10QSB 1 dbog_10qsb-70831.htm FORM 10QSB FOR THE PERIOD ENDED AUGUST 31, 2007 dbog_10qsb-70831.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)

[X]
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended August 31, 2007

[   ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period ______ to _______

Commission file number 000-50107

DAYBREAK OIL AND GAS, INC.
(Name of small business issuer in its charter)

Washington
 
91-0626366
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

601 W. Main Ave., Suite 1012, Spokane, WA
99201
(Address of principal executive offices)
(Zip code)

Issuer’s telephone number, including area code:  (509) 232-7674

 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ    No ¨

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


At October 10, 2007, the registrant had 41,171,299 outstanding shares of $0.001 par value common stock.

 
Transitional Small Business Disclosure Format (Check One):     Yes ¨    No þ


 
TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
 
ITEM 1.
     
  Balance Sheets at August 31, 2007 (Unaudited) and February 28, 2007
     
  Statements of Operations for the Three Months and Six Months Ended August 31, 2007 and 2006 and from March 1, 2005 (Date of Inception of Exploration Stage) to August 31, 2007 – (Unaudited)
     
 
     
 
     
 
     
ITEM 2.
     
ITEM 3. Controls and Procedures
     
PART II – OTHER INFORMATION
     
ITEM 1.
     
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
     
ITEM 3. Defaults Upon Senior Securites
     
ITEM 4. Submission of Matters To a Vote of Security Holders
     
ITEM 5. Other Information
     
ITEM 6. Exhibits
     
Signatures 
 


PART I
FINANCIAL INFORMATION

 
(An Exploration Stage Company, Date of Inception March 1, 2005)
 
Balance Sheets – Unaudited
 
 
   
 
 
    ASSETS 
 
August 31,
2007
   
February 28,
2007
 
CURRENT ASSETS:
           
Cash  
  $
22,827
    $
377,957
 
Investment in marketable securities, at market, cost of $119,573 and$2,356,213 respectively
   
119,573
     
2,356,213
 
Accounts receivable
               
Oil and gas sales
   
277,367
     
56,906
 
Related party participants
   
26,750
     
41,357
 
Joint interest participants
   
533,652
     
799,970
 
Note receivable including accrued interest of $-0- and $28,336 respectively
   
-
     
828,336
 
Prepaid expenses and other current assets
   
16,411
     
76,895
 
 Total current assets
   
996,580
     
4,537,634
 
                  
OIL AND GAS PROPERTIES, net of accumulated depletion,  depreciation, amortization and impairment, successful efforts method
   
5,245,369
     
4,552,850
 
VEHICLES AND EQUIPMENT, net of accumulated depreciation
   
23,754
     
18,556
 
OTHER ASSETS  
   
397,969
     
102,426
 
 Total assets  
  $
6,663,672
    $
9,211,466
 
                 
LIABILITITES AND STOCKHOLDERS’ EQUITY
               
CURRENT LIABILITIES:
               
Account payable and other accrued liabilities
  $
1,179,657
    $
2,110,458
 
Notes Payable – related party
   
41,755
     
200,000
 
Convertible debentures, net of discount of $35,386 and $90,002 respectively
   
164,615
     
134,999
 
 Total current liabilities
   
1,386,027
     
2,445,457
 
OTHER LIABILITIES:
               
Asset retirement obligation
   
104,280
     
99,427
 
 Total liabilities
   
1,490,307
     
2,544,884
 
COMMITMENTS
               
STOCKHOLDERS’ EQUITY:
               
Preferred stock – 10,000,000 shares authorized, $0.001 par value;
   
-
     
-
 
Series A Convertible Preferred stock – 2,400,000 shares authorized;$0.001 par value; 6% cumulative dividends, authorized; 1,317,465 and 1,399,765 shares issued and outstanding, respectively
   
1,318
     
1,400
 
Common stock – 200,000,000 shares authorized, $0.001 par value; 41,171,299 and 40,877,230 shares issued and outstanding, respectively
   
41,171
     
40,877
 
Additional paid-in capital
   
20,291,963
     
20,224,411
 
Accumulated deficit
    (736,035 )     (736,035 )
Deficit accumulated during the exploration stage
    (14,425,052 )     (12,864,071 )
Total stockholders’ equity
   
5,173,365
     
6,666,582
 
Total liabilities and stockholders’ equity
  $
6,663,672
    $
9,211,466
 
 
The accompanying notes are an integral part of these financial statements.
3


 
(An Exploration Stage Company, Date of Inception March 1, 2005)
   
 
 
Statements of Operations - Unaudited
 
 
   
 
   
 
   
 
   
From Inception
 
                               
March 1, 2005
 
       
Three Months Ended
   
Six Months Ended
   
Through
 
       
August 31,
   
August 31,
   
August 31,
 
       
2007
   
2006
   
2007
   
2006
   
2007
 
REVENUE:
                             
Oil and gas sales
  $
294,845
    $
270,099
    $
519,739
    $
270,099
    $
1,149,233
 
                                         
OPERATING EXPENSES:
                                       
Production costs
   
96,747
     
31,934
     
206,595
     
31,934
     
580,358
 
Exploration expenses
   
378,186
     
40,404
     
533,396
     
40,404
     
2,057,506
 
Depreciation, depletion, amortization and impairment expense
   
213,283
     
747
     
373,527
     
747
     
2,777,544
 
General and administrative
   
502,733
     
803,130
     
892,835
     
2,950,749
     
8,732,573
 
Total operating expenses
   
1,190,949
     
876,215
     
2,006,353
     
3,023,834
     
14,147,981
 
                                         
LOSS FROM OPERATIONS
    (896,104 )     (606,116 )     (1,486,614 )     (2,753,735 )     (12,998,748 )
                                         
OTHER INCOME(EXPENSE):
                                       
Interest income
   
1,925
     
5,590
     
34,493
     
5,590
     
136,552
 
Dividend income
   
1,945
     
-
     
2,819
     
-
     
8,216
 
Miscellaneous income
   
950
     
-
     
1,100
     
-
     
1,100
 
Interest expense
    (52,039 )     (363,345 )     (112,780 )     (676,573 )     (1,572,172 )
Total other income (expense)
    (47,219 )     (357,755 )     (74,368 )     (670,983 )     (1,426,304 )
NET LOSS 
  $ (943,323 )   $ (963,871 )   $ (1,560,982 )   $ (3,424,718 )   $ (14,425,052 )
                                         
Cumulative convertible preferred stock dividend requirement
    (67,687 )    
-
      (123,065 )    
-
      (278,381 )
Deemed dividend – Beneficial conversion feature
   
-
      (4,199,295 )    
-
      (4,199,295 )     (4,199,295 )
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS
  $ (1,011,010 )   $ (5,163,166 )   $ (1,684,047 )   $ (7,624,013 )   $ (18,902,728 )
                                             
NET LOSS PER COMMON SHARE
  $ (0.02 )   $ (0.13 )   $ (0.04 )   $ (0.22 )        
                                         
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
   
41,073,017
     
38,665,308
     
41,305,001
     
34,988,496
         
 
The accompanying notes are an integral part of these financial statements.
4

 
(An Exploration Stage Company, Date of Inception March 1, 2005)
Statement of Changes in Stockholders' Equity - Unaudited
For the years ended February 28, 2007 and 2006
                               
     
Series A Convertible
                           
Deficit Accumulated
       
     
Preferred Stock
   
Common Stock
   
Additional
         
During
       
                             
Paid-In
   
Accumulated
   
Exploration
       
     
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
Stage
   
Total
 
                                                   
BALANCE, March 1, 2005 (Date of inception of exploration stage)
   
-
    $
-
     
18,199,419
    $
18,199
    $
709,997
    $ (736,035 )   $
-
    $ (7,839 )
                                                                   
Issuance of common stock for:
                                                           
-
 
 Cash
   
-
     
-
     
4,400,000
     
4,400
     
1,083,100
     
-
     
-
     
1,087,500
 
 Services
   
-
     
-
     
5,352,667
     
5,353
     
3,622,176
     
-
     
-
     
3,627,529
 
 Oil and gas properties
   
-
     
-
     
700,000
     
700
     
411,300
     
-
     
-
     
412,000
 
 Conversion of convertible debentures and interest payable
   
-
     
-
     
806,135
     
806
     
200,728
     
-
     
-
     
201,534
 
 Discount on convertible notes payable
   
-
     
-
     
-
     
-
     
1,240,213
     
-
     
-
     
1,240,213
 
                                                                 
 Net loss
   
-
     
-
     
-
     
-
     
-
     
-
      (4,472,041 )     (4,472,041 )
                                                                   
BALANCE, FEBRUARY 28, 2006
   
-
    $
-
     
29,458,221
    $
29,458
    $
7,267,514
    $ (736,035 )   $ (4,472,041 )   $
2,088,896
 
                                                                   
                                                                 
Issuance of common stock for:
                                                               
Cash
   
-
     
-
     
8,027,206
     
8,027
     
5,180,230
     
-
     
-
     
5,188,257
 
Services
   
-
     
-
     
1,270,000
     
1,270
     
2,606,430
     
-
     
-
     
2,607,700
 
Oil and gas properties
   
-
     
-
     
72,500
     
73
     
378,678
     
-
     
-
     
378,750
 
Conversion of convertible debentures
   
-
     
-
     
2,049,303
     
2,049
     
1,022,473
     
-
     
-
     
1,024,522
 
                                                                   
Issuance of preferred stock for:
                                                               
Cash
   
1,399,765
     
1,400
     
-
     
-
     
3,624,804
     
-
     
-
     
3,626,204
 
Discount on convertible notes payable
   
-
     
-
     
-
     
-
     
25,000
     
-
     
-
     
25,000
 
Deferred financing costs
   
-
     
-
     
-
     
-
     
119,283
     
-
     
-
     
119,283
 
Discount on preferred stock
   
-
     
-
     
-
     
-
     
4,199,295
     
-
     
-
     
4,199,295
 
Deemed dividend on preferred stock
   
-
     
-
     
-
     
-
      (4,199,295 )    
-
     
-
      (4,199,295 )
                                                                 
Net loss
   
-
     
-
     
-
     
-
     
-
     
-
      (8,392,030 )     (8,392,030 )
                                                                 
BALANCE, FEBRUARY 28, 2007
   
1,399,765
    $
1,400
     
40,877,230
    $
40,877
    $
20,224,411
    $ (736,035 )   $ (12,864,071 )   $
6,666,582
 
 
The accompanying notes are an integral part of these financial statements.
5

 
Issuance of common stock for:
                                                               
Conversion of preferred stock
    (52,000 )     (52 )    
156,000
     
156
      (104 )     -       -       -  
Conversion of convertible debentures
                   
37,169
     
37
     
27,841
      -       -      
27,878
 
                                                                 
Net loss
    -       -       -       -       -       -       (617,660 )     (617,660 )
                                                                 
BALANCE, MAY 31, 2007
   
1,347,765
    $
1,348
     
41,070,399
    $
41,070
    $
20,252,148
    $ (736,035 )   $ (13,481,731 )   $
6,076,800
 
                                                                 
Issuance of common stock for:
                                                               
Services
    -       -      
10,000
     
10
     
4,490
      -       -      
4,500
 
Conversion of preferred stock
    (30,300 )     (30 )    
90,900
     
91
      (61 )     -       -      
-
 
Deferred financing costs
    -       -       -       -      
35,386
      -       -      
35,386
 
                                                                 
Net loss
    -       -       -       -       -       -       (943,323 )     (943,323 )
                                                                 
BALANCE, AUGUST 31, 2007
   
1,317,465
    $
1,318
     
41,171,299
    $
41,171
    $
20,291,963
    $ (736,035 )   $ (14,425,052 )   $
5,173,365
 
                                                                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these financial statements.
6

 
                 
(An Exploration Stage Company, Date of Inception March 1, 2005)
             
Statements of Cash Flows - Unaudited
 
 
 
   
Six Months Ended August 31,
   
Six Months Ended August 31,
   
From Inception
 March 1, 2005 Through August 31,
 
   
2007
   
2006
   
2007
 
 CASH FLOWS FROM OPERATING ACTIVITIES
                 
Net Loss
  $ (1,560,982 )   $ (3,424,718 )   $ (14,425,052 )
Adjustments to reconcile net loss to net cash
                       
used in operating activities:
                       
Common stock issued for services
   
4,500
     
2,347,700
     
6,239,729
 
Depreciation, depletion, amortization and impairment expense
   
373,526
     
747
     
2,766,721
 
Exploration expense – dry well
   
33,233
     
-
     
849,753
 
Non cash interest expense and accretion
   
102,770
     
676,575
     
1,412,801
 
Accrued interest and dividend income
    (19,052 )    
-
      (47,637 )
 Changes in assets and liabilities:
                       
Restricted cash
   
-
     
8,333
     
-
 
Accounts receivable – oil and gas sales
    (220,462 )     (270,100 )     (277,368 )
Accounts receivable – related party participants
   
14,607
     
-
      (36,104 )
Accounts receivable – joint interest participants
   
266,318
     
-
      (524,298 )
Prepaid expenses and other assets
   
60,484
      (140 )     (93,147 )
Deferred financing costs
   
-
     
10,000
     
-
 
Accounts payable, other accrued liabilities and other
    (894,023 )    
51,367
     
1,293,886
 
Net cash used in operating activities
    (1,839,079 )     (600,236 )     (2,840,716 )
                         
                         
 CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Sale of (investment in) marketable securities
   
2,236,640
     
-
      (119,573 )
Purchase of reclamation bond
    (250,000 )    
-
      (275,000 )
Refund (deposit) on equipment
   
-
     
250,000
     
-
 
Additions to note receivable
   
-
      (300,000 )    
-
 
Purchase of oil and gas properties
    (1,090,693 )     (2,316,759 )     (7,969,549 )
Purchase of fixed assets
    (8,930 )     (22,417 )     (31,841 )
Proceeds from note receivable
   
800,000
     
-
     
-
 
Other Assets
    (44,823 )    
-
     
-
 
Net cash used in investing activities
   
1,642,194
      (2,389,176 )     (8,395,963 )
                         
 CASH FLOWS FROM FINANCING ACTIVITIES:
                       
Proceeds from sales of preferred stock, net
   
-
     
3,638,700
     
3,626,204
 
Proceeds from sales of common  stock, net
   
-
     
5,188,258
     
6,275,757
 
Proceeds from related party notes payable
   
-
     
200,000
     
200,000
 
Proceeds from (payments of) borrowings
    (158,245 )    
25,000
     
1,202,276
 
Net cash provided by financing activities
    (158,245 )    
9,051,958
     
11,304,237
 
                         
 NET INCREASE IN CASH AND EQUIVALENTS
  $ (355,130 )   $
6,062,546
    $
22,735
 
 
The accompanying notes are an integral part of these financial statements.
7

 
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
   
377,957
     
806,027
     
92
 
                         
CASH AT END OF PERIOD
  $
22,827
    $
6,868,572
    $
22,827
 
                         
                         
CASH PAID FOR:
                       
Interest
  $
10,010
    $
13,769
    $
28,779
 
Income taxes
   
-
     
-
     
-
 
                         
SUPPLEMENTAL CASH FLOW INFORMATION:
                       
Common stock issued for services
  $
4,500
    $
2,347,700
    $
6,239,729
 
Common stock issued for oil and gas properties
   
-
     
193,500
     
940,750
 
Common stock repurchased and cancelled
    -       -       (150,000 )
Common stock issued on conversion of convertible debentures
   
27,878
     
-
     
1,253,933
 
Discount on convertible notes payable
   
35,386
     
-
     
1,300,599
 
Extension warrants on convertible notes payable
   
-
     
-
     
119,283
 
Conversion of preferred stock to common stock
   
165
     
-
     
165
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
The accompanying notes are an integral part of these financial statements.
8

 
 
NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION:

Organization

Originally incorporated as Daybreak Uranium, Inc., (“Daybreak”), under the laws of the State of Washington on March 11, 1955, Daybreak was organized to explore for, acquire, and develop mineral properties in the Western United States.  On March 1, 2005, Daybreak commenced oil and gas operations as an exploration stage company. On October 25, 2005, the shareholders approved a name change to Daybreak Oil and Gas, Inc.

Basis of Presentation

The accompanying unaudited financial statements for Daybreak have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-QSB for quarterly reports under Section 13 or 15 (d) of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and such adjustments are of a normal recurring nature. Operating results for the three months and six months ended August 31, 2007 are not necessarily indicative of the results that may be expected for the year ending February 28, 2008. The audited financial statements at February 28, 2007, which are included in Daybreak’s Annual Report on Form 10-KSB for the year ended February 28, 2007, should be read in conjunction with these financial statements.

Recently Issued Accounting Pronouncements

In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115 (SFAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value (the Fair Value Option). Election of the Fair Value Option is made on an instrument-by-instrument basis and is irrevocable. At the adoption date, unrealized gains and losses on financial assets and liabilities for which the Fair Value Option has been elected would be reported as a cumulative adjustment to beginning retained earnings. If Daybreak elects the Fair Value Option for certain financial assets and liabilities, it will report unrealized gains and losses due to changes in fair value in earnings at each subsequent reporting date. The provisions of SFAS 159 are effective March 1, 2008 for Daybreak. Daybreak is currently assessing the impact, if any, that the adoption of this pronouncement will have on its operating results, financial position or cash flows.

In September 2006, the FASB issued SFAS 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This pronouncement applies to other standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. The provisions of SFAS 157 are effective for Daybreak on March 1, 2008. Daybreak is currently assessing the impact, if any, that the adoption of this pronouncement will have on the its operating results, financial position or cash flows.

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During July 2006, the FASB issued FIN 48, which addresses the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes specific criteria for the financial statement recognition and measurement of the tax effects of a position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition of previously recognized tax benefits, classification of tax liabilities on the balance sheet, recording interest and penalties on tax underpayments, accounting in interim periods, and disclosure requirements. FIN 48 is effective for fiscal periods beginning after December 15, 2006. As a result, Daybreak adopted FIN 48 effective March 1, 2007. The adoption of this pronouncement did not materially impact the its operating results, financial position or cash flows.

Exploration Stage Company

On March 1, 2005 (the inception date of the exploration stage), Daybreak commenced oil and gas operating activities. As of August 31, 2007, Daybreak has not produced significant revenues from its oil and gas operations. Accordingly, Daybreak’s activities have been accounted for as those of an “Exploration Stage Enterprise” as set forth in SFAS No. 7, “Accounting for Development Stage Entities.” Among the disclosures required by SFAS No. 7 are that Daybreak’s financial statements be identified as those of an exploration stage company. In addition the statements of operations, stockholders equity (deficit) and cash flows are required to disclose all activity since Daybreak’s date of inception of exploration stage.

Daybreak will continue to prepare its financial statements and related disclosures in accordance with SFAS No. 7 until such time that Daybreak’s oil and gas properties have generated significant revenues.

Use of Estimates

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

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Oil and Gas Properties

Daybreak uses the successful efforts method of accounting for oil and gas property acquisition, exploration, development, and production activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized as incurred. Costs to drill exploratory wells that are unsuccessful in finding proved reserves are expensed as incurred. In addition, the geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed as incurred. Costs to operate and maintain wells and field equipment are expenses as incurred.

Capitalized proved property acquisition costs are amortized by field using the unit-of-production method based on proved reserves. Capitalized exploration well costs and development cost (plus estimated future dismantlement, surface restoration, and property abandonment costs, net of equipment salvage values) are amortized in a similar fashion (by field) based on their proved developed reserves. Support equipment and other property and equipment are depreciated over their estimated useful lives.
 
10


Pursuant to SFAS No. 144, “Impairment or Disposal of Long-Lived Assets”, the Company reviews proved oil and natural gas properties and other long-lived assets for impairment.  These reviews are predicated by events and circumstances, (such as downward revision of the reserve estimates or commodity prices), that indicate a decline in the recoverability of the carrying value of such properties. Daybreak estimates the future cash flows expected in connection with the properties and compares such future cash flows to the carrying amount of the properties to determine if the carrying amount is recoverable. When the carrying amounts of the properties exceed their estimated undiscounted future cash flows, the carrying amounts of the properties are reduced to their estimated fair value. The factors used to determine fair value include, but are not limited to, estimates of proved reserves, future commodity prices, the timing of future production, future capital expenditures and a risk-adjusted discount rate.

Unproved oil and gas properties that are individually significant are also periodically assessed for impairment of value. An impairment loss for unproved oil and gas properties is recognized at the time of impairment by providing an impairment allowance.

On the retirement or sale of a partial unit of proved property, the cost is charged to accumulated depreciation, depletion, and amortization with a resulting gain or loss recognized in income.

Revenue Recognition

Daybreak uses the sales method to account for sales of crude oil and natural gas. Under this method, revenues are recognized based on actual volumes of oil and gas sold to purchasers. The volumes sold may differ from the volumes to which the Company is entitled based on its interests in the properties. These differences create imbalances, which are recognized as a liability only when the imbalance exceeds the estimate of remaining reserves. Daybreak had no significant imbalances as of August 31, 2007.

Reclamation Bonds

Included in other assets at August 31, 2007 is $250,000 paid to U.S. Specialty Insurance Company to act as surety in pledging a bond to the State of Alabama in connection with asset retirement obligations for future plugging, abandonment and site restoration.

Recent Accounting Pronouncements

Daybreak does not expect the adoption of any recently issued accounting pronouncements to have a significant effect on its material position or results of operation.

Reclassifications

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

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NOTE 3 — GOING CONCERN:

Financial Condition

Daybreak's financial statements for the three months and six months ended August 31, 2007, 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. Daybreak incurred a net loss of $1,560,982 for the six month period ended August 31, 2007, and as of August 31, 2007, Daybreak has accumulated a deficit of $14,425,052. Daybreak had a working capital deficit of $389,447 at August 31, 2007.

Management Plans to Continue as a Going Concern

Daybreak is implementing the following plans to enhance its ability to continue as a going concern.  Daybreak has marketed a Joint Development Program in the Tuscaloosa project which will ensure Daybreak’s continuation of that drilling program. The potential of increased revenue from production will create positive operational cash flows for the wells in Alabama, Louisiana and Texas. The partnership with Chevron U.S.A., Inc. will limit the financial risk and enhance Daybreak’s ability to pursue potentially profitable seismic and drilling programs on the California oil and gas properties. Daybreak believes it has the ability to secure additional debt and equity funding, if necessary.

Daybreak cannot offer any assurances that it will be successful in executing the aforementioned plans to continue as a going concern. Daybreak’s financial statements at August 31, 2007, do not include any adjustments that might result from the implementation and or execution of Daybreak’s plans to improve their ability to continue as a going concern.

NOTE 4 – INVESTMENTS IN MARKETABLE SECURITIES:

Daybreak periodically invests excess cash on hand in marketable securities with the intent to sell the securities in the near term as cash requirements determine. At August 31, 2007, these funds were in a brokerage account which was invested in mutual funds that invested in fixed income securities with relatively low market risk. These securities are classified as trading securities under the provisions of SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities”. The market value of the securities as at August 31, 2007 and February 28, 2007 was equal to their book value and no trading gains or losses occurred during the six months ended August 31, 2007. During the six months ended August 31, 2007, Daybreak sold $2,236,640 of the trading securities.

NOTE 5 – ACCOUNTS RECEIVABLE – JOINT INTEREST PARTICIPANTS:

On June 4, 2007, Daybreak as Operator for the drilling and completion of the Haas-Hirsch No. 1 well, located in the Krotz Springs Field in St. Landry Parish, Louisiana, sent a notice of default to one of the working interest participants for delinquency in meeting their financial commitments in the drilling and completion of the Haas-Hirsch No. 1 well. On August 9, 2007, the Company received a $100,000 payment on this delinquency. As of August 31, 2007, this working interest participant was delinquent $743,469. If the working interest participant is unable to meet its commitments, their working interest percentage will be offered to the other participants in the well. If the other working interest participants decline to increase their ownership Daybreak will become liable for this delinquency and will assume a larger working interest in the project. Daybreak has been informed by this participant that it is their intention to meet all financial commitments.

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NOTE 6 – NOTES RECEIVABLE - DRILLING RIG AGREEMENT:

Daybreak advanced a total of $800,000 to Green River Drilling, LLC through November 30, 2006 under promissory note agreements. In May 2007, Daybreak was informed by Green River that they intended to sell the drilling rig to a third party. The sale has been completed and on June 11, 2007, Daybreak received a total of $846,668 which included the principal of $800,000 and accrued interest in the amount of $46,668.

NOTE 7 — OIL AND GAS PROPERTIES:

Oil and gas properties, at cost:

             
   
August 31, 2007
   
February 28, 2007
 
Proved leasehold costs
  $
2,272,443
    $
2,092,107
 
Unproved leasehold costs
   
736,357
     
902,420
 
Costs of wells and development
   
3,505,888
     
2,035,940
 
Unevaluated capitalized exploratory well costs 
   
1,261,078
     
1,822,619
 
Capitalized asset retirement costs
   
91,235
     
93,457
 
Total cost of oil and gas properties
   
7,867,001
     
6,946,543
 
Accumulated depletion, depreciation, amortization and impairment
    (2,621,634 )     (2,393,693 )
Oil and gas properties, net
  $
5,245,367
    $
4,552,850
 

NOTE 8 — CONVERTIBLE DEBENTURES:

The following table summarizes the activity during the six months ended August 31, 2007 and the fiscal year ended February 28, 2007 related to the Convertible Debentures:


Description
 
Interest Rate
 
Dates of Maturity
 
August 31, 2007
   
February 28, 2007
 
Principal balances, beginning of period
                   
$0.25 Convertible Debentures
   
6%
 
03/22/06 to 08/31/06
  $
-
    $
32,000
 
$0.50 Convertible Debentures
   
10%
 
01/26/07 to 02/26/07
   
-
     
806,700
 
$0.75 Convertible Debentures
   
10%
 
02/26/07 to 10/31/07
   
225,001
     
300,001
 
                           
Principal issuances
                         
$0.75 Convertible Debentures
   
10%
 
10/31/07
   
-
     
25,000
 
               
225,001
     
1,163,701
 
Principal converted during the period
                         
$0.25 Convertible Debentures
             
-
      (32,000 )
$0.50 Convertible Debentures
             
-
      (806,700 )
$0.75 Convertible Debentures
              (25,000 )     (100,000 )
Principal balance, end of period
             
200,001
     
225,001
 
Unamortized discount, end of year
              (35,386 )     (90,002 )
Total debt, net of discount
            $
164,615
    $
134,999
 


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Daybreak has evaluated the application of SFAS No. 133 and EITF 00-19 for the consideration of embedded derivatives with respect to the conversion features for each of the Convertible Debentures and the Convertible Promissory Note. Daybreak has concluded that the instruments did not contain embedded derivatives.

On August 31, 2007, the remaining two debenture holders of the $0.75 convertible debentures agreed to extend the term of the debentures to October 31, 2007. In consideration of this extension they received 112,000 warrants.  These warrants have an exercise price of $0.56 per share and expire on August 31, 2009. The warrants were valued at $35,386 using the Black-Scholes option pricing model. The assumptions used in the Black-Scholes valuation model were: a risk fee interest rate of 4.1 %; the current stock price at date of issuance of $0.53 per share; the exercise price of the warrants of $0.53; the term of two years; volatility of 114%; and dividend yield of 0.0%.

NOTE 9 — RELATED PARTY TRANSACTIONS:

Office Lease

Daybreak leases offices from Terrence Dunne & Associates, a company owned by Terrence Dunne (CFO and a director). In May 2007, Daybreak increased their office size from 850 to approximately 1,000 square feet and monthly lease payments increased from $1,000 to $1,250 per month. This office lease is currently on a month-to-month basis.

Financing of Gas Pipeline

On May 24, 2006, Daybreak financed its forty percent (40%) working interest in the Tuscaloosa project gas pipeline through a financing arrangement with Hooper Oil & Gas Partners, LLC (“Hooper O&G”). This pipeline services the Tensas Farms et al F-1 and F-3 wells in Tensas Parish, Louisiana. Hooper O&G is a company controlled by Keith A. Hooper (a greater than 5% shareholder).

Daybreak has accounted for this agreement as a financing arrangement in the form of a note payable. The principal of the note is $200,000. Daybreak is obligated to pay $5,000 per quarter in interest until the principal is paid in full. Daybreak is also required to pay an additional 1% interest fee based on Daybreak’s original net revenue interest (“NRI”) on the production revenue of the F-1 well for the life of the project. Daybreak is obligated to repay the note between the sixth (6th) and the thirtieth (30th) month after the operation of the pipeline has commenced.  Under the agreement, title transferred to Hooper O&G, however Hooper O&G is obligated to sell the interest and title back to Daybreak and cannot sell the interest to any other party.

Daybreak is required to commence repayment of the loan if production from the F-1 well should cease for any cause for a period exceeding sixty days. From June 14, 2007 through September 28, 2007, Daybreak made principal payments totaling $185,000. The balance of the loan is now past due. The accelerated repayment schedule was triggered by the temporary shut-in status of the F-1 well, due to technical issues with water production. Daybreak and Hooper O&G have agreed to make final payment on the note by November 30, 2007.

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NOTE 10 – WARRANTS:

Warrants outstanding and exercisable as of August 31, 2007 are:

                     
Exercisable
 
         
Exercise
   
Remaining
   
Warrants
 
Description
 
Warrants
   
Price
   
Life (Years)
   
Remaining
 
Spring 2006 Common Stock Private Placement
   
4,013,602
    $
2.00
     
4.25
     
4,013,602
 
Placement Agent Warrants Spring 2006 PP
   
802,721
    $
0.75
     
6.25
     
802,721
 
Placement Agent Warrants Spring 2006 PP
   
401,361
    $
2.00
     
6.25
     
401,361
 
July 2006 Preferred Stock Private Placement
   
2,799,530
    $
2.00
     
4.50
     
2,799,530
 
Placement Agent Warrants Preferred Stock PP
   
419,930
    $
1.00
     
4.50
     
419,930
 
Convertible Debenture Term Extension
   
150,001
    $
2.00
     
4.75
     
150,001
 
Convertible Debenture 2nd Term Extension
   
112,000
    $
0.53
     
2.00
     
112,000
 
     
8,659,145
                     
8,659,145
 

NOTE 11 - INCOME TAXES

Reconciliation between actual tax expense (benefit) and income taxes computed by applying the U.S. federal income tax rate and state income tax rate to income from continuing operations before income taxes is as follows:

 
   
August 31, 2007
 
Computed at U.S. and State statutory rates (40%)
  $ (624,400 )
Permanent differences
   
40,100
 
Changes in valuation allowance
   
584,300
 
Total
  $
0
 

 
Tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred liabilities are presented below:
 
   
August 31, 2007
   
February 28, 2007
 
Deferred tax assets:
           
Net operating loss carryforwards
  $
2,374,000
    $
1,734,000
 
Oil and gas properties
   
892,100
     
947,800
 
Accrued liabilities
               
Less valuation allowance
    (3,266,100 )     (2,681,800 )
Total
  $
-
    $
-
 

At August 31, 2007, Daybreak had estimated net operating loss carryforwards for federal and state income tax purposes of approximately $5,935,000 which will begin to expire, if unused, beginning in 2024. Section 382 Rule will place annual limitations on Daybreak’s net operating loss (NOL) carryforward.

The above estimates are based upon management’s decisions concerning certain elections which could change the relationship between net income and taxable income. Management decisions are made annually and could cause the estimates to vary significantly.

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Safe Harbor Provision

The following Management’s Discussion and Analysis (“MD&A”) is management’s assessment of the historical financial and operating results of Daybreak Oil and Gas, Inc. (the “Company” or “Daybreak”) during the period covered by the financial statements. Certain statements in the MD&A report that are not historical in nature, including statements of management’s expectations, intentions, plans and beliefs, are inherently uncertain and are “forward-looking statements” and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements include those relating to estimated financial results, or expected prices, production volumes, reserve levels and number of drilling locations, expected drilling plans, including the timing, category, number, depth, cost and/or success of wells to be drilled, expected geologic formations or the availability of specific services or technologies. It is important to note that actual results may differ materially from the results predicted in any such forward-looking statements. Investors are cautioned that all forward looking statements involve risk and uncertainty. These risks and uncertainties include: the costs and accidental risks inherent in exploring and developing new oil and natural gas reserves, the price for which such reserves and production can be sold, environmental concerns affecting the drilling of oil and natural gas wells, impairment of oil and gas properties due to depletion or other causes, the uncertainties inherent in estimating quantities of proved reserves and cash flows, as well as general market conditions, competition and pricing. All statements other than statements of historical facts contained in this report, including statements regarding our current expectations and projections about future results, business strategy, performance, prospects and opportunities, are forward-looking statements. To understand about forward looking statements, please refer the section labeled forward looking statements. The following discussion should be read in conjunction with the unaudited financial statements and notes thereto included in this Form 10-QSB and with the Company’s latest audited financial statements as reported in its Form 10-KSB for the year ended February 28, 2007.

Introduction

The following discussion of our results of operations for the three month period ended August 31, 2007 (referred to herein as “the second quarter 2008”) and August 31, 2006 (referred to herein as “the second quarter 2007”) and of our financial condition as of August 31, 2007 should be read in conjunction with our financial statements and related notes thereto included elsewhere in this report.

Plan of Operation

We are an early stage oil and gas exploration company with a limited operating history and minimal proven reserves, production or cash flow. To date, we have had limited revenues and have not been able to generate positive earnings. Daybreak cannot provide any assurances that it will ever operate profitably. As a result of our limited operating history, we are more susceptible to the numerous business risks, investment and industry risks that have been described in our most recent report on Form 10-KSB for our fiscal year ended February 28, 2007 (Item 1. Description of Business - “Risk Factors”).

Our financial statements for the years ended February 28, 2007 and 2006 have been audited by our Independent Registered Public Accounting Firm. The Reports of Independent Registered Public Accounting Firm for each of these years include an explanatory paragraph stating that the financial statements have been prepared assuming the Company will continue as a going concern.

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The report also states that the Company has incurred significant operating losses that raise substantial doubt about its ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from this uncertainty. If Daybreak cannot continue as a going concern, any equity investment in the Company could become devalued or worthless.

As an early stage energy company concentrating on oil and gas exploration and development; our expenditures consist primarily of geological and engineering services, acquiring mineral leases, exploration and drilling costs and travel. Our expenses also consist of consulting and professional services, compensation, legal and accounting and general and administrative expenses which we have incurred in order to address necessary organizational activities.

Our longer term success depends on, among many other factors, the acquisition and drilling of commercial grade oil and gas properties and the prevailing prices for oil and natural gas. Oil and natural gas prices have been extremely volatile in recent years and are affected by many factors outside our control. This 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 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 gas properties and funding projects that we believe have the potential to produce oil or gas in commercial quantities. We are currently developing projects in Alabama, California, Louisiana and Texas. Since November of 2006, we have been involved as the operator of two project areas in Louisiana and in June of 2007, we became the operator of the Gilbertown project in Alabama. In the past we have relied on our working interest partners to negotiate all drilling, and sales contracts. Over the last two fiscal years, we have been involved in the drilling/workover and/or completion of thirteen (13) wells in Alabama, Louisiana, Texas and in Alberta, Canada. We have achieved or increased commercial production results in eight (8) of these wellbores.

Liquidity and Capital Resources
 
Our working capital and current ratio (current assets divided by current liabilities) are as follows.
 
   
August 31, 2007
   
February 28, 2007
 
Current Assets
  $
996,580
    $
4,537,634
 
Current Liabilities
   
1,386,027
     
2,445,457
 
Working Capital
  $ (389,447 )   $
2,092,177
 
                 
Current Ratio
   
0.72
     
1.86
 
 
While these two ratios are important, numerous other factors may also affect the liquidity and capital resources of the Company. Working capital declined from $2,092,177 as of February 28, 2007, to a deficit of $389,000 as of August 31, 2007, a decrease of $2.4 million. This decrease was due primarily to the sale of $2.2 million of marketable securities, which funded losses incurred by the Company during the first and second quarters of the current fiscal year ($1.56 million) coupled with a net increase in investments in oil and gas property ($700,000), principally for the drilling and completion costs of the Haas-Hirsch No. 1 (now the KSU # 59) well in the Krotz Springs prospect.
 
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Our business is capital intensive. Our ability to grow is dependent upon our ability to obtain outside capital and generate cash flows from operating activities to fund our investment activities. At this time, we have not yet demonstrated the ability to generate significant and sustainable cash flow from producing wells developed as a result of our prior exploration and development activities. And, our independent registered auditors have expressed a substantial doubt regarding our ability to continue as a going concern.
 
Our only source of funds in the past has been through the debt or equity markets. Since we have not yet established profitable operations, this is also expected to be our source of funds in the foreseeable future.  Our business model is focused on acquiring developmental properties and also existing production. Our ability to generate future revenues and operating cash flow will depend on successful exploration, and/or acquisition of oil and gas producing properties, which will very likely require the Company to continue to raise equity or debt capital from sources outside of the Company.

The Company 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 certain leases. These ongoing capital commitments may also cause the Company to seek additional capital from sources outside of the Company.
 
Since our future operations will continue to be heavily dependent on our ability to seek and secure capital from exterior sources, should we be unable to continue to find new capital from such sources, the Company may not be able to survive as a going concern, and any equity investment in the company could become worthless or substantially impaired in value.
 
Since our inception, we have suffered recurring losses from operations with negative cash flow and have depended on external financing to sustain our operations. During the fiscal year (“FY”) ended February 28, 2007, we reported losses of $8.39 million. Losses have continued into the 2nd Quarter FY 2008, with the Company reporting a loss of $1,560,982 for the six months ended August 31, 2007. Although these losses are an improvement from the restated loss $3.4 million for the same period in the prior year, there is no assurance that the Company can ever achieve sustainable profitability. Failure to achieve sustainable profitability could prevent the Company from continuing as a going concern, and could cause any equity investment in the company to become worthless.
 
 
Critical Accounting Policies
 
Management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debt, cancellations costs associated with long term commitments, investments, intangible assets, assets subject to disposal, income taxes, service contracts, contingencies and litigation.
 
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We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making estimates and judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on our financial statements, and it is possible that such changes could occur in the near term.

Oil and Gas Properties

We use the successful efforts method of accounting for oil and gas property acquisition, exploration, development, and production activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized as incurred. Costs to drill exploratory wells that are unsuccessful in finding proved reserves are expensed as incurred. In addition, the geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed as incurred. Costs to operate and maintain wells and field equipment are expensed as incurred.

Capitalized proved property acquisition costs are amortized by field using the unit-of-production method based on proved reserves. Capitalized exploration well costs and development costs (plus estimated future dismantlement, surface restoration, and property abandonment costs, net of equipment salvage values) are amortized in a similar fashion (by field) based on their proved developed reserves. Support equipment and other property and equipment are depreciated over their estimated useful lives.

Pursuant to SFAS No. 144, “Impairment or Disposal of Long-Lived Assets”, we review proved oil and natural gas properties and other long-lived assets for impairment. These reviews are predicated by events and circumstances, (such as downward revision of the reserve estimates or commodity prices), that indicate a decline in the recoverability of the carrying value of such properties. We estimate the future cash flows expected in connection with the properties and compare such future cash flows to the carrying amount of the properties to determine if the carrying amount is recoverable. When the carrying amounts of the properties exceed their estimated undiscounted future cash flows, the carrying amounts of the properties are reduced to their estimated fair value. The factors used to determine fair value include, but are not limited to, estimates of proved reserves, future commodity prices, the timing of future production, future capital expenditures and a risk-adjusted discount rate. The charge is included in depreciation, depletion and amortization.

Unproved oil and gas properties that are individually significant are also periodically assessed for impairment of value. An impairment loss for unproved oil and gas properties is recognized at the time of impairment by providing an impairment allowance.

On the retirement or sale of a partial unit of proved property, the cost is charged to accumulated depreciation, depletion, and amortization with a resulting gain or loss recognized in income.

Deposits and advances for services expected to be provided for exploration and development or for the acquisition of oil and gas properties are classified as long term other assets.

Revenue Recognition

We use the sales method to account for sales of crude oil and natural gas. Under this method, revenues are recognized based on actual volumes of oil and gas sold to purchasers. The volumes sold may differ from the volumes to which we are entitled based on its interests in the properties. These differences create imbalances, which are recognized as a liability only when the imbalance exceeds the estimate of remaining reserves. We had no significant imbalances as of August 31, 2007 and May 31, 2007.

19

Suspended Well Costs

On April 4, 2005, the Financial Accounting Standards Board, (FASB) issued FASB Staff Position No. 19-1,"Accounting for Suspended Well Costs" (FSP No. 19-1). This staff position amends SFAS No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies" and provides guidance concerning exploratory well costs for companies that use the successful efforts method of accounting. Daybreak adopted FSP No. 19-1 for the fiscal years ended February 28, 2007 and 2006.

The FSP states that exploratory well costs should continue to be capitalized if: (1) a sufficient quantity of reserves are discovered in the well to justify its completion as a producing well and (2) sufficient progress is made in assessing the reserves and the economic and operating feasibility of the well. If the exploratory well costs do not meet both of these criteria, these costs should be expensed, net of any salvage value. Additional annual disclosures are required to provide information about management's evaluation of capitalized exploratory well costs.

In addition, the FSP requires annual disclosure of: (1) net changes from period to period of capitalized exploratory well costs for wells that are pending the determination of proved reserves, (2) the amount of exploratory well costs that have been capitalized for a period greater than one year after the completion of drilling and (3) an aging of exploratory well costs suspended for greater than one year, designating the number of wells the aging is related to. Further, the disclosures should describe the activities undertaken to evaluate the reserves and the projects, the information still required to classify the associated reserves as proved and the estimated timing for completing the evaluation.

Share Based Payments

Prior to February 28, 2005, we accounted for our stock based compensation plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations, (“APB 25”) as permitted by SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”).

Effective March 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) for our stock based compensation plans under the recognition and measurement provisions of SFAS 123. No awards granted prior to March 1, 2005 were modified or settled in cash during fiscal 2006.

Effective March 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, “Share Based Payment” and related Interpretations (“SFAS 123R”).

Under both SFAS 123 and SFAS 123R, compensation cost for all share based payments granted on or subsequent to March 1, 2005 are based on the grant date fair value estimated in accordance with the provisions of SFAS 123 and SFAS 123R, for the respective fiscal years. Compensation cost is recognized on a straight line basis over the requisite service period for the entire award in accordance with the provisions of SFAS 123R. If at any date the portion of the grant-date fair value of the award that is vested is greater than that amount recognized on a straight line basis, the amount of the vested grant date fair value is recognized.

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We account for transactions in which we issue equity instruments to acquire goods or services from non-employees in accordance with the provisions of SFAS No. 123R (as amended). These transactions are accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

In addition, the financial statements included elsewhere herein, as well as the financial statements included in our most recent report on Form 10K-SB for the year ended February 28, 2007 were prepared as if the Company will continue as a going concern. An assumption otherwise may materially change the information included in the financial statements as well as the information included in the Management’s discussion and analysis of our financial condition and results of operations

Three Months Ended August 31, 2007 compared to the Three Months Ended August 31, 2006

Revenues.  Our revenues are derived entirely from the sale of our share of oil and gas production from our producing wells. The Company realized its first revenues from producing wells in the second quarter of the 2006 – 2007 fiscal year.  Prior to that date, the Company had no revenues. Accordingly, 2nd Quarter 2008 revenues of $294,845 increased as compared to $270,099 in revenues during the 2nd Quarter 2007.  During the 2nd Quarter 2008, the Company recorded revenues from its interest in 19 producing wells. While these results are encouraging, the Company continued to experience mechanical and technical production problems with certain major wells, particularly the F-1 well of the Tuscaloosa Project in Tensas Parish, Louisiana. The F-1 well contributed 0% of total revenues in the 2nd Quarter of 2008.

The F-1 well was shut in pending the resolution of certain mechanical problems in November, 2006.  Production on this property was re-established for a short period of time in February, 2007.  Afterward the F-1 well was shut in again pending resolution of certain gas sales and sales contract issues. The Company believes that these issues can be resolved and the production from this property can be re-established during the 3rd fiscal quarter of 2008.  However, there is no assurance that these efforts will be successful.

Expenses. Our production, exploration and depreciation, depletion, amortization and impairment expenses increased to $688,216 for the 2nd Quarter 2008 as compared to $73,085 for the 2nd quarter 2007. These increases were directly related to the increased number of wells and exploration projects with which we were involved in comparison to the prior year. Our general and administrative costs decreased to $502,733 for the 2nd Quarter 2008 as compared to $803,130 for the 2nd Quarter 2007. This decrease was primarily due the fact there were no stock issuances for compensation in the 2nd Quarter 2008.

Six Months Ended August 31, 2007 compared to the Six Months Ended August 31, 2006

Revenues.  Again, we recorded our first revenue from two producing wells in the first six months of the 2006–2007 year. Prior to that time, we had no revenues. During the first six months of 2008, the Company recorded revenues from its interest in 19 producing wells.

Expenses. Our production, exploration and depreciation, depletion, amortization and impairment expenses increased to $1,113,518 for the first six months of 2008 as compared to $73,085 for the first six months of 2007.
 
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These increases were directly related to the increased number of wells and exploration projects with which we were involved in comparison to the prior year. Our general and administrative costs decreased to $892,835 for the first six months of 2008 as compared to $2,950,749 for the first six months of 2007. This decrease was primarily due the fact there were no stock issuances for compensation in the first six months of 2008.

Oil and Gas Projects Update

California. On June 21, 2007, Daybreak and its partners (“Daybreak et al”), entered into a Seismic Option Farmout Agreement with Chevron U.S.A. Inc. (“Chevron”), for a seismic and drilling program in the East Slopes (Kern County) project area in California. By paying the full cost of the seismic program Chevron will earn a 50% interest in the lands and a 50% working interest for the drilling of future wells in the project area. Daybreak et al will earn a 50% interest in the Chevron lands located in the same project area, by paying 100% of the cost of the first three initial test wells to be drilled on the jointly held lands. The three initial test wells must be drilled within nine months of the seismic data interpretation being completed.

Louisiana. On July 5, 2007, Daybreak and its partners (“Daybreak et al”), entered into a Joint Development Participation Agreement (“JDPA”) with three companies for a drilling program in the Tuscaloosa project area in Louisiana. This JDPA plans on four wells being drilled within the next year. The Daybreak working interest will range from 24.5% to 29.5% on each well. The JDPA does not effect any prior agreement for wells and production infrastructure that is already in place. Daybreak will have a 29.5% interest in all future lease rentals.

The Tensas Farms et al “A-1” well was spud on August 27, 2007 and reached total depth of 8,200 feet on September 19, 2007. The well logs indicate an oil pay interval in the target zone at a depth between 8,094 and 8,118 feet. The well be completed in November, 2007.  Daybreak has a 28.5% working interest in the well before payout which will increase to a 34.75% working interest after payout.

The Tensas Farms et al “F-3” well resumed production on September 28, 2007 after being shut in by its gas market during August 2007 and the third week of September 2007.

Cost and Expenses:

A table of the costs and expenses for the 2nd quarter 2008 compared to the 2nd quarter 2007 follows:

   
Quarter
   
Quarter
 
   
Ended
   
Ended
 
   
August 31, 2007
   
August 31, 2006
 
Production Costs
  $
96,747
    $
31,934
 
Exploration Costs
   
378,186
     
40,404
 
Depreciation, Depletion,
               
Amortization & Impairment
   
213,283
     
747
 
General & Administrative
   
502,733
     
803,130
 
Total Operating Expenses
  $
1,190,949
    $
876,215
 

Expenses incurred by the Company include production costs associated directly with the generation of oil and gas revenues, exploration and drilling costs related to the development of its oil and gas properties and general and administrative expenses, including legal and accounting expenses, management and director fees, investor relations expenses, and other general and administrative costs.
 
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The increase in production costs to $96,747 in the 2nd quarter 2008, as compared to the second quarter 2007 of $31,934, relates entirely to the existence of production from oil and gas operations.

Exploration and drilling expenses increased substantially from $40,404 in the 2nd quarter 2007 to $378,186 in the 2nd quarter 2008 due primarily to an increase in the exploration activity in our California prospects and a rework in the Saxet Field of a salt water disposal well. The Company participated in the development of one (1) new exploratory well during the 2nd quarter 2008, compared to one (1) re-entry well in the comparable period of the prior year.

The increase in depreciation, depletion, amortization and impairment to $213,283 in the 2nd quarter of 2008, as compared to the second quarter 2007 of $747, relates entirely to the increase of production from oil and gas operations.

General and administrative expenses, including management and directors fees, investor relations fees and other general and administrative expenses of $502,733 were substantially lower in the 2nd quarter 2008 compared to $803,130 in the 2nd quarter 2007. Primarily, this decrease is due to the substantial stock compensation that was recorded in the 2nd quarter 2007, for which there are no significant comparable amounts in the 2nd quarter 2008.

Interest expense decreased from $363,345 in the 2nd quarter 2007 to $52,039 in the 2nd quarter 2008 due to lower average debt balances as a result of conversions of debt to common stock.

Due to the nature of its business, as well as the relative immaturity of the business, the Company expects that revenues, as well as all categories of expenses, will continue to fluctuate substantially quarter to quarter and year to year. Production costs will fluctuate according to the number and percentage ownership of producing wells, as well as the amount of revenues being contributed by such wells. Exploration and drilling expenses will be dependant the amount of capital that the Company has to invest in future development projects, as well as the success or failure of such projects. Likewise, the amount of depreciation, depletion, amortization expense and impairment costs will depend upon the similar factors, as well as numerous other factors including general market conditions.

Other Liquidity Factors

The Company has convertible debentures in the amount of $200,001 that, along within accrued interest, were originally due on August 31, 2007. On August 31, 2007, the maturity on these convertible debentures was extended to October 31, 2007. In addition, at May 31, 2007, the Company had a note payable to a related party in the amount of $200,000 related to the pipeline used on the F-1 and F-3 wells. Since June 14, 2007, principal payments of $185,000 have been made to reduce the balance of the note to $15,000 plus accrued interest.

Summary

Our ability to continue as a going concern depends in large part on our ability to raise substantial funds for use in our planned exploration and development activities, and upon the success of our fundraising activities.

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We intend to obtain the funds for our planned exploration and development activities by various methods, which might include the issuance of equity or debt securities or obtaining joint venture partners. No assurance can be given that we will be able to obtain any additional financing on favorable terms, if at all.

Raising additional funds by issuing common or preferred stock will further dilute our existing stockholders.

Off-Balance Sheet Arrangements

As of August 31, 2007, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

FORWARD-LOOKING STATEMENTS

We believe that some statements contained in this Prospectus relate to results or developments that we anticipate will or may occur in the future and 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 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 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. Factors that might cause such a difference include:

-
General economic and business conditions,
-
Exposure to market risks in our financial instruments,
-
Fluctuations in worldwide prices and demand for oil and natural gas,
-
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,
-
Regulatory uncertainties and potential environmental liabilities,
-
Additional matters discussed under “Risk Factors.”

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Disclosure Regarding Forward Looking Statements

Statements in this Form 10-QSB which are not historical in nature, including statements of management’s expectations, intentions, plans and beliefs, are inherently uncertain and are “forward-looking statements” and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements include those relating to estimated financial results, or expected prices, production volumes, reserve levels and number of drilling locations, expected drilling plans, including the timing, category, number, depth, cost and/or success of wells to be drilled, expected geologic formations or the availability of specific services or technologies. It is important to note that actual results may differ materially from the results predicted in any such forward-looking statements. Investors are cautioned that all forward looking statements involve risk and uncertainty. These risks and uncertainties include: the costs and accidental risks inherent in exploring and developing new oil and natural gas reserves, the price for which such reserves and production can be sold, environmental concerns affecting the drilling of oil and natural gas wells, impairment of oil and gas properties due to depletion or other causes, the uncertainties inherent in estimating quantities of proved reserves and cash flows, as well as general market conditions, competition and pricing. Please refer to the “Risk Factors” section of our Form 10-KSB for the fiscal year ended February 28, 2007. This and all our previously filed documents are on file at the Securities and Exchange Commission and can be viewed on our Web site at www.daybreakoilandgas.com. Copies of the filings are available from our Corporate office without charge.

Additional information relating to Daybreak is available on EDGAR at www.edgar-online.com or our web site at www.daybreakoilandgas.com. In the past, our stock has been quoted on the NASDAQ over the counter (OTC.BB) market under the symbol DBRM.OB. However, since July 2007, our stock has been quoted in the OTC pink sheet market, due to SEC filing delinquencies. We plan on applying to return to being quoted on the OTC Bulletin Board market upon the filing of this 10-QSB report.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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(a)
Evaluation of Disclosure Controls and Procedures

As of the end of the reporting period, August 31, 2007, an evaluation was conducted by the Company's management of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) of the Securities  Exchange Act of 1934 (the "Exchange Act"). Such disclosure  controls  and  procedures are  designed to insure that  information required to be  disclosed  by a company in the  reports  that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods specified by the Securities & Exchange Commission rules and forms. Additionally, it is vital that such information is accumulated and communicated to our management in a manner to allow timely decisions regarding required disclosure.

Based upon that evaluation, our management concluded that our disclosure controls needed improvement and were not effective as of August 31, 2007, to ensure timely reporting with the Securities and Exchange Commission (“SEC”).

Material weakness identified included:

The Company’s corporate governance and disclosure controls and procedures do not provide reasonable assurance that material transactions are timely and accurately reported in our Periodic Reports that we file with the SEC.

In particular, the Company does not have adequate controls over the timely filing of our required quarterly 10-QSB and year end 10-KSB reports. For the fiscal year ended February 28, 2007, we were forced to file a 12b-25 “Notification of Late Filing” report for the 10-KSB report. The  filing of the 12b-25 report itself was delinquent. This resulted in the second “E” in less than 12 months being placed behind our trading symbol. Since our 10-KSB report was not filed by the end of the extended due date, this resulted in our Company stock being dropped from being quoted in the OTC (Over-the-Counter) Bulletin Board market. Until Daybreak is current with its SEC filings and is accepted to be quoted again on the Bulletin Board our stock will be quoted in the OTC pink sheet market.

The form 10-QSB report for the first quarter ended May 31, 2007, was delinquent and also not filed in a timely manner as mandated by the SEC.

Due to the amount of administrative staff of the company, certain beneficial control methods are not available for our implementation. This is especially true when evaluating an effective separation of duties and responsibilities in the corporate office.

(b)
Changes in Internal Control.

As required by Rule 13a-15(d), the Company’s management also conducted evaluations of our internal controls over financial reporting to determine whether any changes occurred during the fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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The Company’s control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals. Because of the inherent limitations due to, for example, the potential for human error or circumvention of controls, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

During the preparation of the Company’s financial statements, as of August 31, 2007, the Company concluded that the current system of disclosure controls and procedures are still not effective. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

As a result our evaluations, the Company initiated the changes in internal control described below. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.

Changes Implemented to Correct Material Weaknesses:
  • We have increased administrative staff to assist in the more timely preparation of all required reporting documents
(c)
Limitations.
 
Our management does not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met.
 
Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.

Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

We are not the subject of any pending legal claims or litigation.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On August 21, 2007, we issued 10,000 shares of unregistered common stock to Frank Duval for services.  On the grant date of August 17, 2007, the closing price of our stock was $0.45.  Based on the closing price the value of this stock issuance was $4,500.  The shares issued for services were issued pursuant to a Section 4(2) exemption from registration under the Securities Act of 1933, as amended.

ITEM 3. DEFAULTS UPON SENIOR SECURITES

None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the second quarter of the fiscal year ended February 28, 2008, we did not have any matters submitted to a vote of our security holders of the Company.

ITEM 5.  OTHER INFORMATION

None

ITEM 6.  EXHIBITS

The following Exhibits are filed as part of the report:


Section 1350 Certifications


Section 1350 Certifications
 
28

 

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  DAYBREAK OIL AND GAS, INC.  
       
 
By:
/s/ Eric L. Moe  
    Eric L. Moe, its  
    Chief Executive Officer  
    Date:  October 11, 2007  

 
By:
/s/ Thomas C. Kilbourne  
    Thomas C. Kilbourne, its  
   
Principal Accounting Officer
 
    Date:  October 11, 2007  
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
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