1 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, 1996 [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities 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) DELAWARE 73-1395733 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6104 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 --- --- At April 30, 1996, there were 19,899,547 shares of the registrant's $.10 par value Common Stock outstanding.
2 PART I. FINANCIAL INFORMATION Index to Financial Statements and Management's Discussion and Analysis <TABLE> <CAPTION> Page ---- <S> <C> Chesapeake Energy Corporation: Item 1. Consolidated Financial Statements: Consolidated Balance Sheets at March 31, 1996 and June 30, 1995 . . . . . . . . . . . . . . . . . . . 3 Consolidated Statements of Operations for the Three and Nine Months Ended March 31, 1996 and 1995 . . . . . 4 Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 1996 and 1995 . . . . . . . 5 Notes to Consolidated Financial Statements . . . . . . 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . 13 Chesapeake Exploration Limited Partnership: Item 1. Financial Statements Balance Sheets at March 31, 1996 and June 30, 1995 . . . . . . . . . . . . . . . . . . . . . 19 Statements of Operations for the Three and Nine Months Ended March 31, 1996 and 1995 . . . . . . . 20 Statements of Cash Flows for the Nine Months Ended March 31, 1996 and 1995 . . . . . . . 21 Notes to Financial Statements . . . . . . . . . . . . . 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . 23 </TABLE> Page 2
3 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> ASSETS March 31, June 30, 1996 1995 --------- --------- ($ in thousands) <S> <C> <C> CURRENT ASSETS: Cash and cash equivalents $ 25,948 $ 55,535 Accounts receivable: Oil and gas sales 12,242 10,644 Gas marketing sales 6,189 -- Joint interest and other, net of allowance for doubtful accounts of $237,000 and $452,000 27,138 26,317 Related parties 1,847 4,386 Inventory 7,066 8,926 Other 1,798 633 --------- --------- Total Current Assets 82,228 106,441 --------- --------- PROPERTY AND EQUIPMENT: Oil and gas properties, at cost based on full cost accounting: Evaluated oil and gas properties 279,668 165,302 Unevaluated properties 76,265 27,474 Less: accumulated depreciation, depletion and amortization (77,089) (41,821) --------- --------- 278,844 150,955 Service properties, equipment, and other 22,505 16,966 Less: accumulated depreciation and amortization (5,797) (4,120) --------- --------- Total Property and Equipment 295,552 163,801 --------- --------- OTHER ASSETS 6,939 6,451 --------- --------- TOTAL ASSETS $ 384,719 $ 276,693 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable and current maturities of long-term debt $ 8,496 $ 9,993 Accounts payable 62,491 33,438 Related party payables 6,000 -- Accrued liabilities and other 8,048 7,572 Revenues and royalties due others 31,977 23,786 Income taxes payable 116 116 --------- --------- Total Current Liabilities 117,128 74,905 --------- --------- LONG-TERM DEBT 184,084 145,754 --------- --------- REVENUES AND ROYALTIES DUE OTHERS 5,465 3,779 --------- --------- DEFERRED INCOME TAXES 13,285 7,280 --------- --------- CONTINGENCIES AND COMMITMENTS STOCKHOLDERS' EQUITY: Common Stock, $.10 par value, 45,000,000 shares authorized at March 31, 1996; $.0033 par value, 20,000,000 shares authorized at June 30, 1995; 17,843,149 and 17,540,832 shares issued and outstanding at March 31, 1996 and June 30, 1995, respectively 1,784 58 Paid-in capital 32,354 30,295 Accumulated earnings 30,619 14,622 --------- --------- Total Stockholders' Equity 64,757 44,975 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 384,719 $ 276,693 ========= ========= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. Page 3
4 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, ------------------- ------------------- 1996 1995 1996 1995 ------- ------- ------- ------- ($ in thousands, ($ in thousands, except per share data) except per share data) <S> <C> <C> <C> <C> REVENUES: Oil and gas sales $30,887 $14,025 $77,237 $36,501 Gas marketing sales 11,558 -- 15,345 -- Oil and gas service operations 1,700 1,763 5,317 6,514 Interest and other 250 68 2,041 976 ------- ------- ------- ------- Total Revenues 44,395 15,856 99,940 43,991 ------- ------- ------- ------- COSTS AND EXPENSES: Production expenses and taxes 2,136 1,357 5,839 2,648 Gas marketing expenses 10,788 -- 14,554 -- Oil and gas service operations 1,244 1,433 4,263 5,325 Oil and gas depreciation, depletion and amortization 13,035 6,653 35,268 15,725 Depreciation and amortization of other assets 766 626 2,151 1,590 General and administrative, net 1,435 722 3,347 2,367 Interest 3,173 1,518 9,717 4,455 ------- ------- ------- ------- Total Costs and Expenses 32,577 12,309 75,139 32,110 ------- ------- ------- ------- INCOME BEFORE INCOME TAXES 11,818 3,547 24,801 11,881 INCOME TAX EXPENSE 4,195 1,242 8,804 3,992 ------- ------- ------- ------- NET INCOME $ 7,623 $ 2,305 $15,997 $ 7,889 ======= ======= ======= ======= EARNINGS PER COMMON SHARE COMPUTATION: NET INCOME AVAILABLE TO COMMON $ 7,623 $ 2,305 $15,997 $ 7,889 ======= ======= ======= ======= NET INCOME PER COMMON SHARE $ .39 $ .12 $ .83 $ .43 ======= ======= ======= ======= WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 19,490 18,642 19,328 18,443 ======= ======= ======= ======= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. Page 4
5 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> NINE MONTHS ENDED March 31, ------------------------ 1996 1995 --------- --------- ($ in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 15,997 $ 7,889 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation, depletion and amortization 36,550 16,942 Deferred taxes 8,804 3,992 Amortization of loan costs 869 373 Amortization of bond discount 421 427 Gain on sale of fixed assets and other (366) (164) Purchases and sales of trading securities, net (850) -- Other adjustments (129) 34 CHANGES IN CURRENT ASSETS AND LIABILITIES 38,819 7,737 --------- --------- Cash provided by operating activities 100,115 37,230 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Exploration development and acquisition of oil and gas properties (171,523) (81,323) Proceeds from sale of oil and gas equipment, leasehold and other 8,366 13,505 Proceeds from sale of property, equipment and other 783 835 Investment in gas marketing company, net of cash acquired (363) -- Additions to property, equipment and other (6,334) (5,859) --------- --------- Cash used in investing activities (169,071) (72,842) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term borrowings 41,650 35,082 Payments on long-term borrowings (3,267) (11,740) Cash received from exercise of stock options 986 737 --------- --------- Cash provided by financing activities 39,369 24,079 --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (29,587) (11,533) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 55,535 16,225 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 25,948 $ 4,692 ========= ========= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. Page 5
6 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1996 (unaudited) 1. Accounting Principles The accompanying unaudited consolidated financial statements of Chesapeake Energy Corporation and Subsidiaries (the "Company") have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission. 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 three and nine months ended March 31, 1996, are not necessarily indicative of the results for the full fiscal year. As used in this Form 10-Q, the terms "Restricted Subsidiaries" and "Subsidiary Guarantors" include Chesapeake Operating, Inc. ("COI"), Lindsay Oil Field Supply, Inc., Sander Trucking Company, Inc., Whitmire Dozer Service, Inc., and Chesapeake Exploration Limited Partnership ("CEX"), and the terms "Unrestricted Subsidiaries" and "Non-Guarantor Subsidiaries" include Chesapeake Gas Development Corporation ("CGDC") and Chesapeake Energy Marketing, Inc. ("CEM"), each of which is a direct or indirect wholly owned subsidiary of the Company. 2. Recent Transactions On April 9, 1996, the Company issued 1,650,000 shares of Common Stock in a public offering at a price of $53.00 per share, which resulted in net proceeds to the Company of approximately $82.6 million before certain expenses of the offering. On April 9, 1996, the Company also issued $120 million in 9 1/8% Senior Notes due 2006 (the "9 1/8% Notes"), which resulted in net proceeds to the Company of approximately $116.0 million before certain expenses of the offering. The 9 1/8% Notes were issued at 99.931% of par. On April 12, 1996, the underwriters of the Company's Common Stock Offering exercised an over-allotment option to purchase an additional 346,500 shares of Common Stock at a price of $53.00 per share, resulting in additional net proceeds to the Company of approximately $17.3 million, before certain expenses. On April 30, 1996, the Company purchased interests in certain producing and non-producing oil and gas properties from Amerada Hess Corporation for $35 million, subject to adjustment for activity after the effective date of January 1, 1996. The properties are located in the Knox and Golden Trend fields of southern Oklahoma, most of which are operated by the Company. The Company estimates that it acquired approximately 58 billion cubic feet equivalent ("Bcfe") of proved oil and gas reserves. Additionally, the Company acquired approximately 14,000 net acres of unevaluated leasehold. Page 6
7 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1996 (unaudited) 3. Senior Notes 12% Notes The Company has outstanding $47.5 million in aggregate principal amount of 12% Notes which mature in March 2001. The 12% Notes bear interest at an annual rate of 12%, payable semiannually on each March 1 and September 1. The 12% Notes are senior obligations of the Company and are secured by a pledge of all of the issued and outstanding capital stock of, and partnership interests in, the Company's Restricted Subsidiaries. In addition, the 12% Notes are fully and unconditionally guaranteed, jointly and severally, by the Restricted Subsidiaries. The only subsidiary's securities which constitute a substantial portion of the collateral for the 12% Notes are the partnership interests in CEX, a limited partnership which is 10% owned by COI, as the sole general partner, and 90% owned directly by the Company, as the sole limited partner. Separate financial statements of CEX are presented elsewhere in this Form 10-Q. 10 1/2% Notes The Company has outstanding $90 million in aggregate principal amount of 10 1/2% Notes which mature June 2002. The 10 1/2% Notes bear interest at an annual rate of 10 1/2%, payable semiannually on each June 1 and December 1. The 10 1/2% Notes are senior, unsecured obligations of the Company, and are fully and unconditionally guaranteed, jointly and severally, by the Company's Restricted Subsidiaries. 9 1/8% Notes On April 9, 1996 the Company issued $120 million in aggregate principal amount of 9 1/8% Senior Notes due 2006 which mature April 15, 2006. The 9 1/8% Notes bear interest at an annual rate of 9 1/8%, payable semiannually on each April 15 and October 15, commencing October 15, 1996. The 9 1/8% Notes are senior, unsecured obligations of the Company, and are fully and unconditionally guaranteed, jointly and severally, by the Company's Restricted Subsidiaries. Set forth below are condensed consolidating financial statements of CEX, the other Subsidiary Guarantors, all Subsidiary Guarantors combined, the Non-Guarantor Subsidiaries and the Company. The CEX limited partnership condensed financial statements were prepared on a separate entity basis as reflected in the Company's books and records and include all material costs of doing business as if the partnership were on a stand-alone basis except that interest is not charged or allocated on intercompany advances. No provision has been made for income taxes because the partnership is not a tax paying entity. Page 7
8 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1996 (unaudited) CONDENSED CONSOLIDATING BALANCE SHEET AS OF MARCH 31, 1996 ($ IN THOUSANDS) <TABLE> <CAPTION> SUBSIDIARY GUARANTORS ----------------------------------- ALL NON-GUARANTOR COMPANY CEX OTHERS COMBINED SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED --------- --------- --------- ------------- --------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> ASSETS CURRENT ASSETS: Cash and cash equivalents $ -- $ 12,292 $ 12,292 $ 1,395 $ 12,261 $ -- $ 25,948 Accounts receivable, net 14,549 27,564 42,113 6,980 -- (1,677) 47,416 Inventory -- 7,032 7,032 34 -- -- 7,066 Other -- 569 569 12 1,217 -- 1,798 --------- --------- --------- --------- --------- --------- --------- Total Current Assets 14,549 47,457 62,006 8,421 13,478 (1,677) 82,228 --------- --------- --------- --------- --------- --------- --------- PROPERTY AND EQUIPMENT: Oil and gas properties 270,952 (15,901) 255,051 24,617 -- -- 279,668 Unevaluated leasehold 76,265 -- 76,265 -- -- -- 76,265 Other property and equipment -- 15,197 15,197 21 7,287 -- 22,505 Less: accumulated depreciation, depletion and amortization (69,752) (5,408) (75,160) (7,349) (377) -- (82,886) --------- --------- --------- --------- --------- --------- --------- Total Property & Equipment 277,465 (6,112) 271,353 17,289 6,910 -- 295,552 --------- --------- --------- --------- --------- --------- --------- INVESTMENTS IN SUBSIDIARIES AND INTERCOMPANY ADVANCES 55,344 297,707 353,051 7,325 198,179 (558,555) -- --------- --------- --------- --------- --------- --------- --------- OTHER ASSETS 675 12 687 946 5,306 -- 6,939 --------- --------- --------- --------- --------- --------- --------- TOTAL ASSETS $ 348,033 $ 339,064 $ 687,097 $ 33,981 $ 223,873 $(560,232) $ 384,719 ========= ========= ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable and current maturities of long-term debt $ -- $ 5,227 $ 5,227 $ 3,240 $ 29 $ -- $ 8,496 Accounts payable and other 378 101,405 101,783 4,947 3,604 (1,702) 108,632 --------- --------- --------- --------- --------- --------- --------- Total Current Liabilities 378 106,632 107,010 8,187 3,633 (1,702) 117,128 --------- --------- --------- --------- --------- --------- --------- LONG-TERM DEBT 35,000 2,277 37,277 10,560 136,247 -- 184,084 --------- --------- --------- --------- --------- --------- --------- REVENUES PAYABLE -- 5,465 5,465 -- -- -- 5,465 --------- --------- --------- --------- --------- --------- --------- DEFERRED INCOME TAXES -- 19,235 19,235 962 (6,912) -- 13,285 --------- --------- --------- --------- --------- --------- --------- INTERCOMPANY PAYABLES 238,606 235,269 473,875 8,284 72,601 (554,760) -- --------- --------- --------- --------- --------- --------- --------- STOCKHOLDERS' EQUITY: Common Stock -- 117 117 2 1,667 (2) 1,784 Other 74,049 (29,931) 44,118 5,986 16,637 (3,768) 62,973 --------- --------- --------- --------- --------- --------- --------- Total Stockholders' Equity 74,049 (29,814) 44,235 5,988 18,304 (3,770) 64,757 --------- --------- --------- --------- --------- --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 348,033 $ 339,064 $ 687,097 $ 33,981 $ 223,873 $(560,232) $ 384,719 ========= ========= ========= ========= ========= ========= ========= </TABLE> Page 8
9 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1996 (unaudited) CONDENSED CONSOLIDATING BALANCE SHEET AS OF JUNE 30, 1995 ($ IN THOUSANDS) <TABLE> <CAPTION> SUBSIDIARY GUARANTORS ----------------------------------- ALL NON-GUARANTOR COMPANY CEX OTHERS COMBINED SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED --------- --------- --------- ------------- --------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> ASSETS CURRENT ASSETS: Cash and cash equivalents $ -- $ 53,227 $ 53,227 $ 5 $ 2,303 $ -- $ 55,535 Accounts receivable, net 9,867 30,693 40,560 777 10 -- 41,347 Inventory -- 8,895 8,895 31 -- -- 8,926 Other -- 633 633 -- -- -- 633 --------- --------- --------- --------- --------- --------- Total Current Assets 9,867 93,448 103,315 813 2,313 -- 106,441 --------- --------- --------- --------- --------- --------- --------- PROPERTY AND EQUIPMENT: Oil and gas properties 163,521 (16,723) 146,798 18,504 -- -- 165,302 Unevaluated leasehold 27,474 -- 27,474 -- -- -- 27,474 Other property and equipment -- 12,199 12,199 -- 4,767 -- 16,966 Less: accumulated depreciation, depletion and amortization (36,959) (3,847) (40,806) (4,861) (274) -- (45,941) --------- --------- --------- --------- --------- --------- --------- Total Property & Equipment 154,036 (8,371) 145,665 13,643 4,493 -- 163,801 --------- --------- --------- --------- --------- --------- --------- INVESTMENTS IN SUBSIDIARIES AND INTERCOMPANY ADVANCES 17,559 181,914 199,473 -- 176,795 (376,268) -- --------- --------- --------- --------- --------- --------- --------- OTHER ASSETS 776 41 817 123 5,511 -- 6,451 --------- --------- --------- --------- --------- --------- --------- TOTAL ASSETS $ 182,238 $ 267,032 $ 449,270 $ 14,579 $ 189,112 $(376,268) $ 276,693 ========= ========= ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable and current maturities of long-term debt $ -- $ 7,757 $ 7,757 $ 2,200 $ 36 $ -- $ 9,993 Accounts payable and other 516 61,777 62,293 -- 2,619 -- 64,912 --------- --------- --------- --------- --------- --------- --------- Total Current Liabilities 516 69,534 70,050 2,200 2,655 -- 74,905 --------- --------- --------- --------- --------- --------- --------- LONG-TERM DEBT 10 1,326 1,336 8,600 135,818 -- 145,754 --------- --------- --------- --------- --------- --------- --------- REVENUES PAYABLE -- 3,779 3,779 -- -- -- 3,779 --------- --------- --------- --------- --------- --------- --------- DEFERRED INCOME TAXES -- 9,621 9,621 164 (2,505) -- 7,280 --------- --------- --------- --------- --------- --------- --------- INTERCOMPANY PAYABLES 140,236 201,959 342,195 3,307 30,766 (376,268) -- --------- --------- --------- --------- --------- --------- --------- STOCKHOLDERS' EQUITY: Common Stock -- 31 31 1 58 (32) 58 Other 41,476 (19,218) 22,258 307 22,320 32 44,917 --------- --------- --------- --------- --------- --------- --------- Total Stockholders' Equity 41,476 (19,187) 22,289 308 22,378 -- 44,975 --------- --------- --------- --------- --------- --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 182,238 $ 267,032 $ 449,270 $ 14,579 $ 189,112 $(376,268) $ 276,693 ========= ========= ========= ========= ========= ========= ========= </TABLE> Page 9
10 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1996 (unaudited) CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS ($ IN THOUSANDS) <TABLE> <CAPTION> SUBSIDIARY GUARANTORS ----------------------------------- ALL NON-GUARANTOR COMPANY CEX OTHERS COMBINED SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED -------- -------- -------- ------------- -------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> FOR THE NINE MONTHS ENDED MARCH 31, 1996: REVENUES: Oil and gas sales $ 72,112 $ -- $ 72,112 $ 5,125 $ -- $ -- $ 77,237 Gas marketing sales -- -- -- 17,964 -- (2,619) 15,345 Oil and gas service operations -- 5,317 5,317 -- -- -- 5,317 Interest and other -- 1,379 1,379 105 557 -- 2,041 -------- -------- -------- -------- -------- -------- -------- Total Revenues 72,112 6,696 78,808 23,194 557 (2,619) 99,940 -------- -------- -------- -------- -------- -------- -------- COSTS AND EXPENSES: Production expenses and taxes 4,884 437 5,321 518 -- -- 5,839 Gas marketing expenses -- -- -- 17,173 -- (2,619) 14,554 Oil and gas service operations -- 4,263 4,263 -- -- -- 4,263 Oil and gas depreciation, depletion and amortization 33,359 -- 33,359 1,909 -- -- 35,268 Other depreciation and amortization 181 1,176 1,357 44 750 -- 2,151 General and administrative, net 807 1,735 2,542 291 514 -- 3,347 Interest and other 308 97 405 551 8,761 -- 9,717 -------- -------- -------- -------- -------- -------- -------- Total Costs & Expenses 39,539 7,708 47,247 20,486 10,025 (2,619) 75,139 -------- -------- -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES 32,573 (1,012) 31,561 2,708 (9,468) -- 24,801 INCOME TAX EXPENSE (BENEFIT) -- 11,275 11,275 962 (3,433) -- 8,804 -------- -------- -------- -------- -------- -------- -------- NET INCOME (LOSS) $ 32,573 $(12,287) $ 20,286 $ 1,746 $ (6,035) $ -- $ 15,997 ======== ======== ======== ======== ======== ======== ======== FOR THE NINE MONTHS ENDED MARCH 31, 1995: REVENUES: Oil and gas sales $ 35,764 $ -- $ 35,764 $ 737 $ -- $ -- $ 36,501 Oil and gas service operations -- 6,514 6,514 -- -- -- 6,514 Interest and other -- 902 902 -- 74 -- 976 -------- -------- -------- -------- -------- -------- -------- Total Revenues 35,764 7,416 43,180 737 74 -- 43,991 -------- -------- -------- -------- -------- -------- -------- COSTS AND EXPENSES: Production expenses and taxes 2,144 391 2,535 113 -- -- 2,648 Oil and gas service operations -- 5,325 5,325 -- -- -- 5,325 Oil and gas depreciation, depletion and amortization 15,353 -- 15,353 372 -- -- 15,725 Other depreciation and amortization 97 1,147 1,244 1 345 -- 1,590 General and administrative, net 687 1,055 1,742 33 592 -- 2,367 Interest and other 122 296 418 96 3,941 -- 4,455 -------- -------- -------- -------- -------- -------- -------- Total Costs & Expenses 18,403 8,214 26,617 615 4,878 -- 32,110 -------- -------- -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAX 17,361 (798) 16,563 122 (4,804) -- 11,881 INCOME TAX EXPENSE (BENEFIT) -- 3,992 3,992 -- -- -- 3,992 -------- -------- -------- -------- -------- -------- -------- NET INCOME (LOSS) $ 17,361 $ (4,790) $ 12,571 $ 122 $ (4,804) $ -- $ 7,889 ======== ======== ======== ======== ======== ======== ======== </TABLE> Page 10
11 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1996 (unaudited) CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS ($ IN THOUSANDS) <TABLE> <CAPTION> SUBSIDIARY GUARANTORS ----------------------------------- ALL NON-GUARANTOR COMPANY CEX OTHERS COMBINED SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED -------- -------- -------- ------------- -------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> FOR THE THREE MONTHS ENDED MARCH 31, 1996: REVENUES Oil and gas sales $ 28,579 $ -- $ 28,579 $ 2,308 $ -- $ -- $ 30,887 Gas marketing sales -- -- -- 13,594 -- (2,036) 11,558 Oil and gas service operations -- 1,700 1,700 -- -- -- 1,700 Interest and other -- 143 143 99 8 -- 250 -------- -------- -------- -------- -------- -------- -------- 28,579 1,843 30,422 16,001 8 (2,036) 44,395 -------- -------- -------- -------- -------- -------- -------- COSTS AND EXPENSES Production expenses and taxes 1,785 144 1,929 207 -- -- 2,136 Gas marketing expenses -- -- -- 12,824 -- (2,036) 10,788 Oil and gas service operations -- 1,244 1,244 -- -- -- 1,244 Oil and gas depreciation 12,300 -- 12,300 735 -- -- 13,035 Other depreciation & amortization 72 435 507 26 233 -- 766 General and administrative, net 280 763 1,043 190 202 -- 1,435 Interest and Other 280 44 324 201 2,648 -- 3,173 -------- -------- -------- -------- -------- -------- -------- 14,717 2,630 17,347 14,183 3,083 (2,036) 32,577 -------- -------- -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAX 13,862 (787) 13,075 1,818 (3,075) -- 11,818 -------- -------- -------- -------- -------- -------- -------- INCOME TAX EXPENSE (BENEFIT) -- 4,713 4,713 646 (1,164) -- 4,195 -------- -------- -------- -------- -------- -------- -------- NET INCOME (LOSS) $ 13,862 $ (5,500) $ 8,362 $ 1,172 $ (1,911) $ -- $ 7,623 ======== ======== ======== ======== ======== ======== ======== FOR THE THREE MONTHS ENDED MARCH 31, 1995: REVENUES Oil and gas sales $ 13,494 $ -- $ 13,494 $ 531 $ -- $ -- $ 14,025 Oil and gas service operations -- 1,763 1,763 -- -- -- 1,763 Interest and other -- 30 30 -- 38 -- 68 -------- -------- -------- -------- -------- -------- -------- 13,494 1,793 15,287 531 38 -- 15,856 -------- -------- -------- -------- -------- -------- -------- COSTS AND EXPENSES Production expenses and taxes 1,111 163 1,274 83 -- -- 1,357 Oil and gas service operations -- 1,433 1,433 -- -- -- 1,433 Oil and gas depreciation 6,360 -- 6,360 293 -- -- 6,653 Other depreciation & amortization (120) 621 501 1 124 -- 626 General and administrative, net 252 283 535 27 160 -- 722 Interest and Other 89 595 684 96 738 -- 1,518 -------- -------- -------- -------- -------- -------- -------- 7,692 3,095 10,787 500 1,022 -- 12,309 -------- -------- -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAX 5,802 (1,302) 4,500 31 (984) -- 3,547 -------- -------- -------- -------- -------- -------- -------- INCOME TAX EXPENSE (BENEFIT) -- 1,242 1,242 -- -- -- 1,242 -------- -------- -------- -------- -------- -------- -------- NET INCOME (LOSS) $ 5,802 $ (2,544) $ 3,258 $ 31 $ (984) $ -- $ 2,305 ======== ======== ======== ======== ======== ======== ======== </TABLE> Page 11
12 CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1996 (unaudited) CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS ($ IN THOUSANDS) <TABLE> <CAPTION> SUBSIDIARY GUARANTORS ----------------------------------- ALL NON-GUARANTOR COMPANY CEX OTHERS COMBINED SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED -------- -------- -------- ------------- -------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> FOR THE NINE MONTHS ENDED MARCH 31, 1996: CASH FLOWS FROM OPERATING ACTIVITIES $ 50,767 $ 53,200 $ 103,967 $ 2,877 $ (6,729) $ -- $ 100,115 --------- --------- --------- --------- --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Oil and gas properties (159,478) (5,365) (164,843) (11,980) -- 5,300 (171,523) Proceeds from sales 5,300 9,149 14,449 -- -- (5,300) 9,149 Investment in gas marketing company -- -- -- 266 (629) -- (363) Other additions (182) (3,218) (3,400) (40) (2,894) -- (6,334) --------- --------- --------- --------- --------- --------- --------- (154,360) 566 (153,794) (11,754) (3,523) -- (169,071) --------- --------- --------- --------- --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term borrowings 30,000 1,350 31,350 10,300 -- -- 41,650 Payments on borrowings -- (753) (753) (2,494) (20) -- (3,267) Cash received from exercise of stock options -- -- -- -- 986 -- 986 Intercompany advances, net 73,593 (95,298) (21,705) 2,461 19,244 -- -- --------- --------- --------- --------- --------- --------- --------- 103,593 (94,701) 8,892 10,267 20,210 -- 39,369 --------- --------- --------- --------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents -- (40,935) (40,935) 1,390 9,958 -- (29,587) Cash, beginning of period -- 53,227 53,227 5 2,303 -- 55,535 --------- --------- --------- --------- --------- --------- --------- Cash, end of period $ -- $ 12,292 $ 12,292 $ 1,395 $ 12,261 $ -- $ 25,948 ========= ========= ========= ========= ========= ========= ========= FOR THE NINE MONTHS ENDED MARCH 31, 1995: CASH FLOWS FROM OPERATING ACTIVITIES $ 36,643 $ 5,573 $ 42,216 $ 10 $ (4,996) $ -- $ 37,230 --------- --------- --------- --------- --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Oil and gas properties (81,323) -- (81,323) (5,500) -- 5,500 (81,323) Proceeds from sales 8,881 10,959 19,840 -- -- (5,500) 14,340 Other additions 11 (3,640) (3,629) (57) (2,173) -- (5,859) --------- --------- --------- --------- --------- --------- --------- (72,431) 7,319 (65,112) (5,557) (2,173) -- (72,842) --------- --------- --------- --------- --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term borrowings 28,433 1,149 29,582 5,500 -- -- 35,082 Payments on borrowings (9,933) (1,881) (11,814) (300) 374 -- (11,740) Cash received from exercise of stock options -- -- -- -- 737 -- 737 Intercompany advances, net 17,288 (31,133) (13,845) 383 13,462 -- -- --------- --------- --------- --------- --------- --------- --------- 35,788 (31,865) 3,923 5,583 14,573 -- 24,079 --------- --------- --------- --------- --------- --------- --------- Net increase (decrease)in cash and cash equivalents -- (18,973) (18,973) 36 7,404 -- (11,533) Cash, beginning of period -- 13,946 13,946 -- 2,279 -- 16,225 --------- --------- --------- --------- --------- --------- --------- Cash, end of period $ -- $ (5,027) $ (5,027) $ 36 $ 9,683 $ -- $ 4,692 ========= ========= ========= ========= ========= ========= ========= </TABLE> Page 12
13 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RECENT EVENTS On April 9, 1996 the Company completed a public offering of 1,650,000 shares of Common Stock (the "Common Stock Offering") at a price of $53.00 per share, resulting in net proceeds to the Company of approximately $82.6 million before certain expenses of the offering. On April 12, 1996, the underwriters of the Company's Common Stock Offering exercised an over-allotment option to purchase an additional 346,500 shares of Common Stock at a price of $53.00 per share, resulting in additional net proceeds to the Company of approximately $17.3 million. On April 9, 1996 the Company also concluded the sale of $120 million in 9 1/8% Senior Notes due 2006 (the "9 1/8% Notes"), which offering (the "9 1/8% Notes Offering") resulted in net proceeds to the Company of approximately $116.0 million before certain expenses of the offering. The 9 1/8% Notes were issued at 99.931% of par. On April 30, 1996, the Company purchased interests in certain producing and non-producing oil and gas properties from Amerada Hess Corporation for $35 million, subject to adjustment for activity after the effective date of January 1, 1996. The properties are located in the Knox and Golden Trend fields of southern Oklahoma, most of which are operated by the Company. The Company estimates that it acquired approximately 58 billion cubic feet equivalent ("Bcfe") of proved oil and gas reserves. Additionally, the Company acquired approximately 14,000 net acres of unevaluated leasehold. THREE MONTHS ENDED MARCH 31, 1996 VS. MARCH 31, 1995 Net income for the three months ended March 31, 1996 (the "Current Quarter") was $7.6 million, a $5.3 million increase from net income of $2.3 million for the quarter ended March 31, 1995 (the "Prior Quarter"). This increase was caused primarily by the Company's significantly higher oil and gas production. Revenues from oil and gas sales for the Current Quarter were $30.9 million, an increase of $16.9 million, or 121%, from the Prior Quarter. Gas production increased to 13.5 billion cubic feet ("Bcf"), an increase of 6.7 Bcf, or 100%, compared to the Prior Quarter. Additionally, oil production increased 67 thousand barrels ("MBbls"), or 24%, from 275 MBbls to 342 MBbls. The increase in oil and gas production was accompanied by increases in the average oil and gas prices realized. In the Current Quarter, the Company received an average oil price of $18.44 per barrel, an increase of $0.93 per barrel, or 5%, from the $17.51 per barrel realized in the Prior Quarter. Gas price realizations increased to $1.83 per thousand cubic feet ("Mcf") in the Current Quarter, an increase of 34% from the $1.37 per Mcf realized in the Prior Quarter. The following table sets forth oil and gas production for the Company's major producing areas during the Current Quarter. <TABLE> <CAPTION> PRODUCING OIL GAS TOTAL PERCENT FIELD WELLS (MBLS) (MMCF) (MMCFE) % ----- --------- ------ ------ ------- ------- <S> <C> <C> <C> <C> <C> Giddings 160 215 11,365 12,657 81% Southern Oklahoma 215 77 1,334 1,794 12 All Other 88 50 764 1,066 7 ------ ------ ------ ------ ------ TOTAL 463 342 13,463 15,517 100% ====== ====== ====== ====== ====== </TABLE> Revenues from the Company's gas marketing operations, which commenced in December 1995 with the purchase of Chesapeake Energy Marketing, Inc. ("CEM"), were $11.6 million. Gas marketing expenses were $10.8 million, resulting in a gross profit margin during the Current Quarter of $0.8 million. Page 13
14 Revenues from oil and gas service operations for the Current Quarter were $1.7 million, essentially unchanged from the Prior Quarter. The gross profit margin on service operations in the Current Quarter increased to 27% from 19% in the Prior Quarter as the result of a different mix of operations. Margins vary, depending upon the mix of trucking, construction and roustabout services provided. The Company continues to de-emphasize the use of Company-owned service equipment as a component of its exploration and production strategy. In many of its exploration projects, the Company relies exclusively on third party service contractors. The Company continues to pursue disposition of its service operations by merger or sale. Production expenses and taxes increased to $2.1 million in the Current Quarter from $1.4 million in the Prior Quarter. This increase was the result of a significant increase in oil and gas production volumes during the Current Quarter. On a gas equivalent production unit ("Mcfe") basis, production expenses and taxes were $0.14 per Mcfe in the Current Quarter compared to $0.16 per Mcfe in the Prior Quarter. Much of the Company's gas production from wells drilled before September 1996 in the downdip Giddings Field, qualifies for exemption from Texas state production taxes for production through August 31, 2001. Additionally, certain oil and gas production from the Company's wells in the Knox and Sholem Alechem fields in Oklahoma qualifies for exemption until well costs are recovered. These exemptions, combined with the fact that many of the Company's wells are high volume gas wells that tend to have lower operating costs per Mcfe than lower volume wells, result in the Company's low production costs per Mcfe. Depreciation, depletion and amortization ("DD&A") of oil and gas properties for the Current Quarter was $13.0 million, an increase of $6.4 million from the Prior Quarter. The increase in DD&A expense for oil and gas properties between quarters is the result of a 7.1 Bcfe increase in production volumes and an increase in the DD&A rate per Mcfe. The average DD&A rate per Mcfe, a function of capitalized and estimated future development costs and the related proved reserves, was $0.84 for the Current Quarter and $0.79 for the Prior Quarter. General and administrative expenses increased to $1.4 million during the Current Quarter, a $0.7 million, or 100%, increase from the Prior Quarter. This increase is the result of the continued growth of the Company, including the recent acquisition of the gas marketing operation. During the Current Quarter, the Company capitalized $0.5 million of payroll and other internal costs directly related to oil and gas exploration and developmental activities, net of partner reimbursements. In the Prior Quarter, partner reimbursements exceeded capitalized payroll and other internal costs by $0.1 million. Interest expense increased significantly to $3.2 million during the Current Quarter, a $1.7 million increase from the Prior Quarter, as a result of substantially higher levels of debt outstanding during the Current Quarter. During the Current Quarter, the Company capitalized $1.6 million of interest costs representing the estimated costs to carry its unevaluated leasehold inventory, compared to $0.4 million in the Prior Quarter. This increase in capitalized interest costs is the result of significantly higher investments made during the Current Quarter in leasehold that has yet to be evaluated. Income tax expense increased to $4.2 million in the Current Quarter from $1.2 million in the Prior Quarter. The Company's estimated effective income tax rate was 35.5% for the Current Quarter, compared to 35% for the Prior Quarter. The Company estimates its effective rate based on anticipated levels of income for the year and estimated production in excess of that allowed in computing statutory depletion for tax purposes. The provision for income tax expense is deferred because the Company is not currently a cash income taxpayer. The Company has significant tax net operating loss carryovers generated from the intangible drilling cost deduction for income tax purposes associated with the Company's drilling activities which are available to offset regular taxable income in the future. NINE MONTHS ENDED MARCH 31, 1996 VS. MARCH 31, 1995 Net income for the nine months ended March 31, 1996 (the "Current Period") increased to $16.0 million from $7.9 million for the nine months ended March 31, Page 14
15 1995 (the "Prior Period"). This increase of $8.1 million, or 103%, was caused primarily by the Company's significantly higher oil and gas production and lower costs per production unit. Revenues from oil and gas sales for the Current Period were $77.2 million, an increase of $40.7 million, or 112%, over the $36.5 million of oil and gas sales revenues in the Prior Period. This increase was caused primarily by a 113% increase in gas equivalent production volumes, from 20.0 Bcfe in the Prior Period to 42.6 Bcfe in the Current Period. The production increase was accompanied by increases in the average prices realized during the Current Period. In the Current Period, the Company realized an average price of $1.62 per Mcf as compared to $1.51 in the Prior Period and average realized oil prices of $17.46 in the Current Period as compared to $17.05 in the Prior Period. Revenues from CEM, the Company's gas marketing operation, were $15.3 million for the Current Period. Gas marketing expenses were approximately $14.5 million, resulting in a gross profit margin of approximately $0.8 million. Revenues from oil and gas service operations were $5.3 million in the Current Period as compared to $6.5 million in the Prior Period. The gross profit margin on service operations in the Current Period increased slightly to 20% from 18% in the Prior Period as a result of a different mix of operations. Margins vary, depending upon the mix of trucking, construction and roustabout services provided. The Company's equipment was substantially fully utilized in both the Current Period and Prior Period. The Company continues to de-emphasize the use of Company-owned service equipment as a component of the Company's exploration and production strategy. In many of its exploration projects, the Company relies exclusively on third party service contractors. The Company continues to pursue disposition of its service operations by merger or sale. Interest and other revenues were $2.0 million in the Current Period compared to $0.9 million in the Prior Period. This increase was due primarily to significantly higher interest and investment income earned as a result of working capital available to the Company for short-term investment during the Current Period. Production expenses and taxes increased to $5.8 million in the Current Period from $2.6 million in the Prior Period. This increase was the result of significant increases in oil and gas production volumes during the Current Period and a $594,000 severance tax credit recorded in the Prior Period attributable to production from earlier periods. Without regard to the prior period tax credit, on a gas equivalent basis, production expenses and taxes decreased from $0.16 per Mcfe in the Prior Period to $0.14 per Mcfe in the Current Period. Much of the Company's gas production from wells drilled before September 1996 in the downdip Giddings Field qualifies for exemption from Texas state production taxes for production through August 31, 2001. Additionally, certain oil and gas production from the Company's wells in the Knox and Sholem Alechem fields in Oklahoma qualifies for exemption until well costs are recovered. These exemptions, combined with the fact that many of the Company's wells are high volume gas wells that tend to have lower operating costs per Mcfe than lower volume wells, result in the Company's low production costs per Mcfe. DD&A of oil and gas properties for the Current Period was $35.3 million, compared to $15.7 million in the Prior Period. This $19.6 million increase, or 124%, was caused primarily by the 113% increase in oil and gas production. The DD&A rate per Mcfe increased from $0.79 in the Prior Period to $0.83 in the Current Period. Depreciation and amortization of other assets increased from $1.6 million in the Prior Period to $2.2 million in the Current Period. This increase is primarily the result of an increase in non-oil and gas property and equipment from approximately $15.2 million at the end of the Prior Period to $22.5 million at the end of the Current Period. General and administrative expenses increased to $3.3 million in the Current Period, an increase of $0.9 million, or 41%, over the $2.4 million in the Prior Period. During the Current Period, the Company capitalized $0.9 million of payroll and other internal costs directly related to oil and gas exploration and Page 15
16 development activities, net of partner reimbursements, compared to $0.1 million in the Prior Period. Interest expense increased to $9.7 million in the Current Period from $4.5 million in the Prior Period. This increase was the result of significantly higher average levels of debt outstanding in the Current Period compared to the Prior Period. During the Current Period, the Company capitalized $3.5 million of interest costs attributable to the carrying costs of the Company's unevaluated leasehold inventory positions, compared to $0.9 million of capitalized interest costs in the Prior Period. This increase in capitalized interest costs is the result of significantly higher investments made during the Current Period in leasehold that has yet to be evaluated. Income tax expense increased to $8.8 million in the Current Period from $4.0 million in the Prior Period. This increase was the result of higher income before income taxes in the Current Period and an increase to 35.5% in the estimated tax rate in the Current Period compared to 33.6% in the Prior Period. The provision for income tax expense is deferred because the Company is not currently a cash income taxpayer. The Company has significant tax net operating loss carryovers generated from the intangible drilling cost deduction for income tax purposes associated with the Company's drilling activities which are available to offset regular taxable income in the future. HEDGING ACTIVITIES Periodically the Company utilizes hedging strategies to hedge the price of a portion of its future oil and gas production. These strategies include swap and floor arrangements. The swap arrangements establish an index-related price above which the Company pays the hedging counterparty and below which the Company is paid by the counterparty. The floor arrangements establish an index-related strike price for a put purchased by the Company for a cash premium. If the index price closes below the strike price, the put seller pays the Company the difference between the strike price and the closing index price. The Company has the following oil swap arrangements for periods after the Current Period: <TABLE> <CAPTION> NYMEX-Index Month (1996) Volume(1) Strike Price ------------ --------- ------------ <S> <C> <C> April 60,000 $18.17/Bbl May 62,000 $18.04/Bbl June 60,000 $17.95/Bbl July 62,000 $17.88/Bbl August 62,000 $17.82/bbl </TABLE> (1) Volume in barrels. Volume to be reduced by one-half if index price closes below strike price. The Company has the following gas swap arrangements for periods after the Current Period: <TABLE> <CAPTION> NYMEX-Index Months (1996) Volume (1) Strike Price ------------- ----------- ------------ <S> <C> <C> April-October 1,200,000 $1.830/Mmbtu April-October 1,500,000 $1.805/Mmbtu April-October 600,000 $1.780/Mmbtu </TABLE> (1) Million btu's per month ("Mmbtu"). (2) Volume is reduced by one-half if index price closes below strike price. The Company has the following gas floor arrangements for periods after the Current Period: Page 16
17 <TABLE> <CAPTION> Houston Ship Channel Months Volume(1) Index Strike Price ------ --------- -------------------- <S> <C> <C> August 1996- February 1997 620,000 $2.230/Mmbtu July-October 1996 620,000 $2.125/Mmbtu July-October 1996 620,000 $2.132/Mmbtu </TABLE> (1) Mmbtu's per month Additionally, the Company has entered into additional basis swaps which convert a portion of the NYMEX-based natural gas swap prices from a Henry Hub Index delivery basis into a Houston Ship Channel Index delivery basis, less an average of $0.085/Mmbtu for May through October 1996, and certain other exchanges designed to minimize basis risk and provide for upside in the event natural gas prices rise. The Company experienced a short-term basis differential of approximately $0.50/mmbtu between the NYMEX-based Henry Hub index prices used to determine the swap settlement and the Houston Ship Channel prices realized on hedged natural gas volumes during April 1996 that will result in reduced natural gas price realizations for April. The Company estimates that as a result it will realize an average gas sales price of $1.45 per Mcf for April. The Company does not anticipate significant basis differentials for hedged volumes from May 1996 forward, based on actual May index settlements and basis swaps established by the Company. Gains or losses on the crude oil and natural gas swaps are recognized as price adjustments in the month of related production. The Company estimates that had all of the crude oil and natural gas swap agreements in effect for production periods beginning May 1, 1996 terminated on May 10, 1996, based on the closing prices for NYMEX futures contracts as of that date, the Company would have paid the counterparty approximately $9.1 million, which would have represented the "fair value" at that date. These agreements were not terminated. CAPITAL RESOURCES AND LIQUIDITY The Company had a working capital deficit of approximately $34.9 million as of March 31, 1996, compared to working capital of $31.5 million at June 30, 1995. This decrease in working capital was the result of significant capital expenditures for exploration and development of the Company's oil and gas properties, acquisition of undeveloped leasehold inventory, and to a lesser extent acquisition of other assets. To a large extent these expenditures were financed with working capital, cash flow from operations, and supplementally with borrowings under the Company's Revolving and Term Credit Facilities. The Company's $35 million Revolving Credit Facility with Union Bank matures in November 2000, and provides for interest at the option of the Company equal to (i) Union Bank's reference rate (8.25% at March 31, 1996) or (ii) the Eurodollar Rate plus from 1.375% to 1.875%, depending on the ratio of the amount outstanding to the commitment amount. The borrowing base and the amount outstanding at March 31, 1996 was $35.0 million. The borrowing base will reduce to zero thirty days prior to any scheduled principal payment under the Company's 12% Notes, 10 1/2% Notes and 9 1/8% Notes (collectively, the "Senior Notes"). The respective indentures governing the Company's Senior Notes limit the incurrence of indebtedness. Without regard to the incurrence limitations, the Company may incur secured bank indebtedness up to the greater of $15 million or 15% of the Company's adjusted consolidated net tangible assets ("ACNTA"). The Company paid all amounts outstanding under the Revolving Credit Facility on April 9, 1996, upon the closing of the 9 1/8% Note Offering. As a result of the 9 1/8% Notes Offering and Common Stock Offering, the Company estimates that the ACNTA limitation described above would currently allow the Company to incur, as permitted indebtedness, approximately $75 million in secured bank indebtedness. At March 31, 1996, on a pro forma basis, after giving effect to the completion of the Common Stock Offering and the 9 1/8% Notes Offering, and the application of the net proceeds therefrom, the Company had $277 million of Page 17
18 indebtedness, including current maturities of long-term indebtedness, stockholders' equity of $164 million, and working capital of $146 million. The Company's wholly-owned subsidiary, Chesapeake Gas Development Corporation ("CGDC"), has a Term Credit Facility with Union Bank with an outstanding balance of $13.8 million at March 31, 1996. Collateral for the Term Credit Facility is limited to CGDC's producing oil and gas properties, all of which are located in the Knox and Golden Trend areas of southern Oklahoma. The Term Credit Facility has not been guaranteed by the Company or any of its other subsidiaries and has recourse only to the assets of CGDC. CGDC acquired producing oil and gas properties from CEX in December 1994, June 1995, and December 1995 in exchange for $5.5 million, $6.0 million and $5.3 million in cash, respectively, using proceeds borrowed under the Term Facility. CGDC has not guaranteed the payment of the Company's Senior Notes. The Term Credit Facility prohibits the payment of dividends by CGDC. The Company anticipates additional amounts of credit will be available under the Term Credit Facility as properties are developed in southern Oklahoma. The Company's cash provided by operating activities increased to $100.1 million during the Current Period, compared to $37.2 million during the Prior Period. The increase of $62.9 million is the result of increases in net income, adjusted for non-cash charges (such as DD&A and deferred income taxes), and cash provided by changes in current assets and current liabilities between the two periods. Net cash used in investing activities increased to $169.1 million in the Current Period, up from $72.8 million in the Prior Period. The $96.3 million increase is a result of the Company's increased drilling activity and increased investment in leasehold during the Current Period. The Company anticipates capital expenditures for fiscal 1996 of approximately $240 million, of which $70 million will be for leasehold, primarily in Louisiana. Through March 31, 1996, approximately $163.2 million had been expended for exploration and development of the Company's oil and gas properties net of proceeds from sale of equipment and leasehold, including approximately $48.8 million for unevaluated leasehold, primarily in the Austin Chalk Trend of Louisiana. Based on internal estimates as of March 31, 1996, the Company believes that as a result of its successful exploration and development efforts, proved oil and gas reserves have increased to approximately 355 Bcfe, of which approximately 151 Bcfe (43%) are proved developed. Production in the Current Period was 42.6 Bcfe, resulting in a reserve to production replacement ratio of approximately 3.5:1. The Company's expected cash flow from operations is subject to a number of factors, many of which are beyond the Company's control, including the level of production and oil and gas prices. In the event the Company experiences unforeseen changes in its working capital position or capital resources, management will revise its capital expenditure program accordingly. Consolidated cash provided by financing activities was $39.4 million during the Current Period, as compared to consolidated cash provided by financing activities of $24.1 million during the Prior Period. The increase resulted primarily from additional borrowings under the Revolving and Term Credit Facilities during the Current Period. FORWARD LOOKING STATEMENTS When used in this document, the words "anticipate", "estimate", "believe" and similar expressions are intended to identify forward looking statements. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. Among the key factors that have a direct bearing on the Company's ability to attain its goals are oil and gas prices, the ability to develop reserves and replace production at levels and costs estimated by the Company, the ability to fund the significant capital expenditures anticipated, environmental risks, drilling and operating risks, competition, government regulation, and the ability of the Company to manage significant anticipated growth and implement its overall business strategy. Page 18
19 CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP (A WHOLLY-OWNED PARTNERSHIP OF CHESAPEAKE ENERGY CORPORATION) BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> ASSETS March 31, June 30, 1996 1995 --------- --------- ($ in thousands) <S> <C> <C> CURRENT ASSETS: Accounts receivable $ 14,549 $ 9,867 --------- --------- Total Current Assets 14,549 9,867 --------- --------- PROPERTY AND EQUIPMENT: Oil and gas properties, at cost based on full cost accounting: Evaluated oil and gas properties 270,952 163,521 Unevaluated properties 76,265 27,474 Less: accumulated depreciation, depletion and amortization (69,752) (36,959) --------- --------- Total Property and Equipment 277,465 154,036 --------- --------- INTERCOMPANY RECEIVABLES: Chesapeake Energy Corporation 46,373 14,682 Chesapeake Gas Development Corporation 8,590 2,877 Other 381 -- --------- --------- 55,344 17,559 --------- --------- OTHER ASSETS 675 776 --------- --------- TOTAL ASSETS $ 348,033 $ 182,238 ========= ========= LIABILITIES AND PARTNERS' CAPITAL CURRENT LIABILITIES: Accrued Expenses $ 378 $ 516 --------- --------- Total Current Liabilities 378 516 --------- --------- LONG-TERM DEBT 35,000 10 --------- --------- INTERCOMPANY PAYABLES: Chesapeake Operating, Inc. 236,416 138,046 Lindsay Oil Field Supply, Inc. 2,190 2,190 --------- --------- 238,606 140,236 --------- --------- CONTINGENCIES AND COMMITMENTS PARTNERS' CAPITAL: Contributions 424 424 Accumulated Earnings 73,625 41,052 --------- --------- Total Partners' Capital 74,049 41,476 --------- --------- TOTAL LIABILITIES & PARTNERS' CAPITAL $ 348,033 $ 182,238 ========= ========= </TABLE> The accompanying notes are an integral part of these financial statements. Page 19
20 CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP (A WHOLLY-OWNED PARTNERSHIP OF CHESAPEAKE ENERGY CORPORATION) STATEMENTS OF OPERATIONS (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, ------------------- ------------------- 1996 1995 1996 1995 -------- -------- -------- -------- ($ in thousands) ($ in thousands) <S> <C> <C> <C> <C> REVENUES: Oil and gas sales $ 28,579 $ 13,494 $ 72,112 $ 35,764 -------- -------- -------- -------- Total revenues 28,579 13,494 72,112 35,764 -------- -------- -------- -------- COSTS AND EXPENSES: Production expenses and taxes 1,785 1,111 4,884 2,144 Oil and gas depreciation, depletion and amortization 12,300 6,360 33,359 15,353 Amortization 72 (120) 181 97 General and administrative 280 252 807 687 Interest 280 89 308 122 -------- -------- -------- -------- Total costs and expenses 14,717 7,692 39,539 18,403 -------- -------- -------- -------- NET INCOME $ 13,862 $ 5,802 $ 32,573 $ 17,361 ======== ======== ======== ======== </TABLE> The accompanying notes are an integral part of these financial statements. Page 20
21 CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP (A WHOLLY-OWNED PARTNERSHIP OF CHESAPEAKE ENERGY CORPORATION) STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> NINE MONTHS ENDED MARCH 31, ----------------------- 1996 1995 --------- --------- ($ in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 32,573 $ 17,361 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Oil and gas depreciation 33,359 15,353 Amortization 181 97 CHANGES IN CURRENT ASSETS AND LIABILITIES (15,346) 3,832 --------- --------- Cash provided by operating activities 50,767 36,643 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Development and acquisition of oil and gas properties (159,478) (81,323) Proceeds from sales of fixed assets and other -- 3,381 Sale of properties to CGDC 5,300 5,500 Other additions (182) 11 --------- --------- Cash used in investing activities (154,360) (72,431) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long term borrowings 30,000 28,433 Payments on long-term borrowings - -- (9,933) Financial resources and proceeds on intercompany transactions 220,513 128,064 Financial resources and payments applied to intercompany transactions (146,920) (110,776) --------- --------- Cash provided by financing activities 103,593 35,788 --------- --------- NET INCREASE (DECREASE) IN CASH -- -- CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD -- -- --------- --------- CASH & CASH EQUIVALENTS, END OF PERIOD $ -- $ -- ========= ========= </TABLE> The accompanying notes are an integral part of these consolidated financial statements. Page 21
22 CHESAPEAKE EXPLORATION LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS MARCH 31, 1996 (UNAUDITED) 1. Accounting Principles The accompanying unaudited financial statements of Chesapeake Exploration Limited Partnership ("CEX") have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission. 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 nine months ended March 31, 1996, are not necessarily indicative of the results to be expected for the full fiscal year. The CEX financial statements were prepared on a separate entity basis as reflected in the Company's books and records and include all material costs of doing business as if the partnership were on a stand-alone basis, except that interest is not charged on intercompany accounts, or allocated. These financial statements should be read in conjunction with the March 31, 1996 consolidated financial statements and related notes of Chesapeake Energy Corporation and Subsidiaries (the "Company") included in this Form 10-Q and the Company's annual report on Form 10-K for the year ended June 30, 1995. Page 22
23 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTHS AND NINE MONTHS ENDED MARCH 31, 1996 VS. MARCH 31, 1995 CEX represents substantially all of the Company's oil and gas operations. Therefore, the discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations, included elsewhere in this report, for the Company relate primarily to CEX. CEX is a member of the consolidated group of companies of which Chesapeake Energy Corporation is the parent company. Although CEX has separate financing capabilities, CEX is largely dependent on the Company and the Company is dependent on the operations of CEX. Accordingly, capital resources and liquidity issues for CEX are not typical of an entity that operates on a stand alone basis and therefore should be considered only in conjunction with the discussion of the Company's capital resources and liquidity included elsewhere in this report. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - - Not applicable. ITEM 2. CHANGES IN SECURITIES - - Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES - - Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - - Not applicable ITEM 5. OTHER INFORMATION - - Not applicable Page 23
24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as a part of this report: Exhibit No. 4.1 Agreement dated as of March 7, 1996, Agreement dated as of March 8, 1996, Agreement dated as of March 27, 1996 and Fourth Amendment to Amended and Restated Credit Agreement dated as of April 2, 1996, among Chesapeake Energy Corporation, Chesapeake Exploration Limited Partnership, an Oklahoma Limited Partnership and Union Bank. 11 Statement regarding computation of earnings per common share 27 Financial Data Schedule (b) Form 8-K No reports on Form 8-K were filed during the three months ended March 31, 1996. Page 24
25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CHESAPEAKE ENERGY CORPORATION ----------------------------- (Registrant) May 15, 1996 /s/ Aubrey K. McClendon - ------------- ----------------------------- Date Aubrey K. McClendon Chairman and Chief Executive Officer May 15, 1996 /s/ Marcus C. Rowland - ------------- ----------------------------- Date Marcus C. Rowland Vice President and Chief Financial Officer Page 25
26 Index to Exhibits Exhibit No. Description Page - ----------- ----------- ---- 4.1 Agreement dated as of March 7, 1996, Agreement dated as of March 8, 1996, Agreement dated as of March 27, 1996 and Fourth Amendment to Amended and Restated Credit Agreement dated as of April 2, 1996, among Chesapeake Energy Corporation, Chesapeake Exploration Limited Partnership, an Oklahoma Limited Partnership and Union Bank. 11 Statement regarding computation of earnings per common share 27 Financial Data Schedule