SHORT-TERM AND LONG-TERM BORROWINGS:
Short-Term Notes Payable
May 18, 2012, the Company entered into a loan agreement with Luberski, Inc. (Luberski) as lender and another
party as co-borrower, pursuant to which the Company and the co-borrower together borrowed a principal amount of $1,500,000.
The Companys share in the loan amounted to $719,062 with the remainder of the loan proceeds paid to
the co-borrower. The loan bore interest at a rate of 5% per month, which interest was to be paid by the co-borrower, had a
term of 120 days, and was eligible to be prepaid at any time in part or in full without premium or penalty. The loan called
for a minimum interest payment of $150,000. The Company recognized $123,318 in deferred financing fees associated with this
loan. Either the Companys or the co-borrowers failure to repay the principal at maturity would constitute an
event of default and give the lender the right to call the loan due. The loan was a joint and several obligation of the
Company and the co-borrower, and was secured by the Companys currently producing leases in Kern Country, California
and certain personal property, accounts receivable and net profits of the co-borrower as well as a personal
unconditional guarantee of the loan by the co-borrowers sole managing member.
October 31, 2012, the Company paid Luberski $1,500,000 pursuant to
the terms of a Settlement and Release Agreement between Luberski and the Company. The payment satisfied the Companys indebtedness and as a result of the payoff, the Company
recognized a loss on settlement of debt of $780,938. Additionally, under terms of the settlement agreement, the Company agreed
to allow Luberski to pursue collection of other amounts owed in connection with the loan from the co-borrower
before the Company pursues any action against the co-borrower for amounts owed to the Company. The security interest granted by
Daybreak in favor of Luberski in the Companys Kern County, California leases was terminated in connection with the payoff.
May 22, 2012, the Company paid Well Works, LLC, a Utah limited liability company, $595,744 representing the outstanding principal
balance and all interest and fees due in regards to the secured convertible promissory note between the Company and Well Works
that was executed on September 17, 2010. The security interest granted by Daybreak in favor of Well Works in the Companys
Kern County, California leases was terminated in connection with the payoff.
Short-Term (Related Party)
On August 21, 2012, the
Companys President and Chief Executive Officer loaned the Company $15,000 to reduce the outstanding balance on the
Companys Line of Credit with UBS Bank. The loan is a non-interest bearing loan. Repayment will be made upon a mutually
agreeable date in the future.
On January 31, 2012, the Company
issued a $35,100 non-interest bearing note to the Companys President and Chief Executive Officer. The term of the note provided
for repayment on such date as may be agreed to by the Company and its President. Proceeds from the note were used to pay an extension fee
related to a loan from a third party.
On June 20, 2011, the Company
issued a $200,000 non-interest bearing note to the Companys President and Chief Executive Officer. The term of the note
provided for repayment on or before June 30, 2011, or such date as may be agreed to by the Company and its President. Proceeds from the note
were used to meet the escrow requirement on a loan commitment from a third party that was announced in June 2011.
On October 31, 2012, the Company entered
into a loan agreement with Maximilian which provides for a revolving credit facility of up to $20 million, maturing
on October 31, 2016, with a minimum commitment of $2.5 million. The loan bears annual interest of 18% and a monthly
commitment fee of 0.5%. The loan is secured by a perfected first priority security interest in substantially all of the
assets of the Company, including the Companys leases in Kern County, California. The Company also granted Maximilian a
10% working interest in its share of the oil and gas leases in Kern County, California. The relative fair value of this 10%
working interest amounting to $515,638 was recognized as a debt discount and is being amortized over the term of the loan. Amortization
expense for the three months ended November 30, 2012 amounted to $9,603. Unamortized debt discount amounted to $506,035 as
of November 30, 2012.
The Company borrowed an initial amount from
the credit facility of $1,650,691 in which $1,500,000 was used to settle the loan with Luberski and the remaining amount was used
to pay for the related loan fees and closing costs. Future advances under the facility will primarily be used for oil and gas
exploration and development activities. The Company recognized $321,836 in deferred financing costs associated with this
The loan agreement contained customary covenants
for loans of such type, including among other things, covenants that restrict the Companys ability to make capital expenditures,
incur indebtedness, incur liens and dispose of property. In the event of a default, all of the Companys obligations under
the loan agreement may be accelerated by the lender, causing all loans outstanding (including accrued interest and fees payable
thereunder) to be declared immediately due and payable.
The Company also issued 2,435,517 warrants
to third parties who assisted in the closing of the loan. The warrants have an exercise price of $0.044; contain a cashless exercise
provision; have piggyback registration rights; and are exercisable for a period of five years expiring on October 31, 2017. The
fair value of the warrants, as determined by the Black-Scholes option pricing model, was $98,084 and included the following assumptions:
a risk free interest rate of 0.72%; stock price of $0.04, volatility of 153.44%; and a dividend yield of 0.0%. The fair value of
the warrants was recognized as a deferred financing cost and is being amortized over the term of the loan. Amortization expense
of deferred financing costs for the three months ended November 30, 2012 was $6,705
12% Subordinated Notes
On January 13, 2010, the Company
commenced a private placement of 12% Subordinated Notes (Notes). On March 16, 2010, the Company closed its private
placement of Notes to 13 accredited investors resulting in total gross proceeds of $595,000. Interest on the Notes accrues at
12% per annum, payable semi-annually. The note principal is payable in full at the expiration of the term of the Notes, which
is January 29, 2015. Should the Board of Directors, on the maturity date, decide that the payment of the principal and any unpaid
interest would impair the financial condition or operations of the Company, the Company may then elect a mandatory conversion
of the unpaid principal and interest into the Companys Common Stock at a conversion rate equal to 75% of the average closing
price of the Companys Common Stock over the 20 consecutive trading days preceding December 31, 2014. A $250,000 Note was
sold to a related party, the Companys President and Chief Executive Officer. The terms and conditions of the related party
Note were identical to the terms and conditions of the other participants Notes.
In conjunction with the Notes
private placement, a total of 1,190,000 common stock purchase warrants were issued at the rate of two warrants for every dollar
raised through the private placement. The warrants have an exercise price of $0.14 and expire on January 29, 2015. The fair value
of the warrants, as determined by the Black-Scholes option pricing model, was $116,557 using the following weighted-average assumptions:
a risk free interest rate of 2.33%; volatility of 147.6%; and dividend yield of 0.0%. The fair value of the warrants was recognized
as a discount to debt and is being amortized over the term of the Notes using the effective interest method. Amortization expense
for the nine months ended November 30, 2012 amounted to $16,574. Unamortized debt discount amounted to $63,509 as of November