Edgar Filing: CHESAPEAKE ENERGY CORP

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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 September 30, 2016

[ ] 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 October 28, 2016, there were 887,389,891 shares of our $0.01 par value common stock outstanding.

CHESAPEAKE ENERGY CORPORATION

INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016



	PART I. FINANCIAL INFORMATION	Page
Item 1.	Condensed Consolidated Financial Statements (Unaudited):	1
	Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015	1
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2016 and 2015	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015	5
	Condensed Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2016 and 2015	7
	Notes to the Condensed Consolidated Financial Statements
	Note 1. Basis of Presentation	8
	Note 2. Earnings per Share	9
	Note 3. Debt	10
	Note 4. Contingencies and Commitments	14
	Note 5. Other Liabilities	17
	Note 6. Equity	18
	Note 7. Share-Based Compensation	19
	Note 8. Derivative and Hedging Activities	22
	Note 9. Oil and Natural Gas Property Transactions	29
	Note 10. Variable Interest Entities	31
	Note 11. Impairments	31
	Note 12. Income Taxes	32
	Note 13. Fair Value Measurements	33
	Note 14. Segment Information	34
	Note 15. Recently Issued Accounting Standards	36
	Note 16. Subsequent Events	37
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	38
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64
Item 4.	Controls and Procedures	68

	PART II OTHER INFORMATION
Item 1.	Legal Proceedings	69
Item 1A.	Risk Factors	71
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	72
Item 3.	Defaults Upon Senior Securities	72
Item 4.	Mine Safety Disclosures	72
Item 5.	Other Information	72
Item 6.	Exhibits	72

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION


Item 1.	Condensed Consolidated Financial Statements (Unaudited)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



	September 30, 2016			December 31, 2015
	($ in millions)
CURRENT ASSETS:
Cash and cash equivalents ($1 and $1 attributable to our VIE)	$	4		$	825
Accounts receivable, net	893			1,129
Short-term derivative assets	—			366
Other current assets	170			160
Total Current Assets	1,067			2,480
PROPERTY AND EQUIPMENT:
Oil and natural gas properties, at cost based on full cost accounting:
Proved oil and natural gas properties ($488 and $488 attributable to our VIE)	65,977			63,843
Unproved properties	5,198			6,798
Other property and equipment	2,096			2,927
Total Property and Equipment, at Cost	73,271			73,568
Less: accumulated depreciation, depletion and amortization (($457) and ($428) attributable to our VIE)	(62,296		)	(59,365		)
Property and equipment held for sale, net	76			95
Total Property and Equipment, Net	11,051			14,298
LONG-TERM ASSETS:
Long-term derivative assets	—			246
Other long-term assets	405			290
TOTAL ASSETS	$	12,523		$	17,314

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(Unaudited)



	September 30, 2016			December 31, 2015
	($ in millions)
CURRENT LIABILITIES:
Accounts payable	$	660		$	944
Current maturities of long-term debt, net	656			381
Accrued interest	137			101
Short-term derivative liabilities	160			40
Other current liabilities ($2 and $8 attributable to our VIE)	1,993			2,219
Total Current Liabilities	3,606			3,685
LONG-TERM LIABILITIES:
Long-term debt, net	9,022			10,311
Long-term derivative liabilities	17			60
Asset retirement obligations, net of current portion	403			452
Other long-term liabilities	407			409
Total Long-Term Liabilities	9,849			11,232
CONTINGENCIES AND COMMITMENTS (Note 4)
EQUITY:
Chesapeake Stockholders’ Equity:
Preferred stock, $0.01 par value, 20,000,000 shares authorized: 7,225,713 and 7,251,515 shares outstanding	3,036			3,062
Common stock, $0.01 par value, 1,500,000,000 and 1,000,000,000 shares authorized: 777,020,715 and 664,795,509 shares issued	8			7
Additional paid-in capital	12,923			12,403
Accumulated deficit	(17,028		)	(13,202		)
Accumulated other comprehensive loss	(101		)	(99		)
Less: treasury stock, at cost; 1,289,587 and 1,437,724 common shares	(29		)	(33		)
Total Chesapeake Stockholders’ Equity (Deficit)	(1,191		)	2,138
Noncontrolling interests	259			259
Total Equity (Deficit)	(932		)	2,397
TOTAL LIABILITIES AND EQUITY	$	12,523		$	17,314

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



		Three Months Ended September 30,						Nine Months Ended September 30,
		2016			2015			2016			2015
	($ in millions except per share data)
REVENUES:
Oil, natural gas and NGL		$	1,177		$	1,363		$	2,610		$	4,122
Marketing, gathering and compression		1,099			2,013			3,241			5,993
Total Revenues		2,276			3,376			5,851			10,115
OPERATING EXPENSES:
Oil, natural gas and NGL production		164			251			552			826
Oil, natural gas and NGL gathering, processing and transportation		473			483			1,436			1,429
Production taxes		17			25			54			87
Marketing, gathering and compression		1,261			1,955			3,410			5,751
General and administrative		63			49			172			174
Restructuring and other termination costs		—			53			3			39
Provision for legal contingencies		8			—			112			359
Oil, natural gas and NGL depreciation, depletion and amortization		255			488			791			1,773
Depreciation and amortization of other assets		25			31			83			100
Impairment of oil and natural gas properties		433			5,416			2,331			15,407
Impairments of fixed assets and other		751			79			795			167
Net (gains) losses on sales of fixed assets		—			(1		)	(5		)	3
Total Operating Expenses		3,450			8,829			9,734			26,115
LOSS FROM OPERATIONS		(1,174		)	(5,453		)	(3,883		)	(16,000		)
OTHER INCOME (EXPENSE):
Interest expense		(73		)	(88		)	(197		)	(210		)
Losses on investments		(1		)	(33		)	(3		)	(57		)
Loss on sale of investment		—			—			(10		)	—
Gains on purchases or exchanges of debt		87			—			255			—
Other income (expense)		7			(2		)	13			3
Total Other Income (Expense)		20			(123		)	58			(264		)
LOSS BEFORE INCOME TAXES		(1,154		)	(5,576		)	(3,825		)	(16,264		)
INCOME TAX BENEFIT:
Current income taxes		—			—			—			(6		)
Deferred income taxes		—			(937		)	—			(3,808		)
Total Income Tax Benefit		—			(937		)	—			(3,814		)
NET LOSS		(1,154		)	(4,639		)	(3,825		)	(12,450		)
Net income attributable to noncontrolling interests		(1		)	(13		)	(1		)	(50		)
NET LOSS ATTRIBUTABLE TO CHESAPEAKE		(1,155		)	(4,652		)	(3,826		)	(12,500		)
Preferred stock dividends		(42		)	(43		)	(127		)	(128		)
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS		$	(1,197	)	$	(4,695	)	$	(3,953	)	$	(12,628	)
LOSS PER COMMON SHARE:
Basic		$	(1.54	)	$	(7.08	)	$	(5.47	)	$	(19.07	)
Diluted		$	(1.54	)	$	(7.08	)	$	(5.47	)	$	(19.07	)
CASH DIVIDEND DECLARED PER COMMON SHARE		$	—		$	—		$	—		$	0.0875
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic		777			663			722			662
Diluted		777			663			722			662

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	($ in millions)
NET LOSS	$	(1,154	)	$	(4,639	)	$	(3,825	)	$	(12,450	)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAX:
Unrealized gains (losses) on derivative instruments, net of income tax expense (benefit) of $0, $5, ($1) and $4	(4		)	7			(23		)	6
Reclassification of losses on settled derivative instruments, net of income tax expense of $0, $2, $3 and $11	7			5			21			18
Other Comprehensive Income (Loss)	3			12			(2		)	24
COMPREHENSIVE LOSS	(1,151		)	(4,627		)	(3,827		)	(12,426		)
COMPREHENSIVE INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS	(1		)	(13		)	(1		)	(50		)
COMPREHENSIVE LOSS ATTRIBUTABLE TO CHESAPEAKE	$	(1,152	)	$	(4,640	)	$	(3,828	)	$	(12,476	)

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Nine Months Ended September 30,
	2016			2015
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET LOSS	$	(3,825	)	$	(12,450	)
ADJUSTMENTS TO RECONCILE NET LOSS TO CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Depreciation, depletion and amortization	874			1,873
Deferred income tax expense (benefit)	—			(3,808		)
Derivative (gains) losses, net	283			(642		)
Cash receipts on derivative settlements, net	487			850
Stock-based compensation	40			61
Impairment of oil and natural gas properties	2,331			15,407
Net (gains) losses on sales of fixed assets	(5		)	3
Renegotiation of natural gas gathering contract	(66		)	—
Impairments of fixed assets and other	785			159
Losses on investments	3			57
Loss on sale of investment	10			—
Gains on purchases or exchanges of debt	(255		)	—
Restructuring and other termination costs	1			39
Provision for legal contingencies	77			359
Other	(92		)	24
Changes in assets and liabilities	(598		)	(877		)
Net Cash Provided By Operating Activities	50			1,055
CASH FLOWS FROM INVESTING ACTIVITIES:
Drilling and completion costs	(948		)	(2,696		)
Acquisitions of proved and unproved properties	(583		)	(407		)
Proceeds from divestitures of proved and unproved properties	988			188
Additions to other property and equipment	(32		)	(114		)
Proceeds from sales of other property and equipment	70			80
Cash paid for title defects	(69		)	—
Additions to investments	—			(1		)
Decrease in restricted cash	—			52
Other	(5		)	(7		)
Net Cash Used In Investing Activities	(579		)	(2,905		)

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)

(Unaudited)



	Nine Months Ended September 30,
	2016			2015
	($ in millions)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash paid to purchase debt	(1,979		)	—
Proceeds from revolving credit facility borrowings	5,097			—
Payments on revolving credit facility borrowings	(4,857		)	—
Proceeds from issuance of term loan	1,500			—
Cash paid for common stock dividends	—			(118		)
Cash paid for preferred stock dividends	—			(128		)
Cash paid to repurchase noncontrolling interest of CHK C-T	—			(143		)
Distributions to noncontrolling interest owners	(8		)	(78		)
Other	(45		)	(32		)
Net Cash Used In Financing Activities	(292		)	(499		)
Net decrease in cash and cash equivalents	(821		)	(2,349		)
Cash and cash equivalents, beginning of period	825			4,108
Cash and cash equivalents, end of period	$	4		$	1,759

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

	Nine Months Ended September 30,
	2016			2015
	($ in millions)
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid, net of capitalized interest	$	209		$	134
Income taxes paid, net of refunds received	$	(20	)	$	50

SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:
Change in accrued drilling and completion costs	$	(22	)	$	(124	)
Change in accrued acquisitions of proved and unproved properties	$	(1	)	$	61
Change in divested proved and unproved properties	$	12		$	1,046
Debt exchanged for common stock	$	471		$	—
Repurchase of noncontrolling interest in CHK C-T	$	—		$	(872	)

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)



	Nine Months Ended September 30,
	2016			2015
	($ in millions)
PREFERRED STOCK:
Balance, beginning of period	$	3,062		$	3,062
Conversions of 25,802 and 0 shares of preferred stock for common stock	(26		)	—
Balance, end of period	3,036			3,062
COMMON STOCK:
Balance, beginning of period	7			7
Exchange of senior notes and contingent convertible notes	1			—
Balance, end of period	8			7
ADDITIONAL PAID-IN CAPITAL:
Balance, beginning of period	12,403			12,531
Stock-based compensation	49			52
Exchange of contingent convertible notes for 55,427,782 and 0 shares of common stock	241			—
Exchange of senior notes for 53,923,925 and 0 shares of common stock	229			—
Conversion of preferred stock for 1,021,506 and 0 shares of common stock	26			—
Equity component of convertible notes repurchases	(25		)	—
Dividends on common stock	—			(59		)
Dividends on preferred stock	—			(128		)
Decrease in tax benefit from stock-based compensation	—			(11		)
Balance, end of period	12,923			12,385
RETAINED EARNINGS (ACCUMULATED DEFICIT):
Balance, beginning of period	(13,202		)	1,483
Net loss attributable to Chesapeake	(3,826		)	(12,500		)
Balance, end of period	(17,028		)	(11,017		)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period	(99		)	(143		)
Hedging activity	(2		)	24
Balance, end of period	(101		)	(119		)
TREASURY STOCK – COMMON:
Balance, beginning of period	(33		)	(37		)
Purchase of 33,955 and 37,687 shares for company benefit plans	—			(1		)
Release of 182,092 and 81,104 shares from company benefit plans	4			2
Balance, end of period	(29		)	(36		)
TOTAL CHESAPEAKE STOCKHOLDERS’ EQUITY (DEFICIT)	(1,191		)	4,282
NONCONTROLLING INTERESTS:
Balance, beginning of period	259			1,302
Net income attributable to noncontrolling interests	1			50
Distributions to noncontrolling interest owners	(1		)	(73		)
Repurchase of noncontrolling interest of CHK C-T	—			(1,015		)
Balance, end of period	259			264
TOTAL EQUITY (DEFICIT)	$	(932	)	$	4,546

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

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


1.	Basis of Presentation

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Chesapeake Energy Corporation ("Chesapeake" or the "Company") and its subsidiaries were 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. These financial statements were prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all disclosures required for financial statements prepared in conformity with U.S. GAAP.

This Form 10-Q relates to the three and nine months ended September 30, 2016 (the "Current Quarter" and the “Current Period”, respectively) and the three and nine months ended September 30, 2015 (the "Prior Quarter" and the “Prior Period”, respectively). Chesapeake's annual report on Form 10-K for the year ended December 31, 2015 ("2015 Form 10-K") includes certain definitions and a summary of significant accounting policies that 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 statement of the results for the interim periods have been reflected. The results for the Current Quarter and the Current Period are not necessarily indicative of the results to be expected for the full year.

Risks and Uncertainties

Our ability to grow, make capital expenditures and service our debt depends primarily upon the prices we receive for the oil, natural gas and natural gas liquids (NGL) we sell. Substantial expenditures are required to replace reserves, sustain production and fund our business plans. Historically, oil and natural gas prices have been very volatile, and may be subject to wide fluctuations in the future. The substantial decline in oil, natural gas and NGL prices from 2014 levels has negatively affected the amount of cash we have available for capital expenditures and debt service. A substantial or extended decline in oil, natural gas and NGL prices could have a material impact on our financial position, results of operations, cash flows and on the quantities of reserves that we may economically produce. Other risks and uncertainties that could affect us in the current commodity price environment include, but are not limited to, counterparty credit risk for our receivables, access to capital markets, regulatory risks and our ability to meet financial ratios and covenants in our financing agreements.

Reclassifications

In April 2015, the Financial Accounting Standards Board (FASB) issued guidance that requires debt issuance costs related to term debt to be presented in the balance sheet as a direct deduction from the associated debt liability. This standard requires retrospective application and is effective for annual reporting periods beginning after December 15, 2015. This change in accounting principle is preferable since it allows debt issuance costs and debt issuance discounts to be presented similarly in the consolidated balance sheets as a reduction to the face amount of our debt balances. A retrospective change to our consolidated balance sheet as of December 31, 2015, as previously presented, is required pursuant to the guidance. The retrospective adjustment to the December 31, 2015 consolidated balance sheet is shown below.



	As Previously Reported		December 31, 2015 Adjustment Effect			As Adjusted
	$ in millions
Other long-term assets	$	333	$	(43	)	$	290
Long-term debt, net	$	10,354	$	(43	)	$	10,311

Beginning in the fourth quarter of 2015, we began presenting third party gathering, processing and transportation costs as a component of operating expenses in our statement of operations. Previously, these costs were reflected as deductions to oil, natural gas and NGL sales. These costs have been reclassified in our condensed consolidated statement of operations for the Prior Quarter and the Prior Period to conform to the presentation used for the Current Quarter and the Current Period. The net effect of this reclassification did not impact our previously reported net loss, stockholders’ equity or cash flows; however, previously reported oil, natural gas and NGL sales have increased from the amounts previously reported, and total operating expenses have increased by those same amounts.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


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 the issuance of common shares for all potentially dilutive securities, provided the effect is not antidilutive. For the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, 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.

For the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, shares of the following securities and associated adjustments to net income, representing dividends on preferred stock and allocated earnings on participating securities, were excluded from the calculation of diluted EPS as the effect was antidilutive.



	Net Income Adjustments		Shares
	($ in millions)		(in millions)
Three Months Ended September 30, 2016
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	21	58
5.75% cumulative convertible preferred stock (series A)	$	16	42
5.00% cumulative convertible preferred stock (series 2005B)	$	2	6
4.50% cumulative convertible preferred stock	$	3	6
Participating securities	$	—	1

Three Months Ended September 30, 2015
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	21	59
5.75% cumulative convertible preferred stock (series A)	$	16	42
5.00% cumulative convertible preferred stock (series 2005B)	$	3	6
4.50% cumulative convertible preferred stock	$	3	6

Nine Months Ended September 30, 2016
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	63	58
5.75% cumulative convertible preferred stock (series A)	$	48	42
5.00% cumulative convertible preferred stock (series 2005B)	$	7	6
4.50% cumulative convertible preferred stock	$	9	6
Participating securities	$	—	1

Nine Months Ended September 30, 2015
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	64	59
5.75% cumulative convertible preferred stock (series A)	$	47	42
5.00% cumulative convertible preferred stock (series 2005B)	$	8	6
4.50% cumulative convertible preferred stock	$	9	6
Participating securities	$	—	2

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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 September 30, 2016 and December 31, 2015:



	September 30, 2016						December 31, 2015
	Principal Amount			Carrying Amount			Principal Amount			Carrying Amount
	($ in millions)
Term loan due 2021	$	1,500		$	1,500		$	—		$	—
3.25% senior notes due 2016	—			—			381			381
6.25% euro-denominated senior notes due 2017^(a)	299			299			329			329
6.5% senior notes due 2017	233			233			453			453
7.25% senior notes due 2018	460			460			538			538
Floating rate senior notes due 2019	504			504			1,104			1,104
6.625% senior notes due 2020	807			807			822			822
6.875% senior notes due 2020	291			291			304			304
6.125% senior notes due 2021	555			555			589			589
5.375% senior notes due 2021	272			272			286			286
4.875% senior notes due 2022	453			453			639			639
8.00% senior secured second lien notes due 2022	2,425			3,459			2,425			3,584
5.75% senior notes due 2023	339			339			384			384
2.75% contingent convertible senior notes due 2035^(b)	2			2			2			2
2.5% contingent convertible senior notes due 2037^(b)(c)	130			125			1,110			1,027
2.25% contingent convertible senior notes due 2038^(b)(c)	207			184			340			290
Revolving credit facility	240			240			—			—
Debt issuance costs	—			(49		)	—			(43		)
Discount on senior notes	—			(2		)	—			(4		)
Interest rate derivatives^(d)	—			6			—			7
Total debt, net	8,717			9,678			9,706			10,692
Less current maturities of long-term debt, net^(e)	(662		)	(656		)	(381		)	(381		)
Total long-term debt, net	$	8,055		$	9,022		$	9,325		$	10,311

___________________________________________


(a)	The principal and carrying amounts shown are based on the exchange rate of $1.1235 to €1.00 and $1.0862 to €1.00 as of September 30, 2016 and December 31, 2015, respectively. See Foreign Currency Derivatives in Note 8 for information on our related foreign currency derivatives.


(b)	The repurchase, conversion, contingent interest and redemption provisions of our contingent convertible senior notes are as follows:

Holders’ Demand Repurchase Rights. 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Optional Conversion by Holders. At the holder’s option, prior to maturity under certain circumstances, the notes are convertible into cash and, if applicable, shares of our common stock using a net share settlement process. One 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. During the specified period in the Current Quarter, the price of our common stock was below the threshold level for each series of the contingent convertible senior notes and, as a result, the holders do not have the option to convert their notes into cash and common stock in the fourth quarter of 2016 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 during the Current Quarter and 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 the principal amount.

Contingent Interest. We will pay contingent interest on the convertible senior notes after they have been outstanding at least ten years during certain periods if the average trading price of the notes exceeds the threshold defined in the indenture.

The holders’ demand repurchase dates, the common stock price conversion threshold amounts (as adjusted to give effect to cash dividends on our common stock) 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	Holders' Demand Repurchase Dates	Common Stock Price Conversion Thresholds		Contingent Interest First Payable (if applicable)
2.75% due 2035	November 15, 2020, 2025, 2030	$	45.02	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$	59.44	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$	100.20	June 14, 2019

Optional Redemption by the Company. We may redeem the contingent 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. In addition, we may redeem our 2.75% Contingent Convertible Senior Notes due 2035 at any time.


(c)	The carrying amount associated with the equity component of our contingent convertible senior notes as of September 30, 2016 and December 31, 2015 is net of $28 million and $133 million, respectively. This amount is amortized based on an effective yield method.


(d)	See Interest Rate Derivatives in Note 8 for further discussion related to these instruments.

(e)

As of September 30, 2016, current maturities of long-term debt, net includes our 6.25% Euro-denominated Senior Notes due 2017, 6.5% Senior Notes due 2017 and our 2.5% Contingent Convertible Senior Notes due 2037 (2037 Notes). As discussed in footnote (b) above, the holders of our 2037 Notes could exercise their individual demand repurchase rights on May 15, 2017, which would require us to repurchase all or a portion of the principal amount of the notes. As of September 30, 2016, there was $5 million associated with the equity component of the 2037 Notes.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Term Loan Facility

In the Current Quarter, we entered into a secured five-year term loan facility in aggregate principal amount of $1.5 billion for net proceeds of approximately $1.482 billion. Our obligations under the new facility are unconditionally guaranteed on a joint and several basis by the same subsidiaries that guarantee our revolving credit facility and are secured by first-priority liens on the same collateral securing our revolving credit facility (with a position in the collateral proceeds waterfall junior to the revolving credit facility). The term loan bears interest at a rate of London Interbank Offered Rate (LIBOR) plus 7.50% per annum, subject to a 1.00% LIBOR floor, or the Alternative Base Rate (ABR) plus 6.50% per annum, subject to a 2.00% ABR floor, at our option. The loan was made at par without original discount. We used the net proceeds to finance tender offers for our unsecured notes.

The term loan matures in August 2021 and is subject to a make-whole premium prior to the second anniversary of the closing of the term loan, a premium to par of 4.25% from the second anniversary until but excluding the third anniversary, a premium to par of 2.125% from the third anniversary until but excluding the fourth anniversary and at par beginning on the fourth anniversary. The term loan may be subject to mandatory prepayments and offers to prepay with net cash proceeds of certain issuances of debt, certain sales and other dispositions of collateral.

The term loan contains covenants limiting our ability to incur additional indebtedness, incur liens, consummate mergers and similar fundamental changes, make restricted payments, sell collateral and use proceeds from such sales, make investments, repay certain subordinate, unsecured or junior lien indebtedness, and enter into transactions with affiliates.

Events of default under the term loan include, among other things, nonpayment of principal, interest or other amounts; violation of covenants; incorrectness of representations and warranties in any material respect; cross-payment default and cross acceleration with respect to other indebtedness with an outstanding principal balance of $125 million or more; bankruptcy; judgments involving liability of $125 million or more that are not paid; and ERISA events. Many events of default are subject to customary notice and cure periods.

Chesapeake Senior Notes and Contingent Convertible Senior Notes

In the Current Quarter, we used the net proceeds from our term loan discussed above to purchase and retire $898 million principal amount of our outstanding senior notes and $708 million principal amount of our outstanding contingent convertible senior notes for an aggregate $1.5 billion pursuant to tender offers. We recognized an aggregate gain of $87 million associated with these debt retirements, which was net of $25 million associated with the equity component of the retired contingent convertible senior notes. In the Current Period, in addition to these tender offers and the repayment upon maturity of $259 million principal amount of our 3.25% Senior Notes due 2016, we repurchased in the open market approximately $181 million principal amount of our outstanding senior notes for $151 million and $118 million principal amount of our outstanding contingent convertible senior notes for $63 million. Additionally, we privately negotiated exchanges of approximately $290 million principal amount of our outstanding senior notes for 53,923,925 shares of common stock and $287 million principal amount of our outstanding contingent convertible senior notes for 55,427,782 shares of common stock. In the Current Period, we recorded an aggregate gain of approximately $255 million associated with the tender offers, debt repurchases and exchanges discussed above.

Chesapeake Energy Corporation is a holding company and has no independent assets or operations. Our obligations under our outstanding senior notes and contingent convertible senior notes are fully and unconditionally guaranteed, jointly and severally, by certain of our 100% owned subsidiaries on a senior unsecured basis. Our non-guarantor subsidiaries are minor and, as such, we have not included condensed consolidating financial information.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Revolving Credit Facility

We have a $4.0 billion senior secured revolving credit facility that matures in December 2019. As of September 30, 2016, we had outstanding borrowings of $240 million under the revolving credit facility and had used $709 million of the revolving credit facility for various letters of credit (including the $461 million supersedeas bond with respect to the 2019 Notes litigation discussed in Note 4). The terms of the revolving credit facility include covenants limiting, among other things, our ability to incur additional indebtedness, make investments or loans, create liens, consummate mergers and similar fundamental changes, make restricted payments, make investments in unrestricted subsidiaries and enter into transactions with affiliates. We were in compliance with all applicable financial covenants under the agreement as of September 30, 2016.

In the Current Period, we entered into the third amendment to our revolving credit facility. Pursuant to the amendment, our borrowing base was reaffirmed in the amount of $4.0 billion and the next scheduled borrowing base redetermination review was postponed until June 15, 2017, with the consenting lenders agreeing not to exercise their interim redetermination right prior to that date. Our borrowing base may be reduced if we dispose of a certain percentage of the value of the collateral securing the facility. As a result of asset sales discussed in Note 16 and all other sales of collateral since the date of the most recent amendment, as of October 31, 2016, our borrowing base was reduced to $3.8 billion. The amendment also provides temporary financial covenant relief, with the revolving credit facility’s existing first lien secured leverage ratio and net debt to capitalization ratio suspended until September 30, 2017 and the interest coverage ratio maintenance covenant reduced as noted below. In addition, we agreed to grant liens and security interests on a majority of our assets, as well as maintain a minimum liquidity amount (defined as cash and cash equivalents and availability under our revolving credit facility) of $500 million until the suspension of the existing maintenance covenants ends.

The amendment reduces the interest coverage ratio from 1.1 to 1.0 to 0.65 to 1.0 through the first quarter of 2017, after which it will increase to 0.70 to 1.0 through the second quarter of 2017, 1.2 to 1.0 through the third quarter of 2017 and 1.25 to 1.0 thereafter. The amendment also includes a collateral value coverage test whereby if the collateral value coverage ratio, tested as of December 31, 2016, falls below 1.1 to 1.0, the $500 million minimum liquidity covenant increases to $750 million, and if the collateral value coverage ratio, tested as of March 31, 2017, falls below 1.25 to 1.0, our borrowing ability will be reduced in order to satisfy such ratio. The amendment also gives us the ability to incur up to $2.5 billion of first lien indebtedness secured on a pari passu basis with the existing obligations under the credit agreement, subject to a position in the collateral proceeds waterfall in favor of the revolving lenders and the other limitations on junior lien debt set forth in the credit agreement. After taking into account the term loan, the amount of additional first lien indebtedness permitted by the revolving credit facility is $1.0 billion.

Fair Value of Debt

We estimate the fair value of our senior notes using quoted market prices (Level 1). The fair value of all other debt, including borrowings under our revolving credit facility, 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.



	September 30, 2016				December 31, 2015
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
			($ in millions)
Short-term debt (Level 1)	$	656	$	661	$	381	$	366
Long-term debt (Level 1)	$	7,299	$	6,031	$	10,304	$	3,735
Long-term debt (Level 2)	$	1,717	$	1,788	$	—	$	—

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


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.

2016 Shareholder Litigation. On April 19, 2016, a derivative action was filed in the U.S. District Court for the Western District of Oklahoma against the Company and current and former directors and officers of the Company alleging, among other things, violation of and conspiracy to violate the federal Racketeer Influenced and Corrupt Organizations Act, breach of fiduciary duties, waste of corporate assets, gross mismanagement and violations of Sections 10(b) and Rule 10b-5 of the Exchange Act related to actions allegedly taken by such persons since 2008. The lawsuit seeks certification as a class action, damages, attorneys’ fees and other costs.

Regulatory and Related Proceedings. The Company has received, from the U.S. Department of Justice (DOJ) and certain state governmental agencies and authorities, subpoenas and demands for documents, information and testimony in connection with investigations into possible violations of federal and state antitrust laws relating to our purchase and lease of oil and natural gas rights in various states. The Company also has received DOJ, U.S. Postal Service and state subpoenas seeking information on the Company’s royalty payment practices. Chesapeake has engaged in discussions with the DOJ, U.S. Postal Service and state agency representatives and continues to respond to such subpoenas and demands.

In addition, the Company received a DOJ subpoena and a voluntary document request from the SEC seeking information on our accounting methodology for the acquisition and classification of oil and natural gas properties and related matters. Chesapeake has engaged in discussions with the DOJ and SEC about these matters. On October 4, 2016, a securities class action was filed in the U.S. District Court for the Western District of Oklahoma against the Company and certain current directors and officers of the Company alleging, among other things, violations of federal securities laws for purported misstatements in the Company’s SEC filings and other public disclosures regarding the Company’s accounting for the acquisition and classification of oil and natural gas properties. The lawsuit seeks certification as a class action, damages, attorneys’ fees and other costs.

Redemption of 2019 Notes. As previously disclosed in the 2015 Form 10-K, in connection with the litigation related to the Company’s notice issued on March 15, 2013 to redeem all of the 2019 Notes at par (plus accrued interest through the redemption date) pursuant to the special early redemption provision of the supplemental indenture governing the 2019 Notes, the Company filed a notice of appeal on July 27, 2015 of an amended judgment entered on July 17, 2015 by the U.S. District Court for the Southern District of New York awarding the Trustee for the 2019 Notes $380 million plus prejudgment interest in the amount of $59 million. The Company posted a supersedeas bond in the amount of $461 million (reflected as an outstanding letter of credit under the Company’s revolving credit facility) to stay execution of the judgment while appellate proceedings are pending. The Company accrued a loss contingency of $100 million for this matter in 2014 and an additional $339 million in 2015. On September 15, 2016, the United States Court of Appeals for the Second Circuit affirmed the trial court’s ruling. We intend to seek a rehearing en banc of the appeal by the U.S. Court of Appeals for the Second Circuit and may file a petition for writ of certiorari with the United States Supreme Court.

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 oil and natural gas 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 failure-to-close cases in various courts, has settled and resolved other such cases and disputes and believes that its remaining loss exposure for these claims will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

Regarding royalty claims, Chesapeake and other natural gas producers have been named in various lawsuits alleging royalty underpayment. The suits against us allege, among other things, 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. Plaintiffs have varying royalty provisions in their respective leases, oil and gas law varies from state to state, and royalty owners and producers differ in their interpretation of the legal effect of lease provisions governing royalty calculations. The Company has resolved a number of these claims through negotiated settlements of past and future royalties and has prevailed in various other lawsuits. We are currently defending lawsuits seeking damages with respect to royalty underpayment in various states, including, but not limited to, Texas, Pennsylvania, Ohio, Oklahoma, Kentucky, Louisiana and Arkansas. These lawsuits include cases filed by individual royalty owners and putative class actions, some of which seek to certify a statewide class. The Company also has received DOJ, U.S. Postal Service and state subpoenas seeking information on the Company’s royalty payment practices.

Chesapeake is defending numerous lawsuits filed by individual royalty owners alleging royalty underpayment with respect to properties in Texas. On April 8, 2015, Chesapeake obtained a transfer order to move a substantial portion of these lawsuits to the 348th District Court of Tarrant County for pre-trial purposes (MDL). These lawsuits, which primarily relate to the Barnett Shale, generally allege that Chesapeake underpaid royalties by making improper deductions and using incorrect production volumes. Chesapeake entered into a settlement agreement with MDL plaintiffs representing over 97% of the hydrocarbons at issue by volume and, on July 22, 2016, the plaintiffs who accepted the settlement filed to dismiss such lawsuits. Chesapeake funded the settlement amount of approximately $29 million in cash and signed a $10 million, three-year promissory note in July 2016, which is accrued for as of September 30, 2016. Additional plaintiffs are continuing to accept the settlement on a rolling basis. Chesapeake expects that additional lawsuits filed by plaintiffs not participating in the settlement will continue to be pursued and that new plaintiffs will file other lawsuits making similar allegations.

On December 9, 2015, the Commonwealth of Pennsylvania, by the Office of Attorney General, filed a lawsuit in the Bradford County Court of Common Pleas related to royalty underpayment and lease acquisition and accounting practices with respect to properties in Pennsylvania. The lawsuit, which primarily relates to the Marcellus Shale and Utica Shale, alleges that Chesapeake violated the Pennsylvania Unfair Trade Practices and Consumer Protection Law (UTPCPL) by making improper deductions and entering into arrangements with affiliates that resulted in underpayment of royalties. The lawsuit seeks statutory restitution, civil penalties and costs, as well as temporary injunction from exploration and drilling activities in Pennsylvania until restitution, penalties and costs have been paid and permanent injunction from further violations of the UTPCPL. On February 8, 2016, the Office of Attorney General amended the complaint to, among other things, add an additional UTPCPL claim and antitrust claim alleging that a joint exploration agreement to which Chesapeake is a party established unlawful market allocation for the acquisition of leases. In response to Chesapeake’s preliminary objections, the Office of Attorney General filed a second amended complaint on May 3, 2016, alleging further violations of the UTPCPL based upon alleged predicate violations of the federal Sherman Act and the Federal Trade Commission Act. Chesapeake removed the case to the United States District Court for the Middle District of Pennsylvania on May 27, 2016. On August 15, 2016, the federal court remanded the case to state court.

Putative statewide class actions in Pennsylvania and Ohio and purported class arbitrations in Pennsylvania have been filed on behalf of royalty owners asserting various claims for damages related to alleged underpayment of royalties as a result of the Company’s divestiture of substantially all of its midstream business and most of its gathering assets in 2012 and 2013. These cases include claims for violation of and conspiracy to violate the federal Racketeer Influenced and Corrupt Organizations Act and for an unlawful market allocation agreement for mineral rights. One of the cases includes claims of intentional interference with contractual relations and violations of antitrust laws related to purported markets for gas mineral rights, operating rights and gas gathering sources.

We believe losses are reasonably possible in certain of the pending royalty cases for which we have not accrued a loss contingency, but we are currently unable to estimate an amount or range of loss or the impact the actions could have on our future results of operations or cash flows. Uncertainties in pending royalty cases generally include the complex nature of the claims and defenses, the potential size of the class in class actions, the scope and types of the properties and agreements involved, and the applicable production years.

The Company is also defending lawsuits alleging various violations of the Sherman Antitrust Act and state antitrust laws. In 2016, putative class action lawsuits have been filed in the United States District Court for the Western District of Oklahoma and in Oklahoma state courts, and an individual lawsuit was filed in the United States District Court of Kansas, in each case against the Company and other defendants. The lawsuits generally allege that, since 2007 and continuing through April 2013, the defendants conspired to rig bids and depress the market for the purchases of oil and natural gas leasehold interests and properties in the Anadarko Basin containing producing oil and natural gas wells. The lawsuits seek damages, attorney’s fees, costs and interest, as well as enjoinment from adopting practices or plans which would restrain competition in a similar manner as alleged in the lawsuits.

In April 2016, a class action lawsuit on behalf of holders of the Company’s 6.875% Senior Notes due 2020 (the 2020 Notes) and 6.125% Senior Notes due 2021 (2021 Notes) was filed in the U.S. District Court for the Southern District of New York relating to the Company’s December 2015 debt exchange, whereby the Company privately exchanged newly issued 8.00% Senior Secured Second Lien Notes due 2022 (Second Lien Notes) for certain outstanding senior unsecured notes and contingent convertible notes. The lawsuit alleges that the Company violated the Trust Indenture Act of 1939 and the implied covenant of good faith and fair dealing by benefiting themselves and a minority of noteholders who are qualified institutional buyers (QIBs). According to the lawsuit, as a result of the Company’s private debt exchange in which only QIBs (and non-U.S. persons under Regulation S) were eligible to participate, the Company unjustly enriched itself at the expense of class members by reducing indebtedness and reducing the value of the 2020 Notes and the 2022 Notes. The lawsuit seeks damages and attorney’s fees, in addition to declaratory relief that the debt exchange and the liens created for the benefit of the Second Lien Notes are null and void and that the debt exchange effectively resulted in a default under the indentures for the 2020 Notes and the 2021 Notes. In June 2016, the lawsuit was transferred to the United States District Court for the Western District of Oklahoma, and in October 2016, the Company filed a motion to dismiss for failure to state a claim. A hearing date for the motion has not been set.

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 future 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 Contingencies

The nature of the oil and gas business carries with it certain environmental risks for Chesapeake and its subsidiaries. Chesapeake has implemented various policies, programs, 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 address 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Commitments

Gathering, Processing and Transportation Agreements

We have contractual commitments with midstream service companies and pipeline carriers for future gathering, processing and transportation of oil, natural gas and NGL 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 in our estimates of proved reserves.

The aggregate undiscounted commitments under our gathering, processing and transportation agreements, excluding any proportionate share of these costs from working interest and royalty interest owners, credits for third-party volumes or future costs under cost-of-service agreements, are presented below.



	September 30, 2016
	($ in millions)
2016	$	465
2017	1,872
2018	1,667
2019	1,382
2020	1,052
2021 – 2099	6,590
Total	$	13,028

In addition, we have entered into long-term agreements for certain natural gas gathering and related services within specified acreage dedication areas in exchange for cost-of-service based fees redetermined annually, or tiered fees based on volumes delivered relative to scheduled volumes. Future gathering fees vary with the applicable agreement.

Drilling Contracts

We have contracts with various drilling contractors to utilize drilling services with terms ranging from one year to three years at market-based pricing. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of September 30, 2016, the aggregate undiscounted minimum future payments under these drilling service commitments were approximately $144 million.

Pressure Pumping Contracts

We have an agreement for pressure pumping services. Throughout the term of the agreement, which expires in June 2017, the services agreement requires us to utilize, at market-based pricing, the lesser of (i) three pressure pumping crews through June 30, 2017 or (ii) 50% of the total number of all pressure pumping crews working for us in all of our operating regions during the respective year. We are also required to utilize the pressure pumping services for a minimum number of fracture stages as set forth in the agreement. We are entitled to terminate the agreement in certain situations, including if the contractor fails to provide the overall quality of service provided by similar service providers. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of September 30, 2016, the aggregate undiscounted minimum future payments under this agreement were approximately $79 million.

Oil, Natural Gas and NGL Purchase Commitments

We commit to purchase oil, natural gas and NGL from other owners in the properties we operate, including owners associated with our volumetric production payment (VPP) transactions. Production purchases under these arrangements are based on market prices at the time of production, and the purchased oil, natural gas and NGL are resold at market prices. See Volumetric Production Payments in Note 9 for further discussion of our VPP transactions.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Net Acreage Maintenance Commitments

Under the terms of our Utica Shale joint venture agreements with Total S.A., we are required to extend, renew or replace expiring joint leasehold, at our cost, to ensure that the net acreage is maintained in certain designated areas as of a future measurement date.

Other Commitments

As part of our normal course of business, we enter into various agreements providing, or otherwise arranging for, 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 acquisitions and 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 and/or other specified matters. 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 entering into or consummating a particular transaction. For divestitures of oil and natural gas properties, our purchase and sale agreements may require the return of a portion of the proceeds we receive as a result of uncured title defects.

Certain of our oil and natural gas 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 these interests have been created, we have the responsibility to bear the cost of developing and producing the reserves attributable to these interests. See Volumetric Production Payments in Note 9 for further discussion of our VPP transactions.

While executing our strategic priorities, we have incurred certain cash charges, including contract termination charges, financing extinguishment costs and charges for unused natural gas transportation and gathering capacity. As we continue to focus on our strategic priorities, we may take certain actions that reduce financial leverage and complexity, and we may incur additional cash and noncash charges.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


5.	Other Liabilities

Other current liabilities as of September 30, 2016 and December 31, 2015 are detailed below.



	September 30, 2016		December 31, 2015
	($ in millions)
Revenues and royalties due others	$	499	$	500
Accrued drilling and production costs	172		212
Joint interest prepayments received	74		169
Accrued compensation and benefits	198		264
Other accrued taxes	55		37
Bank of New York Mellon legal accrual	440		439
Minimum gathering volume commitment	—		201
Accrual for termination of Barnett gathering agreement	334		—
Other	221		397
Total other current liabilities	$	1,993	$	2,219

Other long-term liabilities as of September 30, 2016 and December 31, 2015 are detailed below.



	September 30, 2016		December 31, 2015
	($ in millions)
CHK Utica ORRI conveyance obligation^(a)	$	168	$	190
Financing obligations	—		29
Unrecognized tax benefits	94		64
Other	145		126
Total other long-term liabilities	$	407	$	409

____________________________________________

(a)

The CHK Utica, L.L.C. investors’ right to receive, proportionately, a 3% overriding royalty interest (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 through 2023. The liability represents the obligation to deliver future ORRIs. Approximately $36 million and $21 million of the total $204 million and $211 million obligations are recorded in other current liabilities as of September 30, 2016 and December 31, 2015, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


6.	Equity

Common Stock

A summary of the changes in our common shares issued for the Current Period and the Prior Period are detailed below.



	Nine Months Ended September 30,
	2016	2015
	(in thousands)
Shares issued as of January 1	664,796	664,944
Exchange of convertible notes	55,428	—
Exchange of senior notes	53,924	—
Conversion of preferred stock	1,021	—
Restricted stock issuances (net of forfeitures and cancellations)	1,852	85
Stock option exercises	—	14
Shares issued as of September 30	777,021	665,043

On May 20, 2016, our shareholders approved an amendment to our certificate of incorporation to increase our authorized common stock from 1,000,000,000 shares to 1,500,000,000 shares, par value $0.01 per share.

Preferred Stock

Outstanding shares of our preferred stock for the Current Period and the Prior Period are detailed below.



	5.75%		5.75% (A)		4.50%	5.00% (2005B)
	(in thousands)
Shares outstanding as of January 1, 2016	1,497		1,100		2,559	2,096
Preferred stock conversions^(a)	(25	)	(1	)	—	—
Shares outstanding as of September 30, 2016	1,472		1,099		2,559	2,096

Shares outstanding as of January 1, 2015 and September 30, 2015	1,497		1,100		2,559	2,096

____________________________________________

(a)

In the Current Period, holders of our 5.75% Cumulative Convertible Preferred Stock converted 24,601 shares into 975,488 shares of common stock. Also in the Current Period, holders of our 5.75% (Series A) Cumulative Convertible Preferred Stock converted 1,201 shares into 46,018 shares of common stock. Subsequent to September 30, 2016, we exchanged additional shares of our outstanding preferred stock for shares of our common stock. See Note 16 for information regarding the exchanges.

Dividends

In January 2016, we announced that we were suspending dividend payments on each series of our outstanding convertible preferred stock. Suspension of the dividends did not constitute an event of default under our revolving credit facility or bond indentures. Our preferred stock dividends for the Current Period (paid in arrears) are detailed below.



	5.75%		5.75% (A)		4.50%		5.00% (2005B)
	($ in millions)
Dividends in arrears	$	63	$	48	$	7	$	9

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Accumulated Other Comprehensive Income (Loss)

For the Current Period and the Prior Period, changes in accumulated other comprehensive income (loss) for cash flow hedges, net of tax, are detailed below.



	Nine Months Ended September 30,
	2016			2015
	($ in millions)
Balance, December 31	$	(99	)	$	(143	)

Other comprehensive income before reclassifications	(23		)	6
Amounts reclassified from accumulated other comprehensive income	21			18
Net other comprehensive income (loss)	(2		)	24

Balance, September 30	$	(101	)	$	(119	)

For the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, net losses on cash flow hedges for commodity contracts reclassified from accumulated other comprehensive income (loss), net of tax, to oil, natural gas and NGL revenues in the condensed consolidated statements of operations were $7 million, $5 million, $21 million and $18 million, respectively.


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 common stock and restricted stock granted to non-employee directors under our long term incentive plans. 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 units to employees and non-employee directors. Prior to 2014, we also granted restricted stock awards as equity compensation. We refer to both types of awards as restricted stock. A summary of the changes in unvested restricted stock during the Current Period is presented below.



	Shares of Unvested Restricted Stock		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested restricted stock as of January 1, 2016	10,455		$	17.31
Granted	4,533		$	4.55
Vested	(4,551	)	$	17.32
Forfeited	(999	)	$	13.42
Unvested restricted stock as of September 30, 2016	9,438		$	11.59

The aggregate intrinsic value of restricted stock that vested during the Current Period was approximately $20 million based on the stock price at the time of vesting.

As of September 30, 2016, there was approximately $68 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 1.59 years.

Stock Options. In the Current Period and the Prior Period, we granted members of senior management stock options that vest ratably over a three-year period. In January 2013, we also granted retention awards of stock options to certain officers that 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 expire seven to ten years from the date of grant.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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. 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 dividend policy, over the expected life of the option. The Company used the following weighted average assumptions to estimate the grant date fair value of the stock options granted in the Current Period.



Expected option life – years	6.0
Volatility	46.07	%
Risk-free interest rate	1.70	%
Dividend yield	—	%

The following table provides information related to stock option activity in the Current Period.



	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 as of January 1, 2016	5,377		$	19.37	5.80	$	—
Granted	4,932		$	3.71
Exercised	—		$	—		$	—
Expired	(771	)	$	19.46
Forfeited	(945	)	$	5.66
Outstanding as of September 30, 2016	8,593		$	11.88	7.47	$	10

Exercisable as of September 30, 2016	2,844		$	19.60	5.78	$	—

___________________________________________


(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 September 30, 2016, there was $9 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 1.83 years.

Restricted Stock and Stock Option Compensation. We recognized the following compensation costs related to restricted stock and stock options for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	($ in millions)
General and administrative expenses	$	10	$	9	$	28	$	33
Oil and natural gas properties	4		3		13		18
Oil, natural gas and NGL production expenses	4		4		10		14
Marketing, gathering and compression expenses	—		—		1		3
Total	$	18	$	16	$	52	$	68

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Liability-Classified Awards

Performance Share Units. We have granted PSUs to senior management that vest ratably over a three-year term and are settled in cash on the third anniversary of the awards. The ultimate amount earned is based on achievement of performance metrics established by the Compensation Committee of the Board of Directors, which include total shareholder return (TSR) and, for certain of the awards, operational performance goals such as finding and development costs and production levels.

For PSUs granted in 2016, the TSR component can range from 0% to 100% and the operational component can range from 0% to 100%, resulting in a maximum payout of 200%. For PSUs granted in 2015, the TSR component can range from 0% to 100%, and each of the two operational components can range from 0% to 50% resulting in a maximum total payout of 200%. For PSUs granted in 2014, the TSR component can range from 0% to 200%, with no operational components. Compensation expense associated with PSU grants is recognized over the service period based on the graded-vesting method. The value of the PSU awards at the end of each reporting period is dependent upon the Company’s estimates of the underlying performance measures. The Company utilized the Monte Carlo simulation for the TSR performance measure and the following assumptions to determine the grant date fair value of the PSUs. The payout percentage for all PSU grants is capped at 100% if the Company's absolute TSR is less than zero.



Volatility	87.15	%
Risk-free interest rate	0.80	%
Dividend yield for value of awards	—	%

The following table presents a summary of our 2016, 2015 and 2014 PSU awards.



		Grant Date Fair Value		September 30, 2016
	Units	Grant Date Fair Value		Fair Value		Vested Liability
		($ in millions)
2016 Awards:
Payable 2019	2,348,893	$	10	$	18	$	8
2015 Awards:
Payable 2018	629,694	$	13	$	3	$	3
2014 Awards:
Payable 2017	561,215	$	16	$	—	$	—

PSU Compensation. We recognized the following compensation costs (credits) related to PSUs for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period.



	Three Months Ended September 30,					Nine Months Ended September 30,
	2016		2015			2016		2015
	($ in millions)
General and administrative expenses	$	7	$	(2	)	$	10	$	(16	)
Restructuring and other termination costs	—		(1		)	1		(16		)
Marketing, gathering and compression	—		—			—		(1		)
Oil and natural gas properties	—		—			—		(1		)
Total	$	7	$	(3	)	$	11	$	(34	)

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


8.	Derivative and Hedging Activities

Chesapeake uses derivative instruments to secure attractive pricing and margins on its share of expected 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 its exposure to foreign currency exchange rate fluctuations. All of our commodity 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.

Oil, Natural Gas and NGL Derivatives

As of September 30, 2016 and December 31, 2015, our oil, natural gas and NGL 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. In exchange for higher fixed prices on certain of our swap trades, we granted options that allow the counterparty to double the notional amount.

•

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 the excess on sold call options and Chesapeake receives the 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.


•	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.


•	Basis Protection Swaps: These instruments are arrangements that guarantee a fixed price differential to NYMEX from a specified delivery point. Chesapeake receives the fixed price differential and pays the floating market price differential to the counterparty for the hedged commodity.

The estimated fair values of our oil, natural gas and NGL derivative instrument assets (liabilities) as of September 30, 2016 and December 31, 2015 are provided below.



	September 30, 2016				December 31, 2015
	Volume	Fair Value			Volume	Fair Value
		($ in millions)				($ in millions)
Oil (mmbbl):
Fixed-price swaps	21.8	$	(49	)	13.5	$	144
Call options	8.7	(2		)	19.2	(7		)
Total oil	30.5	(51		)	32.7	137

Natural gas (tbtu):
Fixed-price swaps	640	(43		)	500	229
Collars	38	1			—	—
Call options	160	(26		)	295	(99		)
Basis protection swaps	44	1			57	—
Total natural gas	882	(67		)	852	130

NGL (mmgal):
Fixed-price swaps	36	(3		)	—	—

Total estimated fair value		$	(121	)		$	267

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).

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Interest Rate Derivatives

As of September 30, 2016 and December 31, 2015, there were no interest rate derivatives outstanding.

We have terminated fair value hedges related to certain of our 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 four years, we will recognize $6 million in net gains related to these transactions.

Foreign Currency Derivatives

We are party to cross currency swaps to mitigate our exposure to foreign currency exchange rate fluctuations. In the Current Quarter, in connection with our tender offers, we retired €36 million in aggregate principal amount of our 6.25% Euro-denominated Senior Notes due 2017, and we simultaneously unwound the cross currency swaps for the same principal amount at a cost of $8 million. Under the terms of the remaining cross currency swaps, on each semi-annual interest payment date, the counterparties pay us €8 million and we pay the counterparties $13 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay us €266 million and we will pay the counterparties $355 million. 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. 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 sheets as liabilities of $56 million and $52 million as of September 30, 2016 and December 31, 2015, respectively. The euro-denominated debt in long-term debt has been adjusted to $299 million as of September 30, 2016, using an exchange rate of $1.1235 to €1.00.

Supply Contract Derivatives

From time to time and in the normal course of business, our marketing subsidiary enters into supply contracts under which we commit to deliver a predetermined quantity of natural gas to certain counterparties in an attempt to earn attractive margins. Under certain contracts, we receive a sales price that is based on the price of a product other than natural gas, thereby creating an embedded derivative requiring bifurcation. In one of these supply contracts, we were committed to supply a minimum of 90 bbtu per day of natural gas through March 2025. In the Current Quarter, we sold the long-term natural gas supply contract to a third party for cash proceeds of $146 million, which is included in marketing, gathering and compression revenues as a realized gain. We reversed the cumulative unrealized gains, resulting in an unrealized loss of $280 million in the Current Quarter and $297 million in the Current Period, respectively.

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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 September 30, 2016 and December 31, 2015 on a gross basis and after same-counterparty netting:

Balance Sheet Classification

Gross

Fair Value

Amounts Netted

in Condensed

Consolidated

Balance Sheet

Net Fair Value Presented

in Condensed Consolidated

Balance Sheet

($ in millions)

As of September 30, 2016

Commodity Contracts:

Short-term derivative asset

(31

)