ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is managements assessment of the current and historical financial and operating results of the Company and of our financial condition. It is intended to provide information relevant to an understanding of our financial condition, changes in our financial condition and our results of operations and cash flows and should be read in conjunction with our unaudited financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the six months ended August 31, 2016 and in our Annual Report on Form 10-K for the year ended February 29, 2016. References to Daybreak, the Company, we, us or our mean Daybreak Oil and Gas, Inc.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained in our Managements Discussion and Analysis
of Financial Condition and Results of Operations (MD&A) are intended to be covered by the safe harbor provided for under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act.
All statements other than statements of historical fact contained in this MD&A report are inherently uncertain and are forward-looking statements. Statements that relate to results or developments that we anticipate will or may occur in the future are not statements of historical fact. Words such as anticipate, believe, could, estimate, expect, intend, may, plan, predict, project, will and similar expressions identify forward-looking statements. Examples of forward-looking statements include, without limitation, statements about the following:
·
Our future operating results;
·
Our future capital expenditures;
·
Our future financing;
·
Our expansion and growth of operations; and
·
Our future investments in and acquisitions of oil and natural gas properties.
We have based these forward-looking statements on assumptions and analyses made in light of our experience and our perception of historical trends, current conditions, and expected future developments. However, you should be aware that these forward-looking statements are only our predictions and we cannot guarantee any such outcomes. Future events and actual results may differ materially from the results set forth in or implied in the forward-looking statements. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to, the following risks and uncertainties:
·
General economic and business conditions;
·
Exposure to market risks in our financial instruments;
·
Fluctuations in worldwide prices and demand for oil and natural gas;
·
Our ability to find, acquire and develop oil and natural gas properties;
·
Fluctuations in the levels of our oil and natural gas exploration and development activities;
·
Risks associated with oil and natural gas exploration and development activities;
·
Competition for raw materials and customers in the oil and natural gas industry;
·
Technological changes and developments in the oil and natural gas industry;
·
Legislative and regulatory uncertainties, including proposed changes to federal tax law and climate change legislation, regulation of hydraulic fracturing and potential environmental liabilities;
·
Our ability to continue as a going concern;
·
Our ability to secure financing under any commitments as well as additional capital to fund operations; and
·
Other factors discussed elsewhere in this Form 10-Q; in our other public filings and press releases; and discussions with Company management.
Our reserve estimates are determined through a subjective process and are subject to revision.
Should one or more of the risks or uncertainties described above or elsewhere in our Form 10-K for the year ended February 29, 2016 and in this Form 10-Q occur, or should any underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We specifically undertake no obligation to publicly update or revise any information contained in any forward-looking statement or any forward-looking statement in its entirety, whether as a result of new information, future events, or otherwise, except as required by law.
All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.
15
Introduction and Overview
We are an independent oil and natural gas exploration, development and production company. Our basic business model is to increase shareholder value by finding and developing oil and natural gas reserves through exploration and development activities, and selling the production from those reserves at a profit. To be successful, we must, over time, be able to find oil and natural gas reserves and then sell the resulting production at a price that is sufficient to cover our finding costs, operating expenses, administrative costs and interest expense, plus offer us a return on our capital investment. A secondary means of generating returns can include the sale of either producing or non-producing lease properties.
Our longer-term success depends on, among many other factors, the acquisition and drilling of commercial grade oil and natural gas properties and on the prevailing sales prices for oil and natural gas along with associated operating expenses. The volatile nature of the energy markets makes it difficult to estimate future prices of oil and natural gas; however, any prolonged period of depressed prices, such as we are now experiencing, would have a material adverse effect on our results of operations and financial condition.
Our operations are focused on identifying and evaluating prospective oil and natural gas properties and funding projects that we believe have the potential to produce oil or natural gas in commercial quantities. We conduct all of our drilling, exploration and production activities in the United States, and all of our revenues are derived from sales to customers within the United States. Currently, we are in the process of developing two multi-well oilfield projects; one in Lawrence County, Kentucky and the other in Kern County, California.
Our management cannot provide any assurances that Daybreak will ever operate profitably. We have not been able to generate sustained positive earnings on a Company-wide basis. As a small company, we are more susceptible to the numerous business, investment and industry risks that have been described in Item 1A. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended February 29, 2016 and in Part III, Item 1A. Risk Factors of this 10-Q Report. Throughout this Quarterly Report on Form 10-Q, oil is shown in barrels (Bbls); natural gas is shown in thousands of cubic feet (Mcf) unless otherwise specified, and hydrocarbon totals are expressed in barrels of oil equivalent (BOE).
Below is summary of our oil and natural gas projects in Kentucky and California.
Lawrence County, Kentucky (Twin Bottoms Field)
The Twin Bottoms Field, comprising approximately 7,220 acres in two large contiguous blocks, is located in the Appalachian Basin of eastern Kentucky. Log data from existing vertical natural gas wells in the field indicate the existence of proved oil reserves in the Berea sandstone, located at approximately 2,000 feet. Since October 2013, we have participated in the drilling of 14 horizontal oil wells in this project. The oil produced from our acreage in Kentucky is light sweet crude oil measuring between 42
°
and 44
°
API (American Petroleum Institute) gravity. During the six month ended August 31, 2016, we had production from 14 wells.
Our average working interest (WI) and net revenue interest (NRI) in these 14 wells is 22.6% and 19.7%, respectively. We are not the Operator of the Twin Bottoms Field project, but we rely on the experience of the current Operator and their knowledge of this Field. However, we have our own personnel onsite during critical operations such as drilling, fracturing and completing operations.
Kentucky Drilling Plans
Selected wells may be drilled from time to time to maintain production and leases, however; implementation of our full development plan will not resume until there is a sustained improvement in crude oil prices and additional financing is put in place.
We plan to spend approximately $0.5 million in new capital investments in the Twin Bottoms Field Project area in the 2016 - 2017 fiscal year if we are able to secure financing.
Kern County, California (East Slopes Project)
The East Slopes Project is located in the southeastern part of the San Joaquin Basin near Bakersfield, California. Drilling targets are porous and permeable sandstone reservoirs which exist at depths of 1,200 feet to 4,500 feet. Since January 2009, we have participated in the drilling of 25 wells in this project. The oil produced in our acreage from the Vedder Sand is considered heavy oil. The oil ranges from 14
°
to 16
°
API gravity and must be heated to separate and remove water prior to sale. During the six months ended August 31, 2016 we had production from 20 vertical oil wells. Our average WI and NRI in these 20 wells is 36.6% and 28.4%, respectively. We have been the Operator at the East Slopes Project since March 2009.
16
California Drilling Plans
Planned drilling activity and implementation of our oilfield development plan will not resume until there is a sustained improvement in crude oil prices and additional financing is in put in place. No capital investments are currently planned within the East Slopes Project area in the 2016 2017 fiscal year.
Encumbrances
The Companys debt obligations, pursuant to a loan agreement entered into by and between Maximilian Resources LLC, a Delaware limited liability company and successor by assignment to Maximilian Investors LLC (either party, as appropriate, is referred to Maximilian), as lender, and the Company are secured by a perfected first priority security interest in substantially all of the personal property of the Company, and a mortgage on our leases in Kern County, California encompassing the Sunday, Bear, Black, Ball and Dyer Creek properties. For further information on the loan agreement refer to the discussion under the caption Current Debt (Short-Term Borrowings) in this MD&A.
Results of Operations Six months ended August 31, 2016 compared to the six months ended August 31, 2015
Hydrocarbon Prices
The price we receive for oil sales in both Kentucky and California is based on prices quoted on the New York Mercantile Exchange (NYMEX) for spot West Texas Intermediate (WTI) Cushing, Oklahoma delivery contracts, less deductions that vary by grade of crude oil sold and transportation costs. The price we receive for natural gas sales in Kentucky per Mcf is based on the Columbia Gas Transmission Corp. Appalachia Index (TCO Appalachia) whereby we will receive either 76% or 79% (depending on buyer) of the TCO Appalachia price per dekatherm (DTH) less $0.25 compression cost for each Mcf of natural gas delivered. We do not have any natural gas revenues in California.
Since June 2014, there has been a significant decline in the WTI price of crude oil and subsequently in the realized price we receive from oil sales.
This decline in the price of crude oil has had a substantial negative impact on our cash flow from both our Kentucky and California properties as shown in the table below.
|
|
|
|
|
|
|
|
|
|
|
August 2016
|
|
June 2014
|
|
Percentage Decline
|
Monthly average WTI crude oil price
|
|
$
|
44.72
|
|
$
|
105.79
|
|
57.7%
|
Monthly average realized crude oil sales price (Bbl)
|
|
$
|
37.93
|
|
$
|
101.45
|
|
62.6%
|
Monthly crude oil revenue sales (Adjusted for June 2014 volume)
|
|
$
|
69,864
|
|
$
|
191,347
|
|
63.5%
|
Crude Oil and Natural Gas Revenue, Production and Prices in Aggregate
Our revenues are derived entirely from the sale of our share of crude oil production in Kentucky and California and natural gas sales in Kentucky. Crude oil and natural gas revenues for the six months ended August 31, 2016 in
aggregate decreased $373,765 or 46.1%, to $437,353 in comparison to revenues of $811,118 for the six months ended August 31, 2015. Crude oil and natural gas sales volume decreased 5,174 BOE (barrels of oil equivalent) or 27.8% to 13,463 (BOE) for the six months ended August 31, 2016, in comparison to 18,637 (BOE) for the six months ended August 31, 2015.
The decrease in volume was primarily due to the natural decline in oil producing reservoir pressure in Kentucky. The average WTI price for the six months ended August 31, 2016 was $43.86 in comparison to $52.57 for the six months ended August 31, 2015. Our average realized sale price on a BOE basis for the six months ended August 31, 2016 was $32.49 in comparison to $43.52 for the six months ended August 31, 2015, representing a decline of $11.04 or 25.4% per barrel. Approximately $205,682 or 55.0% of the decline in revenue can be directly attributed to the decline in hydrocarbon prices for the six months ended August 31, 2016.
Kentucky Oil Prices
For the six months ended August 31, 2016, our average realized oil sale price was $42.54 in comparison to the average WTI price of $43.86 representing a discount of $1.32 per barrel or 3.0% lower than the average WTI price. In comparison, for the six months ended August 31, 2015, the average WTI price was $52.57 and our average realized sale price was $51.36 representing a discount of $1.21 per barrel or 2.3% lower than the average WTI price.
17
Kentucky Crude Oil Revenue and Production
Crude oil revenue in Kentucky for the six months ended August 31, 2016 decreased $269,934 or 58.1% to $194,504 in comparison to revenue of $464,438 for the six months ended August 31, 2015. The average realized sale price of a barrel of oil for the six months ended August 31, 2016 was $42.54 in comparison to $51.36 for the six months ended August 31, 2015. The decrease of $8.82 or 17.2% in the average realized price of a barrel of oil accounted for $79,777 or 29.6% of the decline in oil revenue while a decrease of $190,157 or 70.4% can be attributed to a decline in production for the six months ended August 31, 2016 in comparison to the six months ended August 31, 2015.
Our net sales volume for the six months ended August 31, 2016 was 4,573 barrels of oil in comparison to 9,043 barrels sold for the six months ended August 31, 2015. This decrease in oil sales volume of 4,470 barrels or 49.4% was due to the natural decline in reservoir pressure.
The gravity of our produced oil in Kentucky ranges between 42° API and 44° API. Production for the six months ended August 31, 2016 was from 14 wells resulting in 2,017 well days of production in comparison to 2,188 well days of production from 13 wells for the six months ended August 31, 2015. The decline of 7.8% in well days of production was primarily due to field infrastructure work that was being done on the natural gas pipeline and associated equipment during the six months ended August 31, 2016. Our gross average daily oil production was 135 Bbls/Day (Barrels per Day) during the six months ended August 31, 2016.
Kentucky Natural Gas Prices
For the six months ended August 31, 2016, our average realized natural gas sale price was $1.09 per Mcf (thousand cubic feet) in comparison to the average Henry Hub price of $2.30 per million BTU representing a discount of $1.21 per Mcf or 52.6% lower than the average Henry Hub price. In comparison, for the six months ended August 31, 2015, the average realized sale price was $1.75 per Mcf in comparison to the average Henry Hub price of $2.78 per million BTU representing a discount of $1.03 or 37.0% lower than the average Henry Hub price.
Kentucky Natural Gas Revenue and Production
Natural gas revenue for the six months ended August 31, 2016 decreased $12,245 or 47.5% to $13,559 in comparison to revenue of $25,804 for the six months ended August 31, 2015. The average sale price per Mcf for the six months ended August 31 2016 was $1.09 in comparison to $1.75 for the six months ended August 31, 2015.
Our net sales volume for the six months ended August 31, 2016 was 12,441 Mcf or 2,074 BOE in comparison to 14,733 Mcf or 2,456 BOE for the six months ended August 31, 2015. The decline in natural gas production volume was due to the natural decline in reservoir pressure.
California Oil Prices
For the six months ended August 31, 2016, the average WTI price was $43.86 and our average realized oil sale price was $33.64, representing a discount of $10.22 per barrel or 23.3% lower than the average WTI price. In comparison, for the six months ended August 31, 2015, the average WTI price was $52.57 and our average realized sale price was $44.95 representing a discount of $7.62 per barrel or 7.6% lower than the average WTI price. Historically, the sale price we receive for California heavy oil has been less than the quoted WTI price because of the lower API gravity of our California oil in comparison to WTI oil API gravity.
California Crude Oil Revenue and Production
Crude oil revenue in California for the six months ended August 31, 2016 decreased $91,586 or 28.5% to $229,290 in comparison to revenue of $320,876 for the six months ended August 31, 2015. The average sale price of a barrel of crude oil for the six months ended August 31, 2016 was $33.64 in comparison to $44.95 for the six months ended August 31, 2015. The decrease of $11.31 or 25.2% in the average realized price of a barrel of oil accounted for $80,767 or 88.2% of the decline in oil revenue while a decrease of $10,818 or 11.8% can be attributed to a decline in production for the six months ended August 31, 2016.
Our net sales volume for the six months ended August 31, 2016 was 6,817 barrels of oil in comparison to 7,138 barrels sold for the six months ended August 31, 2015. This decrease in oil sales volume of 322 barrels or 4.5% was primarily due to the natural decline in reservoir pressure during the six months ended August 31, 2016.
18
The gravity of our produced oil in California ranges between 14° API and 16° API. Production for the six months ended August 31, 2016 was from 20 wells resulting in 3,656 well days of production in comparison to 3,662 well days of production from 20 wells for the six months ended August 31, 2015. Our gross average daily oil production was 127 Bbls/Day (Barrels per Day) during the six months ended August 31, 2016.
Crude oil and natural gas revenues for the six months ended August 31, 2016 and 2015 are set forth in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
August 31, 2016
|
|
Six Months Ended
August 31, 2015
|
Project
|
|
Revenue
|
|
Percentage
|
|
Revenue
|
|
Percentage
|
Kentucky - Twin Bottoms Field (Crude oil)
|
|
$
|
194,504
|
|
44.5%
|
|
$
|
464,438
|
|
57.3%
|
Kentucky Twin Bottoms Field (Natural gas)
|
|
|
13,559
|
|
3.1%
|
|
|
25,804
|
|
3.2%
|
California - East Slopes Project (Crude oil)
|
|
|
229,290
|
|
52.4%
|
|
|
320,876
|
|
39.5%
|
|
|
$
|
437,353
|
|
100.0%
|
|
$
|
811,118
|
|
100.0%
|
*Our average realized sale price on a BOE basis for the six months ended August 31, 2016 was $32.49 in comparison to $43.52 for the six months ended August 31, 2015, representing a decrease of $11.04 or 25.4% per barrel.
Of the $373,765 or 46.1% decline in revenue for six months ended August 31, 2016 in comparison to the six months ended August 31, 2015, approximately $205,682 or 55.0% can be directly attributed to the decline in the price of crude oil and natural gas.
Operating Expenses
Total
operating expenses for the six months ended August 31, 2016 were $796,898, a decrease of $161,007 or 16.8% compared to $957,905 for the six months ended August 31, 2015. Decreases were achieved in all categories of operating expenses for the six months ended August 31, 2016 in comparison to the six months ended August 31, 2015. Operating expenses for the six months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
August 31, 2016
|
|
Six Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
BOE
Basis
|
|
Expenses
|
|
Percentage
|
|
BOE
Basis
|
Production expenses
|
|
$
|
123,176
|
|
15.4%
|
|
|
|
|
$
|
145,606
|
|
15.2%
|
|
|
|
Exploration and drilling expenses
|
|
|
7,069
|
|
0.9%
|
|
|
|
|
|
20,067
|
|
2.1%
|
|
|
|
Depreciation, Depletion, Amortization (DD&A)
|
|
|
151,910
|
|
19.1%
|
|
|
|
|
|
257,729
|
|
26.9%
|
|
|
|
General and Administrative (G&A) expenses
|
|
|
514,743
|
|
64.6%
|
|
|
|
|
|
534,503
|
|
55.8%
|
|
|
|
Total operating expenses
|
|
$
|
796,898
|
|
100.0%
|
|
$
|
59.19
|
|
$
|
957,905
|
|
100.0%
|
|
$
|
51.40
|
Production expenses include expenses associated with the production of oil and natural gas. These expenses include contract pumpers, electricity, road maintenance, control of well insurance, property taxes and well workover expenses; and, relate directly to the number of wells that are in production. For the six months ended August 31, 2016, these expenses decreased by $22,430 or 15.4% to $123,176 in comparison to $145,606 for the six months ended August 31, 2015. For the six months ended August 31, 2016 we had 20 wells on production in California and 14 wells on production in Kentucky in comparison to 20 wells in California and 13 wells in Kentucky for the six months ended August 31, 2015. Production expenses represented 15.4% of total operating expenses.
Production expenses in Kentucky and California for the six months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
August 31, 2016
|
|
Six Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
Expenses
|
|
Percentage
|
Kentucky Twin Bottoms Field
|
|
$
|
43,116
|
|
35.0%
|
|
$
|
58,555
|
|
40.2%
|
California East Slopes Project
|
|
|
80,060
|
|
65.0%
|
|
|
87,051
|
|
59.8%
|
Total production expenses
|
|
$
|
123,176
|
|
100.0%
|
|
$
|
145,606
|
|
100.0%
|
19
Production expenses on a BOE basis in Kentucky and California for the six months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
August 31, 2016
|
|
August 31, 2015
|
Kentucky Twin Bottoms Field (BOE)
|
|
$
|
6.49
|
|
$
|
5.09
|
California East Slopes Project (BOE)
|
|
$
|
11.74
|
|
$
|
12.19
|
Aggregate production expenses (BOE)
|
|
$
|
9.15
|
|
$
|
7.81
|
Exploration and drilling expenses include geological and geophysical (G&G) expenses as well as leasehold maintenance and dry hole expenses. These expenses decreased $12,998 or 64.8% to $7,069 for the six months ended August 31, 2016 in comparison to $20,067 the six months ended August 31, 2015. Exploration and drilling expenses represented 0.9% of total operating expenses.
DD&A expenses relate to equipment, proven reserves and property costs, along with impairment and is another component of operating expenses. For the six months ended August 31, 2016, DD&A expenses decreased $105,819 or 41.1% to $151,910 in comparison to $257,729 for the six months ended August 31, 2015. The decrease in DD&A is directly related to the level of our hydrocarbon production in both Kentucky and California. DD&A expenses represented 19.1% of total operating expenses.
DD&A and impairment expenses in Kentucky and California for the six months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
August 31, 2016
|
|
Six Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
Expenses
|
|
Percentage
|
Kentucky Twin Bottoms Field
|
|
$
|
96,016
|
|
63.2%
|
|
$
|
174,725
|
|
67.8%
|
California East Slopes Project
|
|
|
55,894
|
|
36.8%
|
|
|
83,004
|
|
32.2%
|
Total DD&A expenses
|
|
$
|
151,910
|
|
100.0%
|
|
$
|
257,729
|
|
100.0%
|
DD&A and impairment expenses on a BOE basis in Kentucky and California for the six months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
August 31, 2016
|
|
August 31, 2015
|
Kentucky Twin Bottoms Field (BOE)
|
|
$
|
14.45
|
|
$
|
15.20
|
California East Slopes Project (BOE)
|
|
$
|
8.20
|
|
$
|
11.63
|
Aggregate DD&A expenses (BOE)
|
|
$
|
11.28
|
|
$
|
13.83
|
G&A expenses include the salaries of our six full-time employees, including management. Fifty percent of certain employees salaries are currently being deferred until the Companys cash flow improves, however the entire expense is currently being recognized in G&A. Other items included in our G&A expenses are legal and accounting expenses, director fees, stock compensation, investor relations fees, travel expenses, insurance, Sarbanes-Oxley (SOX) compliance expenses and other administrative expenses necessary for an operator of oil and natural gas properties as well as for running a public company. For the six months ended August 31, 2016, G&A expenses decreased $19,760 or 3.7% to $514,743 in comparison to $534,503 for the six months ended August 31, 2014. We received, as Operator in California, administrative overhead reimbursement of $26,644 during the six months ended August 31, 2016 for the East Slopes Project which was used to directly offset certain employee salaries. We are continuing a program of reducing all of our G&A costs wherever possible. G&A expenses represented 64.6% of total operating expenses.
Interest income for the six months ended August 31, 2016 increased $126,724 or 29.8% to $551,328 in comparison to $424,604 for the six months ended August 31, 2015 due to the loan modification terms of the note receivable from App Energy. Refer to the discussion of the App Loan Agreement under Capital Resources and Liquidity Cash Flow Provided by (Used in) Financing Activities, Current Debt (Short-Term Borrowings) in this MD&A.
Interest expense for the six months ended August 31, 2016 increased $969,246 or 72.8%
to $2,299,717 in comparison to $1,330,471 for the six months ended August 31, 2015. The increase in interest expense is directly related to the modified loan payment terms on our credit facility with Maximilian. Refer to
the discussion of the Maximilian Credit Facility Amended and Restated Loan Agreement under Capital Resources and Liquidity Cash Flow Provided by (Used in) Financing Activities, Current Debt (Short-Term Borrowings) in this MD&A.
20
Results of Operations Three months ended August 31, 2016 compared to the three months ended August 31, 2015
Crude Oil and Natural Gas Revenue, Production and Prices in Aggregate
Our revenues are derived entirely from the sale of our share of crude oil production in Kentucky and California and natural gas sales in Kentucky. Crude oil and natural gas revenues for the three months ended August 31, 2016 in aggregate decreased $145,957 or 39.5%, to $223,877 in comparison to revenues of $369,834 for the three months ended August 31, 2015. Crude oil and natural gas sales volume decreased 2,834 BOE (barrels of oil equivalent) or 32.7% to 5,846 (BOE) for the three months ended August 31, 2016, in comparison to 8,680 (BOE) for the three months ended August 31, 2015. The decrease in volume was primarily due to the natural decline in oil producing reservoir pressure in Kentucky. Our average realized sale price on a BOE basis for the three months ended August 31, 2016 was $38.29 in comparison to $42.61 for the three months ended August 31, 2015, representing a decline of $4.32 or 10.1% per barrel. Approximately $37,450 or 25.7% of the decline in revenue can be directly attributed to the decline in hydrocarbon prices for the three months ended August 31, 2016 in comparison to the three months ended August 31, 2015.
Kentucky Crude Oil Prices
For the three months ended August 31, 2016, our average realized crude oil sale price was $45.01 in comparison to the average WTI price of $46.04 representing a discount of $1.03 per barrel or 2.3% lower than the average WTI price. In comparison, for the three months ended August 31, 2015, the average WTI price was $51.28 and our average realized sale price was $50.78 representing a discount of $0.50 per barrel or 1.0% lower than the average WTI price.
Kentucky Crude Oil Revenue and Production
Crude Oil revenue in Kentucky for the three months ended August 31, 2016 decreased $105,263 or 53.7% to $90,791 in comparison to revenue of $196,054 for the three months ended August 31, 2015. The average sale price of a barrel of crude oil for the three months ended August 31, 2016 was $45.01 in comparison to $50.78 for the three months ended August 31, 2015. The decrease of $5.77 or 11.4% in the average realized price of a barrel of oil accounted for $22,290 or 21.2% of the decline in oil revenue while a decrease of $82,974 or 78.8% can be attributed to a decline in production for the three months ended August 31, 2016 in comparison to the three months ended August 31, 2015.
Our net sales volume for the three months ended August 31, 2016 was 2,017 barrels of crude oil in comparison to 3,861 barrels sold for the three months ended August 31, 2015. This decrease in oil sales volume of 1,844 barrels or 47.8% was due to the natural decline in reservoir pressure.
The gravity of our produced oil in Kentucky ranges between 42° API and 44° API. Production for the three months ended August 31, 2016 was from 14 wells resulting in 842 well days of production in comparison to 1,044 well days of production from 13 wells for the three months ended August 31, 2015. The decline of 19.3% in well days of production was primarily due to field infrastructure work that was being done on the natural gas pipeline and associated equipment during the three months ended August 31, 2016. Our gross average daily oil production was 123 Bbls/Day (Barrels per Day) during the three months ended August 31, 2016.
Kentucky Natural Gas Prices
For the three months ended August 31, 2016, our average realized natural gas sale price was $4.53 per Mcf (thousand cubic feet) in comparison to the average Henry Hub price of $2.74 per million BTU representing an increase of $1.79 per Mcf or 65.2% higher than the average Henry Hub price. The reason we received a premium to the Henry Hub price was due to an adjustment in production volume estimates from the prior quarter. In comparison, for the three months ended August 31, 2015, the average realized sale price was $1.63 per Mcf in comparison to the average Henry Hub price of $2.80 per million BTU representing a discount of $1.17 or 41.7% lower than the average Henry Hub price.
21
Kentucky Natural Gas Revenue and Production
Natural gas revenue for the three months ended August 31, 2016 decreased $2,582 or 22.4% to $8,942 in comparison to revenue of $11,524 for the three months ended August 31, 2015. The average sale price per Mcf for the three months ended August 31 2016 was $4.53 in comparison to $1.63 for the three months ended August 31, 2015. The reason for the increase in the realized price for the quarter was due to an adjustment in production volume estimates from the prior quarter.
Our net sales volume for the three months ended August 31, 2016 was 1,976 Mcf or 329 BOE in comparison to 7,059 Mcf or 1,177 BOE for the three months ended August 31, 2015. The decrease in natural gas production volume was due to an adjustment in production volume estimates from the prior quarter.
California Crude Oil Prices
For the three months ended August 31, 2016, the average WTI price was $46.04 and our average realized crude oil sale price was $35.47, representing a discount of $10.57 per barrel or 23.0% lower than the average WTI price. In comparison, for the three months ended August 31, 2015, the average WTI price was $51.28 and our average realized sale price was $44.55 representing a discount of $6.73 per barrel or 13.1% lower than the average WTI price. Historically, the sale price we receive for California heavy oil has been less than the quoted WTI price because of the lower API gravity of our California oil in comparison to WTI oil API gravity.
California Crude Oil Revenue and Production
Crude oil revenue in California for the three months ended August 31, 2016 decreased $38,110 or 23.5% to $124,145 in comparison to revenue of $162,255 for the three months ended August 31, 2015. The average sale price of a barrel of crude oil for the three months ended August 31, 2016 was $35.47 in comparison to $44.55 for the three months ended August 31, 2015. The decrease of $9.08 or 20.4% in the average realized price of a barrel of crude oil accounted for $33,047 or 86.7% of the decline in oil revenue while a decrease of $5,062 or 13.3% can be attributed to a decline in production for the three months ended August 31, 2016 in comparison to the three months ended August 31, 2015.
Our net sales volume for the three months ended August 31, 2016 was 3,500 barrels of crude oil in comparison to 3,642 barrels sold for the three months ended August 31, 2015. This decrease in oil sales volume of 142 barrels or 3.9% was primarily due to the natural decline in reservoir pressure during the three months ended August 31, 2016.
The gravity of our produced oil in California ranges between 14° API and 16° API. Production for the three months ended August 31, 2016 was from 20 wells resulting in 1,827 well days of production in comparison to 1,837 well days of production from 20 wells for the three months ended August 31, 2015. Our gross average daily oil production was 129 Bbls/Day (Barrels per Day) during the three months ended August 31, 2016.
Oil and natural gas revenues for the three months ended August 31, 2016 and August 31, 2015 are set forth in the following table.
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
August 31, 2016
|
|
Three Months Ended
August 31, 2015
|
Project
|
|
Revenue
|
|
Percentage
|
|
Revenue
|
|
Percentage
|
Kentucky - Twin Bottoms Field (Oil)
|
|
$
|
90,791
|
|
40.5%
|
|
$
|
196,054
|
|
53.0%
|
Kentucky Twin Bottoms Field (Natural Gas)
|
|
|
8,941
|
|
4.0%
|
|
|
11,525
|
|
3.1%
|
California - East Slopes Project (Oil)
|
|
|
124,145
|
|
55.5%
|
|
|
162,255
|
|
43.9%
|
|
|
$
|
223,877
|
|
100.0%
|
|
$
|
369,834
|
|
100.0%
|
*Our average realized sale price on a BOE basis for the three months ended August 31, 2016 was $38.29 in comparison to $42.61 for the three months ended August 31, 2015, representing a decrease of $4.31 or 10.1% per barrel.
Of the $145,957 or 39.5% decline in revenue for three months ended August 31, 2016 in comparison to the three months ended August 31, 2015, approximately $37,450 or 25.7% can be directly attributed to the decline in the price of crude oil and natural gas prices.
22
Operating Expenses
Total
operating expenses for the three months ended August 31, 2016 were $349,850, a decrease of $96,295 or 21.6% compared to $446,145 for the three months ended August 31, 2015. Decreases were achieved in all categories of operating expenses for the three months ended August 31, 2016 in comparison to the three months ended August 31, 2015. Operating expenses for the three months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
August 31, 2016
|
|
Three Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
BOE
Basis
|
|
Expenses
|
|
Percentage
|
|
BOE
Basis
|
Production expenses
|
|
$
|
59,117
|
|
16.9%
|
|
|
|
|
$
|
70,001
|
|
15.7%
|
|
|
|
Exploration and drilling expenses
|
|
|
126
|
|
-%
|
|
|
|
|
|
8,400
|
|
1.9%
|
|
|
|
Depreciation, Depletion, Amortization (DD&A)
|
|
|
62,634
|
|
17.9%
|
|
|
|
|
|
118,889
|
|
26.6%
|
|
|
|
General and Administrative (G&A) expenses
|
|
|
227,973
|
|
65.2%
|
|
|
|
|
|
248,855
|
|
55.8%
|
|
|
|
Total operating expenses
|
|
$
|
349,850
|
|
100.0%
|
|
$
|
59.84
|
|
$
|
446,145
|
|
100.0%
|
|
$
|
51.40
|
For the three months ended August 31, 2016, production expenses decreased by $10,884 or 15.5% to $59,117 in comparison to $70,001 for the three months ended August 31, 2015. For the three months ended August 31, 2016 we had 20 wells on production in California and 14 wells on production in Kentucky in comparison to 20 wells in California and 13 wells in Kentucky for the three months ended August 31, 2015. Production expenses represented 16.9% of total operating expenses for the three months ended August 31, 2016.
Production expenses in Kentucky and California for the three months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
August 31, 2016
|
|
Three Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
Expenses
|
|
Percentage
|
Kentucky Twin Bottoms Field
|
|
$
|
20,076
|
|
34.0%
|
|
$
|
28,847
|
|
41.2%
|
California East Slopes Project
|
|
|
39,041
|
|
66.0%
|
|
|
41,154
|
|
58.8%
|
Total production expenses
|
|
$
|
59,117
|
|
100.0%
|
|
$
|
70,001
|
|
100.0%
|
Production expenses on a BOE basis in Kentucky and California for the three months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
August 31, 2016
|
|
August 31, 2015
|
Kentucky Twin Bottoms Field (BOE)
|
|
$
|
8.56
|
|
$
|
5.73
|
California East Slopes Project (BOE)
|
|
$
|
11.16
|
|
$
|
11.30
|
Aggregate production expenses (BOE)
|
|
$
|
10.11
|
|
$
|
8.06
|
For the three months ended August 31, 2016, exploration and drilling expenses decreased $8,274 or 98.5% to $126 in comparison to $8,400 for the three months ended August 31, 2015. Exploration and drilling expenses represented -% of total operating expenses for the three months ended August 31, 2016.
For the three months ended August 31, 2016, DD&A expenses decreased $56,255 or 47.3% to $62,634 in comparison to $118,889 for the three months ended August 31, 2015. The decrease in DD&A is directly related to the lower hydrocarbon production volumes in both Kentucky and California. DD&A expenses represented 17.9% of total operating expenses for the three months ended August 31, 2016.
DD&A and impairment expenses in Kentucky and California for the three months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
August 31, 2016
|
|
Three Months Ended
August 31, 2015
|
|
|
Expenses
|
|
Percentage
|
|
Expenses
|
|
Percentage
|
Kentucky Twin Bottoms Field
|
|
$
|
33,966
|
|
54.2%
|
|
$
|
76,572
|
|
64.4%
|
California East Slopes Project
|
|
|
28,668
|
|
45.8%
|
|
|
42,317
|
|
35.6%
|
Total DD&A expenses
|
|
$
|
62,634
|
|
100.0%
|
|
$
|
118,889
|
|
100.0%
|
23
DD&A and impairment expenses on a BOE basis in Kentucky and California for the three months ended August 31, 2016 and August 31, 2015 are set forth in the table below:
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|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
August 31, 2016
|
|
August 31, 2015
|
Kentucky Twin Bottoms Field (BOE)
|
|
$
|
14.47
|
|
$
|
15.20
|
California East Slopes Project (BOE)
|
|
$
|
8.19
|
|
$
|
11.62
|
Aggregate DD&A expenses (BOE)
|
|
$
|
10.71
|
|
$
|
13.70
|
For the three months ended August 31, 2016, G&A expenses decreased $20,882 or 8.4% to $227,973 in comparison to $248,855 for the three months ended August 31, 2015. We received, as Operator in California, administrative overhead reimbursement of $13,322 during the three months ended August 31, 2016 for the East Slopes Project which was used to directly offset certain employee salaries. We are continuing a program of reducing all of our G&A costs wherever possible. G&A expenses represented 65.2% of total operating expenses
for the three months ended August 31, 2016.
Interest income for the three months ended August 31, 2016 increased $68,722 or 34.0% to $270,573 in comparison to $201,851 for the three months ended August 31, 2015 due to the loan modification of the note receivable from App Energy.
Interest expense for the three months ended August 31, 2016 increased $522,416 or 79.0% to $1,184,020 in comparison to $661,604 for the three months ended August 31, 2015. The increase in interest expense is
directly related to the modified loan payment terms on our credit facility with Maximilian.
The credit facility activity is discussed further in the discussion of the Maximilian Credit Facility Amended and Restated Loan Agreement under Capital Resources and Liquidity Cash Flow Provided by (Used in) Financing Activities, Current Debt (Short-Term Borrowings) in this MD&A.
Due to the nature of our business, we expect that revenues, as well as all categories of expenses, will continue to fluctuate substantially on a quarter-to-quarter and year-to-year basis. Revenues are dependent upon both hydrocarbon production levels and the price we receive for hydrocarbon sales. Since June of 2014, there has been a significant decline in the WTI price of crude oil and subsequently in the realized price we receive from oil sales. This decline in the price of crude oil has had a substantial negative impact on our cash flow from both our Kentucky and California properties. Production expenses will fluctuate according to the number and percentage ownership of producing wells that we own. Exploration and drilling expenses will be dependent upon the amount of capital that we have to invest in future development projects, as well as the success or failure of such projects. Likewise, the amount of DD&A expense will depend upon the factors cited above including the size of our proven reserves base and the market price of energy products. G&A expenses will also fluctuate based on our current requirements, but will generally tend to increase as we expand the business operations of the Company. An ongoing goal of the Company is to improve cash flow to cover the current level of G&A expenses and to fund our development drilling programs in California and Kentucky.
Capital Resources and Liquidity
Our primary financial resource is our proven oil and natural gas reserve base. Our ability to fund any future capital expenditure programs is dependent upon the prices we receive from oil sales, the success of our development drilling program in Kentucky, our exploration and development program in Kern County, California and the availability of capital resource financing. Since June 2014, there has been a significant decline in the WTI price of crude oil and consequently in the realized price we receive from oil sales. This decline in the price of crude oil has had a substantial negative impact on our cash flow from both our Kentucky and California properties.
In the current fiscal year we plan to spend approximately $500,000 in capital investments in Kentucky, dependent on the successful completion of refinancing our credit facility. However our actual expenditures may vary significantly from this estimate if our plans for exploration and development activities change during the year or if we are not able to obtain financing to fund these capital investments. Factors such as changes in operating margins and the availability of capital resources could increase or decrease our ultimate level of expenditures during the current fiscal year.
The Company has engaged an investment banking firm to assist in securing refinancing of its debt at more favorable terms and implement our development plans in California and Kentucky.
24
Changes in our capital resources at August 31, 2016 in comparison to February 29, 2016 are set forth in the table below:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
Percentage
|
|
August 31, 2016
|
|
February 29, 2016
|
|
(Decrease)
|
|
Change
|
Cash
|
$
|
23,974
|
|
$
|
6,995
|
|
$
|
16,979
|
|
242.7%
|
Current Assets
|
$
|
357,732
|
|
$
|
834,480
|
|
$
|
(476,748)
|
|
(57.1%)
|
Total Assets
|
$
|
9,306,778
|
|
$
|
8,960,004
|
|
$
|
346,774
|
|
3.9%
|
Current Liabilities
|
$
|
(20,720,979)
|
|
$
|
(18,270,014)
|
|
$
|
2,450,965
|
|
13.4%
|
Total Liabilities
|
$
|
(20,804,701)
|
|
$
|
(18,349,993)
|
|
$
|
2,454,708
|
|
13.4%
|
Working Capital Deficit
|
$
|
(20,363,247)
|
|
$
|
(17,435,534)
|
|
$
|
2,927,713
|
|
16.8%
|
Our working capital deficit increased $2,927,713 or 16.8% to $20,363,247 at August 31, 2016 in comparison to $17,435,534 at February 29, 2016. The increase in our working capital deficit was due to our operating loss of $359,545; the reclassification of the short-term portion of the App Energy note receivable to long-term, and the increase in interest and fees on the Maximilian loan due to our inability to make principal and interest payments since December 2015. Refer to the discussion below under Current Debt (Short-Term Borrowings) Maximilian Loan (Credit Facility) for more information on the loan payment modifications.
While we have ongoing positive cash flow from our oil and natural gas operations in Kentucky and California, we have not yet been able to generate sufficient cash flow to cover all of our G&A and interest expense requirements. We anticipate an increase in our cash flow from our Twin Bottoms Field in Lawrence County, Kentucky will occur when we are able to return to our planned drilling program that will result in an increase in the number of wells on production.
Our business is capital intensive. Our ability to grow is dependent upon favorably obtaining outside capital and generating cash flows from operating activities necessary to fund our investment activities. There is no assurance that we will be able to achieve profitability. Since our future operations will continue to be dependent on successful exploration and development activities and our ability to seek and secure capital from external sources, should we be unable to achieve sustainable profitability this could cause any equity investment in the Company to become worthless.
Major sources of funds in the past for us have included the debt or equity markets. While we have achieved positive cash flow from operations in Kentucky and California, we will have to rely on these capital markets to fund future operations and growth. Our business model is focused on acquiring exploration or development properties as well as existing production. Our ability to generate future revenues and operating cash flow will depend on successful exploration, and/or acquisition of oil and natural gas producing properties, and stabilized hydrocarbon prices, which may very likely require us to continue to raise equity or debt capital from outside sources or sales of all or part of our working interests in our properties.
Daybreak has ongoing capital commitments to develop certain leases pursuant to their underlying terms. Failure to meet such ongoing commitments may result in the loss of the right to participate in future drilling on certain leases or the loss of the lease itself. These ongoing capital commitments will cause us to seek additional forms of financing through various methods, including issuing debt securities, equity securities, bank debt, or combinations of these instruments which could result in dilution to existing security holders and increased debt and leverage. The current uncertainty in the credit and capital markets as well as the decline in oil prices may restrict our ability to obtain needed capital. No assurance can be given that we will be able to obtain funding under any loan commitments or any additional financing on favorable terms, if at all. Sales of all or part of our working interests in our properties may be another source of cash flow available to us.
The Companys financial statements for the six months ended August 31, 2016 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. Since entering the oil and gas exploration industry, we have mostly incurred quarterly net losses. As of August 31, 2016, we have an accumulated deficit of $34,518,849 and a working capital deficit of $20,363,247 which raises substantial doubt about our ability to continue as a going concern.
In the current fiscal year, we will continue to seek additional financing for our planned exploration and development activities in both Kentucky and California. The Company has engaged an investment banking firm to assist in securing refinancing of its debt under more favorable terms and implement its development plans in California and Kentucky. We plan to obtain financing through various methods, including issuing debt securities, equity securities, or bank debt, or combinations of these instruments, which could result in dilution to existing security holders and increased debt and leverage. No assurance can be given that we will be able to obtain funding under any loan commitments or any additional financing on favorable terms, if at all. Sales of all or part of our working interests in our properties may be another source of cash flow available to us.
25
Changes in Financial Condition
During the six months ended August 31, 2016, we received oil and natural gas sales revenue from 14 wells in Kentucky and 20 wells in California. Our commitment to improving corporate profitability remains unchanged. During the six months ended August 31, 2016, we had an operating loss of $359,545. We experienced a decline in revenues of 46.1% or $373,765 to $437,353 for the six months ended August 31, 2016 in comparison to revenues of $811,118 for the six months ended August 31, 2015. The decline in the realized sale price we received on a BOE basis was $11.04 to $32.49 in comparison to $43.52 for the six months ended August 31, 2015. Of the $373,765 decline in revenue $205,682 was related to the decline in price and $168,083 was related to the decline in sales volume.
Our balance sheet at August 31, 2016 reflects total assets of approximately $9.3 million in comparison to approximately $8.9 million at February 29, 2016. This increase of approximately $0.4 million is due to modifications of the App Energy loan from Daybreak.
At August 31, 2016, total liabilities were approximately $20.8 million in comparison to approximately $18.3 million at February 29, 2016. The increase in liabilities of approximately $2.5 million was due to increases in payables and our credit facility balance with Maximilian.
There was no change in our common stock issued and outstanding at August 31, 2016 in comparison to the 51,487,373 common shares issued and outstanding at February 29, 2016.
Cash Flows
Changes in the net funds provided by and (used in) our operating, investing and financing activities are set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
Six Months
Ended
August 31, 2016
|
|
Six Months
Ended
August 31, 2015
|
|
Increase
(Decrease)
|
|
Percentage
Change
|
Net cash provided by (used in) operating activities
|
$
|
28,499
|
|
$
|
(263,103)
|
|
|
291,602
|
|
110.8%
|
Net cash provided by investing activities
|
$
|
1,340
|
|
$
|
491,786
|
|
|
(490,446)
|
|
(99.7%)
|
Net cash used in financing activities
|
$
|
(12,860)
|
|
$
|
(602,963)
|
|
|
(590,103)
|
|
(97.9%)
|
Cash Flow Provided by (Used In) Operating Activities
Cash flow from operating activities is derived from the production of our oil and natural gas reserves and changes in the balances of non-cash accounts, receivables, payables or other non-energy property asset account balances. For the six months ended August 31, 2016, cash flow provided by operating activities was $28,499 in comparison to cash flow used in operating activities of $263,103 for the six months ended August 31, 2015. This increase in operating cash flow of $291,602 or 110.8% is directly related to a decline in our receivables balances; an increase in our payables balances; and, an increase in accrued interest offset by our net loss for the six months ended August 31, 2016. Non-cash account balances relating to DD&A; amortization of debt discount; deferred financing costs and debt modification fees were $1,198,394 in aggregate for the six months ended August 31, 2016. Variations in cash flow from operating activities may impact our level of exploration and development expenditures.
Cash Flow Provided by Investing Activities
Cash flow from investing activities is derived from changes in oil and gas property balances and our lending activities associated with the App Energy loan. Cash flow provided by investing activities for the six months ended August 31, 2016 was $1,340 a decline of $490,446 from the $491,786 provided by investing activities for the six months ended August 31, 2015.
This decline of $490,446 was due to a decline in drilling activity because of lower hydrocarbon prices and the inability of App Energy to make the principal and interest payments during the six months ended August 31, 2016. The credit facility and our lending activity to App Energy is discussed further under the caption Current Debt (Short-Term Borrowings) Maximilian Loan (Credit Facility) in this MD&A.
26
Cash Flow Used In Financing Activities
Cash flow from financing activities is derived from changes in long-term liability account balances or in equity account balances, excluding retained earnings. Cash flow used in our financing activities was $12,860 for the six months ended August 31, 2016 in comparison to cash flow used in our financing activities of $602,963 for the six months ended August 31, 2015. This decline of $590,103 in cash flow used was due to our inability to make principal and interest payments on our credit facility with Maximilian. The credit facility and our lending activity to App Energy is discussed further in the discussion of the Maximilian Credit Facility Amended and Restated Loan Agreement under Capital Resources and Liquidity Cash Flow Provided by (Used in) Financing Activities, Non-current Debt (Short-Term Borrowings) in this MD&A.
The following discussion is a summary of cash flows provided by, and used in, the Companys financing activities at August 31, 2016.
Current Debt (Short-Term Borrowings)
Related Party
During the years ended February 29, 2012 and February 28, 2013, the Companys President and Chief Executive Officer loaned the Company $250,100 in aggregate that was used for a variety of corporate purposes including an escrow requirement on a loan commitment; extension fees on third party loans; and, a reduction of principal on the Companys 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.
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 our President and Chief Executive Officer. At August 31, 2016, the Line of Credit had an outstanding balance of $830,947. Interest is payable monthly at a stated reference rate of 0.249% + 337.5 basis points and was $8,227 for the six months ended August 31, 2016. The reference rate is based on the 30 day LIBOR (London Interbank Offered Rate) and is subject to change from UBS.
12% Subordinated Notes
The Companys 12% Subordinated Notes (the Notes) were issued pursuant to a March 2010 private placement (of which $250,000 was issued to a related party) 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. The note principal of $565,000 is payable in full at the amended maturity of the Notes. 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 Companys common stock at a conversion rate equal to 75% of the average closing price of the Companys common stock over the 20 consecutive trading days preceding December 31, 2016.
12% Notes balances at August 31, 2016 and February 29, 2016 are set forth in the table below:
|
|
|
|
|
|
|
August 31, 2016
|
|
February 29, 2016
|
12% Subordinated Notes
|
$
|
315,000
|
|
$
|
315,000
|
12% Subordinated Notes, related party
|
|
250,000
|
|
|
250,000
|
|
$
|
565,000
|
|
$
|
565,000
|
In conjunction with the Notes private placement, a total of 1,190,000 common stock purchase warrants were issued at a rate of two warrants for every dollar raised through the private placement. The warrants have an exercise price of $0.14 and an amended expiration date of January 29, 2017. The 12% Note warrants that have been exercised are set forth in the table below.
|
|
|
|
|
|
|
Fiscal Period
|
|
Warrants
Exercised
|
|
Shares of
Common Stock
Issued
|
|
Number of
Accredited
Investors
|
Year ended February 28, 2014
|
|
100,000
|
|
100,000
|
|
1
|
Year ended February 28, 2015
|
|
50,000
|
|
50,000
|
|
1
|
Year ended February 29, 2016
|
|
-
|
|
-
|
|
-
|
Six months ended August 31, 2016
|
|
-
|
|
-
|
|
-
|
Totals
|
|
150,000
|
|
150,000
|
|
2
|
27
Maximilian Loan (Credit Facility)
On October 31, 2012, the Company entered into a loan agreement with Maximilian, which provided for a revolving credit facility of up to $20 million, maturing on October 31, 2016, with a minimum commitment of $2.5 million. The loan had annual interest of 18% and a monthly commitment fee of 0.5%. The Company also granted Maximilian a 10% working interest in its share of the oil and natural gas leases in Kern County, California. The relative fair value of this 10% working interest amounting to $515,638 was recognized as a debt discount and is being amortized over the term of the loan. Amortization expense was $55,912 for the six months ended August 31, 2016. Unamortized debt discount amounted to $16,039 at August 31, 2016.
In 2012, the Company also issued 2,435,517 warrants to third parties who assisted in the closing of the loan. The warrants have an exercise price of $0.044; contain a cashless exercise provision; have piggyback registration rights; and are exercisable for a period of five years expiring on October 31, 2017. The fair value of the warrants, as determined by the Black-Scholes option pricing model, was $98,084 and included the following assumptions: a risk free interest rate of 0.72%; stock price of $0.04, volatility of 153.44%; and a dividend yield of 0.0%. The fair value of the warrants was recognized as a financing cost and is being amortized as a part of deferred financing cost over the term of the loan. On March 10, 2014, one of the third parties exercised 2,118,900 warrants resulting in the issuance of 1,873,554 shares of our common stock. As of August 31, 2016, there were 316,617 of these warrants unexercised.
Maximilian Credit Facility - Amended and Restated Loan Agreement
In connection with the Companys acquisition of a working interest from App Energy, LLC (App) the Twin Bottoms Field in Lawrence County, Kentucky, the Company amended its loan agreement with Maximilian on August 28, 2013. The amended loan agreement provided for an increase in the revolving credit facility from $20 million to $90 million and a reduction in the annual interest rate from 18% to 12%. The monthly commitment fee of 0.5% per month on the outstanding principal balance remained unchanged. Advances under the amended loan agreement will mature on August 28, 2017. The obligations under the amended loan agreement continue to be secured by a perfected first priority security interest in substantially all of the personal property of the Company, and a mortgage on the Companys leases in Kern County, California. The amended loan agreement also provided for the revolving credit facility to be divided into two borrowing sublimits. The first borrowing sublimit is $50 million and is for borrowing by the Company, primarily for its ongoing oil and natural gas exploration and development activities. The second borrowing sublimit, of $40 million, is for loans to be extended by the Company, as lender, to App, as borrower pursuant to a Loan and Security Agreement entered into between the Company and App on August 28, 2013 (See Note 6 Note Receivable).
The amended loan agreement contains customary covenants for loan of such type, including among other things, covenants that restrict the Companys ability to make capital expenditures, incur indebtedness, incur liens and dispose of property. The amended loan agreement also contains various events of default, including failure to pay principal and interest when due, breach of covenants, materially incorrect representations and bankruptcy or insolvency. If an event of default occurs, all of the Companys obligations under the amended loan agreement could be accelerated by Maximilian, causing all loans outstanding (including accrued interest and fees payable thereunder) to be declared immediately due and payable.
As consideration for Maximilian facilitating the Companys transactions with App and entering into the amended loan agreement, the Company (a) issued to Maximilian approximately 6.1 million common shares, representing 9.99% of the Companys outstanding common stock on a fully-diluted basis at the time of grant, and (b) issued approximately 6.1 million warrants to purchase shares of the Companys common stock representing the right to purchase up to an additional 9.99% of the Companys outstanding common stock on a fully-diluted basis, calculated as of the date of grant. The warrants had an exercise price of $0.10; include a cash exercise provision; were exercisable for a period of three years expiring on August 28, 2016; and contain an exercise blocker provision that prevents any exercise of the warrants if such exercise and related issuance of common stock would increase the Maximilian holdings of the Companys common stock to more than 9.99% of the Companys currently issued and outstanding shares at the time of the exercise. The Company also granted to Maximilian a 50% net profits interest in the Companys 25% working interest, after the Company recovers its investment, in the Companys working interest in its Kentucky acreage, pursuant to an Assignment of Net Profits Interest entered into as of August 28, 2013 by and between the Company and Maximilian.
On May 28, 2014 at Maximilians request, the Company finalized a share-for-warrant exchange agreement in which Maximilian returned to the Company 427,729 common shares and was in turn issued the same number of warrants containing the same provisions as the originally issued warrants. This share-for-warrant exchange occurred so that Maximilian would hold no more than 9.99% of the Companys common shares issued and outstanding. The Company determined that the share-for-warrant exchange did not result in any incremental fair value.
28
On August 21, 2014, the Company entered into a First Amendment to Amended and Restated Loan and Security Agreement and Share Repurchase Agreement (the Amendment) with Maximilian under its Amended and Restated Loan and Security Agreement dated as of August 28, 2013. The Amendment secured for the Company an additional advance of $2,200,000 under its credit facility with Maximilian since the advances made by Maximilian had already exceeded its minimum funding commitment. Additionally, Maximilian agreed to temporarily decrease the required monthly payment made by the Company until it had paid $1,000,000 less than the principal payments required by the previous agreement. Furthermore, Maximilian agreed to reduce the regular interest rate applicable to the loan from 12% per annum to 9% per annum and the default interest rate by 3%.
The additional advance, the reduction in the required monthly payment and the reduction in the interest rate were facilitated through the companys acquisition of 5,694,823 shares of our common stock held by Maximilian. The repurchased shares were cancelled and restored to the status of authorized, but unissued stock. The Company paid for the share repurchase transaction through an advance of $1,708,447 under the existing loan agreement with Maximilian.
On May 20, 2015, the Company entered into a Second Amendment to Amended and Restated Loan and Security Agreement (the 2
nd
Amendment) with Maximilian under its Amended and Restated Loan and Security Agreement dated as of August 28, 2013. The 2
nd
Amendment modified the calculation of the required monthly payment for a three-month period ending June 30, 2015. As consideration for entering into the loan modification, the Company agreed to lower the exercise price of the warrants Maximilian currently holds from $0.10 to $0.04. No other terms of the warrant agreement were changed.
On October 14, 2015, the Company entered into a Third Amendment to the Amended and Restated Loan and Security Agreement and Second Warrant Amendment with Maximilian, which amended the Companys loan agreement with Maximilian (the Maximilian Amendment). Pursuant to the Maximilian Amendment, Maximilian agreed to a reduction in the Companys monthly payments under the loan agreement to $50,000 per month for a period of six months ending on February 29, 2016. The reduction in monthly payments allows for additional funds to be used by the Company in drilling and completing additional wells in Kentucky. As consideration for the reduction in the monthly payment amount, the Company agreed that twenty percent (20%) of the amount by which the monthly payment was reduced would be added to the loan balance, and the portion of the monthly payment savings that constitutes savings in interest or commitment fees would be treated as an additional advance of principal under the loan agreement (the Deemed Advances). The Company also agreed to grant to Maximilian an overriding royalty interest of one and one-half percent (1.5%) of its working interest in four wells in Kentucky. As part of the Maximilian Amendment, the Company also agreed to extend the expiration date of the warrants held by Maximilian to purchase up to 6,550,281 shares of common stock of the Company to August 28, 2018. The Company determined that the accounting of the loan modification was not substantial. Likewise the Company determined that the modification of the warrant term did not result in any accounting since these warrants were deemed to be investor warrants.
With the cooperation of Maximilian, the Company is currently working with an investment banking firm to assist in securing refinancing of its debt with Maximilian, since the long-term commitment needed to develop the Kentucky and California projects no longer fits the Maximilian business model. Due to a decline in crude oil and natural gas revenues, the Company has been unable to make the interest or principal payments required under the terms of the credit facility since December 2015. The unpaid monthly interest payments and associated fees have been added to the principal balance including the previously discussed 20% fee. A series of waivers have been granted by Maximilian for the principal and interest payments that have not been made. During the six months ended August 31, 2016, an additional $1,924,823 in interest and fees were added to the outstanding loan balance.
Due to the waivers granted by Maximilian for the six month period ended August 31, 2016, and for the months September and October 2016, the Company is currently not considered to be in default under terms of the credit facility. Maximilian is continuing to work with the Company in modifying the credit facility terms during this period of lower hydrocarbon prices, but there can be no assurance this cooperation will continue. Furthermore, there can be no assurances that Maximilian will not declare the Company to be in default under the terms of the credit facility. In accordance with the guidance found in ASC-470-10-45, the entire balance of the Maximilian loan is presented under the current liabilities section of the balance sheets. In accordance with the guidance found ASC 835-35 the net amount of the deferred finance costs are included with the debt discount as a reduction of the loan balance shown on the Balance Sheets as of August 31, 2016 and February 29, 2016, respectively.
The Maximilian loan balances at August 31, 2016 and February 29, 2016 are set forth in the table below:
|
|
|
|
|
|
|
August 31, 2016
|
|
February 29, 2016
|
Principal amount
|
$
|
16,305,954
|
|
$
|
14,381,131
|
Less unamortized discount and debt issuance costs
|
|
(442,067)
|
|
|
(713,026)
|
Net Maximilian loan balance
|
$
|
15,863,887
|
|
$
|
13,668,105
|
29
App Loan Agreement
In connection with amending and restating its loan agreement with Maximilian, on August 28, 2013 the Company extended to App Energy, LLC, a Kentucky limited liability company (App) a credit facility for the development of a shallow oil project in an existing natural gas field in Lawrence County, Kentucky pursuant to a Loan and Security Agreement between the Company as lender and App as borrower (the App Loan Agreement).
The App Loan Agreement provides for a revolving credit facility of up to $40 million, maturing on August 28, 2017, with a minimum commitment of $2.65 million (the Initial Advance). All funds advanced to App, as borrower, by Daybreak, as lender, are to be borrowed by Daybreak under its Amended Loan Agreement with Maximilian. The Initial Advance bears interest at a rate per annum equal to 16.8%, and subsequent loans under the Loan Agreement bear interest at a rate per annum equal to 12%. The App Loan Agreement also provides for a monthly commitment fee of 0.6% per month of the outstanding principal balance of the loans. The obligations under the App Loan Agreement are secured by a perfected first priority security interest in substantially all of the assets of App, including the App leases in Lawrence County, Kentucky.
The proceeds of the initial borrowing by App of $2.65 million under the App Loan Agreement were primarily used to (a) pay loan fees and closing costs, (b) repay indebtedness and (c) finance the drilling of three wells by App in the Twin Bottoms Field in Lawrence County, Kentucky in which the Company has a 25% working interest. Future advances under the facility would primarily be used for oil and natural gas exploration and development activities.
The App Loan Agreement contains customary covenants for loan of such type, including, among other things, covenants that restrict Apps ability to make capital expenditures, incur indebtedness, incur liens and dispose of property. The App Loan Agreement also contains various events of default, including failure to pay principal and interest when due, breach of covenants, materially incorrect representations and bankruptcy or insolvency. If an event of default occurs, all of Apps obligations under the App Loan Agreement could be accelerated by the Company, causing all loans outstanding (including accrued interest and fees payable thereunder) to be declared immediately due and payable.
In connection with the App Loan Agreement, App also granted to the Company the 25% working interest approximately 6,400 acres in two large contiguous blocks in the Twin Bottoms Field in Lawrence County, Kentucky and entered into a corresponding promissory note and a Mortgage, Leasehold Mortgage, Assignment of Production, Security Agreement and Financing Statement, both dated as of August 28, 2013. Apps manager, John A. Piedmonte, Jr., also entered into a limited Indemnity Agreement in connection with the loan. The loans under the App Loan Agreement are also guaranteed by certain of Apps affiliates.
On August 21, 2014, a First Amendment to the Loan and Security Agreement by and between the Company and App was executed whereby Section 1.5 (f) of the original Loan and Security Agreement was deleted and intentionally left blank. The affected section removed Apps ability to have the Required Monthly Payment be equal to zero for a maximum of three payments. All other terms of the original agreement remained unchanged.
On May 20, 2015, a Second Amendment to the Loan and Security Agreement by and between Daybreak and App was executed whereby the Required Monthly Payment definition was modified for the months of March, April, May and June of 2015. All other terms of the original agreement remained unchanged.
In connection with entering into the Third Amendment with Maximilian, the Company concurrently entered into a Third Amendment to Loan and Security Agreement with App (the App Amendment), which amended the Companys loan agreement with App in which the Company, as lender, lends to App, as borrower, a portion of the advances it receives pursuant to its loan agreement with Maximilian. The App Amendment provided for a reduction in interest rate and a reduction in monthly payments to be made by App to the Company for the same payment cycles as the reduced payment to be made by the Company under the Maximilian Amendment. The reduction in monthly payments by App would allow App to fund its share of drilling and completing additional wells in Kentucky with the Company. As consideration for the reduction in the monthly payment amount, App agreed that certain amounts would be treated as additional advances under the App Energy loan agreement, and that it would fund a portion of the Companys drilling and development expenses with respect to two wells. App also agreed to grant to Maximilian an overriding royalty interest on the same terms as the overriding royalty interest agreed to by the Company.
Due to a decline in crude oil and natural gas revenues, App has been unable to make the interest or principal payments required under the terms of the credit facility with the Company since November 2015. Unpaid monthly interest and fees have been added to the principal balance of the loan. A series of waivers have been granted by the Company to App for the principal and interest payments that App has been unable to make. During the six months ended August 31, 2016, an additional $538,794 in interest and fees has been added to the App outstanding loan balance.
30
Due to the waivers granted by the Company to App for the missed principal and interest payments, App is currently not considered to be in default under terms of the credit facility. The Company is continuing to work with App in modifying the credit facility terms during this period of lower hydrocarbon prices. As a consequence of Apps inability to make interest and principal payments to the Company, the entire balance of the App loan is presented as a non-current item on the balance sheet at August 31, 2016.
Note receivable balances at August 31, 2016 and February 29, 2016 are set forth in the table below:
|
|
|
|
|
|
|
August 31, 2016
|
|
February 29, 2016
|
Note receivable current
|
$
|
-
|
|
$
|
420,901
|
Note receivable non-current
|
|
5,194,307
|
|
|
4,234,612
|
|
$
|
5,194,307
|
|
$
|
4,655,513
|
Capital Commitments
Daybreak has ongoing capital commitments to develop certain leases pursuant to their underlying terms. Failure to meet such ongoing commitments may result in the loss of the right to participate in future drilling on certain leases or the loss of the lease itself. These ongoing capital commitments may also cause us to seek additional capital from sources outside of the Company. The current uncertainty in the credit and capital markets, and the current economic downturn in the energy sector, may restrict our ability to obtain needed capital.
Encumbrances
The Companys debt obligations, pursuant to the loan agreement entered into by and among Maximilian and the Company are secured by a perfected first priority security interest in substantially all of the personal property of the Company, and a mortgage on our leases in Kern County, California encompassing the Sunday, Bear, Black, Ball and Dyer Creek properties. For further information on the loan agreement with Maximilian refer to the discussion above under the caption Current Debt (Short-Term Borrowings) in this MD&A.
Restricted Stock and Restricted Stock Unit Plan
On April
6, 2009, the Board approved the Restricted Stock and Restricted Stock Unit Plan (the 2009 Plan) allowing the executive officers, directors, consultants and employees of Daybreak and its affiliates to be eligible to receive restricted common stock and restricted common stock unit awards. Subject to adjustment, the total number of shares of Daybreak common stock that will be available for the grant of awards under the 2009 Plan may not exceed 4,000,000 shares; provided, that, for purposes of this limitation, any stock subject to an award that is forfeited in accordance with the provisions of the 2009 Plan will again become available for issuance under the 2009 Plan. We believe that awards of this type further align the interests of our employees and our shareholders by providing significant incentives for these employees to achieve and maintain high levels of performance. Restricted stock and restricted stock units also enhance our ability to attract and retain the services of qualified individuals.
At August 31, 2016, a total of 3,000,000 shares of restricted stock had been awarded under the 2009 Plan, with 2,986,220 shares outstanding and fully vested. A total of 1,013,780 common stock shares remained available at August 31, 2016 for issuance pursuant to the 2009 Plan. A summary of the 2009 Plan issuances is set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
Grant
Date
|
|
Shares
Awarded
|
|
Vesting
Period
|
|
Shares
Vested
(1)
|
|
Shares
Returned
(2)
|
|
Shares
Outstanding
(Unvested)
|
4/7/2009
|
|
1,900,000
|
|
3 Years
|
|
1,900,000
|
|
-
|
|
-
|
7/16/2009
|
|
25,000
|
|
3 Years
|
|
25,000
|
|
-
|
|
-
|
7/16/2009
|
|
625,000
|
|
4 Years
|
|
619,130
|
|
5,870
|
|
-
|
7/22/2010
|
|
25,000
|
|
3 Years
|
|
25,000
|
|
-
|
|
-
|
7/22/2010
|
|
425,000
|
|
4 Years
|
|
417,090
|
|
7,910
|
|
-
|
|
|
3,000,000
|
|
|
|
2,986,220
(1)
|
|
13,780
(2)
|
|
-
|
(1)
Does not include shares that were withheld to satisfy such tax liability upon vesting of a restricted award by a Plan Participant, and subsequently returned to the 2009 Plan.
(2)
Reflects the number of common shares that were withheld pursuant to the settlement of the number of shares with a fair market value equal to such tax withholding liability, to satisfy such tax liability upon vesting of a restricted award by a Plan Participant.
31
For the six months ended August 31, 2016, the Company did not recognize any stock compensation expense related to the above restricted stock grants since all issuances have been fully amortized.
Management Plans to Continue as a Going Concern
The Company currently has a net revenue interest in 20 producing 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. The Companys average working interest in these wells is 36.6% with an average net revenue interest of 28.5%.
Additionally, Daybreak currently has a net revenue interest in 14 producing horizontal oil wells in the Twin Bottoms Field in Lawrence County, Kentucky, with associated natural gas production. Our average working interest in these 14 oil wells is 22.6% with an average net revenue interest of 19.7%.
We anticipate revenues will continue to increase as the Company participates in the drilling of more wells in the Twin Bottoms Field in Kentucky and the East Slopes Project in California. However given the current decline and instability in hydrocarbon prices, the timing of any drilling activity in Kentucky and California will be dependent on a sustained improvement in hydrocarbon prices and a successful refinancing or restructuring of our credit facility.
We believe that our liquidity will improve when there is a sustained improvement in hydrocarbon prices. Our sources of funds in the past have included the debt or equity markets and the sale of assets. While the Company does have positive cash flow from its 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, we cannot offer any assurance that we will be successful in executing the aforementioned plans to continue as a going concern.
Our financial statements as of August 31, 2016 do not include any adjustments that might result from the inability to implement or execute Daybreaks plans to improve our ability to continue as a going concern.
Critical Accounting Policies
Refer to Daybreaks Annual Report on Form 10-K for the fiscal year ended February 29, 2016.
Off-Balance Sheet Arrangements
As of August 31, 2016, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partners that have been, or are reasonably likely to have, a material effect on our financial position or results of operations.
32