UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended November 30, 2018May 31, 2019

OR

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   ______________   to   _______________

Commission File Number: 000-50107

DAYBREAK OIL AND GAS, INC.

(Exact name of registrant as specified in its charter)

(509) 232-7674

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

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.   þ Yes   ¨ 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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes þ   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,company., or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,”filer”, and “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   ¨ Yes   þ No

At January 14,July 11, 2019 the registrant had 51,532,36453,532,364 outstanding shares of $0.001 par value common stock.

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

PART II - OTHER INFORMATION

PART I

FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

DAYBREAK OIL AND GAS, INC.

Balance Sheets – Unaudited

The accompanying notes are an integral part of these unaudited financial statements

DAYBREAK OIL AND GAS, INC.

Statements of Operations – Unaudited

The accompanying notes are an integral part of these unaudited financial statements

DAYBREAK OIL AND GAS, INC.

Statements of Cash Flows – UnauditedChanges in Stockholders' Deficit

For the Three Months Ended May 31, 2019 and 2018

The accompanying notes are an integral part of these unaudited financial statements

DAYBREAK OIL AND GAS, INC.

Statements of Cash Flows – Unaudited

The accompanying notes are an integral part of these unaudited financial statements

DAYBREAK OIL AND GAS, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION:

Organization

Originally incorporated as Daybreak Uranium, Inc., (“Daybreak Uranium”) under the laws of the State of Washington on March 11, 1955, Daybreak Uranium was organized to explore for, acquire, and develop mineral properties in the Western United States.  During 2005, management of the Company decided to enter the crude oil and natural gas exploration and production industry.  On October 25, 2005, the Company shareholders approved a name change from Daybreak Mines, Inc. to Daybreak Oil and Gas, Inc. (referred to herein as “Daybreak” or the “Company”) to better reflect the business of the Company.

All of the Company’s crude oil and natural gas production is sold under contracts which are market-sensitive.  Accordingly, the Company’s financial condition, results of operations, and capital resources are highly dependent upon prevailing market prices of, and demand for, crude oil and natural gas.oil.  These commodity prices are subject to wide fluctuations and market uncertainties due to a variety of factors that are beyond the control of the Company.  These factors include the level of global demand for petroleum products, foreign supply of crude oil, and natural gas, the establishment of and compliance with production quotas by crude oil-exporting countries, the relative strength of the U.S. dollar, weather conditions, the price and availability of alternative fuels, and overall economic conditions, both foreign and domestic.

Basis of Presentation

The accompanying unaudited interim financial statements and notes for the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q for quarterly reports under Section 13 or 15(d)15 (d) of the Securities Exchange Act of 1934 (the “Exchange Act”).  Accordingly, they do not include all of the information and footnote disclosures normally required by accounting principles generally accepted in the United States of America for complete financial statements.

In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements have been included and such adjustments are of a normal recurring nature.  Operating results for the ninethree months ended November 30, 2018May 31, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2019.29, 2020.

These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2018.2019.

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions.  These estimates and assumptions may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period.  Actual results could differ materially from those estimates.  The accounting policies most affected by management’s estimates and assumptions are as follows:

·

The reliance on estimates of proved reserves to compute the provision for depreciation, depletion and amortization (“DD&A”) and to determine the amount of any impairment of proved properties;

·

The valuation of unproved acreage and proved crude oil and natural gas properties to determine the amount of any impairment of crude oil and natural gas properties;

·

Judgment regarding the productive status of in-progress exploratory wells to determine the amount of any provision for abandonment; and

·

Estimates regarding abandonment obligations.

Reclassifications

Certain reclassifications have been made to conform the prior period’s financial information to the current period’s presentation.  These reclassifications had no effect on previously reported net loss or accumulated deficit.

Earnings per Share

The Company follows ASC Topic 260, Earnings per Share, to account for the earnings per share.  Basic earnings per common share (“EPS”) calculations are determined by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per common share calculations are determined by dividing net income (loss) by the weighted average number of common shares and dilutive common share equivalents outstanding.  During periods when common stock equivalents, if any, are anti-dilutive they are not considered in the computation.

Reclassifications

Certain reclassifications have been made to conform the prior period’s financial information to the current period’s presentation.  These reclassifications had no effect on previously reported net loss or accumulated deficit.

NOTE 2 — GOING CONCERN:

Financial Condition

The Company’s financial statements for the ninethree months ended November 30, 2018May 31, 2019 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business.  The Company has incurred net operating losses since entering the crude oil and natural gas exploration industry and as of November 30, 2018May 31, 2019 has an accumulated deficit of $40,322,732$28.4 million and a working capital deficit of $17,954,363$5.5 million, which raises substantial doubt about the Company’s ability to continue as a going concern.

Management Plans to Continue as a Going Concern

The Company continues to implement plans to enhance its ability to continue as a going concern.  Daybreak currently has a net revenue interest (“NRI”) in 20 producing crude oil wells in its East Slopes Project located in Kern County, California (the “East Slopes Project”).  The revenue from these wells has created a steady and reliable source of revenue.income for the Company.  The Company’s average working interest (“WI”) in these wells is 36.6% and the NRIaverage net revenue interest (“NRI”) is 28.4% for these same wells.

The Company anticipates its revenue will continue to increase as the Company participates in the drilling of more wells in the East Slopes Project in California and as our exploratory drilling project begins in Michigan.  However, given the current volatility and instability in hydrocarbon prices,prices; the timing of any drilling activity in California and Michigan will be dependent on a sustained improvement in hydrocarbon prices and a successful refinancing or restructuring of the Company’s credit facility.success in securing financing for its drilling programs.

The Company believes that ourits liquidity will improve when there is a sustained improvement in hydrocarbon prices.  Daybreak’s sources of funds in the past have included the debt or equity markets and the sale of assets.  While the Company has experienced revenue growth, which has resulted in positive cash flow from its crude oil and natural gas properties, it has not yet established a positive cash flow on a company-wide basis.  It will be necessary for the Company to obtain additional funding from the private or public debt or equity markets in the future.  However, the Company cannot offer any assurance that it will be successful in executing the aforementioned plans to continue as a going concern.

Daybreak’s financial statements as of November 30, 2018May 31, 2019 do not include any adjustments that might result from the inability to implement or execute the Company’sDaybreak’s plans to improve itsour ability to continue as a going concern.

On December 27, 2018, the Company settled its outstanding indebtedness with Maximilian including a release of and termination of all liens and security interests granted to Maximilian with respect to the Company’s California and Michigan Projects.  Please refer to Note 14 – Subsequent Events for further discussion on this transaction.

NOTE 3 — RECENT ACCOUNTING PRONOUNCEMENTS:

Accounting Standards Issued and Adopted

In May 2014,On June 20, 2018, the FASBFinancial Accounting Standards Board (“FASB”) issued ASC updated No. 2014-09, Accounting Standards Update (“ASU”) 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.  The amendments in this ASU expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees.  The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards.  The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers (Topic 606(ASU 2014-09).  UnderCustomers.  For public entities, the amendments in this update, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  The amendments in this updateASU are effective for fiscal years and interimannual periods within those years beginning after December 15, 2017, and supersedes any previous revenue recognition guidance.  Implementation of2018.  ASC Topic 606 was done using the modified retrospective approach.  Adoption of this new standard did not have an impact on the Company’s balance sheet, statement of operations, statement of stockholder’s equity (deficit) or statement of cash flows.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash” (“ASU 2016-18”).  The update is718 became effective for years beginning December 15, 2017, including interim reporting periods within those fiscal years.  Early adoption is permitted.  The purpose of Update 2016-18 is to clarify guidancethe Company on March 1, 2019 and presentation related to restricted cash in the Statements of Cash Flows.  The amendment requires beginning-of-period and end-of-period total amounts shown on the Statements of Cash Flows to include cash and cash equivalents as well as restricted cash and restricted cash equivalents.  Adoption of this new standard did not have a material impact on the Company’s financial statements.

NOTE 4 —RESTRICTED CASH:8

On March 13, 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740).  The ASU adds seven paragraphs to the Accounting Standards Codification (“ASC”) 740, Income Taxes, that contain SEC guidance related to Staff Accounting Bulletin 118 (“Income Tax Accounting Implications of the Tax Cuts and Jobs Act”) as a result of the tax legislation passed in 2017 known as the “Tax Cuts and Jobs Act” (the “Act”).  Specifically, the staff intended to address situations where the accounting under ASC Topic 740 is incomplete for certain income tax effects of the Act upon issuance of an entity’s financial statements for the reporting period in which the Act was enacted.  The Company notes that it has considered the updates to ASC 740 as a result of the Act and has prepared its financial statements in accordance with the Act.

A reconciliationIn February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” and subsequent amendments to the initial guidance: ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01 (collectively, Topic 842).  ASU 2016-02 increases the transparency and comparability of cash, cash equivalentsleases among entities and restricted cash reportedrequires an entity to recognize a right-of-use asset (“ROU”) and lease liability for all leases and provide enhanced disclosures.  Recognition, measurement, and presentation of expenses depends on classification as a finance lease or an operating lease.  The Company has determined that it has only operating leases.  ASC 842 supersedes the lease accounting guidance in ASC 840 “Leases”.  On March 1, 2019, the Company adopted Topic 842 using the modified retrospective approach and the impact of the adoption of ASC 842 resulted in the recognition of a right of use asset and lease payable obligation on the Company’s Balance Sheets of approximately $13,787.  Results for reporting periods after March 1, 2019 are presented under Topic 842, while prior periods have not been adjusted.  The Company elected the package of practical expedients permitted under the transition guidance within the statement of financial position that sum to the total of the same such cash amounts shown in the statement of cash flows is set forth in the table below.

Amounts included in restricted cash represent those required to be set aside in the form of a short-term time deposit (CD) pledged as collateral in connection with any obligation for plugging, abandonment and site remediation requirements for our crude oil operations in California.  Effective March 19, 2018, the collateral requirement obligation was rescinded.  These funds then became available fornew standard, which among other things, allowed the Company to use for regular business purposes.carry forward the historical lease classification.  Refer to Note 9 - Leases.

NOTE 54 — CONCENTRATION OF CREDIT RISK:

Substantially all of the Company’s trade accounts receivable result from crude oil and natural gas sales or joint interest billings to its working interest partners.  This concentration of customers and joint interest owners may impact the Company’s overall credit risk, as these entities could be affected by similar changes in economic conditions including lower crude oil prices as well as other related factors.  Trade accounts receivable are generally not collateralized.

At the Company’s East Slopes project in California, there is only one buyer available for the purchase of crude oil production.  The Company has no natural gas production in California.  At November 30, 2018May 31, 2019 and February 28, 20182019 this one customer represented 100.0% of the crude oil sales receivable balance.receivable.  If this buyer is unable to resell its products or if they lose a significant sales contract, the Company may incur difficulties in selling its crude oil production.

The Company’s accounts receivable balances from California crude oil sales of $90,987$116,982 and $104,840$75,410 at November 30, 2018May 31, 2019 and February 28, 2018,2019, respectively were from one customer, Plains MarketingMarketing; and represent crude oil sales that occurred in NovemberMay and February 2018,2019, respectively.

Joint interest participant receivables balances of $55,769$51,267 and $58,452$54,883 at November 30, 2018May 31, 2019 and February 28, 2018,2019, respectively represent amounts due from working interest partners in California, where the Company is the Operator.  There were no allowances for doubtful accounts for the Company’s trade accounts receivable at November 30, 2018May 31, 2019 and February 28, 20182019, as the joint interest owners have a history of paying their obligations.

At November 30, 2018, the Company owed our principal lender, Maximilian Resources LLC, a Delaware limited liability company and successor by assignment to Maximilian Investors LLC (either party, as appropriate, is referred to in these notes to the financial statements as “Maximilian”), an aggregate $12.6 million or approximately 69.4% of the Company’s total debt.

On December 27, 2018, the Company settled its outstanding indebtedness with Maximilian.  Please refer to Note 14 – Subsequent Events for further discussion about this transaction.

NOTE 65 — CRUDE OIL AND NATURAL GAS PROPERTIES:

Crude oil and natural gas property balances at November 30, 2018May 31, 2019 and February 28, 20182019 are set forth in the table below.

9

NOTE 76 — ACCOUNTS PAYABLE:

On March 1, 2009, the Company became the operator for its East Slopes Project in California.Project.  Additionally, the Company then assumed certain original defaulting partners’ approximate $1.5 million liability representing a 25% working interest in the drilling and completion costs associated with the East Slopes Project four earning well program.  The Company subsequently sold the same 25% working interest on June 11, 2009.  Of the $1.5 million liability, $244,849 remains unpaid and is included in both the November 30, 2018 and February 28, 2018May 31, 2019 accounts payable balances.balance.  Payment of this liability has been delayed until the Company’s cash flow situation improves.  On October 17, 2018, a working interest partner in California filed a UCC financing statement in regards to payables owed to the partner by the Company.  At November 30, 2018,May 31, 2019, the balance owed this working interest partner was $122,746.$114,019 and is included in the approximate $1.5 million balance.

NOTE 87 — ACCOUNTS PAYABLE- RELATED PARTIES:

The November 30, 2018May 31, 2019 and February 28, 20182019 accounts payable – related parties balances of approximately $1.8$2.0 million and $1.7$1.9 million respectively, were comprised primarily of deferred salaries of the Company’s Executive Officers and certain employees; directors’ fees; expense reimbursements; and deferred interest payments on a 12% Subordinated Notes owed to the Company’s President and Chief Executive Officer.  Payment of these deferred items has been delayed until the Company’s cash flow situation improves.

NOTE 98 — SHORT-TERM AND LONG-TERM BORROWINGS:

Current debt (Short-term borrowings)

Note Payable – Related Party

The Company has a note payable-related party loan balance of $250,100 as of November 30, 2018May 31, 2019 and February 28, 2018.2019.  The Company’s Chairman, President and Chief Executive Officer has loaned the Company an aggregate $250,100 that was used for a variety of corporate purposes including an escrow requirement on a loan commitment; maturity extension fees on third party loans; and a reduction of principal on the Company’s credit line with UBS Bank.  These loans are non-interest bearing loans and repayment will be made upon a mutually agreeable date in the future.

12% Subordinated Notes

The Company’s 12% Subordinated Notes (“the Notes”) issued pursuant to a January 2010 private placement offering to accredited investors, resulted in $595,000 in gross proceeds (of which $250,000 was from a related party) to the Company and accrue interest at 12% per annum, payable semi-annually on January 29th and July 29th.  On January 29, 2015, the Company and 12 of the 13 holders of the Notes agreed to extend the maturity date of the Notes for an additional two years to January 29, 2017.  Effective January 29, 2017, the maturity date of the Notes and the expiration date of the warrants that were issued in conjunction with the Notes were extended for an additional two years to January 29, 2019.  The exercise price of the associated warrants was lowered from $0.14 to $0.07 as part of the Note maturity extension.  There are ten noteholders, holding 980,000 warrants (including 500,000 warrants held by a related party) who have not yet exercised their warrants.ten noteholders expired on January 29, 2019.

The Company has informed the Note holders that the payment of principal and final interest will be late and is subject to future financing being completed.  The Notes principal of $565,000 iswas payable in full at the amended maturity date of the Notes.Notes, and has not been paid.  The fair valueterms of the warrant modification, as determined by the Black-Scholes option pricing model, was $29,075 and was recognized as a discount to debt and is being amortized over the extended maturity date of the Notes.  The Black-

Scholes valuation encompassed the following weighted average assumptions: a risk free interest rate of 1.22%; volatility of 378.73%; and dividend yield of 0.0%.

The Notes, principal of $565,000 is payable in full at the amended maturity date of the Notes.  Shouldstate that should the Board of Directors on the maturity date, decide that the payment of the principal and any unpaid interest would impair the financial condition or operations of the Company, the Company may then elect a mandatory conversion of the unpaid principal and interest into the Company’s common stock at a conversion rate equal to 75% of the average closing price of the Company’s common stock over the 20 consecutive trading days preceding December 31, 2018.  Amortization expenseThere was $10,903 at November 30, 2018 and 2017, respectively.  Theno unamortized debt discount remaining at November 30, 2018May 31, 2019 and February 28, 2018 was $2,423 and $13,326, respectively.2019.

12% Note balances at November 30, 2018May 31, 2019 and February 28, 20182019 are set forth in the table below:

12% Note balances – related parties at November 30, 2018 and February 28, 2018 are set forth in the table below:

In conjunction with the Notes private placement, a total of 1,190,000 common stock purchase warrants (including 500,000 held by a related party) were issued at a rate of two warrants for every dollar raised through the private placement.  The warrants have an amended exercise price of $0.07 and an amended expiration date of January 29, 2019.  The 12% Note warrants that have been exercised are set forth in the table below.  At November 30, 2018, there were 980,000 warrants (including 500,000 held by a related party) that were not exercised and had not expired.

Maximilian Loan Agreement (Credit Facility)

On October 31, 2012, the Company entered into a loan agreement with Maximilian Resources LLC, a Delaware limited liability company and successor by assignment to Maximilian Investors LLC (either party, as appropriate, is referred to in these notes to the financial statements as “Maximilian”), which provided for a revolving credit facility of up to $20 million, that matured on October 31, 2016, with a minimum commitment of $2.5 million.  In August 2013, the Company amended its loan agreement with Maximilian thereby increasing the amount of the credit facility to $90 million and reduced the annual interest rate to 12%.  The Company evaluated the amendment of the revolving credit facility under ASC 470-50-40 and determined that the Company’s borrowing capacity under the amended loan agreement exceeded its borrowing capacity under the old loan agreement.  Consequently, the unamortized discount and deferred financing costs as of the date of amendment were amortized over the term of the loan agreement.

On October 31, 2016 through the Fourth Amendment to the Amended and Restated Loan and Security Agreement (the “Restructuring Agreement”), the maturity date of the loan was changed to February 28, 2020.

As a result of the decline in hydrocarbon prices that started in June of 2014, the Company has been unable to make any type of interest or principal payments required under the amended terms of its credit facility with Maximilian since December of 2015.  Due to the Company’s default on the Maximilian loan, all unamortized discount and deferred financing costs were fully amortized during the twelve months ended February 28, 2018.  Under the terms of the Restructuring Amendment all unpaid interest is currently being accrued.  Accrued interest on the credit facility loan at November 30, 2018 and February 28, 2018 was $3,459,858 and $1,812,128, respectively.  During the nine months ended November 30, 2018 and 2017, the Company received advances of $-0- and $102,700, respectively, under the terms of the credit facility.10

On December 27, 2018, the Company settled its outstanding indebtedness with Maximilian including a release and termination of all liens and security interests granted to Maximilian with respect to the Company’s California and Michigan projects.  Please refer to Note 14 – Subsequent Events for further discussion on this transaction.

Maximilian Promissory Note – Michigan Exploratory Joint Drilling Project

The Company has a note payable loan balance to Maximilian of $94,650 as of November 30, 2018 and February 28, 2018.  The Company has received $94,650 in aggregate from multiple advances since January 2017 from Maximilian under a separate promissory note agreement dated January 17, 2017 and amended on February 10, 2017 regarding the development of an exploratory joint drilling project in Michigan.  Advances under this agreement are subject to a 5% (five percent) per annum interest rate.  In the event of a default of any of the Company’s obligations under the promissory note, the amounts due may be called immediately due and payable at Maximilian’s option.

Due to a lack of available funding from Maximilian, we have been unable to spud a well on the Michigan project.  The Company is currently considered to be in default under the terms of its loan agreement.  Maximilian is currently in receivership.  The United States District Court for the Eastern District of New York, Southern Division has hired consultants to assist in finding a new lender.  No assurances can be made as to who the new lender will be or how the structure of the loan will affect the Company.  Accrued interest on the Michigan promissory note at November 30, 2018 and February 28, 2018 was $8,774 and $5,158, respectively.  During the nine months ended November 30, 2018 and 2017, the Company received advances of $-0- and $10,650.  The $10,650 was paid directly to the Operator of the Michigan project by Maximilian on the Company’s behalf.

In accordance with the guidance found in ASC-470-10-45, the entire balance of both the Maximilian credit facility loan and the Michigan loan is presented under the current liabilities section of the balance sheets.  Current debt balances at November 30, 2018 and February 28, 2018 are set forth in the table below:

On December 27, 2018, the Company settled its outstanding indebtedness with Maximilian including a release and termination of all liens and security interests granted to Maximilian with respect to the Company’s California and Michigan projects.  Please refer to Note 14 – Subsequent Events for further information on this transaction.

Line of Credit

The Company has an existing $890,000 line of credit for working capital purposes with UBS Bank USA (“UBS”), established pursuant to a Credit Line Agreement dated October 24, 2011 that is secured by the personal guarantee of its Chairman, President and Chief Executive Officer.  On July 10, 2017, $700,000 of the outstanding line of credit balance was converted to a 24 month fixed term annual interest rate of 3.244% with interest payable monthly.  The remaining principal balance of the line of credit has a stated monthly reference rate of 0.249% + 337.5 basis points with interest payable monthly.  The monthly interest rate on the remaining principal balance for November 2018 was 0.483%.  The reference rate is based on the 30 day LIBOR (“London Interbank Offered Rate”) and is subject to change from UBS.

At November 30,During the three months ended May 31, 2019 and 2018, and February 28, 2018,the Company received advances on the line of credit had an outstanding balance of $834,329$29,000 and $873,350,$-0-, respectively.  During the ninethree months ended November 30, 2018May 31, 2019 and 2017, the Company received advances of $33,300 and $65,000 from the line of credit.  Additionally during the nine months ended November 30, 2018, the Company made payments to the line of credit of $95,000$15,000 and $45,000,$65,000, respectively.  Interest incurredconverted to principal for the ninethree months ended November 30,May 31, 2019 and 2018 was $7,787 and 2017$7,563, respectively.  At May 31, 2019 and February 28, 2019, the line of credit had an outstanding balance of $848,640 and $826,853, respectively.

Note Payable

In December 2018, the Company was $22,680able to settle an outstanding balance owed to one of its third-party vendors.  This settlement resulted in a $120,000 note payable issued to the vendor.  Additionally, the Company agreed to issue 2,000,000 shares of the Company’s common stock as a part of the settlement agreement.  Based on the closing price of the Company’s common stock on the date of the settlement agreement, the value of the common stock transaction was determined to be $6,000.  The common stock shares were issued during the three months ended May 31, 2019.  The note has a maturity date of January 1, 2022 and $24,903, respectively.bears an interest rate of 10% rate per annum.  Monthly interest is accrued and payable on January 1^st of each anniversary date through maturity of the note.

Production Revenue Payable

Since December 2018, the Company has been selling interests in certain portions of its production in order to fund the drilling of future wells in California and Michigan and to settle some of its historical debt.  The purchasers of production payment interests receive a production revenue payment on future wells to be drilled in California and Michigan in exchange for their purchase.  As of May 31, 2019, the sales of production payment interests had raised $700,000 of which $300,000 of proceeds were received from a related party - the Company’s Chairman, President and Chief Executive Officer.

The production payment interest entitles the purchasers to receive production payments equal to twice their original amount paid, payable from a percentage of the Company’s future net production payments from wells drilled after the date of the purchase and until the Production Payment Target (as described below) is met.  The Company shall pay fifty percent of its net production payments from the relevant wells to the purchasers until each purchaser has received two times the purchase price (the “Production Payment Target”).  Once the Company pays the purchasers amounts equal to the Production Payment Target, it shall thereafter pay a pro-rated eight percent of $1.3 million on its net production payments from the relevant wells to each of the purchasers.  However, if the Production Payment Target is not met within the first three years, the Company shall pay seventy-five percent of its production payments from the relevant wells to the purchasers until the Production Payment Target is met.

The Company accounted for the amounts received from these sales in accordance with ASC 470-10-25 and 470-10-35 which require amounts recorded as debt to be amortized under the interest method as described in ASC 835-30, Interest Method.  Consequently, the net proceeds received of $700,000 was recognized as a production revenue payable.  The Company determined an effective interest rate based on future expected cash flows to be paid to the holders of the production payment interests.  This rate represents the discount rate that equates estimated cash flows with the initial proceeds received from the sales and is used to compute the amount of interest to be recognized each period.  Estimating the future cash outflows under this agreement requires the Company to make certain estimates and assumptions about future revenues and payments and such estimates are subject to significant variability.  Therefore, the estimates are likely to change which may result in future adjustments to the accretion of the interest expense and the amortized cost based carrying value of the related payables.

Accordingly, the Company has estimated the cash flows associated with the production revenue payments and determined a discount of $1,320,353 which is being accounted as interest expense over the estimated period over which payments will be made based on expected future revenue streams.  For the three months ended May 31, 2019, amortization of the debt discount on these payables amounted to $124,923 which has been included in interest expense in the statements of operations.

Production revenue payable balances at May 31, 2019 and February 28, 2019 are set forth in the table below:

Encumbrances

On October 17, 2018, a working interest partner in California filed a UCC financing statement in regards to payables owed to the partner by the Company.  As of May 31, 2019, we had no encumbrances on our crude oil project in Michigan.

NOTE 9 — LEASES:

The Company leases approximately 988 rentable square feet of office space from an unaffiliated third party for our corporate office located in Spokane Valley, Washington.  Additionally, we lease approximately 416 and 695 rentable square feet from unaffiliated third parties for our regional operations office in Friendswood, Texas and storage and auxiliary office space in Wallace, Idaho, respectively.  The lease in Friendswood is a 24 month lease that expires in October 2020.  The Company’s lease for Friendswood does not include an option to renew.  The Spokane Valley and Wallace leases are currently on a month-to-month basis.  The Company’s lease agreements do not contain any residual value guarantees, restrictive covenants or variable lease payments.  The Company has not entered into any financing leases.

The Company determines if an arrangement is a lease at inception.  Operating leases are recorded in operating lease right of use assets, net, operating lease liability – current, and operating lease liability, long-term on its balance sheet.

Operating lease assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease.  Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term.  As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments.  The incremental borrowing rate used at adoption was 5.85%.  Significant judgement is required when determining the Company’s incremental borrowing rate.  Lease expense for lease payments are recognized on a straight-line basis over the lease term.

The Balance Sheet classification of lease assets and liabilities was as follows:

Future minimum lease payments as of May 31, 2019 under non-cancellable operating leases are as follows:

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Rent expense for the three months ended May 31, 2019 and 2018 was $5,879, respectively.

NOTE 10 — STOCKHOLDERS’ DEFICIT:

Preferred Stock

The Company is authorized to issue up to 10,000,000 shares of preferred stock with a par value of $0.001.  The Company’s preferred stock may be entitled to preference over the common stock with respect to the distribution of assets of the Company in the event of liquidation, dissolution, or winding-up of the Company, whether voluntarily or involuntarily, or in the event of any other distribution of assets of the Company among its shareholders for the purpose of winding-up its affairs.  The authorized but unissued shares of preferred stock may be divided into and issued in designated series from time to time by one or more resolutions adopted by the Board of Directors.  The directors in their sole discretion shall have the power to determine the relative powers, preferences, and rights of each series of preferred stock.

Series A Convertible Preferred Stock

The Company has designated 2,400,000 shares of the 10,000,000 preferred shares as Series A Convertible Preferred Stock (“Series A Preferred”), with a $0.001 par value.  At November 30, 2018May 31, 2019 and February 28, 2018,2019, there were 709,568 shares issued and outstanding, respectively, that had not been converted into our common stock.  As of November 30, 2018,May 31, 2019, there are 44 accredited investors who have converted 690,197 Series A Preferred shares into 2,070,591 shares of Daybreak common stock.

The conversions of Series A Preferred that have occurred since the Series A Preferred was first issued in July 2006 are set forth in the table below.

Holders of Series A Preferred shall accrue dividends, in the amount of 6% of the original purchase price per annum.  Dividends may be paid in cash or common stock at the discretion of the Company.  Dividends are cumulative whether or not in any dividend period or periods the Company haswe have assets legally available for the payment of such dividends.  Accumulations of dividends on Series A Preferred do not bear interest.  Dividends are payable upon declaration by the Board of Directors.

As of November 30, 2018May 31, 2019 no dividends have been declared or paid.  Dividends earned since issuance for eachby fiscal year and the ninethree months ended November 30, 2018May 31, 2019 are set forth in the table below:

Common Stock

The Company is authorized to issue up to 200,000,000 shares of $0.001 par value common stock of which 53,532,364 and 51,532,364 shares were issued and outstanding as of November 30, 2018May 31, 2019 and February 28, 2018,2019, respectively.

NOTE 11— WARRANTS:

Warrants outstanding and exercisable as of November 30, 2018 are set forth in the table below:

Warrant activity for the nine months ended November 30, 2018 is set forth in the table below:

During the nine months ended November 30, 2018, there were no warrants issued, exercised or cancelled.  There were 6,859,784 warrants that expired.  These warrants had been issued to either Maximilian or to third parties in relation to financing that occurred in 2012 and 2013 through Maximilian.  The remaining outstanding warrants as of November 30, 2018, have a weighted average exercise price of $0.07, a weighted average remaining life of 0.17 years, and an intrinsic value of $-0-.

NOTE 12 — INCOME TAXES:

On December 22, 2017, the federal government enacted a tax bill H.R.1, an act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018, commonly referred to as the Tax Cuts and Jobs Act.  The Tax Cuts and Jobs Act contains significant changes to corporate taxation, including, but not limited to, reducing the U.S. federal corporate income tax rate from 35% to 21% and modifying or limiting many business deductions.  The Company hasWe re-measured its deferred tax liabilities based on rates at which they are expected to be utilized in the future, which is generally 21%.

Reconciliation between actual tax expense (benefit) and income taxes computed by applying the U.S. federal income tax rate and state income tax rates to income from continuing operations before income taxes is set forth in the table below:

Tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred liabilities are set forth in the table below:

At November 30, 2018, the CompanyMay 31, 2019, Daybreak had estimated net operating loss (“NOL”) carryforwards for federal and state income tax purposes of approximately $30,206,552$18,095,615 which will begin to expire, if unused, beginning in 2024.  Under the Tax Cuts and Jobs Act, the NOL portion of the loss incurred in the 2018 period of $2,963,803$340,749 and the loss incurred for the three months ended May 31, 2019 in the amount of $127,226 will not expire and will carry over indefinitely.  The valuation allowance increased $591,755 and $1,959,784$40,888 for the ninethree months ended November 30, 2018May 31, 2019 and decreased approximately $3,060,558 for the year ended February 28, 2018,2019, respectively.  Section 382 of the Internal Revenue Code places annual limitations on the Company’s net operating loss (NOL) carryforward.

The above estimates are based on management’s decisions concerning elections which could change the relationship between net income and taxable income.  Management decisions are made annually and could cause estimates to vary significantly.  The Company files federal income tax returns with the United States Internal revenue Service and state income tax returns in various state tax jurisdictions.  As a general rule the Company’s tax returns for the fiscal years after 2014 currently remain subject to examinations by appropriate tax authorities.  None of our tax returns are under examination at this time.

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NOTE 1312 — COMMITMENTS AND CONTINGENCIES:

Various lawsuits, claims and other contingencies arise in the ordinary course of the Company’s business activities.  While the ultimate outcome of any future contingency is not determinable at this time, management believes that any liability or loss resulting therefrom will not materially affect the financial position, results of operations or cash flows of the Company.

The Company, as an owner or lessee and operator of crude oil and natural gas properties, is subject to various federal, state and local laws and regulations relating to discharge of materials into, and protection of, the environment.  These laws and regulations may, among other things, impose liability on the lessee under a crude oil and natural gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages.  In some instances, the Company may be directed to suspend or cease operations in the affected area.  The Company maintains insurance coverage that is customary in the industry, although the Company is not fully insured against all environmental risks.

The Company is not aware of any environmental claims existing as of November 30, 2018.May 31, 2019.  There can be no assurance, however, that current regulatory requirements will not change or that past non-compliance with environmental issues will not be discovered on the Company’s crude oil and natural gas properties.

The Company’s minimum annual office rental lease commitments by fiscal year as of November 30, 2018 is shown in the table below: