ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is management’s
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 three months ended May 31, 2020 and in our Annual Report on Form 10-K for
the year ended February 28, 2019. 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 Management’s
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 expansion and growth of operations; and
|
|
·
|
Our future investments in and acquisitions of crude oil 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;
|
|
·
|
National and international pandemics such as the novel
coronavirus COVID-19 outbreak;
|
|
·
|
Exposure to market risks in our financial instruments;
|
|
·
|
Fluctuations in worldwide prices and demand for crude oil;
|
|
·
|
Our ability to find, acquire and develop crude oil properties;
|
|
·
|
Fluctuations in the levels of our crude oil exploration and development
activities;
|
|
·
|
Risks associated with crude oil exploration and development activities;
|
|
·
|
Competition for raw materials and customers in the crude oil industry;
|
|
·
|
Technological changes and developments in the crude oil 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 and in our other
public filings, press releases, and discussions with Company management.
|
Our reserve estimates are determined through
a subjective process and are subject to periodic revision.
In December 2019, the 2019 novel coronavirus
(“COVID-19") surfaced in Wuhan, China. The World Health Organization declared a global emergency on January 30, 2020,
with respect to the outbreak and several countries, including the United States, Japan and Australia have initiated travel restrictions
to and from China. The full economic impact of the outbreak is unknown and rapidly evolving. This widespread health crisis and
the governmental restrictions associated with it, have adversely affected demand for crude oil and natural gas, depressed crude
oil prices, and affected our ability to access capital. These factors, in turn, have had a negative impact on our operations, and
financial condition as evidenced by the unprecedented decline in crude oil prices and our revenues during this same time period.
Should one or more of the risks or uncertainties
described above or elsewhere in our Form 10-K for the year ended February 29, 2020 and in this Form 10-Q for the three months
ended May 31, 2020 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.
Introduction and Overview
We are an independent crude oil exploration,
development and production company. Our basic business model is to increase shareholder value by finding and developing crude oil
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 crude oil 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 crude oil properties and on the prevailing sales prices for crude
oil along with associated operating expenses. The volatile nature of the energy markets makes it difficult to estimate future prices
of crude oil; however, any prolonged period of depressed prices would have a material adverse effect on our results of operations
and financial condition.
Our operations are focused on identifying and
evaluating prospective crude oil properties and funding projects that we believe have the potential to produce crude oil 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 a multi-well oilfield
project in Kern County, California and an exploratory joint drilling project in Michigan.
Our management cannot provide any assurances
that Daybreak will ever operate profitably. While we have positive cash flow from our crude oil operations in California, we have
not yet generated sustainable positive cash flow or 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, 2020 and in Part III, Item 1A. Risk Factors of this 10-Q Report. Throughout
this Quarterly Report on Form 10-Q, crude 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 crude oil equivalent (“BOE”).
Below is brief summary of our crude oil projects
in California and Michigan. Refer to our discussion in Item 2. Properties, in our Annual Report on Form 10-K for the year ended
February 29, 2020 for more information on our multi-well oilfield project in California and our exploratory joint drilling project
in Michigan.
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 that
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.
We have been the Operator at the East Slopes Project since March 2009.
The crude oil produced from our acreage from
the Vedder Sand is considered heavy oil. The crude oil ranges from 14° to 16°
API (American Petroleum Institute) gravity and must be heated to separate and remove water prior to sale. Our crude oil wells in
the East Slopes Project produce from five reservoirs at our Sunday, Bear, Black, Ball and Dyer Creek locations. The Sunday property
has six producing wells, while the Bear property has nine producing wells. The Black property is the smallest of all currently
producing reservoirs, and currently has two producing wells at this property. The Ball property also has two producing wells while
the Dyer Creek property has one producing well. During the three months ended May 31, 2020, we had production from 20 vertical
crude oil wells. Our average working interest and net revenue interest (NRI) in these 20 wells is 36.6% and 28.4%,
respectively.
We plan on acquiring additional acreage exhibiting
the same seismic characteristics and on trend with the Bear, Black and Dyer Creek reservoirs. Some of these prospects, if successful,
would utilize the Company’s existing production facilities. In addition to the current field development, there are several
other exploratory prospects that have been identified from the seismic data, which we plan to drill in the future.
California Drilling Plans
Planned
drilling activity and implementation of our oilfield development plan will not begin until there is a sustained improvement in
crude oil prices and additional financing is in put in place. We do not plan to make any capital investments within the East Slopes
Project area in the 2020-2021 fiscal year if no new financing is in place. If new financing is secured, we plan to spend approximately
$525,000 drilling four development wells in the 2020-2021 fiscal year.
Michigan Acreage Acquisition
In January 2017, we acquired a 30% working
interest in 1,400 acres in the Michigan Basin. The leases have been secured and multiple targets were identified through a 2-D
seismic interpretation. A 3-D seismic survey was obtained in January and February of 2017 on the first prospect. An analysis of
the 3-D seismic survey confirmed the first prospect originally identified on the 2-D seismic, as well as several additional drilling
locations. We have plans to obtain an additional 3-D survey on the second prospect after drilling a well on the first prospect,
however the two prospects are independent of each other and the success or lack of results of either prospect does not affect the
potential of the other prospect. The wells will be drilled vertically with conventional completions and no hydraulic fracturing
is anticipated. With the settlement of our debt obligations to a former lender in December 2018, we acquired an additional 40%
working interest, bringing our aggregate working interest to 70% in Michigan. The first well is expected to be drilled when new
financing is secured.
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, 2020, we
had no encumbrances on our crude oil project in Michigan.
Results of Operations – Three Months
Ended May 31, 2020 compared to the Three Months Ended May 31, 2019
California Crude Oil Prices
The price we receive for crude oil sales in
California is based on prices posted for Midway-Sunset crude oil delivery contracts, less deductions that vary by grade of crude
oil sold and transportation costs. The posted Midway-Sunset price generally moves in correlation to, and at a discount to, prices
quoted on the New York Mercantile Exchange (NYMEX”) for spot West Texas intermediate (“WTI”) crude oil, Cushing,
Oklahoma delivery contracts. We do not have any natural gas revenues in California.
There continues to be a significant amount
of volatility in crude oil prices and a dramatic decline in our realized sale price of crude oil since June of 2014, when the monthly
average price of WTI crude oil was $105.79 per barrel and our realized sale price per barrel of crude oil was $98.78. This volatility
and decline in crude oil prices has continued as evidenced by the NYMEX daily closing price of WTI crude oil on April 20, 2020
when it closed at a negative $36.98; the April 2020 monthly average WTI price was $16.55; and our monthly realized price for April
2020 was $16.96 per barrel. This volatility and decline in the price of crude oil has had a substantial negative impact on our
cash flow from our producing California properties. While there has been some improvement in crude oil prices since April 2020,
there is no guarantee that this trend will continue.
It is beyond our ability to accurately predict
how long crude oil prices will continue to remain at these lower crude oil price levels; when or at what level they may begin to
stabilize; or if they may start to rebound, as there are many factors beyond our control such as the current COVID-19 restrictions
and the crude oil price dispute between Saudi Arabia and Russia, that dictate the price we receive on our crude oil sales.
A comparison of the average WTI price and the
average realized crude oil sales price for the three months ended May 31, 2020 and 2019 is shown in the table below:
|
|
Three Months Ended
|
|
|
|
|
|
May 31, 2020
|
|
May 31, 2019
|
|
Percentage Change
|
|
Average three month WTI crude oil price (Bbl)
|
|
$
|
24.77
|
|
$
|
60.95
|
|
|
(59.4
|
%)
|
Average three month realized crude oil sales price (Bbl)
|
|
$
|
24.29
|
|
$
|
64.91
|
|
|
(62.6
|
%)
|
For the three months ended May 31, 2020, the
average WTI price was $24.77 and our average realized crude oil sale price was $24.29, representing a discount of $0.48 per barrel
or 1.9% lower than the average WTI price. In comparison, for the three months ended May 31, 2019, the average WTI price was $60.95
and our average realized sale price was $64.91 representing a premium of $3.96 per barrel or 6.5% higher than the average WTI
price. Historically, the sale price we receive for California heavy crude oil has been less than the quoted WTI price because
of the lower API gravity of our California crude oil in comparison to the API gravity of quoted WTI crude oil.
California Crude Oil Revenue and Production
Crude oil revenue in California for the three
months ended May 31, 2020 decreased $127,159 or 64.8% to $69,199 in comparison to revenue of $196,358 for the three months ended
May 31, 2019. The average realized sale price of a barrel of crude oil for the three months ended May 31, 2020 was $24.29 in comparison
to $64.91 for the three months ended May 31, 2019. The 2019 novel coronavirus (“COVID-19") that has spread to countries
throughout the world including the United States has had a substantial negative impact on the demand for crude oil and is largely
responsible for the decline in crude oil prices.
Our net sales volume for the three months ended
May 31, 2020 was 2,849 barrels of crude oil in comparison to 3,025 barrels sold for the three months ended May 31, 2019. This decrease
in crude oil sales volume of 176 barrels or 5.8% accounted for 3.4% of the decrease in crude oil revenue for the three months ended
May 31, 2020, and was primarily due to the natural decline in reservoir pressure.
The gravity of our produced crude oil in California
ranges between 14° API and 16° API. Production for the three months ended May 31, 2020 was from 20 wells resulting in 1,838
well days of production in comparison to 1,803 well days of production for the three months ended May 31, 2019.
Our crude oil sales revenue for the three months
ended May 31, 2020 and 2019 is set forth in the following table:
|
|
Three Months Ended
May 31, 2020
|
|
|
Three Months Ended
May 31, 2019
|
|
Project
|
|
Revenue
|
|
|
Percentage
|
|
|
Revenue
|
|
|
Percentage
|
|
California – East Slopes Project
|
|
$
|
69,199
|
|
|
|
100.0
|
%
|
|
$
|
196,358
|
|
|
|
100.0
|
%
|
*Our average
realized sale price on a BOE basis for the three months ended May 31, 2020 was $24.29 in comparison to $64.91 for the three months
ended May 31, 2019, representing a decrease of $40.62 or 62.6% per barrel.
Operating Expenses
Our total operating expenses for the three
months ended May 31, 2020 were $205,723, a decrease of $100,126 or 32.7% compared to $305,849 for the three months ended May 31,
2019. Operating expenses for the three months ended May 31, 2020 and 2019 are set forth in the table below:
|
|
Three Months Ended
May 31, 2020
|
|
|
Three Months Ended
May 31, 2019
|
|
|
|
Expenses
|
|
|
Percentage
|
|
|
BOE
Basis
|
|
|
Expenses
|
|
|
Percentage
|
|
|
BOE
Basis
|
|
Production expenses
|
|
$
|
39,195
|
|
|
|
19.0
|
%
|
|
|
|
|
|
$
|
43,717
|
|
|
|
14.3
|
%
|
|
|
|
|
Exploration and drilling expenses
|
|
|
—
|
|
|
|
0.0
|
%
|
|
|
|
|
|
|
98
|
|
|
|
0.0
|
%
|
|
|
|
|
Depreciation, depletion, amortization (“DD&A”)
|
|
|
14,159
|
|
|
|
6.9
|
%
|
|
|
|
|
|
|
16,066
|
|
|
|
5.3
|
%
|
|
|
|
|
General and administrative (“G&A”) expenses
|
|
|
152,369
|
|
|
|
74.1
|
%
|
|
|
|
|
|
|
245,968
|
|
|
|
80.4
|
%
|
|
|
|
|
Total operating expenses
|
|
$
|
205,723
|
|
|
|
100.0
|
%
|
|
$
|
72.21
|
|
|
$
|
305,849
|
|
|
|
100.0
|
%
|
|
$
|
101.11
|
|
Production expenses include expenses associated
with the production of crude oil. These expenses include pumpers, electricity, road maintenance, control of well insurance, property
taxes and well workover costs; and, relate directly to the number of wells that are in production. For the three months ended May
31, 2020, these expenses decreased by $4,522 or 10.3% to $39,195 in comparison to $43,717 for the three months ended May 31, 2019.
For the three months ended May 31, 2020 and 2019, we had 20 wells on production in California. Production expense on a barrel of
oil equivalent (“BOE”) basis for the three months ended May 31, 2020 and 2019 were $13.76 and $14.45, respectively.
Production expenses represented 19.0% and 14.3% of total operating expenses for the three months ended May 31, 2020 and 2019, respectively.
Exploration and drilling expenses include geological
and geophysical (“G&G”) expenses as well as leasehold maintenance, plugging and abandonment (“P&A”)
expenses and dry hole expenses. For the three months ended May 31, 2020, these expenses were $-0- in comparison to $98 for the
three months ended May 31, 2019. Exploration and drilling expenses represented 0.0% of total operating expenses for the three months
ended May 31, 2020 and 2019, respectively.
Depreciation,
depletion and amortization (“DD&A”) expenses relate to equipment, proven reserves and property costs, along with
impairment, and is another component of operating expenses. For the three months ended May 31, 2020, DD&A expenses decreased
$1,907 or 11.9% to $14,159 in comparison to $16,066 for the three months ended May 31, 2019. On a BOE basis DD&A expense was
$4.97 and $5.31 for the three months ended May 31, 2020 and 2019, respectively. DD&A and impairment expenses represented 6.9%
and 5.3% of total operating expenses for the three months ended May 31, 2020 and 2019, respectively.
General and administrative (“G&A”)
expenses include the salaries of our six employees, including management. Other items included in our G&A expenses are legal
and accounting expenses, director fees, stock compensation, travel expenses, insurance, Sarbanes-Oxley (“SOX”) compliance
expenses and other administrative expenses necessary for an operator of crude oil properties as well as for running a public company.
For the three months ended May 31, 2020, these expenses decreased $93,599 or 38.1% to $152,369 in comparison to $245,968 for the
three months ended May 31, 2019. For the three months ended May 31, 2020, we received, as Operator, administrative overhead reimbursement
of $13,322 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 74.1%
and 80.4% of total operating expenses for the three months ended May 31, 2020 and 2019, respectively.
Interest expense, net for the three months
ended May 31, 2020 decreased $93,621 or 60.8% to $60,473 in comparison to $154,094 for the three months ended May 31, 2019.
In December 2019, the 2019 novel coronavirus
(“COVID-19") surfaced in Wuhan, China. The World Health Organization declared a global emergency on January 30, 2020,
with respect to the outbreak and several countries, including the United States, Japan and Australia have initiated travel restrictions
to and from China. The impacts of the outbreak are unknown and rapidly evolving. This widespread health crisis and the governmental
restrictions associated with it, have adversely affected demand for oil and gas, depressed crude oil prices, and affected our ability
to access capital. These factors, in turn, have had a negative impact our operations, and financial condition as evidenced by the
unprecedented decline in crude oil prices and our revenues during this same time period.
On March 27, 2020, President Trump signed into
law the Coronavirus Aid, Relief, and Economic Security Act commonly referred to as the CARES Act. One component of the CARES Act
was the paycheck protection program (“PPP”) which provides small business with the resources needed to maintain their
payroll and cover applicable overhead. The PPP is implemented by the Small Business Administration (“SBA”) with support
from the Department of the Treasury. The PPP provides funds to pay up to eight weeks of payroll costs including benefits. Funds
can also be used to pay interest on mortgages, rent, and utilities. The Company applied for, and was accepted to participate in
this program. On May 11, 2020, the Company received funding for approximately $74,355. The receipt of these funds is reflected
in the Company’s first quarter financial statements covering the three month period ended May 31, 2020.
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 highly dependent on the volatility of hydrocarbon prices and production volumes. Production expenses will fluctuate
according to the number and percentage ownership of producing wells as well as the amount of revenues we receive based on the price
of crude oil. 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 drilling
programs in California and Michigan.
Capital Resources and Liquidity
Our primary financial resource is our proven
crude oil reserve base. Our ability to fund any future capital expenditure programs is dependent upon the prices we receive from
crude oil sales, the success of our drilling programs in California and Michigan and the availability of capital resource financing.
There continues to be a significant amount of volatility in crude oil prices and dramatic decline in our realized sale price of
crude oil since June of 2014, when the monthly average price of WTI crude oil was $105.79 per barrel, and our realized sale price
per barrel of crude oil was $98.78. This volatility and decline in crude oil prices has continued as evidenced by the NYMEX daily
closing price of WTI crude oil on April 20, 2020 when it closed at a negative $36.98; the April 2020 monthly average WTI price
was $16.55; and our monthly realized price for April 2020 was $16.96 per barrel. This volatility and decline in the price of crude
oil has had a substantial negative impact on our cash flow from our producing California properties. While there has been some
improvement in crude oil prices since April 2020, there is no guarantee that this trend will continue. It is beyond our ability
to accurately predict how long crude oil prices will continue to remain at these lower price levels; when or at what level they
may begin to stabilize; or when they may start to rebound as there are many factors beyond our control that dictate the price we
receive on our crude oil sales.
In
the current fiscal year we plan to spend approximately $525,000 in capital investments in California and $300,000 in Michigan
if new financing is secured; 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.
Changes in our capital resources at May 31,
2020 in comparison with February 29, 2020 are set forth in the table below:
|
|
May 31, 2019
|
|
|
February 29, 2020
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
Cash
|
|
$
|
31,161
|
|
|
$
|
94,043
|
|
|
$
|
(62,882
|
)
|
|
|
(66.9
|
%)
|
Current assets
|
|
$
|
150,206
|
|
|
$
|
240,434
|
|
|
$
|
(90,228
|
)
|
|
|
(37.5
|
%)
|
Total assets
|
|
$
|
811,833
|
|
|
$
|
917,456
|
|
|
$
|
(105,623
|
)
|
|
|
(11.5
|
%)
|
Current liabilities
|
|
$
|
(4,121,273
|
)
|
|
$
|
(4,063,712
|
)
|
|
$
|
57,561
|
|
|
|
1.4
|
%
|
Total liabilities
|
|
$
|
(5,645,963
|
)
|
|
$
|
(5,556,063
|
)
|
|
$
|
89,900
|
|
|
|
1.6
|
%
|
Working capital
|
|
$
|
(3,971,067
|
)
|
|
$
|
(3,823,278
|
)
|
|
$
|
147,789
|
|
|
|
3.9
|
%
|
Our working capital deficit increased approximately
$147,789 or 3.9% to $4.0 million at May 31, 2020 in comparison to $3.8 million at February 29, 2020. The increase in our working
capital deficit was primarily due to a reduction in cash balances and the recognition of the Paycheck Protection Program (PPP)
loan that we received in the amount of $74,355. We anticipate an increase in our cash flow 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 and we anticipate that 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 crude
oil producing properties, which may very likely require us to continue to raise equity or debt capital from outside sources.
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 instability and volatility in crude oil prices since June
of 2014, has restricted our ability to obtain needed capital. The 2019 novel coronavirus (“COVID-19") that has spread
to countries throughout the world including the United States has had a substantial negative impact on the demand for crude oil
and is largely responsible for the decline in crude oil prices. 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 interests in our assets may be another
source of cash flow available to us.
The
Company’s financial statements for the three months ended May 31, 2020 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. We have incurred a
cumulative net loss since entering the crude oil exploration industry and as of three months ended May 31, 2020 have an accumulated
deficit of $29.1 million and a working capital deficit of $4.0 million 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 California and Michigan. We could obtain
financing through one or more 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 interests in our assets may be another source of cash flow.
Changes in Financial Condition
During the three months ended May 31, 2020,
we received crude oil sales revenue from 20 wells in our East slopes Project in Kern County, California. Our commitment to improving
corporate profitability remains unchanged. Since June 2014, there has been significant volatility and uncertainty in the WTI price
of crude oil and correspondently in the realized price we receive from oil sales. This volatility in the price of crude oil has
created a substantial negative impact on the cash flow of our producing crude oil properties in California. During the three months
ended May 31, 2020 and 2019, crude oil revenue from California was $69,199 and $196,358, respectively. Of the $127,159 decrease
in revenue during the three months ended May 31, 2020, $122,884 or 96.6% can be attributed to the decline in our realized crude
oil sales price and $4,275 or 3.4% of the decline can be attributed to our lower sales volume of 176 barrels. The 2019 novel coronavirus
(“COVID-19") that has spread to countries throughout the world including the United States has had a substantial negative
impact on the demand for crude oil and is largely responsible for the decline in crude oil prices. For the three months ended May
31, 2020 and 2019, we had an operating loss of $136,524 and $109,491, respectively.
Our balance sheet at May 31, 2020
reflects total assets of approximately $0.8 million in comparison to approximately $0.9 million at February 29, 2020. This
decrease is primarily due to a decrease in cash accounts receivable from crude oil sales resulting from lower average
realized prices, and a reduction in prepaid expenses.
At May 31, 2020, total liabilities were
approximately $5.65 million in comparison to approximately $5.56 million at February 29, 2020. The increase in liabilities
was due to recognition of the Paycheck Protection Program (PPP) loan that we received in the amount of $74,355 and in
estimates of the production revenue payable debt discount.
Common stock shares issued and outstanding
were 53,532,364 at May 31, 2020 and February 29, 2020, respectively.
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:
|
|
Three Months
Ended
May 31, 2020
|
|
|
Three Months
Ended
May 31, 2019
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
Net cash used in operating activities
|
|
$
|
(105,277
|
)
|
|
$
|
(31,266
|
)
|
|
|
74,011
|
|
|
|
236.7
|
%
|
Net cash provided by (used in) investing activities
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Net cash provided by financing activities
|
|
$
|
42,395
|
|
|
$
|
14,000
|
|
|
|
28,395
|
|
|
|
202.8
|
%
|
Cash Flow Used In Operating Activities
Cash flow from operating activities is derived
from the production of our crude oil reserves and changes in the balances of non-cash accounts, receivables, payables or other
non-energy property asset account balances. For the three months ended May 31, 2020, cash flow used in operating activities was
$105,277 in comparison to $31,266 used in operating activities for the three months ended May 31, 2019. This increase of $74,011
in our cash flow used in operating activities was due to a reduction in our net loss offset by decreases in both our accounts
receivable and accounts payable for the three months ended May 31, 2020 in comparison to the three months ended May 31, 2019.
Variations in cash flow from operating activities may impact our level of exploration and development expenditures.
Our expenditures in operating activities consist
primarily of exploration and drilling expenses, production expenses, geological, geophysical and engineering services and maintenance
of existing mineral leases. Our expenses also consist of consulting and professional services, employee compensation, legal, accounting,
travel and other G&A expenses that we have incurred in order to address normal and necessary business activities.
Cash Flow Provided By (Used In) Investing
Activities
Cash flow from investing activities is derived
from changes in oil and gas property balances and other investment activities. Cash flow used in investing activities for the three
months ended May 31, 2020 and 2019 was $-0-, respectively.
Cash Flow Provided By Financing Activities
Cash flow from financing activities is derived
from changes in long-term liability account balances, our borrowing activities or in equity account balances, excluding retained
earnings. Cash flow provided by financing activities for the three months ended May 31, 2020 was $42,395 in comparison to the $14,000
provided by financing activities in the three months ended May 31, 2019. For the three months ended May 31, 2020, we made payments
of $15,000 to our line of credit with UBS Bank.
The following discussion is a summary of cash
flows provided by or used in our financing activities at May 31, 2020.
Current debt (Short-term
borrowings)
Convertible Promissory Note
During the twelve months ended February 29,
2020, the Company’s Chairman, President and Chief Executive Officer loaned the Company $27,835 for general operating expenses
under a Convertible Note Purchase Agreement. The Note has a maturity date of 180 days, or July 12, 2020 and carries no interest,
fees or penalties. By the terms of the Convertible Note Purchase Agreement, Mr. Westmoreland had also agreed to loan up to
an additional $22,165 in funding for the Company, if and when agreed upon, but this additional amount was not ever loaned pursuant
to the Note. The Company may prepay the Note at any time. If the Note is not repaid in full on or before the maturity date
then, on the day following the maturity date, the Note will automatically convert into that number of conversion shares equal to
the quotient obtained by dividing (x) the outstanding principal balance of the Note on the date of such conversion by (y) a conversion
price of $0.004. The balance of the Note was $27,835 and $27,835 at May 31, 2020 and February 29, 2020, respectively.
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 was
extended for an additional two years to January 29, 2019. The 980,000 warrants held by 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 was payable in full at the amended maturity date of the Notes, and has not been paid. Interest continues to accrue
on the unpaid $565,000 principal balance. The terms of the Notes, state that should the Board of Directors, on any future 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. The accrued interest on the 12% Notes at May 31, 2020 and February 29, 2020 was $289,332
and $272,428, respectively. Amortization expense was $-0- at May 31, 2020 and 2019, respectively. There was no unamortized
debt discount remaining at February 29, 2020 and February 28, 2019.
12% Note balances at May 31, 2020 and February
29, 2020 are set forth in the table below:
|
|
May 31, 2020
|
|
|
February 29, 2020
|
|
12% Subordinated Notes
|
|
$
|
315,000
|
|
|
$
|
315,000
|
|
12% Subordinated Notes, related party
|
|
|
250,000
|
|
|
|
250,000
|
|
Total 12% Subordinated Note balance
|
|
$
|
565,000
|
|
|
$
|
565,000
|
|
The accrued interest owed on the 12% Subordinated
Note to the related party is presented on the Company’s Balance Sheets under the caption Accounts payable – related
party rather than under the caption Accrued interest.
Production Revenue Payable
Since
December 2018, we have been selling interests in certain portions of our 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.
On August 22, 2019, the Company entered into a Note Payoff Agreement with the Company’s Chairman, President and Chief
Executive Officer as payment in full of the $250,100 in previous loans made to the Company. The production revenue payment is
an interest in certain of the Company’s production revenue from the drilling of future wells in California and
Michigan. The production payment interest was granted for a deemed consideration amount of the balance of the Notes. The
grant was made on the same terms as the Company has sold production payment interests to other third parties in the 2018-2019
fiscal year pursuant to its previously disclosed program. As of May 31, 2020 and February 29, 2020, the production revenue
payment program balance was $950,100, respectively of which $550,100 and $550,100, respectively was owed to 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 (8%) of $1.3
million on its net production payments from the relevant wells to each of the purchasers. However, if the total raised is less
than the target $1.3 million, then the payment will be a proportionate amount of the eight percent (8%). Additionally, 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.
We 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 program balance of $950,100 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 $1,139,305 as of May 31, 2020, 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, 2020 and 2019, amortization of the debt discount on these payables amounted to $31,970
and $124,923, respectively, which has been included in interest expense in the statements of operations.
Production revenue payable balances at May
31, 2020 and February 29, 2020 are set forth in the table below:
|
|
May 31, 2020
|
|
|
February 29, 2020
|
|
Estimated payments of production revenue payable
|
|
$
|
2,089,405
|
|
|
$
|
2,054,766
|
|
Less: unamortized discount
|
|
|
(669,164
|
)
|
|
|
(666,495
|
)
|
|
|
|
1,420,241
|
|
|
|
1,388,271
|
|
Less: current portion
|
|
|
(43,660
|
)
|
|
|
(43,069
|
)
|
Net production revenue payable – long term
|
|
$
|
1,376,581
|
|
|
$
|
1,345,202
|
|
Paycheck Protection Program (PPP) Loan
On March 27, 2020, President Trump signed into
law the Coronavirus Aid, Relief, and Economic Security Act commonly referred to as the CARES Act. One component of the CARES Act
was the paycheck protection program (“PPP”) which provides small business with the resources needed to maintain their
payroll and cover applicable overhead. The PPP is implemented by the Small Business Administration (“SBA”) with support
from the Department of the Treasury. The PPP provides funds to pay up to eight weeks of payroll costs including benefits. Funds
can also be used to pay interest on mortgages, rent, and utilities. The Company applied for, and was accepted to participate in
this program. On May 11, 2020, the Company received funding for approximately $74,355.
The loan is a two-year loan with a maturity
date of May 5, 2022. The loan bears an annual interest rate of 1%. The loan shall be payable monthly with the first six monthly
payments deferred. It is the Company’s intent to apply for loan forgiveness under the provisions of Section 1106 of the CARES
Act. Loan forgiveness is subject to the sole approval of the SBA. The Company is eligible for loan forgiveness in an amount equal
to payments made during the 8-week period beginning on the Loan date, with the exception that no more than 25.0% of the amount
of loan forgiveness may be for expenses other than payroll expenses. The Company used all loan proceeds to partially subsidize
direct payroll expenses.
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 investments and guarantee of our President and Chief Executive Officer. On July
10, 2017 a $700,000 portion 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. On July 10, 2019, the 24-month fixed term loan amount of $700,000 was renewed at the same
annual percentage interest rate of 3.244% for an additional 24 months. The remaining principal balance of the line of credit has
a stated reference rate of 0.249% + 337.5 basis points with interest payable monthly. The reference rate is based on the 30 day
LIBOR (“London Interbank Offered Rate”) and is subject to change from UBS.
During the three months ended May 31, 2020
and 2019, we received advances on the line of credit of $-0- and $29,000, respectively. During the three months ended May 31, 2020
and 2019, we made payments to the line of credit of $15,000 and $15,000, respectively. Interest converted to principal for the
three months ended May 31, 2020 and 2019 was $7,389 and $7,787, respectively. At May 31, 2020 and February 29, 2020, the line of
credit had an outstanding balance of $864,790 and $872,401, respectively.
Note Payable
In December 2018, the Company was able to settle
an outstanding balance owed to one of its third-party vendors. This settlement resulted in a $120,000 note payable being 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 twelve months
ended February 29, 2020. The note has a maturity date of January 1, 2022 and bears an interest rate of 10% rate per annum. Monthly
interest is accrued and payable on January 1st of each anniversary date until maturity of the note. At May 31, 2020,
the note principle balance of $120,000 and the accrued interest had not been paid and were outstanding. The accrued interest on
the Note at May 31, 2020 and February 29, 2020 was $17,000 and $14,000, respectively.
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, 2020 we
had no encumbrances on our crude oil project in Michigan.
Operating Leases
We lease 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 lease for Friendswood does not include an option to renew. The Spokane Valley and Wallace leases are
currently on a month-to-month basis. Our lease agreements do not contain any residual value guarantees, restrictive covenants or
variable lease payments. We have not entered into any financing leases.
We determine 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 our 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 our leases do not provide an implicit rate, we use our 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 our 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 is as follows:
|
May 31, 2020
|
|
|
February 29, 2020
|
|
Assets
|
|
|
|
|
|
|
|
Operating lease right-of use assets, beginning balance
|
$
|
5,857
|
|
|
$
|
13,787
|
|
Current period amortization
|
|
(2,196
|
)
|
|
|
(7,930
|
)
|
Total operating lease right-of-use asset
|
|
3,661
|
|
|
|
5,857
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
Operating lease liability - current
|
|
3,661
|
|
|
|
5,857
|
|
Operating lease liability – long term
|
|
—
|
|
|
|
—
|
|
Total lease liabilities
|
$
|
3,661
|
|
|
$
|
5,857
|
|
Future minimum lease payments as of May 31,
2020 under non-cancellable operating leases are as follows:
Fiscal Year Ended
|
|
Annual Office
Lease Obligation
|
|
February 28, 2021
|
|
$
|
5,250
|
|
Total lease payments
|
|
|
5,250
|
|
Less: imputed interest
|
|
|
(1,589
|
)
|
Operating lease liability
|
|
|
3,661
|
|
Less: operating lease liability - current
|
|
|
(3,661
|
)
|
Operating lease liability, long-term
|
|
$
|
—
|
|
Rent expense for the three months ended May
31, 2020 and 2019 was $5,872 and $5,879, respectively.
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 economic downturn, may restrict our ability to obtain needed capital.
Management Plans to Continue as a Going
Concern
We continue to implement plans to enhance Daybreak’s
ability to continue as a going concern. The Company currently has a net revenue interest in 20 producing crude oil wells in our
East Slopes Project located in Kern County, California. The revenue from these wells has created a steady and reliable source of
revenue for the Company. Our average working interest in these wells is 36.6% and the average net revenue interest is 28.5%.
In December 2019, the 2019 novel coronavirus
(“COVID-19") surfaced in Wuhan, China. The World Health Organization declared a global emergency on January 30, 2020,
with respect to the outbreak and several countries, including the United States, Japan and Australia have initiated travel restrictions
to and from China. The impacts of the outbreak are unknown and rapidly evolving. This widespread health crisis and the governmental
restrictions associated with it, have adversely affected demand for crude oil, depressed crude oil prices, and affected our ability
to access capital. These factors, in turn, have had a negative impact on our operations, and financial condition as evidenced by
the unprecedented decline in crude oil prices and our revenues during this same time period.
On March 27, 2020, President Trump signed into
law the Coronavirus Aid, Relief, and Economic Security Act commonly referred to as the CARES Act. One component of the CARES Act
was the paycheck protection program (“PPP”) which provides small business with the resources needed to maintain their
payroll and cover applicable overhead. The PPP is implemented by the Small Business Administration (“SBA”) with support
from the Department of the Treasury. The PPP provides funds to pay up to eight weeks of payroll costs including benefits. Funds
can also be used to pay interest on mortgages, rent, and utilities. The Company applied for, and was accepted to participate in
this program. On May 11, 2020, the Company received funding for approximately $74,355. We plan on participating in any future plans
that become available to help businesses deal with the negative impact of this outbreak.
We anticipate revenues will continue to increase
as the Company participates in the drilling of more wells in the East Slopes Project in California and as our drilling operations
begin in Michigan. However given the current volatility and instability in hydrocarbon 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 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 crude oil 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 May 31, 2020
do not include any adjustments that might result from the inability to implement or execute Daybreak’s plans to improve our
ability to continue as a going concern.
Critical Accounting Policies
Refer to Daybreak’s Annual Report on
Form 10-K for the fiscal year ended February 29, 2020.
Off-Balance Sheet Arrangements
As of May 31, 2020, 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.