividends paid through redemption at the rate of 6% per annum and optional distributions made through the applicable redemption date. In the event that redemption does not occur on or prior to March 31, 2019, the optional redemption valuation will increase to provide a 15% internal rate of return to the investors. The preferred shares can be redeemed on a pro-rata basis in accordance with the then-applicable redemption valuation formula. As of March 31, 2014 and December 31, 2013, the redemption price and the liquidation preference were each approximately $1,230 and $1,245, respectively, per preferred share.

We initially committed to drill and complete, for the benefit of CHK C-T in the area of mutual interest, a minimum of 37.5 net wells per six-month period through 2013, inclusive of wells drilled in 2012, and 25 net wells per six-month

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

period in 2014 through 2016, up to a minimum cumulative total of 300 net wells. In April 2014, the drilling commitment was amended to require us only to drill and complete 12.5 net wells in each of the six-month periods ending June 30, 2014 and December 31, 2014. If we fail to meet the then-current cumulative drilling commitment in any six-month period, any optional cash distributions would be distributed 100% to the investors. If we fail to meet the then-current cumulative drilling commitment in two consecutive six-month periods, the then-applicable internal rate of return to investors at redemption would increase by 3% per annum. In addition, if we fail to meet the then-current cumulative drilling commitment in four consecutive six-month periods, the then-applicable internal rate of return to investors at redemption would be increased by an additional 3% per annum. Any such increase in the internal rate of return would be effective only until the end of the first succeeding six-month period in which we have met our then-current cumulative drilling commitment. CHK C-T is responsible for all capital and operating costs of the wells drilled for the benefit of the entity. Under the development agreement, approximately 3 and 21 qualified net wells were added in the Current Quarter and the Prior Quarter, respectively. Through March 31, 2014, we had met all current drilling commitments associated with the CHK C-T transaction.

The CHK C-T investors’ right to receive, proportionately, a 3.75% ORRI in the contributed wells and up to 1,000 future net wells on our contributed leasehold is subject to an increase to 5% on net wells earned in any year following a year in which we do not meet our net well commitment under the ORRI obligation, which runs from 2012 through the first quarter of 2025. However, in no event would we be required to deliver to investors more than a total ORRI of 3.75% in existing wells and 1,000 future net wells. If at any time CHK C-T holds fewer net acres than would enable us to drill all then-remaining net wells on 160-acre spacing, the investors have the right to require us to repurchase their right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs. CHK C-T retains the right to repurchase the investors’ right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs once we have drilled a minimum of 867 net wells. The obligation to deliver future ORRIs has been recorded as a liability which will be settled through the conveyance of the underlying ORRIs to the investors on a net-well basis, at which time the associated liability will be reversed and the sale of the ORRIs reflected as an adjustment to the capitalized cost of our natural gas and oil properties. Under the ORRI obligation, we delivered an ORRI in approximately 3 net wells in the Current Quarter and 22 net wells in the Prior Quarter. Although operations began on April 1, 2012, all wells completed since January 1, 2012 are credited to the ORRI obligation of 1,000 future net wells.

As of March 31, 2014 and December 31, 2013, $1.015 billion of noncontrolling interests on our condensed consolidated balance sheets was attributable to CHK C-T. In both the Current Quarter and the Prior Quarter, income of $19 million was attributable to the noncontrolling interests of CHK C-T.

Utica Financial Transaction. We formed CHK Utica in October 2011 to develop a portion of our Utica Shale natural gas and oil assets. CHK Utica is an unrestricted subsidiary under our corporate credit facility agreement and is not a guarantor of, or otherwise liable for, any of our indebtedness or other liabilities, including indebtedness under our indentures. In exchange for all of the common shares of CHK Utica, we contributed to CHK Utica approximately 700,000 net acres of leasehold and the existing wells within an area of mutual interest in the Utica Shale play covering 13 counties located primarily in eastern Ohio. During November and December 2011, in private placements, third-party investors contributed $1.25 billion in cash to CHK Utica in exchange for (i) 1.25 million preferred shares, and (ii) our obligation to deliver a 3% ORRI in 1,500 net wells to be drilled on certain of our Utica Shale leasehold. Subject to customary minority interest protections afforded the investors by the terms of the CHK Utica limited liability company agreement (the CHK Utica LLC Agreement), as the holder of all the common shares and the sole managing member of CHK Utica, we maintain voting and managerial control of CHK Utica and therefore include it in our condensed consolidated financial statements. Of the $1.25 billion of investment proceeds, we allocated $300 million to the ORRI obligation and $950 million to the preferred shares based on estimates of fair values. The remaining ORRI obligation is included in other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our condensed consolidated balance sheets. Pursuant to the CHK Utica LLC Agreement, CHK Utica is required to retain a cash balance equal to the next two quarters of preferred dividend payments. The amount reserved for paying such dividends, approximately $37 million as of March 31, 2014 and December 31, 2013, was reflected as restricted cash on our condensed consolidated balance sheets. In addition, pursuant to the CHK Utica LLC Agreement, with respect to any divestiture proceeds as defined by the agreement, CHK Utica is required to separately account for, and dedicate all of such divestiture proceeds to either (i) capital expenditures made by CHK Utica in connection with its assets or (ii) the redemption of CHK Utica preferred shares.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Dividends on the preferred shares are payable on a quarterly basis at a rate of 7% per annum based on $1,000 per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as, any dividend amount is not paid in full for any quarter. As the managing member of CHK Utica, we may, at our sole discretion and election at any time after December 31, 2013, distribute certain excess cash of CHK Utica, as determined in accordance with the CHK Utica LLC Agreement. Any such optional distribution of excess cash is allocated 70% to the preferred shares (which is applied toward redemption of the preferred shares) and 30% to the common shares. We may also, at our sole discretion and election, in accordance with the CHK Utica LLC Agreement, cause CHK Utica to redeem the CHK Utica preferred shares for cash, in whole or in part. The preferred shares may be redeemed at a valuation equal to the greater of a 10% internal rate of return or a return on investment of 1.4x, in each case inclusive of dividends paid at the rate of 7% per annum and optional distributions made through the applicable redemption date. In the event that redemption does not occur on or prior to October 31, 2018, the optional redemption valuation will increase to provide the investors the greater of a 17.5% internal rate of return or a return on investment of 2.0x. The preferred shares can be redeemed on a pro-rata basis in accordance with the then-applicable redemption valuation formula. As of March 31, 2014 and December 31, 2013, the redemption price and the liquidation preference were each approximately $1,235 and $1,252, respectively, per preferred share.

We have committed to drill and complete, for the benefit of CHK Utica in the area of mutual interest, a minimum of 50 net wells per year from 2012 through 2016, up to a minimum cumulative total of 250 net wells. CHK Utica is responsible for all capital and operating costs of the wells drilled for the benefit of the entity. If we fail to meet the then-current drilling commitment in any year, we must pay CHK Utica $5 million for each well we are short of such drilling commitment. CHK Utica also receives its proportionate share of the benefit of the drilling carry associated with our joint venture with Total in the Utica Shale. See Note 9 for further discussion of the joint venture. Under the development agreement, approximately 22 and 28 qualified net wells were added in the Current Quarter and the Prior Quarter, respectively. Through March 31, 2014, we had met all current drilling commitments associated with the CHK Utica transaction.

The CHK Utica investors’ right to receive, proportionately, a 3% ORRI in the first 1,500 net wells drilled on our Utica Shale leasehold is subject to an increase to 4% on net wells earned in any year following a year in which we do not meet our net well commitment under the ORRI obligation, which runs from 2012 through 2023. However, in no event would we be required to deliver to investors more than a total ORRI of 3% in 1,500 net wells. If at any time we hold fewer net acres than would enable us to drill all then-remaining net wells on 150-acre spacing, the investors have the right to require us to repurchase their right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs. We retain the right to repurchase the investors’ right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs once we have drilled a minimum of 1,300 net wells. The obligation to deliver future ORRIs has been recorded as a liability which will be settled through the future conveyance of the underlying ORRIs to the investors on a net-well basis, at which time the associated liability will be reversed and the sale of the ORRIs reflected as an adjustment to the capitalized cost of our natural gas and oil properties. Under the ORRI obligation, we delivered an ORRI in approximately 32 new net wells in the Current Quarter and 14 net wells in the Prior Quarter. Because we did not meet our ORRI commitment in 2012, the ORRI increased to 4% for wells earned in 2013, and the ultimate number of wells in which we must assign an interest will be reduced accordingly. Through March 31, 2014, we were on target to meet the ORRI conveyance commitments associated with the CHK Utica transaction.

As of March 31, 2014 and December 31, 2013, $807 million of noncontrolling interests on our condensed consolidated balance sheets was attributable to CHK Utica. In the Current Quarter and the Prior Quarter, income of approximately $19 million and $22 million, respectively, was attributable to the noncontrolling interests of CHK Utica.

Chesapeake Granite Wash Trust. In November 2011, Chesapeake Granite Wash Trust (the “Trust”) sold 23,000,000 common units representing beneficial interests in the Trust at a price of $19.00 per common unit in its initial public offering. The common units are listed on the New York Stock Exchange and trade under the symbol “CHKR”. We own 12,062,500 common units and 11,687,500 subordinated units, which in the aggregate represent an approximate 51% beneficial interest in the Trust. The Trust has a total of 46,750,000 units outstanding.

In connection with the initial public offering of the Trust, we conveyed royalty interests to the Trust that entitle the Trust to receive (i) 90% of the proceeds (after deducting certain post-production expenses and any applicable taxes) that we receive from the production of hydrocarbons from 69 producing wells, and (ii) 50% of the proceeds (after deducting certain post-production expenses and any applicable taxes) in 118 development wells that have been or will be drilled on approximately 45,400 gross acres (29,000 net acres) in the Colony Granite Wash play in Washita County

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

in the Anadarko Basin of western Oklahoma. Pursuant to the terms of a development agreement with the Trust, we are obligated to drill, or cause to be drilled, the development wells at our own expense prior to June 30, 2016, and the Trust will not be responsible for any costs related to the drilling of the development wells or any other operating or capital costs of the Trust properties. In addition, we granted to the Trust a lien on our remaining interests in the undeveloped properties that are subject to the development agreement in order to secure our drilling obligation to the Trust, although the maximum amount that may be recovered by the Trust under such lien could not exceed $263 million initially and is proportionately reduced as we fulfill our drilling obligation over time. As of March 31, 2014 and 2013, we had drilled or caused to be drilled approximately 89 and 64 development wells, respectively, as calculated under the development agreement, and the maximum amount recoverable under the drilling support lien was approximately $65 million and $120 million, respectively.

The subordinated units we hold in the Trust are entitled to receive pro rata distributions from the Trust each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is not less than the applicable subordination threshold for such quarter. If there is not sufficient cash to fund such a distribution on all of the Trust units, the distribution to be made with respect to the subordinated units will be reduced or eliminated for such quarter in order to make a distribution, to the extent possible, of up to the subordination threshold amount on the common units. The distribution made with respect to the subordinated units to Chesapeake was either reduced or eliminated for each of the most recent seven quarters of distributions paid. In exchange for agreeing to subordinate a portion of our Trust units, and in order to provide additional financial incentive to us to satisfy our drilling obligation and perform operations on the underlying properties in an efficient and cost-effective manner, Chesapeake is entitled to receive incentive distributions equal to 50% of the amount by which the cash available for distribution on the Trust units in any quarter exceeds the applicable incentive threshold for such quarter. The remaining 50% of cash available for distribution in excess of the applicable incentive threshold will be paid to Trust unitholders, including Chesapeake, on a pro rata basis. At the end of the fourth full calendar quarter following our satisfaction of our drilling obligation with respect to the development wells, the subordinated units will automatically convert into common units on a one-for-one basis and our right to receive incentive distributions will terminate. After such time, the common units will no longer have the protection of the subordination threshold, and all Trust unitholders will share in the Trust’s distributions on a pro rata basis.

For the Current Quarter and the Prior Quarter, the Trust declared and paid the following distributions:



Production Period	Distribution Date	Cash Distribution per Common Unit		Cash Distribution per Subordinated Unit
September 2013 - November 2013	March 3, 2014	$	0.6624	$	—
September 2012 - November 2012	March 1, 2013	$	0.6700	$	0.3772

We have determined that the Trust constitutes a VIE and that Chesapeake is the primary beneficiary. As a result, the Trust is included in our condensed consolidated financial statements. As of March 31, 2014 and December 31, 2013, $306 million and $314 million, respectively, of noncontrolling interests on our condensed consolidated balance sheets were attributable to the Trust. In both the Current Quarter and the Prior Quarter, income of approximately $5 million was attributable to the Trust’s noncontrolling interests in our condensed consolidated statements of operations. See Note 11 for further discussion of VIEs.

Wireless Seismic, Inc. We have a controlling 51% equity interest in Wireless Seismic, Inc. (Wireless), a privately owned company engaged in research, development and production of wireless seismic systems and any related technology that deliver seismic information obtained from standard geophones in real time to laptop and desktop computers. As of March 31, 2014 and December 31, 2013, $8 million and $9 million, respectively, of noncontrolling interests on our condensed consolidated balance sheets were attributable to Wireless. In both the Current Quarter and the Prior Quarter, losses of $1 million were attributable to noncontrolling interests of Wireless in our condensed consolidated statements of operations.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

7. Share-Based Compensation

Chesapeake’s share-based compensation program consists of restricted stock, stock options and performance share units (PSUs) granted to employees and restricted stock granted to non-employee directors under our Long Term Incentive Plan. The restricted stock and stock options are equity-classified awards and the PSUs are liability-classified awards.

Equity-Classified Awards

Restricted Stock. We grant restricted stock to employees and non-employee directors. Restricted stock vests over a minimum of three years and the holder receives dividends or dividend equivalents on unvested shares. A summary of the changes in unvested shares of restricted stock during the Current Quarter is presented below.



	Number of Unvested Restricted Shares		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested shares as of January 1, 2014	13,400		$	23.38
Granted	3,943		$	25.13
Vested	(2,350	)	$	26.41
Forfeited	(638	)	$	25.69
Unvested shares as of March 31, 2014	14,355		$	23.26

The aggregate intrinsic value of restricted stock that vested during the Current Quarter was approximately $62 million based on the stock price at the time of vesting.

As of March 31, 2014, there was $255 million of total unrecognized compensation expense related to unvested restricted stock. The expense is expected to be recognized over a weighted average period of approximately 2.5 years.

The vesting of certain restricted stock grants may result in state and federal income tax benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. During the Current Quarter, we recognized excess tax benefits related to restricted stock of $3 million and during the Prior Quarter we recognized reductions in tax benefits related to restricted stock of $10 million, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

Stock Options. In the Current Quarter and the Prior Quarter, we granted members of senior management stock options that will vest ratably over a three-year period. In the Prior Quarter, we also granted retention awards to certain officers of stock options that will vest one-third on each of the third, fourth and fifth anniversaries of the grant date. Each stock option award has an exercise price equal to the closing price of the Company’s common stock on the grant date. Outstanding options generally expire ten years from the date of grant.

We utilize the Black-Scholes option pricing model to measure the fair value of stock options. The expected life of an option is determined using the "simplified method", as there is no adequate historical exercise behavior available. Volatility assumptions are estimated based on an average of historical volatility of Chesapeake stock over the expected life of an option. The risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the grant over the expected life of the option. The dividend yield is based on an annual dividend yield, taking into account the Company's current dividend policy over the expected life of the option. The Company used the following assumptions to estimate the grant date fair value of the stock options granted in the Current Quarter:



Expected option life - years	6.0
Volatility	48.33	%
Risk-free interest rate	1.97	%
Dividend yield	1.36	%

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The following table provides information related to stock option activity during the Current Quarter:



	Number of Shares Underlying Options		Weighted Average Exercise Price Per Share		Weighted Average Contract Life in Years	Aggregate Intrinsic Value^(a)
	(in thousands)					($ in millions)
Outstanding at January 1, 2014	5,268		$	19.28	6.66	$	41
Granted	786		$	25.71
Exercised	(270	)	$	18.23		$	2
Expired	—		$	—
Outstanding at March 31, 2014	5,784		$	20.20	7.15	$	31

Exercisable at March 31, 2014	1,766		$	18.95	3.72	$	12

___________________________________________


(a)	The intrinsic value of a stock option is the amount by which the current market value or the market value upon exercise of the underlying stock exceeds the exercise price of the option.

As of March 31, 2014, there was $21 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 2.4 years.

The vesting of certain stock option grants may result in state and federal income tax benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. During the Current Quarter and the Prior Quarter, we recognized excess tax benefits related to stock options of a nominal amount and $0, respectively. All amounts were recorded as adjustments to additional paid-in capital and deferred income taxes.

Compensation Expenses. We recorded the following compensation expenses related to restricted stock and stock options during the Current Quarter and the Prior Quarter:



	Three Months Ended March 31,
	2014		2013
	($ in millions)
General and administrative expenses	$	12	$	20
Natural gas and oil properties	7		21
Natural gas, oil and NGL production expenses	4		6
Marketing, gathering and compression expenses	2		3
Oilfield services expenses	2		3
Total	$	27	$	53

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Liability-Classified Awards

Performance Share Units. In 2012, 2013 and 2014, we granted PSUs to senior management under our Long Term Incentive Plan that settle in cash at the end of their respective performance periods and vest ratably over their respective terms. The 2012 awards were granted in one-, two- and three-year tranches and are settled in cash on the first, second and third anniversary dates of the awards, and the 2013 and 2014 awards are settled in cash on the third anniversary of the awards. The ultimate amount earned is based on the performance metrics established by the Compensation Committee of the Board of Directors, which include relative and absolute total shareholder return (TSR) and, for certain of the awards, the achievement of operational performance goals such as production and proved reserve growth. The TSR metric is considered a market condition and generally requires a Monte Carlo simulation to determine the fair value.

For PSUs granted in 2012, each of the TSR and operational payout components can range from 0% to 125% resulting in a maximum total payout of 250%. For PSUs granted in 2013, the TSR component can range from 0% to 125% and each of the two operational components can range from 0% to 62.5%; however, the maximum total payout is capped at 200%. For PSUs granted in 2014, the TSR component can range from 0% to 200%, with no operational components. For the 2013 and 2014 PSUs, the payout percentage is capped at 100% if the Company’s absolute TSR is less than zero. The following table presents a summary of our PSU awards as of March 31, 2014:



	Units	Fair Value as of Grant Date		Fair Value		Liability for Vested Amount
		($ in millions)
2012 Awards ^(a)
Payable 2015	834,248	$	23	$	21	$	21

2013 Awards
Payable 2016	1,600,438	$	35	$	52	$	45

2014 Awards
Payable 2017	620,669	$	17	$	16	$	4

___________________________________________


(a)	In the Current Quarter and the Prior Quarter, we paid $11 million and $2 million, respectively, related to 2012 PSU awards.

Compensation Expenses. We recorded the following compensation expenses related to PSUs during the Current Quarter and the Prior Quarter:



	Three Months Ended March 31,
	2014			2013
	($ in millions)
Natural gas and oil properties	$	1		$	4
General and administrative expenses	(1		)	5
Marketing, gathering and compression expenses	—			2
Total	$	—		$	11

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


8.	Derivative and Hedging Activities

Chesapeake uses commodity derivative instruments to secure attractive pricing and margins on production, to reduce its exposure to fluctuations in future commodity prices and to protect its expected operating cash flow against significant market movements or volatility. Chesapeake also uses derivative instruments to mitigate a portion of our exposure to interest rate and foreign currency exchange rate fluctuations. All of our derivative instruments are net settled based on the difference between the fixed-price payment and the floating-price payment, resulting in a net amount due to or from the counterparty.

Natural Gas and Oil Derivatives

As of March 31, 2014 and December 31, 2013, our natural gas and oil derivative instruments consisted of the following types of instruments:


•	Swaps: Chesapeake receives a fixed price and pays a floating market price to the counterparty for the hedged commodity.

•

Collars: These instruments contain a fixed floor price (put) and ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, Chesapeake receives the fixed price and pays the market price. If the market price is between the put and the call strike prices, no payments are due from either party. Three-way collars include an additional put option in exchange for a more favorable strike price on the call option. This eliminates the counterparty’s downside exposure below the second put option strike price.

•

Options: Chesapeake sells, and occasionally buys, call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess on sold call options, and Chesapeake receives such excess on bought call options. If the market price settles below the fixed price of the call option, no payment is due from either party.


•	Swaptions: Chesapeake sells call swaptions in exchange for a premium that allows a counterparty, on a specific date, to enter into a fixed-price swap for a certain period of time.

•

Basis Protection Swaps: These instruments are arrangements that guarantee a price differential to NYMEX from a specified delivery point. Our current natural gas basis protection swaps have negative differentials to NYMEX. Chesapeake receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract. Our current oil basis protection swaps have positive differentials to NYMEX. Chesapeake receives a payment from the counterparty if the price differential is less than the stated terms of the contract and pays the counterparty if the price differential is greater than the stated terms of the contract.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The estimated fair values of our natural gas and oil derivative instrument assets (liabilities) as of March 31, 2014 and December 31, 2013 are provided below.



	March 31, 2014				December 31, 2013
	Volume	Fair Value			Volume	Fair Value
		($ in millions)				($ in millions)
Natural gas (tbtu):
Fixed-price swaps	394	$	(125	)	448	$	(23	)
Three-way collars	387	(48		)	288	(7		)
Call options	193	(202		)	193	(210		)
Call swaptions	—	—			12	—
Basis protection swaps	151	(14		)	68	3
Total natural gas	1,125	(389		)	1,009	(237		)
Oil (mmbbl):
Fixed-price swaps	22.8	(81		)	25.3	(50		)
Call options	41.9	(257		)	42.5	(265		)
Basis protection swaps	0.3	1			0.4	1
Total oil	65.0	(337		)	68.2	(314		)
Total estimated fair value		$	(726	)		$	(551	)

We have terminated certain commodity derivative contracts that were previously designated as cash flow hedges for which the hedged production is still expected to occur. See further discussion below under Effect of Derivative Instruments - Accumulated Other Comprehensive Income (Loss).

Interest Rate Derivatives

As of March 31, 2014 and December 31, 2013, our interest rate derivative instruments consisted of swaps. Chesapeake enters into fixed-to-floating interest rate swaps (we receive a fixed interest rate and pay a floating market rate) to mitigate our exposure to changes in the fair value of our senior notes. We enter into floating-to-fixed interest rate swaps (we receive a floating market rate and pay a fixed interest rate) to manage our interest rate exposure related to our bank credit facilities borrowings.

The notional amount of our interest rate derivative liabilities as of March 31, 2014 and December 31, 2013 was $2.250 billion. The estimated fair value of our interest rate derivative liabilities as of March 31, 2014 and December 31, 2013 was $80 million and $98 million, respectively.

We have terminated certain fair value hedges related to senior notes. Gains and losses related to these terminated hedges will be amortized as an adjustment to interest expense over the remaining term of the related senior notes. Over the next seven years, we will recognize $13 million in net gains related to such transactions.

Foreign Currency Derivatives

We are party to cross currency swaps to mitigate our exposure to foreign currency exchange rate fluctuations that may result from the €344 million principal amount of our euro-denominated senior notes. The terms of the cross currency swaps were based on the dollar/euro exchange rate on the issuance date of $1.3325 to €1.00. Under the terms of the cross currency swaps we currently hold, on each semi-annual interest payment date, the counterparties pay us €11 million and we pay the counterparties $17 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay us €344 million and we will pay the counterparties $459 million. The swaps are designated as cash flow hedges and, because they are entirely effective in having eliminated any potential variability in our expected cash flows related to changes in foreign exchange rates, changes in their fair value do not impact earnings. The fair values of the cross currency swaps are recorded on the condensed consolidated balance sheet as an asset of $7 million as of March 31, 2014. The euro-denominated debt in long-term debt has been adjusted to $473 million as of March 31, 2014 using an exchange rate of $1.3769 to €1.00.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Effect of Derivative Instruments – Condensed Consolidated Balance Sheets

The following table presents the fair value and location of each classification of derivative instrument included in the condensed consolidated balance sheets as of March 31, 2014 and December 31, 2013 on a gross basis and after same-counterparty netting:



	March 31, 2014
Balance Sheet Classification	Gross Fair Value			Amounts Netted in Condensed Consolidated Balance Sheet			Net Fair Value Presented in Condensed Consolidated Balance Sheet
	($ in millions)
Commodity Contracts
Short-term derivative asset	$	13		$	(11	)	$	2
Long-term derivative asset	3			1			4
Short-term derivative liability	(425		)	11			(414		)
Long-term derivative liability	(317		)	(1		)	(318		)
Total commodity contracts	(726		)	—			(726		)

Interest Rate Contracts
Short-term derivative liability	(3		)	—			(3		)
Long-term derivative liability	(77		)	—			(77		)
Total interest rate contracts	(80		)	—			(80		)

Foreign Currency Contracts^(a)
Long-term derivative asset	7			—			7
Total foreign currency contracts	7			—			7

Total Derivatives	$	(799	)	$	—		$	(799	)



	December 31, 2013
Balance Sheet Classification	Gross Fair Value			Amounts Netted in Condensed Consolidated Balance Sheet			Net Fair Value Presented in Condensed Consolidated Balance Sheet
	($ in millions)
Commodity Contracts
Short-term derivative asset	$	29		$	(29	)	$	—
Long-term derivative asset	11			(9		)	2
Short-term derivative liability	(231		)	29			(202		)
Long-term derivative liability	(362		)	9			(353		)
Total commodity contracts	(553		)	—			(553		)

Interest Rate Contracts
Short-term derivative liability	(6		)	—			(6		)
Long-term derivative liability	(92		)	—			(92		)
Total interest rate contracts	(98		)	—			(98		)

Foreign Currency Contracts^(a)
Long-term derivative asset	2			—			2
Total foreign currency contracts	2			—			2

Total Derivatives	$	(649	)	$	—		$	(649	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

____________________________________________


(a)	Designated as cash flow hedging instruments.

As of March 31, 2014 and December 31, 2013, we did not have any cash collateral balances for these derivatives.

Effect of Derivative Instruments – Condensed Consolidated Statements of Operations

The components of natural gas, oil and NGL sales for the Current Quarter and the Prior Quarter are presented below.



	Three Months Ended March 31,
	2014			2013
	($ in millions)
Natural gas, oil and NGL sales	$	2,148		$	1,595
Losses on undesignated natural gas, oil and NGL derivatives	(365		)	(123		)
Losses on terminated cash flow hedges	(17		)	(19		)
Total natural gas, oil and NGL sales	$	1,766		$	1,453

The components of interest expense for the Current Quarter and the Prior Quarter are presented below.



	Three Months Ended March 31,
	2014			2013
	($ in millions)
Interest expense on senior notes	$	180		$	186
Interest expense on term loans	29			29
Amortization of loan discount, issuance costs and other	19			19
Interest expense on credit facilities	8			12
Gains on terminated fair value hedges	(1		)	—
(Gains) losses on undesignated interest rate derivatives	(18		)	4
Capitalized interest	(178		)	(229		)
Total interest expense	$	39		$	21

Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss)

A reconciliation of the changes in accumulated other comprehensive income (loss) in our condensed consolidated statements of stockholders’ equity related to our cash flow hedges is presented below.



	Three Months Ended March 31,
	2014						2013
	Before Tax			After Tax			Before Tax			After Tax
	($ in millions)
Balance, beginning of period	$	(269	)	$	(167	)	$	(304	)	$	(189	)
Net change in fair value	4			3			(2		)	(1		)
Losses reclassified to income	18			11			19			12
Balance, end of period