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Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2016

In management's opinion, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position of Comstock Resources, Inc. and subsidiaries ("Comstock" or the "Company") as of September 30, 2016, the related results of operations for the three and nine months ended September 30, 2016 and 2015, and cash flows for the nine months ended September 30, 2016 and 2015. Net loss and comprehensive loss are the same in all periods presented. All adjustments are of a normal recurring nature unless otherwise disclosed.

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to those rules and regulations, although Comstock believes that the disclosures made are adequate to make the information presented not misleading. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in Comstock's Annual Report on Form 10-K for the year ended December 31, 2015 and its Current Report on Form 8-K dated August 1, 2016.

The results of operations for the three and nine months ended September 30, 2016 are not necessarily an indication of the results expected for the full year.

These unaudited consolidated financial statements include the accounts of Comstock and its wholly-owned and controlled subsidiaries.

On July 29, 2016, the Company effected a one-for-five (1:5) reverse split of its outstanding shares of common stock. All amounts disclosed in these financial statements have been adjusted to give effect to this reverse stock split in all periods.

Property and Equipment

The Company follows the successful efforts method of accounting for its oil and gas properties. Costs incurred to acquire oil and gas leasehold are capitalized.

At September 30, 2016, the Company reflected certain of its natural gas properties located in South Texas as assets held for sale in the accompanying consolidated balance sheet. On October 14, 2016, the Company entered into an agreement with a third party to sell such properties for $28.0 million, with an effective date of August 1, 2016. The sale is expected to close in December 2016 and is subject to customary closing conditions. At September 30, 2016, these assets were reflected on the balance sheet at $29.4 million, representing their estimated net realizable value from the pending sale less selling costs. The asset retirement obligation related to these properties of $3.4 million is included in accrued liabilities at September 30, 2016. The Company has recognized a loss on the pending sale totaling $13.2 million for the three and nine months ended September 30, 2016, respectively in addition to an impairment charge of $20.8 million that was recognized in the nine months ended September 30, 2016 to adjust the carrying value of these assets to their net realizable value. The Company also sold certain oil and gas properties during the first nine months of 2016 for total proceeds of $2.1 million. The Company recognized a loss of $1.6 million on these divestitures. During the nine months ended September 30, 2015, the Company completed the sale of certain oil and gas properties located in and near Burleson County, Texas under which it received net proceeds of $102.7 million and recognized a net loss on sale of $111.8 million.

Results of operations for the properties that were sold or are being held for sale were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	(In thousands)
Total oil and gas sales	$	2,345		$	5,096		$	5,873		$	27,851
Total operating expenses⁽¹⁾		(1,124	)		(5,022	)		(4,522	)		(77,999	)
Operating income (loss)	$	1,221		$	74		$	1,351		$	(50,148	)

(1)

Includes direct operating expenses, depreciation, depletion and amortization and exploration expense. Excludes interest expense, general and administrative expenses and depreciation, depletion and amortization expense subsequent to the date the assets were designated as held for sale.

In January 2016, the Company exchanged certain oil and gas properties with another operator in a non-monetary exchange. Under the exchange, the Company received 3,637 net acres in DeSoto Parish, Louisiana, prospective for the Haynesville shale, including four producing wells (3.5 net). The Company exchanged 2,547 net acres in Atascosa County, Texas, including seven producing wells (5.3 net) for the Haynesville shale properties. The Company recognized a gain of $0.7 million on this transaction which is included in the loss on sales and exchange of oil and gas properties for the nine months ended September 30, 2016.

Unproved oil and gas properties are periodically assessed and any impairment in value is charged to exploration expense. The costs of unproved properties which are determined to be productive are transferred to oil and gas properties and amortized on an equivalent unit-of-production basis. The capitalized costs reflected as unproved oil and gas properties at December 31, 2015 related to the Company's undeveloped leases in the Tuscaloosa Marine shale in Louisiana and Mississippi. Given the continued low oil prices, the Company has determined that it is unlikely that oil prices will recover in a time period to allow the development of its Tuscaloosa Marine shale leases prior to their expiration. Accordingly, the Company recognized an impairment included in exploration expense of $76.4 million in the three months ended September 30, 2016. Comstock had $5.1 million of impairments in the three months ended September 30, 2015 and $84.1 million and $68.6 million during the nine months ended September 30, 2016 and 2015, respectively.

The Company also assesses the need for an impairment of the capitalized costs for its proved oil and gas properties on a property basis. Reductions to management's oil and natural gas price outlooks in 2016 and 2015 resulted in indications of impairment of certain of the Company's properties. Accordingly, the Company recognized additional impairments of its oil and gas properties of $0.1 million and $544.7 million for the three months ended September 30, 2016 and 2015, respectively, and $24.6 million and $547.1 million for the nine months ended September 30, 2016 and 2015, respectively, to reduce the carrying value of these properties to their estimated fair value.

The Company determines the fair values of its oil and gas properties using a discounted cash flow model and proved and risk adjusted probable reserves. Undrilled acreage can also be valued based on sales transactions in comparable areas. Significant Level 3 assumptions associated with the calculation of discounted future cash flows included in the cash flow model include management's outlook for oil and natural gas prices, production costs, capital expenditures, and future production as well as estimated proved reserves and risk-adjusted probable reserves. Management's oil and natural gas price outlook is developed based on third-party longer-term price forecasts as of each measurement date. The expected future net cash flows are discounted using an appropriate discount rate in determining a property's fair value.

It is reasonably possible that the Company's estimates of undiscounted future net cash flows attributable to its oil and gas properties may change in the future. The primary factors that may affect estimates of future cash flows include future adjustments, both positive and negative, to proved and appropriate risk-adjusted probable oil and gas reserves, results of future drilling activities, future prices for oil and natural gas, and increases or decreases in production and capital costs. As a result of these changes, or if in the future the Company does not have access to sufficient capital to develop any undrilled reserves used in its assessment, there may be further impairments in the carrying values of these or other properties.

Accrued Liabilities

Accrued liabilities at September 30, 2016 and December 31, 2015 consist of the following:

	As of September 30, 2016		As of December 31, 2015
	(In thousands)
Accrued interest	$	5,685	$	29,075
Accrued drilling costs		876		5,306
Accrued ad valorem taxes		3,600		—
Asset retirement obligation of assets held for sale		3,442		—
Accrued transportation costs		2,466		2,818
Other accrued liabilities		4,329		1,245
	$	20,398	$	38,444

Reserve for Future Abandonment Costs

Comstock's asset retirement obligations relate to future plugging and abandonment expenses on its oil and gas properties and related facilities disposal. The following table summarizes the changes in Comstock's total estimated liability for such obligations during the nine months ended September 30, 2016 and 2015:

	Nine Months Ended September 30,
	2016			2015
	(In thousands)
Future abandonment costs — beginning of period	$	20,093		$	14,900
Accretion expense		716			600
New wells placed on production		2			309
Liabilities settled and assets disposed of		(1,217	)		(703	)
Assets held for sale		(3,442	)		—
Future abandonment costs — end of period	$	16,152		$	15,106

Derivative Financial Instruments and Hedging Activities

Comstock periodically uses swaps, floors and collars to hedge oil and natural gas prices and interest rates. Swaps are settled monthly based on differences between the prices specified in the instruments and the settlement prices of futures contracts. Generally, when the applicable settlement price is less than the price specified in the contract, Comstock receives a settlement from the counterparty based on the difference multiplied by the volume or amounts hedged. Similarly, when the applicable settlement price exceeds the price specified in the contract, Comstock pays the counterparty based on the difference. Comstock generally receives a settlement from the counterparty for floors when the applicable settlement price is less than the price specified in the contract, which is based on the difference multiplied by the volumes hedged. For collars, generally Comstock receives a settlement from the counterparty when the settlement price is below the floor and pays a settlement to the counterparty when the settlement price exceeds the cap. No settlement occurs when the settlement price falls between the floor and cap. All of the Company's derivative financial instruments are used for risk management purposes and, by policy, none are held for trading or speculative purposes. Comstock minimizes credit risk to counterparties of its derivative financial instruments through formal credit policies, monitoring procedures, and diversification. The Company is not required to provide any credit support to its counterparties other than cross collateralization with the assets securing its bank credit facility. None of the Company's derivative financial instruments involve payment or receipt of premiums.

The Company had derivative financial instruments outstanding on December 31, 2015 that hedged production through June 30, 2016 and had no derivative financial instruments outstanding on September 30, 2016. None of the Company's derivative contracts were designated as cash flow hedges. The Company recognized cash settlements and changes in the fair value of its derivative financial instruments as a single component of other income (expenses). The Company recognized gains of $0.7 million related to the change in fair value of its natural gas swap agreements during the nine months ended September 30, 2016. The Company recognized a gain of $1.1 million and $1.7 million related to the change in fair value of its natural gas swap agreements during the three and nine months ended September 30, 2015, respectively. The Company received cash settlements of $2.1 million and $0.4 million from derivative financial instruments for the nine months ended September 30, 2016 and 2015, respectively.

Subsequent to September 30, 2016, the Company has entered into natural gas swaps for approximately 12.6 billion cubic feet of natural gas to be produced in 2017 at an average price of $3.27 per Mcf.

Stock-Based Compensation

Comstock accounts for employee stock-based compensation under the fair value method. Compensation cost is measured at the grant date based on the fair value of the award and is recognized over the award vesting period. During the three months ended September 30, 2016 and 2015, the Company recognized $1.1 million and $2.1 million, respectively, of stock-based compensation expense within general and administrative expenses related to awards of restricted stock and performance stock units ("PSUs") to its employees and directors. For the nine months ended September 30, 2016 and 2015, the Company recognized $3.6 million and $6.1 million, respectively, of stock-based compensation expense within general and administrative expenses.

During the nine months ended September 30, 2016, the Company granted 229,644 shares of restricted stock with a grant date fair value of $1.8 million, or $5.46 per share, to its employees. The fair value of each restricted share on the date of grant was equal to its market price. As of September 30, 2016, Comstock had 354,986 shares of unvested restricted stock outstanding at a weighted average grant date fair value of $15.27 per share. Total unrecognized compensation cost related to unvested restricted stock grants of $3.6 million as of September 30, 2016 is expected to be recognized over a period of 1.5 years.

During the nine months ended September 30, 2016, the Company granted 60,015 PSUs with a grant date fair value of $0.4 million, or $7.00 per unit, to its employees. As of September 30, 2016, Comstock had 134,650 PSUs outstanding at a weighted average grant date fair value of $22.09 per unit. The number of shares of common stock to be issued related to the PSUs is based on the Company's stock price performance as compared to its peers which could result in the issuance of anywhere from zero to 269,300 shares of common stock. Total unrecognized compensation cost related to these grants of $1.4 million as of September 30, 2016 is expected to be recognized over a period of 1.5 years.

As of September 30, 2016, Comstock had outstanding options to purchase 11,730 shares of common stock at a weighted average exercise price of $166.10 per share which expire on December 14, 2016. All of the stock options were exercisable and there were no unrecognized compensation costs related to the stock options as of September 30, 2016. No stock options were granted or exercised during the nine months ended September 30, 2016.

Income Taxes

Deferred income taxes are provided to reflect the future tax consequences or benefits of differences between the tax basis of assets and liabilities and their reported amounts in the financial statements using enacted tax rates. The deferred tax provision in the first nine months of 2016 related to an increase in the Company's deferred income tax liability resulting from certain state tax law changes enacted during the period. In recording deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of its deferred income tax assets will be realized in the future. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those deferred income tax assets would be deductible. The Company believes that after considering all the available objective evidence, historical and prospective, with greater weight given to historical evidence, management is not able to determine that it is more likely than not that all of its deferred tax assets will be realized and, therefore, has recorded a valuation allowance of $27.6 million and $8.3 million against its net federal deferred tax assets and state deferred tax assets (net of the federal tax benefit), respectively, during the nine months ended September 30, 2016. The Company will continue to assess the valuation allowance against deferred tax assets considering all available information obtained in future reporting periods.

The following is an analysis of consolidated income tax expense (benefit):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016		2015
	(In thousands)
Current provision	$	7		$	687		$	36	$	1,170
Deferred provision (benefit)		(832	)		(31,333	)		3,687		(146,118	)
Provision for (benefit from) income taxes	$	(825	)	$	(30,646	)	$	3,723	$	(144,948	)

The difference between the Company's effective tax rate and the 35% federal statutory rate is caused by valuation allowances on deferred taxes and state taxes. The impact of these items varies based upon the Company's projected full year loss and the jurisdictions that are expected to generate the projected losses. The difference between the Company's customary rate of 35% and the effective tax rate on the loss before income taxes is due to the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	(In thousands)
Tax at statutory rate		35.0	%		35.0	%		35.0	%		35.0	%
Tax effect of:
Valuation allowance on deferred tax assets		(45.0	)		(31.7	)		(47.8	)		(21.0	)
State income taxes net of federal benefit		12.4			2.0			7.8			2.1
Nondeductible stock-based compensation		0.4			—			—			(0.1	)
Other		0.1			—			—			—
Effective tax rate		2.9	%		5.3	%		(5.0	)%	16.0		%

The Company's federal income tax returns for the years subsequent to December 31, 2012, remain subject to examination. The Company's income tax returns in major state income tax jurisdictions remain subject to examination for the year ended December 31, 2008 and for various periods subsequent to December 31, 2010. A state tax return in one state jurisdiction is currently under review. The Company has evaluated the preliminary findings in this jurisdiction and believes it is more likely than not that the ultimate resolution of these matters will not have a material effect on the Company's financial statements. The Company currently believes that all other significant filing positions are highly certain and that all of its other significant income tax positions and deductions would be sustained under audit or the final resolution would not have a material effect on the consolidated financial statements. Therefore, the Company has not established any significant reserves for uncertain tax positions.

As a result of the debt exchange the Company completed on September 6, 2016 and repurchases of its senior notes in exchange for common stock and cash that occurred prior to the debt exchange, Comstock generated approximately $258.5 million of taxable cancellation of debt income which is expected to be offset by utilizing net operating loss carryforwards.

Future use of the Company's federal and state net operating loss carryforwards may be limited in the event that a cumulative change in the ownership of Comstock's common stock by more than 50% occurs within a three-year period. Such a change in ownership could result in a substantial portion of the Company's net operating loss carryforwards being eliminated or becoming restricted, and the Company may need to recognize an additional valuation allowance reflecting the restricted use of these net operating loss carryforwards in the period when such an ownership change occurred. It is highly likely that a change in ownership that would result from conversion of the Company's convertible notes would result in limits on the future use of its net operating loss carryforwards.

Fair Value Measurements

The Company holds or has held certain items that are required to be measured at fair value. These include cash and cash equivalents held in bank accounts and derivative financial instruments in the form of oil and natural gas price swap agreements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A three-level hierarchy is followed for disclosure to show the extent and level of judgment used to estimate fair value measurements:

Level 1 — Inputs used to measure fair value are unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date.

Level 2 — Inputs used to measure fair value, other than quoted prices included in Level 1, are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.

Level 3 — Inputs used to measure fair value are unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management's estimates of market participant assumptions.

The Company's valuation of cash and cash equivalents is a Level 1 measurement. The Company's natural gas price swap agreements are not traded on a public exchange. Their value is determined utilizing a discounted cash flow model based on inputs that are readily available in public markets and, accordingly, the valuation of these swap agreements is categorized as a Level 2 measurement. There were no price swap agreements outstanding as of September 30, 2016.

As of September 30, 2016, the Company's financial assets and liabilities accounted for at fair value consisted of cash and cash equivalents of $26.6 million, a Level 1 measurement. As of September 30, 2016, the Company's other financial instruments, comprised solely of its fixed rate debt, had a carrying value of $1.0 billion and a fair value of $980.9 million. The fair market value of the Company's fixed rate debt was based on quoted prices as of September 30, 2016, a Level 2 measurement. As part of the Company's debt exchange in September 2016, the Company determined the fair value of its new two new convertible second lien PIK notes based upon the average trading prices for those notes subsequent to closing of the exchange. This valuation, a Level 2 measurement, resulted in the determination of discounts to the face value of these notes of $111.9 million which was recognized as a component of the net gain on extinguishment of debt for the three and nine months ended September 30, 2016. The discounts are being amortized over the life of the notes using the effective interest rate method.

Earnings Per Share

Basic earnings per share is determined without the effect of any outstanding potentially dilutive stock options, PSUs, unexercised common stock warrants or shares issuable for convertible debt and diluted earnings per share is determined with the effect of outstanding stock options, PSUs, unexercised stock warrants and shares issuable for convertible debt that are potentially dilutive. Unvested share-based payment awards containing nonforfeitable rights to dividends are considered to be participatory securities and are included in the computation of basic and diluted earnings per share pursuant to the two-class method. PSUs represent the right to receive a number of shares of the Company's common stock that may range from zero to up to two times the number of PSUs granted on the award date based on the achievement of certain performance measures during a performance period. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective period, assuming that date was the end of the contingency period. The treasury stock method is used to measure the dilutive effect of PSUs. Unexercised common stock warrants represent the right to convert the warrants into common stock at an exercise price of $0.01 per share. The treasury stock method is used to measure the dilutive effect of unexercised common stock warrants. The shares that would be issuable upon exercise of the conversion rights contained in the Company's convertible debt for each period are based on the if-converted method for computing potentially dilutive shares of common stock that could be issued upon conversion.

Basic and diluted loss per share for the three and nine months ended September 30, 2016 and 2015 were determined as follows:

	Three Months Ended September 30,
	2016								2015
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(In thousands, except per share amounts)

Basic and Diluted net loss attributable to common stock	$	(28,476	)		12,293	$	(2.32	)	$	(544,996	)		9,230	$	(59.05	)

	Nine Months Ended September 30,
	2016								2015
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(In thousands, except per share amounts)

Basic and Diluted net loss attributable to common stock	$	(80,201	)		11,255	$	(7.13	)	$	(758,566	)		9,220	$	(82.27	)

At September 30, 2016 and December 31, 2015, 354,986 and 314,060 shares of restricted stock, respectively, are included in common stock outstanding as such shares have a nonforfeitable right to participate in any dividends that might be declared and have the right to vote on matters submitted to the Company's stockholders. Weighted average shares of unvested restricted stock outstanding during the three months and nine months ended September 30, 2016 and 2015 were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	(In thousands)
Unvested restricted stock		355		315		340		286

For the three and nine months ended September 30, 2016 and 2015, all stock options, unvested PSUs, warrants exercisable into common stock and contingently issuable shares related to the convertible debt were anti-dilutive to earnings and excluded from weighted average shares used in the computation of earnings per share in all periods presented due to the net loss in those periods. Options to purchase common stock, warrants exercisable into common stock, PSUs that were outstanding and contingently issuable shares related to the convertible debt that were excluded as anti-dilutive from the determination of diluted earnings per share are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	(In thousands except per share/unit data)
Weighted average stock options		12		21		12		21
Weighted average exercise price per share	$	166.10	$	164.72	$	166.10	$	164.89

Weighted average warrants for common stock		377		—		127		—
Weighted average exercise price per share	$	0.01	$	—	$	0.01	$	—

Weighted average PSUs		135		134		137		126
Weighted average grant date fair value per unit	$	22.09	$	45.67	$	22.09	$	45.67

Weighted average contingently convertible shares		9,770		—		3,257		—
Weighted average conversion price per share	$	12.32	$	—	$	12.32	$	—

Supplementary Information With Respect to the Consolidated Statements of Cash Flows

For the purpose of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

The following is a summary of cash payments made for interest and income taxes:

	Nine Months Ended September 30,
	2016		2015
	(In thousands)
Interest payments	$	109,642	$	68,877
Income tax payments	$	—	$	77

The Company capitalizes interest on its unevaluated oil and gas property costs during periods when it is conducting exploration activity on this acreage. No interest was capitalized during the nine months ended September 30, 2016. The Company capitalized interest of $0.9 million for the nine months ended September 30, 2015 which reduced interest expense. Interest of $2.6 million in the three months and nine months ended September 30, 2016 is being paid in kind.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which supersedes nearly all existing revenue recognition guidance under existing generally accepted accounting principles. This new standard is based upon the principal that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted beginning with periods after December 15, 2016 and entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements or decided upon the method of adoption.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"). ASU 2014-15 provides guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and sets rules for how this information should be disclosed in the financial statements. ASU 2014-15 is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company has elected to not adopt ASU 2014-15 early.

In February 2016, the FASB issued ASU No. 2016-02, Leases, ("ASU 2016-02"). ASU 2016-02 requires lessees to put most leases on their balance sheets, but recognize lease costs in their financial statements in a manner similar to accounting for leases prior to ASC 2016-02. ASU 2016-02 is effective for annual periods ending after December 15, 2018 and interim periods thereafter. Early adoption is permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements or decided upon the method of adoption.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, ("ASU 2016-09"). ASU 2016-09 will change how companies account for certain aspects of share-based payments, including recognizing the income tax effects of awards in the income statement when the awards vest or are settled. ASC 2016-09 revises guidance on employers' accounting for employee's use of shares to satisfy the employer's statutory income tax withholding obligation and the treatment of forfeitures. ASU 2016-09 is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted, but all guidance must be adopted in the same period. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements.