Daybreak Oil & Gas, Inc. - FORM 10-Q - XML - IDEA: XBRL DOCUMENT - January 11, 2013

NOTE 8 — SHORT-TERM AND LONG-TERM BORROWINGS:

Short-Term Notes Payable

On 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 Company’s 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 Company’s or the co-borrower’s 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 Company’s 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-borrower’s sole managing member.

On 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 Company’s 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 Company’s Kern County, California leases was terminated in connection with the payoff.

On 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 Company’s Kern County, California leases was terminated in connection with the payoff.

Short-Term (Related Party)

On August 21, 2012, the Company’s President and Chief Executive Officer loaned the Company $15,000 to reduce the outstanding balance on the Company’s 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 Company’s 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 Company’s 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.

Long-Term Debt

Maximilian Loan

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 Company’s 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 loan.

The loan agreement contained customary covenants for loans of such type, including among other things, covenants that restrict the Company’s ability to make capital expenditures, incur indebtedness, incur liens and dispose of property. In the event of a default, all of the Company’s 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 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, 2014. A $250,000 Note was sold to a related party, the Company’s 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 30, 2012.