COMSTOCK RESOURCES INC - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarter Ended September 30, 2015

OR

Commission File No. 001-03262

COMSTOCK RESOURCES, INC.

(Exact name of registrant as specified in its charter)

5300 Town and Country Blvd., Suite 500, Frisco, Texas 75034

(Address of principal executive offices)

Telephone No.: (972) 668-8800

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock, par value $0.50, as of November 5, 2015 was 47,720,176.

COMSTOCK RESOURCES, INC.

QUARTERLY REPORT

For the Quarter Ended September 30, 2015

INDEX

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

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COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

The accompanying notes are an integral part of these statements.

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COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of these statements.

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COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2015

(Unaudited)

The accompanying notes are an integral part of these statements.

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COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these statements.

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COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Unaudited)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES –

Basis of Presentation

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, 2015, the related results of operations for the three months and nine months ended September 30, 2015 and 2014, and cash flows for the nine months ended September 30, 2015 and 2014. Net income (loss) and comprehensive income (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, 2014.

The results of operations for the three months and nine months ended September 30, 2015 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.

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. The Company recognized impairment charges in exploration expense of $5.1 million and $68.6 during the three and nine months ended September 30, 2015, respectively, related to certain leases that the Company currently does not plan to develop. There were no impairments of unproved property in the first nine months of 2014.

The Company also assesses the need for an impairment of the capitalized costs for its oil and gas properties on a property basis. During the three months ended September 30, 2015, reductions to management's oil and natural gas price outlook resulted in indications of impairment of the Company's oil properties in South Texas and certain natural gas properties in Texas and Louisiana.  Accordingly, the Company recognized an impairment of $544.7 million and $547.1 million for the three months and nine months ended September 30, 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.

The following table presents the fair value and impairments recorded by the Company during the three months ended September 30, 2015, as well as the average oil price per barrel and gas price per thousand cubic feet over the life of the properties and the applicable discount rates utilized in the Company's assessments:

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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 and possible 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 all of its proved and risk-adjusted probable  reserves used in its assessment, there may be further impairments in the carrying values of these or other properties.

During the three months ended September 30, 2015, the Company completed the sale of certain oil and gas properties located in and near Burleson County, Texas.  The Company received net proceeds of $102.7 million and recognized a net loss on sale of $111.8 million.  Results of operations for these properties were as follows:

In January 2015, the Company purchased a 20% interest in an airplane that previously had been owned 80% by the Company and 20% by two executive officers of the Company.  The purchase price for the 20% interest of $1.7 million was based on the then fair market value of the airplane determined by a third party.  This related party transaction was approved by the Company's audit committee and board of directors.

Accrued Liabilities

Accrued liabilities at September 30, 2015 and December 31, 2014 consist of the following:

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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, 2015 and 2014:

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. 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.

As of September 30, 2015, the Company had the following outstanding commodity derivatives:

None of the Company's 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 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 months and nine months ended September 30, 2015, respectively.  Cash settlements on natural gas derivative financial instruments were receipts of $0.4 million for the three months and nine months ended September 30, 2015, respectively.  The Company had gains of $12.0 million and losses of $2.8 million related to its oil swap agreements during the three months and nine months ended September 30, 2014, respectively. Cash settlements on oil derivative financial instruments were payments of $0.4 million and $5.7 million for the three months and nine months ended September 30, 2014, respectively. The estimated fair value and carrying value of the Company's derivative financial instruments was an asset of $1.3 million as of September 30, 2015, and was classified as a current asset. There were no derivative financial instruments outstanding on December 31, 2014.

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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, 2015 and 2014, the Company recognized $2.1 million and $2.8 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, 2015 and 2014, the Company recognized $6.1 million and $7.8 million, respectively, of stock-based compensation expense within general and administrative expenses.

During the nine months ended September 30, 2015, the Company granted 1,010,371 shares of restricted stock with a grant date fair value of $5.4 million or $5.34 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, 2015, Comstock had 1,575,302 shares of unvested restricted stock outstanding at a weighted average grant date fair value of $9.90 per share. Total unrecognized compensation cost related to unvested restricted stock grants of $6.6 million as of September 30, 2015 is expected to be recognized over a period of 1.5 years.

During the nine months ended September 30, 2015, the Company granted 471,249 performance share units ("PSUs") with a grant date fair value of $2.1 million, or $4.38 per unit, to its employees. As of September 30, 2015, Comstock had 669,604 PSUs outstanding at a weighted average grant date fair value of $9.13 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 1,400,173 shares of common stock. Total unrecognized compensation cost related to these grants of $2.6 million as of September 30, 2015 is expected to be recognized over a period of 1.9 years.

As of September 30, 2015, Comstock had outstanding options to purchase 102,650 shares of common stock at a weighted average exercise price of $32.94 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, 2015. No stock options were exercised during the three months or nine months ended September 30, 2015 or 2014.

Income Taxes

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 established a valuation allowance of $178.6 million and $71.6 million against its net federal deferred tax assets and state deferred tax assets, respectively, at September 30, 2015. 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):

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 caused by non-deductible stock compensation, state taxes and the establishing of a valuation allowance on deferred 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.

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The difference between the Company's customary rate of 35% and the effective tax rate on income (loss) before income taxes is due to the following:

The Company's federal income tax returns for the years subsequent to December 31, 2011, 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, 2009. 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.

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 Comstock'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.  The Company established a rights plan on October 1, 2015 to deter ownership changes that would trigger this limitation (see Note 5).

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.

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The following table summarizes financial assets and liabilities accounted for at fair value as of September 30, 2015:

As of September 30, 2015, the Company's other financial instruments, comprised solely of its fixed rate debt, had a carrying value of $1.3 billion and a fair value of $645.6 million.  The fair market value of the Company's fixed rate debt was based on quoted prices as of September 30, 2015, 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 (loss) per share for the three months and nine months ended September 30, 2015 and 2014 were determined as follows:

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At September 30, 2015 and December 31, 2014, 1,575,302 and 1,207,527 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, 2015 and 2014 were as follows:

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:

For the nine months ended September 30, 2014, 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 the three months and nine months ended September 30, 2015 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, 2015 and December 31, 2014, 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:

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 for the three months ended September 30, 2014 and $0.9 million and $7.5 million for the nine months ended September 30, 2015 and 2014, respectively, which reduced interest expense.

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.

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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 and does not expect adoption of ASU 2014-15 to have any impact on its consolidated financial condition or results of operations.

In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest, Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability.  ASU 2015-03 is effective for annual periods ending after December 15, 2015 and interim periods thereafter. Early adoption is permitted. The Company has elected to not adopt ASU 2015-03 early and does not expect adoption of ASU 2015-03 to have a material impact on its consolidated financial condition or results of operations.

(2) STOCKHOLDERS' EQUITY –

The Company did not pay dividends during the nine months ended September 30, 2015, but paid dividends of $17.9 million during the nine months ended September 30, 2014. In 2013, the Board of Directors approved an open market share repurchase plan which permits the Company to repurchase up to $100.0 million of its common stock on the open market. The Company did not make any purchases under this plan during the nine months ended September 30, 2015 or 2014, and future repurchases under this plan are limited under the terms of the Company's outstanding debt.

(3) LONG-TERM DEBT –

At September 30, 2015, long-term debt was comprised of:

In March 2015, Comstock issued $700.0 million of 10% senior secured notes (the "Secured Notes") which are due on March 15, 2020. Interest on the Secured Notes is payable semi-annually on each March 15 and September 15. Net proceeds from the issuance of the Secured Notes of $684.0 million were used to retire the Company's bank credit facility and for general corporate purposes.  Comstock also has outstanding (i) $387.5 million of 7¾% senior notes (the "2019 Notes") which are due on April 1, 2019 and bear interest which is payable semi-annually on each April 1 and October 1 and (ii) $211.6 million of 9½% senior notes (the "2020 Notes") which are due on June 15, 2020 and bear interest which is payable semi-annually on each June 15 and December 15. The Secured Notes are secured on a first-priority basis equally and ratably with the Company's revolving credit facility described below, subject to payment priorities in favor of the revolving credit facility by the collateral securing the revolving credit facility, which consists of, among other things, at least 80% of the Company's and its subsidiaries' oil and gas properties.  The Secured Notes, the 2019 Notes and the 2020 Notes are general obligations of Comstock and are guaranteed by all of Comstock's subsidiaries. Such subsidiary guarantors are 100% owned and all of the guarantees are full and unconditional and joint and several obligations. There are no restrictions on the ability of Comstock to obtain funds from its subsidiaries through dividends or loans.  As of September 30, 2015, Comstock had no material assets or operations which are independent of its subsidiaries.

During the nine months ended September 30, 2015, the Company purchased $12.5 million in principal amount of the 2019 Notes and $88.4 million in principal amount of the 2020 Notes for $37.8 million.  The gain of $59.3 million recognized on the purchase of the 2019 Notes and 2020 Notes and the loss resulting from the write-off of deferred loan costs associated with the Company's bank credit facility of $3.7 million are included in the net gain on extinguishment of debt, which is reported as a component of other income (loss).

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In connection with the issuance of the Secured Notes, Comstock entered into a $50.0 million revolving credit facility with Bank of Montreal and Bank of America, N.A.  The revolving credit facility is a four year credit commitment that matures on March 4, 2019. Indebtedness under the revolving credit facility is guaranteed by all of the Company's subsidiaries and is secured by substantially all of Comstock's and its subsidiaries' assets.  Borrowings under the revolving credit facility bear interest, at Comstock's option, at either (1) LIBOR plus 2.5% or (2) the base rate (which is the higher of the administrative agent's prime rate, the federal funds rate plus 0.5% or 30 day LIBOR plus 1.0%) plus 1.5%. A commitment fee of 0.5% per annum is payable quarterly on the unused credit line.  The revolving credit facility contains covenants that, among other things, restrict the payment of cash dividends and repurchases of common stock, limit the amount of additional debt that Comstock may incur and limit the Company's ability to make certain loans, investments and divestitures. The only financial covenants are the maintenance of a current ratio of at least 1.0 to 1.0 and the maintenance of an asset coverage ratio of proved developed reserves to total debt outstanding under the revolving credit facility of at least 2.5 to 1.0. The Company was in compliance with these covenants as of September 30, 2015.

(4) Commitments and Contingencies –

From time to time, Comstock is involved in certain litigation that arises in the normal course of its operations. The Company records a loss contingency for these matters when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company does not believe the resolution of these matters will have a material effect on the Company's financial position or results of operations.

In connection with its exploration and development activities, the Company contracts for drilling rigs.  As of September 30, 2015, the Company had commitments for contracted drilling services through November 2015 of $1.3 million.

The Company has entered into natural gas transportation and treating agreements through July 2019. Maximum commitments under these transportation agreements as of September 30, 2015 totaled $7.1 million.

(5) SUBSEQUENT EVENTS –

On October 1, 2015, the Company entered into a net operating loss carryforwards ("NOLs") rights plan (the "Rights Plan") with American Stock Transfer & Trust Company, LLC, as rights agent.  In connection therewith, the board of directors of the Company declared a dividend of one preferred share purchase right ("Right") for each outstanding share of the Company's common stock.  The dividend was payable on October 16, 2015 to stockholders of record as of the close of business on October 12, 2015.  In addition, one Right automatically attached to each share of common stock issued between the record date and the date when the Rights become exercisable.

The Rights Plan was adopted in an effort to prevent potential significant limitations under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"), on Comstock's ability to utilize its current NOLs to reduce its future tax liabilities.  If Comstock experiences an "ownership change," as defined in Section 382 of the Code, the Company's ability to fully utilize its NOLs on an annual basis will be substantially limited, and the timing of the usage of the NOLs could be substantially delayed, which could accordingly significantly impair the value of those benefits. The Rights Plan works by imposing a significant penalty upon any person or group that acquires 4.9% or more of the Company's outstanding common stock without the approval of the board of directors (an "Acquiring Person").  The Rights Plan also gives discretion to the Board to determine that someone is an Acquiring Person even if they do not own 4.9% or more of the outstanding common stock but do own 4.9% or more in value of the Company's outstanding stock, as determined pursuant to Section 382 of the Code and the regulations promulgated thereunder. Stockholders who currently own 4.9% or more of the Company's common stock will not trigger the Rights unless they acquire additional shares, subject to certain exceptions set forth in the Rights Plan. In addition, the Board has established procedures to consider requests to exempt certain acquisitions of the Company's securities from the Rights Plan if the board of directors determines that doing so would not limit or impair the availability of the NOLs or is otherwise in the best interests of the Company.

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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains forward-looking statements that involve risks and uncertainties that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those anticipated in our forward-looking statements due to many factors. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this report and in our annual report filed on Form 10-K for the year ended December 31, 2014.

The prices for crude oil and natural gas have been highly volatile over the last twelve months, and we are currently experiencing a period of low prices primarily due to an oversupply of oil and natural gas.  If these prices remain low, we will continue to experience lower revenues and cash flows.  We expect our oil production to continue to decline until we resume drilling on our properties.  We anticipate that our natural gas production will increase through our 2015 drilling program focused on our Haynesville shale properties.  We may also recognize further impairments of our producing oil and gas properties if oil and natural gas prices remain low and as a result the expected future cash flows from these properties becomes insufficient to recover their carrying value or the Company does not have sufficient capital to develop any undeveloped reserves required to recover their carrying value.  In addition, we may recognize additional impairments of our unevaluated oil and gas properties should we determine that we no longer intend to retain these properties for future oil and natural gas development.

Results of Operations

Revenues –

Our oil and natural gas sales decreased $83.6 million (58%) in the third quarter of 2015 to $61.4 million from $145.0 million in the third quarter of 2014 primarily due to the decline in oil and natural gas prices. Gas sales in the third quarter decreased 9% to $33.7 million due to lower gas prices offset in part by higher gas production.  Our natural gas production increased by 40% from the third quarter of 2014 while our realized natural gas price decreased by 35% during the same period.  The increase in our natural gas production has been driven by our successful natural gas drilling program in 2015. Oil sales in the third quarter of 2015 decreased by

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74% to $27.7 million from the third quarter of 2014 due to a 44% decrease in our oil production and a 55% decrease in our realized oil prices as compared with the third quarter of 2014.

In the first nine months of 2015, our oil and natural gas sales decreased by $237.4 million (54%) to $205.2 million from $442.6 million in the first nine months of 2014.  Natural gas sales decreased by $52.9 million (40%) from 2014 and our oil sales in the first nine months of 2015 decreased by $184.5 million (60%) from 2014.  The decrease in natural gas sales is due to lower realized gas prices of 43% offset in part by 7% higher natural gas production.  The decrease in oil sales is attributable to the 51% decline in realized oil prices and an 18% decrease in production as compared with the first nine months of 2014.  

Costs and Expenses –

Production taxes decreased $4.2 million to $2.2 million for the third quarter of 2015 from $6.4 million in the third quarter of 2014. Production taxes of $9.0 million for the first nine months of 2015 decreased $9.4 million as compared with production taxes of $18.4 million for the first nine months of 2014.  These decreases are mainly related to our lower oil and gas sales in 2015 as well as state exemptions on our Haynesville shale wells drilled in 2015.

Gathering and transportation costs for the third quarter of 2015 increased $0.6 million to $3.7 million as compared to $3.1 million in the third quarter of 2014. Gathering and transportation costs for the first nine months of 2015 decreased $0.2 million to $9.8 million as compared to $10.0 million for the first nine months of 2014.  Our gathering and transportation costs have been reduced with the benefit of the volume growth from our Haynesville shale drilling program.

Our lease operating expense of $16.7 million for the third quarter of 2015 increased $0.8 million (5%) from operating expense of $15.9 million for the third quarter of 2014. Our lease operating expense for the first nine months of 2015 of $49.7 million increased $4.8 million or 11% from our lease operating expense of $44.9 million for the first nine months of 2014.  This increase primarily reflects increased lifting costs associated with our oil wells put onto production in 2014 as well as additional costs incurred related to the installation of artificial lift on many of our oil wells.  Our lease operating expense of $1.03 per Mcfe produced for the nine months ended September 30, 2015 was $0.13 per Mcfe higher than the lease operating expense per Mcfe for the same period in 2014.  

Exploration costs of $5.0 million and $70.3 million in the three months and nine months ended September 30, 2015, respectively, primarily include impairments of unevaluated leases and rig termination fees. Exploration costs of $11.4 million in the three months and nine months ended September 30, 2014 relate to exploratory well costs that were expensed as a result of mechanical problems encountered during completion which caused us to abandon the well.

Depreciation, depletion and amortization ("DD&A") decreased $20.6 million (21%) to $79.4 million in the third quarter of 2015 from $100.0 million in the third quarter of 2014. Our DD&A per equivalent Mcf produced decreased $1.50 (25%) to $4.58 for the three months ended September 30, 2015 from $6.08 for the three months ended September 30, 2014. The lower rate in the third quarter of 2015 reflects the lower finding costs of natural gas wells drilled in 2015.  DD&A for the first nine months of 2015 of $261.9 million decreased $21.5 million (8%) from DD&A expense of $283.4 million for the nine months ended September 30, 2014.  For the first nine months of 2015, our per unit DD&A rate of $5.40 decreased $0.28 (5%) from our DD&A rate of $5.68 for the first nine months of 2014.  The lower DD&A rate per Mcfe primarily reflects the lower finding costs related to our natural gas production.

We assess the need for impairment of the capitalized costs for our oil and gas properties on a property basis.  During the three months ended September 30, 2015, we recognized an impairment charge of $544.7 million on our oil and gas properties due to the decline in management's oil and natural gas price outlook.  

General and administrative expenses, which are reported net of overhead reimbursements, decreased to $5.7 million for the third quarter of 2015 from $7.9 million in the third quarter of 2014. Included in general and administrative expenses are stock-based compensation of $2.1 million and $2.8 million for the three months ended September 30, 2015 and 2014, respectively. For the first nine months of 2015, general and administrative expenses of $20.8 million decreased $5.1 million (20%) from general and administrative expenses for the nine months ended September 30, 2014 of $25.9 million.  Included in general and administrative expense is stock-based compensation of $6.1 million and $7.8 million for the nine months ended September 30, 2015 and 2014, respectively.  The lower general and administrative costs are attributable to a reduction in personnel and related compensation costs in 2015.

Interest expense increased $17.3 million to $32.2 million for the third quarter of 2015 from interest expense of $14.9 million in the third quarter of 2014. We did not capitalize any interest during the three months ended September 30, 2015 and we capitalized interest of $2.7 million during the three months ended September 30, 2014.  Interest expense increased $43.3 million to $86.7 million for the first nine months of 2015 from interest expense of $43.4 million in the first nine months of 2014.  We capitalized interest of $0.9 million and $7.5 million on our unevaluated properties during the nine months ended September 30, 2015 and 2014, respectively.  In addition to the lower capitalized interest, these increases are primarily related to the increase in debt outstanding during 2015, including the issuance of $700.0 million of senior secured notes in March 2015.

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We utilize oil and natural gas price swaps to manage our exposure to oil and natural gas prices and protect returns on investment from our drilling activities.  Gains related to our natural gas derivative financial instruments that covered a portion of our production were $1.1 million and $1.7 million for the three months and nine months ended September 30, 2015.  In 2014, we had crude oil price swaps that covered a portion of our production.  Gains related to our oil derivative financial instruments were $12.0 million in the three months ended September 30, 2014 and losses related to our derivative financial statements were $2.8 million in the nine months ended September 30, 2014.  The following table presents our crude oil equivalent prices before and after the effect of cash settlements of our derivative financial instruments:

The following table presents our natural gas equivalent prices before and after the effect of cash settlements of our derivative financial instruments:

We recognized a loss of $111.8 million related to the sale of certain oil and gas properties and a net gain on extinguishment of debt of $55.6 million during the nine months ended September 30, 2015.  

Income taxes for the third quarter of 2015 were a benefit of $30.6 million as compared to a benefit of $0.5 million for the three months ended September 30, 2014. Our effective tax rate for the three months ended September 30, 2015 was a benefit of 5.3% as compared to a benefit of 20.5% for the three months ended September 30, 2014. Income taxes for the nine months ended September 30, 2015 were a benefit of $144.9 million as compared to a provision of $1.5 million for the nine months ended September 30, 2014.  Our effective tax rate was 16.0% for the first nine months of 2015 as compared to 55.6% for the first nine months of 2014.  The effective tax rates for 2015 and 2014 primarily reflect the effect of certain non-deductible expenses and a valuation allowance recognized on deferred tax assets in 2015 of $189.4 million.

We reported a net loss of $545.0 million, or $11.81 per share, for the three months ended September 30, 2015 as compared to a net loss of $1.9 million, or 4¢ per share, for the three months ended September 30, 2014. We reported a net loss of $758.6 million, or $16.45 per share, for the nine months ended September 30, 2015, as compared to net income of $1.2 million, or 2¢ per diluted share, for the nine months ended September 30, 2014.  The net loss in the nine months ended September 30, 2015 was primarily due to the substantial oil and gas property impairment charges recognized, the loss on sale of oil and gas properties, lower oil and natural gas prices, higher exploration costs and higher interest expense.

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Liquidity and Capital Resources

Funding for our activities has historically been provided by our operating cash flow, debt or equity financings or proceeds from asset sales. For the nine months ended September 30, 2015, our primary source of funds were cash provided by operating activities of $23.5 million, net borrowings of $40.0 million under our bank credit facility and net proceeds from our senior secured notes offering of $684.0 million. Our net cash flow from operating activities (excluding working capital changes) decreased $266.3 million (87%) in the first nine months of 2015 to $39.5 million from $305.8 million for the first nine months of 2014.  This decrease primarily reflects our lower revenues from oil and gas sales.

Our primary needs for capital, in addition to funding our ongoing operations, relate to the acquisition, development and exploration of our oil and gas properties and the repayment of our debt. In the first nine months of 2015, we incurred capital expenditures, on an accrual basis, of $209.2 million primarily for our development and exploration activities.

The following table summarizes our capital expenditure activity, on an accrual basis, for the nine months ended September 30, 2015 and 2014:

We expect to spend approximately $28 million for developmental and exploratory drilling and for acquisition of leases during the fourth quarter of 2015. We expect to fund our development and exploration activities with operating cash flow and from cash on hand.

The timing of most of our capital expenditures is discretionary because we have no material long-term capital expenditure commitments except for commitments for contract drilling services. Consequently, we have a significant degree of flexibility to adjust the level of our capital expenditures as circumstances warrant. In March 2015, we released one of the contracted drilling rigs for the payment of a $1.7 million early termination fee.  As of September 30, 2015, we have one drilling rig under contract through November 2015 at a cost of $1.3 million. In addition, we have maximum commitments of $7.1 million to transport and treat natural gas through July 2019. We have obligations to incur future payments for dismantlement, abandonment and restoration costs of oil and gas properties. These payments are currently estimated to be incurred primarily after 2019. We record a separate liability for these asset retirement obligations which totaled $15.1 million as of September 30, 2015.

In March 2015, we issued $700.0 million of 10% senior secured notes (the "Secured Notes") which are due on March 15, 2020.  Interest on the Secured Notes is payable semi-annually on each March 15 and September 15.  Net proceeds from the issuance of the Secured Notes of $684.0 million were used to retire our bank credit facility and for general corporate purposes.  We also have outstanding (i) $387.5 million of 7¾% senior notes (the "2019 Notes") which are due on April 1, 2019 and bear interest which is payable semi-annually on each April 1 and October 1 and (ii) $211.6 million of 9½% senior notes (the "2020 Notes") which are due on June 15, 2020 and bear interest which is payable semi-annually on each June 15 and December 15.  The Secured Notes are secured on a first priority basis equally and ratably with our revolving credit facility described below, subject to payment priorities in favor of the revolving credit facility by the collateral securing the revolving credit facility, which consists of, among other things, at least 80% of our and its subsidiaries' oil and gas properties.  The Secured Notes, the 2019 Notes and 2020 Notes are our general obligations and are guaranteed by all of our subsidiaries. Such subsidiary guarantors are 100% owned and all of the guarantees are full and unconditional and joint and several obligations.  There are no restrictions on our ability to obtain funds from our subsidiaries through dividends or loans. As of September 30, 2015, we had no material assets or operations which are independent of our subsidiaries.  

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During the nine months ended September 30, 2015, we purchased $12.5 million in principal amount of the 2019 Notes and $88.4 million in principal amount of the 2020 Notes for $37.8 million.  The gain of $59.3 million recognized on the purchase of the 2019 Notes and 2020 Notes and the loss resulting from the write-off of deferred loan costs associated with our prior bank credit facility of $3.7 million are included in the net gain on extinguishment of debt, which is reported as a component of other income (loss).