Chesapeake Energy 2012 Annual Report Download - page 135

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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Performance Share Units
In January 2012, we granted performance share units (PSUs) to senior management under our Long Term
Incentive Plan that include both an internal performance measure and an external market condition and that vest over
one-, two- and three-year performance periods. The internal performance measure is considered a performance
condition with a fair value generally equal to the Company's stock price. The external market condition is considered
a market condition and generally requires Monte Carlo simulation to determine the fair value. The latter calculation is
based on the absolute total shareholder return (TSR) of Chesapeake common stock and the relative TSR of Chesapeake
common stock compared to the TSR of certain peers.
The payout for each PSU component can range from 0% to 125%, and therefore the range of payout under a
PSU award is between 0% and 250%. Awards are payable in cash at the end of each performance period. We account
for PSUs under FASB ASC Topic 718 because they include a market-based performance component. They are classified
as a liability in our consolidated financial statements and are required to be measured at fair value as of the grant date,
with such value re-measured at the end of each reporting period. Compensation expense is recognized over the vesting
period with a corresponding adjustment to the liability. Because our PSUs vest over a three-year period, we have
classified some of the liability as short-term and the rest as long-term on our consolidated balance sheet.
As of the grant date, the fair value of the 1,271,240 PSUs issued was $35 million. As of December 31, 2012, the
fair value of the awards had decreased to $18 million. We have recorded $2 million of this value as a short-term liability
for vested PSUs and $12 million as a long-term liability representing the portion of the award for which the requisite
service period has been completed. The remaining $4 million relates to unvested PSUs for which the requisite service
period has not been completed.
Noncontrolling Interests
Cleveland Tonkawa Financial Transaction. We formed CHK Cleveland Tonkawa, L.L.C. (CHK C-T) in March 2012
to continue development of a portion of our natural gas and oil assets in our Cleveland and Tonkawa plays. CHK C-T
is an unrestricted subsidiary under our corporate credit facility agreement and is not a guarantor of, or otherwise liable
for, any of our indebtedness or other liabilities, including under our indentures. In exchange for all of the common
shares of CHK C-T, we contributed to CHK C-T approximately 245,000 net acres of leasehold and the existing wells
within an area of mutual interest in the Cleveland and Tonkawa plays covering Ellis and Roger Mills counties in western
Oklahoma. In March 2012, in a private placement, third-party investors contributed $1.25 billion in cash to CHK C-T
in exchange for (i) 1.25 million preferred shares, and (ii) our obligation to deliver a 3.75% overriding royalty interest
(ORRI) in the existing wells and up to 1,000 new net wells to be drilled on certain of our Cleveland and Tonkawa play
leasehold. Subject to customary minority interest protections afforded the investors by the terms of the CHK C-T limited
liability company agreement (the CHK C-T LLC Agreement), as the holder of all the common shares and the sole
managing member of CHK C-T, we maintain voting and managerial control of CHK C-T and therefore include it in our
consolidated financial statements. Of the $1.25 billion of investment proceeds, we allocated $225 million to the ORRI
obligation and $1.025 billion to the preferred shares based on estimates of fair values. The ORRI obligation is included
in other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our
consolidated balance sheet. Pursuant to the CHK C-T LLC Agreement, CHK C-T is currently required to retain an
amount of cash (measured quarterly) equal to (i) the next two quarters of preferred dividend payments plus (ii) its
projected operating funding shortfall for the next six months. The amount so retained, approximately $57 million as of
December 31, 2012, is reflected as restricted cash on our consolidated balance sheet.
Dividends on the preferred shares are payable on a quarterly basis at a rate of 6% per annum based on $1,000
per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as,
any dividend amount is not paid in full for any quarter. As the managing member of CHK C-T, we may, at our sole
discretion and election at any time after March 31, 2014, distribute certain excess cash of CHK C-T, as determined in
accordance with the CHK C-T LLC Agreement. Any such optional distribution of excess cash is allocated 75% to the
preferred shares (which is applied toward redemption of the preferred shares) and 25% to the common shares unless
we have not met our drilling commitment at such time, in which case an optional distribution would be allocated 100%
to the preferred shares (and applied toward redemption thereof). We may also, at our sole discretion and election, in
accordance with the CHK C-T LLC Agreement, cause CHK C-T to redeem all or a portion of the CHK C-T preferred
shares for cash. The preferred shares will be redeemed at a valuation equal to the greater of a 9% internal rate of
return or a return on investment of 1.35x, in each case inclusive of dividends paid through redemption at the rate of
6% per annum and optional distributions made through the applicable redemption date. In the event that redemption
does not occur on or prior to March 31, 2019, the optional redemption valuation will increase to provide a 15% internal