(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES –

Basis of Presentation

In management’s opinion, the accompanying unaudited consolidated financial statements contain all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position of Comstock Resources, Inc. and subsidiaries (“Comstock” or the “Company”) as of September 30, 2014, the related results of operations and comprehensive income (loss) for the three months and nine months ended September 30, 2014 and 2013, and cash flows for the nine months ended September 30, 2014 and 2013.

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, 2013.

The results of operations for the three months and nine months ended September 30, 2014 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.

Reclassifications

Certain reclassifications have been made to prior periods’ financial statements, consisting primarily of reclassifications to the presentation of the Company’s derivative financial instruments, to conform to the current periods’ presentation.

Marketable Securities

During the nine months ended September 30, 2013, the Company sold 600,000 shares of Stone Energy Corporation common stock and received $13.4 million in proceeds. These shares had a cost basis of $5.5 million. Comstock realized a gain before income taxes of $7.9 million on the sale which is included in other income in the consolidated statements of operations. The Company utilized the specific identification method to determine the cost of the securities that were sold.

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.

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. For the three months and nine months ended September 30, 2013, the Company recognized impairment charges in exploration expense of $3.0 million and $14.9 million, respectively, related to certain leases that were expected to expire prior to the Company conducting drilling operations. There were no unproved property impairments during the nine months ended September 30, 2014.

The Company also assesses the need for an impairment of the costs capitalized for its oil and gas properties on a property basis. The Company recognized impairment charges of $15,000 for the three months ended September 30, 2014, and $0.3 million and $0.7 million for the nine months ended September 30, 2014 and September 30, 2013, respectively, related to its oil and gas properties.

Accrued Liabilities

Accrued liabilities at September 30, 2014 and December 31, 2013 consist of the following:

	As of September 30, 2014		As of December 31, 2013
	(In thousands)
Accrued oil and gas property acquisition costs	$	—	$	40,128
Accrued drilling costs		19,904		34,914
Accrued interest		23,880		7,051
Accrued ad valorem taxes		4,800		—
Other accrued liabilities		8,217		9,204
	$	56,801	$	91,297

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 during the nine months ended September 30, 2014 and 2013:

	Nine Months Ended September 30,
	2014			2013
	(In thousands)
Future abandonment costs – beginning of period	$	14,534		$	16,387
Accretion expense		615			716
New wells placed on production		1,045			599
Liabilities settled and assets disposed of		(76	)		(555	)
Future abandonment costs — end of period	$	16,118		$	17,147

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.

As of September 30, 2014, the Company had the following outstanding commodity derivatives:

Commodity and Derivative Type

Weighted-Average
Contract Price

Volume
(barrels)

Contract Period

Crude Oil Price Swap Agreements

$96.60 per Bbl.

633,000

October 2014 –

December 2014

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. All of Comstock’s derivative financial instruments are with parties that are lenders under its bank credit facility. 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.

None of the derivative contracts have been designated as cash flow hedges. The Company recognizes cash settlements and changes in the fair value of its derivative financial instruments as a single component of other income (expenses). The Company had gains of $12.0 million and losses of $7.4 million related to its oil swap agreements during the three months ended September 30, 2014 and 2013, respectively, and losses of $2.8 million and $10.3 million during the nine months ended September 30, 2014 and 2013, respectively. Cash settlements on derivative financial instruments were payments of $0.4 million and $3.6 million for the three months ended September 30, 2014 and 2013, respectively, and payments of $5.7 million and receipts of $1.6 million during the nine months ended September 30, 2014 and 2013, respectively. The estimated fair value and carrying value of the Company’s derivative financial instruments was an asset of $3.9 million and $1.0 million as of September 30, 2014 and December 31, 2013, respectively, which were classified as current assets.

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, 2014 and 2013, the Company recognized $2.8 million and $3.1 million, respectively, of stock-based compensation expense within general and administrative expenses related to awards of restricted stock and performance stock units to its employees and directors. For the nine months ended September 30, 2014 and 2013, the Company recognized $7.8 million and $9.6 million, respectively, of stock-based compensation expense within general and administrative expenses.

During the nine months ended September 30, 2014, the Company granted 235,524 shares of restricted stock with a grant date fair value of $4.8 million or $20.24 per share to its employees and non-employee directors. The fair value of each restricted share on the date of grant is equal to its market price. As of September 30, 2014, Comstock had 1,209,694 shares of unvested restricted stock outstanding at a weighted average grant date fair value of $19.91 per share. Total unrecognized compensation cost related to unvested restricted stock grants of $8.8 million as of September 30, 2014 is expected to be recognized over a period of 1.2 years.

During the nine months ended September 30, 2014, the Company granted 188,958 performance share units (“PSUs”) with a grant date fair value of $3.7 million or $19.81 per unit to its employees. As of September 30, 2014, Comstock had 364,332 PSUs outstanding at a weighted average grant date fair value of $20.36 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 853,658 shares of common stock. Total unrecognized compensation cost related to these grants of $3.4 million as of September 30, 2014 is expected to be recognized over a period of 1.5 years.

As of September 30, 2014, Comstock had outstanding options to purchase 115,150 shares of common stock at a weighted average exercise price of $32.90 per share. All of the stock options were exercisable and there were no unrecognized compensation costs related to the stock options as of September 30, 2014. No stock options were exercised during the three months or nine months ended September 30, 2014 or 2013.

Income Taxes

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(In thousands)
Current benefit	$	(73	)	$	—		$	(36	)	$	—
Deferred provision (benefit)		(417	)		(12,554	)		1,487			(36,792	)
Provision for (benefit from) income taxes	$	(490	)	$	(12,554	)	$	1,451		$	(36,792	)

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 difference between the Company’s effective tax rate and the 35% federal statutory rate is mainly caused by non-deductible stock compensation and state taxes. The Company estimated the income tax provision for the three months and nine months ended September 30, 2014 using the discrete method. The discrete method is applied when the application of the estimated annual effective tax rate is impractical because it is not possible to reliably estimate the annual effective tax rate. The discrete method treats the year to date period as if it was the annual period and determines the income tax expense or benefit on that basis. The Company believes that, at this time, the use of this discrete method is more appropriate than the annual effective tax rate method as the estimated annual effective tax rate method is not reliable due to (i) the high degree of uncertainty in estimating annual pretax earnings and (ii) the wide variability in the effective tax rate given the significant impact of permanent items.

The difference between the Company’s customary rate of 35% and the effective tax rate on income before income taxes from continuing operations is due to the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Tax at statutory rate		35.0	%		35.0	%		35.0	%		35.0	%
Tax effect of:
Nondeductible stock-based compensation		(15.1	)		(0.6	)		20.1			(1.1	)
State income taxes, net of federal benefit		5.5			(0.3	)		(5.5	)		0.6
Other		(4.9	)		0.3			6.0			(0.1	)
Effective tax rate		20.5	%		34.4	%		55.6	%		34.4	%

The Company’s federal income tax returns for the years subsequent to December 31, 2009, remain subject to examination. The Company’s income tax returns in major state income tax jurisdictions remain subject to examination from various periods subsequent to December 31, 2008. State tax returns in one state jurisdiction are 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.

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 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 oil 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.

The following table summarizes financial assets accounted for at fair value as of September 30, 2014:

	Carrying Value Measured at Fair Value at September 30, 2014		Level 1		Level 2
	(In thousands)
Assets measured at fair value on a recurring basis:
Cash and cash equivalents held in bank accounts	$	6,433	$	6,433	$	—
Derivative financial instruments		3,909		—		3,909
Total assets	$	10,342	$	6,433	$	3,909

The following table presents the carrying amounts and estimated fair value of the Company’s other financial instruments:

	As of September 30, 2014
	Carrying Value		Fair Value
	(In thousands)
Fixed rate debt	$	695,298	$	745,000
Floating rate debt	$	305,000	$	305,000

The fair market value of the Company’s fixed rate debt was based on the market prices as of September 30, 2014, a Level 1 measurement. The fair value of the floating rate debt outstanding at September 30, 2014 approximated its carrying value, a Level 2 measurement.

Earnings Per Share

Basic earnings per share is determined without the effect of any outstanding potentially dilutive stock options or PSUs and diluted earnings per share is determined with the effect of outstanding stock options and PSUs 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 three 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. Basic and diluted earnings per share for the three months and nine months ended September 30, 2014 and 2013 were determined as follows:

	Three Months Ended September 30,
	2014								2013
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(In thousands, except per share amounts)
Net loss from continuing operations	$	(1,903	)						$	(24,034	)
Income allocable to unvested restricted stock		(151	)							(195	)
Basic net loss from continuing operations attributable to common stock	$	(2,054	)		46,651	$	(0.04	)	$	(24,229	)		46,570	$	(0.52	)
Effect of dilutive securities:
Stock options		—			—					—			—
Performance share units		—			—					—			—
Diluted net loss from continuing operations attributable to common stock	$	(2,054	)		46,651	$	(0.04	)	$	(24,229	)		46,570	$	(0.52	)

	Nine Months Ended September 30,
	2014							2013
	Income			Shares		Per Share		Income (Loss)			Shares		Per Share
	(In thousands, except per share amounts)
Net income (loss) from continuing operations	$	1,160						$	(70,082	)
(Income) loss allocable to unvested restricted stock		(444	)						2,254
Basic net income (loss) from continuing operations attributable to common stock	$	716			46,628	$	0.02	$	(67,828	)		46,684	$	(1.45	)
Effect of dilutive securities:
Stock options		—			—				—			—
Performance share units		—			320				—			—
Diluted net income (loss) from continuing operations attributable to common stock	$	716			46,948	$	0.02	$	(67,828	)		46,684	$	(1.45	)
Net income from discontinued operations								$	148,609
Income allocable to unvested restricted stock									(4,782	)
Basic net income from discontinued operations attributable to common stock								$	143,827			46,684	$	3.08
Effect of dilutive securities:
Stock options									—			—
Performance share units									—			—
Diluted net income from discontinued operations attributable to common stock								$	143,827			46,684	$	3.08

At September 30, 2014 and December 31, 2013, 1,209,694 and 1,515,889 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, 2014 and 2013 were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(In thousands)
Unvested restricted stock		1,210		1,520		1,184		1,552

Options to purchase common stock and PSUs that were outstanding and 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,
	2014		2013		2014		2013
	(In thousands except per share/unit data)
Weighted average anti-dilutive stock options		115		115		115		135
Weighted average exercise price per share	$	32.90	$	32.90	$	32.90	$	32.90
Weighted average performance share units		257		91		—		56
Weighted average grant date fair value per unit	$	20.71	$	21.19	$	—	$	21.15

For the three months and nine months ended September 30, 2014 and 2013, the excluded options that were anti-dilutive were at exercise prices in excess of the average stock price. All stock options and unvested PSUs were anti-dilutive to earnings and excluded from weighted average shares used in the computation of earnings per share in the three months ended September 30, 2014 and 2013 and the nine months ended September 30, 2013 due to the net loss in the periods.

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. At September 30, 2014 and December 31, 2013, the Company’s cash investments consisted of cash held in bank accounts.

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

	Nine Months Ended September 30,
	2014		2013
	(In thousands)
Cash Payments:
Interest payments	$	30,441	$	44,228
Income tax payments	$	1,467	$	768

The Company capitalizes interest on its unevaluated oil and gas property costs during periods when it is conducting exploration activity on this acreage. The Company capitalized interest of $2.7 million and $0.7 million for the three months ended September 30, 2014 and 2013, respectively, and $7.5 million and $2.4 million for the nine months ended September 30, 2014 and 2013, respectively, which reduced interest expense.

Comprehensive Income (Loss)

Comprehensive income (loss) consists of the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014		2013
	(In thousands)
Net income (loss)	$	(1,903	)	$	(24,034	)	$	1,160	$	78,527
Other comprehensive income:
Realized gains on marketable securities reclassified to gain on sale of marketable securities, net of a benefit from income taxes of $2,757		—			—			—		(5,120	)
Unrealized gains on marketable securities, net of provision for income taxes of $377		—			—			—		702
Total comprehensive income (loss)	$	(1,903	)	$	(24,034	)	$	1,160	$	74,109

Discontinued Operations

On March 14, 2013, the Company entered into an agreement to sell its oil and gas properties located in Reeves and Gaines counties in West Texas to a third party. The sale closed on May 14, 2013 with an effective date of January 1, 2013. Income from discontinued operations for the nine months ended September 30, 2013 is comprised of the following:

	Nine Months Ended September 30, 2013
	(In thousands)
Revenues:
Oil and gas sales	$	25,125
Costs and expenses:
Production taxes		1,120
Gathering and transportation		501
Lease operating		9,853
Depletion, depreciation and amortization		8,649
Interest expense⁽¹⁾		6,346
Total costs and expenses		26,469

Gain on sale of discontinued operations		230,637
Income from discontinued operations before income taxes		229,293
Income tax expense:
Current		(637	)
Deferred		(80,047	)
Total income tax expense		(80,684	)
Net income from discontinued operations	$	148,609

(1)	Interest expense was allocated to discontinued operations based on the ratio of the net assets of discontinued operations to our consolidated net assets plus long-term debt. Interest expense is net of capitalized interest of $2,010 for the nine months ended September 30, 2013, respectively.