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Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2017

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, 2017, the related results of operations for the three months and nine months ended September 30, 2017 and 2016, and cash flows for the nine months ended September 30, 2017 and 2016. 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, 2016.

The results of operations for the three months and nine months ended September 30, 2017 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 subsidiaries.

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.

In 2017, the Company entered agreements to jointly develop certain acreage prospective for the Haynesville shale in Louisiana and Texas with USG Properties Haynesville, LLC ("USG"). As of September 30, 2017, USG has acquired approximately 7,000 net acres prospective for Haynesville shale development for the joint development program primarily in Caddo Parish, Louisiana. The Company operates wells drilled on USG's acreage and has the right to acquire a 25% working interest in the acreage by reimbursing USG for the attributable acreage costs of the wells being drilled. USG is also participating in four wells being drilled in the Company's Bossier shale acreage in Sabine Parish, Louisiana and in a Haynesville shale drilling program on approximately 5,700 acres of Comstock's acreage in Harrison County, Texas. Under the terms of the participation agreements for Sabine Parish and Harrison County acreage owned by the Company, Comstock will receive between $1.1 million and $1.4 million, respectively, for 50% of Comstock's interest for each location for acreage and infrastructure related to each well location, with $400,000 of that amount being paid only if each well meets or exceeds established production targets. Comstock also receives $80,000 for each well drilled as consideration for the Company's services managing the joint drilling program in addition to customary operating fees for each well drilled except for the four Bossier shale wells. Comstock and USG plan to continue to acquire additional acreage for the joint development venture.

Comstock sold various oil and gas properties in the three months and nine months ended September 30, 2017 for total proceeds of $1.5 million and recognized a loss of $1.0 million on these divestitures. In January 2016, the Company designated certain of its natural gas properties located in South Texas as held for sale and recognized an impairment charge of $20.8 million in the nine months ended September 30, 2016 to adjust the carrying value of these assets to their estimated net realizable value. The sale of these properties was completed in December 2016. The Company also sold certain other oil and gas properties during the first nine months of 2016 for total proceeds of $2.1 million and recognized a loss of $1.6 million on these divestitures.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
	(In thousands)
Total oil and gas sales	$	6		$	2,644		$	392		$	6,551
Total operating expenses⁽¹⁾		(265	)		(1,541	)		(771	)		(5,670	)
Operating income (loss)	$	(259	)	$	1,103		$	(379	)	$	881

(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.

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 Company recognized impairments included in exploration expense of $76.4 million and $84.1 million in the three months and nine months ended September 30, 2016, respectively, related to leases that were expiring on certain of its unproved oil and gas properties.

The Company also assesses the need for an impairment of the capitalized costs for its proved oil and gas properties on a property basis. Accordingly, the Company recognized additional impairments of its oil and gas properties of $0.1 million and $24.6 million for the three months and nine months ended September 30, 2016, respectively, to reduce the carrying value of certain 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 oil and natural gas 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 oil and gas reserves and risk-adjusted probable oil and natural gas 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, there may be further impairments in the carrying values of these or other properties.

Accrued Expenses

Accrued expenses at September 30, 2017 and December 31, 2016 consist of the following:

	As of September 30, 2017		As of December 31, 2016
	(In thousands)
Accrued drilling costs	$	4,834	$	7,498
Accrued interest payable		4,016		22,721
Accrued transportation costs		3,005		2,227
Accrued employee compensation		3,841		6,292
Accrued ad valorem taxes		2,700		—
Other		1,533		1,628
	$	19,929	$	40,366

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, 2017 and 2016:

	Nine Months Ended September 30,
	2017			2016
	(In thousands)
Future abandonment costs — beginning of period	$	15,804		$	20,093
Accretion expense		645			716
New wells placed on production		5			2
Assets held for sale		—			(3,442	)
Liabilities settled and assets disposed of		(356	)		(1,217	)
Future abandonment costs — end of period	$	16,098		$	16,152

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 classifies the fair value amounts of derivative financial instruments as net current or noncurrent assets or liabilities, whichever the case may be, by commodity and counterparty.

The Company had the following outstanding derivative financial instruments used for oil and natural gas price risk management at September 30, 2017:

Commodity and Derivative Type

Weighted-Average
Contract Price

Contract Volume
(MMBtu)

Contract Period

Natural Gas Swap Agreements

$3.38 per MMBtu

11,655,000

October 2017 – March 2018

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 a gain of $1.4 million in the three months ended September 30, 2017, and $14.6 million and $0.7 million in the nine months ended September 30, 2017 and 2016, respectively, related to the change in fair value of its natural gas swap agreements. No gains or losses attributable to derivative financial instruments were recognized during the three months ended September 30, 2016.

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. The Company recognized $1.7 million and $1.1 million 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 in the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016, the Company recognized $4.5 million and $3.6 million, respectively, of stock-based compensation expense within general and administrative expenses.

During the nine months ended September 30, 2017, the Company granted 500,002 shares of restricted stock with a grant date fair value of $5.6 million, or $11.11 per share, to its employees and directors. The fair value of each restricted share on the date of grant was equal to its market price. As of September 30, 2017, Comstock had 619,867 shares of unvested restricted stock outstanding at a weighted average grant date fair value of $11.14 per share. Total unrecognized compensation cost related to unvested restricted stock grants of $4.7 million as of September 30, 2017 is expected to be recognized over a period of 1.9 years.

During the nine months ended September 30, 2017, the Company granted 241,814 PSUs with a grant date fair value of $4.4 million, or $18.17 per unit, to its employees. As of September 30, 2017, Comstock had 281,800 PSUs outstanding at a weighted average grant date fair value of $17.12 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 563,600 shares of common stock. Total unrecognized compensation cost related to these grants of $3.5 million as of September 30, 2017 is expected to be recognized over a period of 2.2 years.

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 three months and nine months of 2017 related to adjustments to the valuation allowances on state net operating loss carryforwards. The deferred income tax provision for the first three months and 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. As a result, the Company established valuation allowances for its deferred tax assets and U.S. federal and state net operating loss carryforwards that are not expected to be utilized due to the uncertainty of generating taxable income prior to the expiration of the carryforward periods.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017		2016
	(In thousands)
Current - State	$	18		$	7		$	115	$	36
- Federal		—			—			—		—

Deferred - State		(87	)		(832	)		768		3,687
- Federal		—			—			—		—
	$	(69	)	$	(825	)	$	883	$	3,723

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 federal statutory rate of 35% and the effective tax rate on the income (loss) before income taxes is due to the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
	(In thousands)
Tax at statutory rate		35.0	%		35.0	%		35.0	%		35.0	%
Tax effect of:
Valuation allowance on deferred tax assets		(37.8	)		(45.0	)		(39.2	)		(47.8	)
State income taxes, net of federal benefit		3.8			12.4			4.1			7.8
Nondeductible stock-based compensation		(0.7	)		0.4			(1.1	)		—
Other		—			0.1			(0.1	)		—
Effective tax rate		0.3	%		2.9	%		(1.3	)%		(5.0	)%

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 various periods subsequent to December 31, 2011. 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.

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. It is highly likely that a change in ownership that would result from the future 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.

The following table summarizes financial assets accounted for at fair value as of September 30, 2017:

	Carrying Value Measured at Fair Value at September 30, 2017		Level 1		Level 2
	(In thousands)
Assets measured at fair value on a recurring basis:
Cash and cash equivalents held in bank accounts	$	25,392	$	25,392	$	—
Derivative financial instruments		3,203		—		3,203
Total assets	$	28,595	$	25,392	$	3,203

As of September 30, 2017, the Company's other financial instruments, comprised solely of its fixed rate debt, had a carrying value of $1.1 billion and a fair value of $1.1 billion. The fair market value of the Company's fixed rate debt was based on quoted prices as of September 30, 2017, a Level 2 measurement.

Earnings Per Share

Basic earnings per share is determined without the effect of any outstanding potentially dilutive securities and diluted earnings per share is determined with the effect of any outstanding securities that are potentially dilutive. Unvested share-based payment awards containing nonforfeitable rights to dividends are considered to be participating securities and 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. 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 outstanding PSUs and 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 months and nine months ended September 30, 2017 and 2016 were determined as follows:

	Three Months Ended September 30,
	2017								2016
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(In thousands, except per share amounts)

Basic and diluted net loss attributable to common stock	$	(24,736	)		14,796	$	(1.67	)	$	(28,476	)		12,293	$	(2.32	)

	Nine Months ended September 30,
	2017								2016
	Loss			Shares		Per Share			Loss			Shares		Per Share
	(In thousands, except per share amounts)

Basic and diluted net loss attributable to common stock	$	(69,109	)		14,591	$	(4.74	)	$	(80,201	)		11,255	$	(7.13	)

At September 30, 2017 and December 31, 2016, 619,867 and 354,986 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, 2017 and 2016 which were excluded from the computation of the loss per share were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
	(In thousands)
Unvested restricted stock		666		355		612		340

For the three months ended September 30, 2017 and 2016, all stock options, unvested PSUs, common stock warrants 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. 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,
	2017		2016		2017		2016
	(In thousands except per share/unit data)
Weighted average stock options		—		12		—		12
Weighted average exercise price per share	$	—	$	166.10	$	—	$	166.10

Weighted average warrants for common stock		415		377		479		127
Weighted average exercise price per share	$	0.01	$	0.01	$	0.01	$	0.01

Weighted average PSUs		303		135		281		137
Weighted average grant date fair value per unit	$	17.12	$	22.09	$	17.12	$	22.09

Weighted average contingently convertible shares		37,624		9,770		36,676		3,257
Weighted average conversion price per share	$	12.32	$	12.32	$	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.

Cash payments made for interest and income taxes for the nine months ended September 30, 2017 and 2016, respectively, were as follows:

	Nine Months Ended September 30
	2017		2016
	(In thousands)
Interest payments	$	72,913	$	109,642
Income tax payments	$	3	$	—

Interest paid in-kind related to the Company's convertible notes was $9.6 million and $2.6 million during the three months ended September 30, 2017 and 2016, respectively and $28.2 million and $2.6 million during the nine months ended September 30, 2017 and 2016, respectively.

Recent Accounting Pronouncements

On January 1, 2017, the Company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). The adoption of this new standard did not have a material impact on the Company's financial statements. The Company is accounting for forfeitures in compensation cost as they occur, and it is applying the prospective transition method for presentation of the income tax effects of vested equity awards in its consolidated statements of cash flows.

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 reviewing its primary oil and natural gas marketing agreements in order to assess the impact of adoption. At this time, adopting this standard is not expected to have a material impact on the Company's financial statements because recognition of revenue is not expected to materially change under the new standard, since most of the Company's revenue will continue to be recognized as production is delivered. However, the Company is still evaluating the ultimate impact of this accounting standard on its consolidated results of operations, financial position, cash flows and financial disclosures. This evaluation will continue throughout 2017, and the Company will adopt this new standard in the first quarter of 2018. The Company currently expects to apply the modified retrospective method of adoption for this new standard.

In February 2016, the FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 requires lessees to include 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 period thereafter. Early adoption is permitted. The Company is currently evaluating the new guidance and anticipates that certain operating leases that it has in place will be reflected as an asset and a liability in its consolidated balance sheet. The Company has not yet determined which method of adoption it will apply for this new standard.