UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-K





(Mark
One)





[X]
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
fiscal year ended February 28, 2009





[   ]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
transition period from ______ to _______





Commission
file number 000-50107





DAYBREAK
OIL AND GAS, INC.


(Exact
name of registrant as specified 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)





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





Securities
registered pursuant to Section 12(b) of the Exchange Act:  None





Securities
registered pursuant to Section 12(g) of the Exchange Act:  Common
Stock, $.001 par value





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes  ̈No þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.   Yes  ̈No þ





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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 þNo  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   Yes  ̈No  ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer  ̈
                  Accelerated
      filer  ̈
                  Non-accelerated
      filer  ̈
                  Smaller
      reporting company þ(Do
      not check if a smaller reporting company)





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





The
aggregate market value of the voting and non-voting stock held by non-affiliates
of the registrant, based on the closing price of $0.10 on May 26, 2009, as
reported by the Over the Counter Bulletin Board was $4,173,193.





At May
26, 2009, the registrant had 46,979,899 outstanding shares of $0.001 par value
common stock.





DOCUMENTS
INCORPORATED BY REFERENCE:





Part III
of the Form 10-K incorporates by reference certain portions of the registrant’s
proxy statement for its 2009 Annual Meeting of Shareholders to be filed with the
Commission not later than 120 days after the end of the fiscal year covered by
this report.







TABLE
OF CONTENTS











PAGEPART I
              
              4ITEM 1.
              DESCRIPTION OF BUSINESS
              9ITEM 1A.
              RISK FACTORS
              9ITEM 2.
              DESCRIPTION OF PROPERTIES
              10ITEM 3.
              LEGAL PROCEEDINGS
              15ITEM 4.
              SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
              15PART II
              
              16ITEM 5.
              MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
      SMALL BUSINESS ISSUER PURCHASE OF EQUITY SECURITIES
              16ITEM 6.
              SELECTED FINANCIAL INFORMATION
              21ITEM 7.
              MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION
              22ITEM 7A.
              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
              34ITEM 8.
              FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
              35Balance Sheets as of
      February 28, 2009 and February 29, 2008
              36Statements of Operations for the
      Years ended February 28, 2009 andFebruary 29,
      2008and for
      the Period from Inception (March 1,
      2005) to February 28, 2009
              37Statement of Changes in Stockholders' Equity for the Period from Inception(March
      1, 2005) through February 28, 2009
              38ITEM 9.
              CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE
              66ITEM 9A(T).
              CONTROLS AND PROCEDURES
              67ITEM 9B.
              OTHER INFORMATION
              69PART III
              
              70ITEM 10.
              DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE
      GOVERNANCE
              70ITEM 11.
              EXECUTIVE COMPENSATION
              70ITEM 12.
              SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS
              70ITEM 13.
              CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
      DIRECTOR INDEPENDENCE
              70ITEM 14.
              PRINCIPAL ACCOUNTANT FEES AND SERVICES
              70PART IV
              
              71ITEM 15.
              EXHIBITS, FINANCIAL STATEMENT SCHEDULES
              71SIGNATURES
              73









CAUTIONARY
STATEMENT ABOUT FORWARD-LOOKING STATEMENTS




We
believe that some statements contained in this 10-K annual report 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, and
- Regulatory
  uncertainties and potential environmental liabilities.






































PART I





ITEM 1. DESCRIPTION OF
BUSINESS





Background





Daybreak
Oil and Gas, Inc. (referred to herein as “we,” “our,” “Daybreak” or the
“Company”) was originally incorporated in the State of Washington on March 11,
1955 as Daybreak Uranium, Inc. The Company was established for the purpose of
mineral exploration and development on claims or leased lands throughout the
western United States. In August 1955, we acquired the assets of Morning Sun
Uranium, Inc. By the late 1950s, the Company had ceased to be a producing mining
company and thereafter engaged in mineral exploration. In May 1964, to reflect
the diversity of its mineral holdings, the Company changed its name to Daybreak
Mines, Inc. The trading symbol for the Company became DBRM.





Our
subsequent efforts in the acquisition, exploration and development of
potentially viable commercial properties were unsuccessful. By February 1967, we
had ceased active operations. After that time, our activities were confined to
annual assessment and maintenance work on our Idaho mineral properties and other
general and administrative functions. In November 2004, we sold our last
remaining mineral rights covering approximately 340 acres in Shoshone County,
Idaho.





Effective
March 1, 2005, we undertook a new business direction for the Company; that of an
exploration and development company in the oil and gas industry.  We
have become an early stage oil and gas exploration and development company with
projects in California, Alabama and Louisiana.  In October of 2005, to
better reflect this new direction of the Company, our shareholders approved
changing our name to Daybreak Oil and Gas, Inc.  Our common stock is
quoted on the OTC Bulletin Board (OTC.BB) market under the symbol
DBRM.OB.





Our
corporate office is located at 601 W. Main Ave., Suite 1012, Spokane, Washington
99201-0613.  Our telephone number is (509) 232-7674.  Our
regional operations office is located at 1414 S. Friendswood Dr., Suite 215,
Friendswood, Texas 77546.  The telephone number of our office in
Friendswood is (281) 996-4176.





Oil and Gas
Overview





We pursue
oil and gas drilling opportunities through joint ventures with industry partners
as a means of limiting our drilling risk.  Our prospects are
generally brought to us by other oil and gas companies or
individuals.  We identify and evaluate prospective oil and gas
properties to determine both the degree of risk and the commercial potential of
the project.  We seek projects that offer a mix of low risk with a
potential of steady reliable revenue as well as projects with a higher risk, but
that may also have a larger return. We strive to use modern 3-D seismic
technology to help us identify potential oil and gas reservoirs and to mitigate
our risk.  We seek to maximize the value of our asset base by
exploring and developing properties that have both production and reserve growth
potential.We seek out
other industry partners to maintain a balanced working interest in all of our
projects.










4


In some
instances, we strive to be operator of our oil and gas properties.  As
the operator, we are more directly in control of the timing, costs of drilling,
completion and production operations on our projects.





Competition





We
compete with independent oil and gas companies for exploration prospects,
property acquisitions and for the equipment and labor required to operate and
develop these properties.  Many of our competitors have substantially
greater financial and other resources than we have.  These competitors
may be able to pay more for exploratory prospects and may be able to define,
evaluate, bid for and purchase a greater number of properties and prospects than
we can.





Significant
Customers





At each
of our property locations in California, Alabama, and Louisiana, we have oil and
gas sales contracts with one dominant purchaser in each respective
area.  If these purchasers are unable to resell their products or if
they lose a significant sales contract then we may incur difficulties in selling
our oil and gas. At February 28, 2009, three customers represented 100% of
crude oil and natural gas sales receivables from all projects in
aggregate.





In
accordance with provisions of Statement of Financial Accounting Standards No.
131 (“SFAS 131”) “Disclosures
about Segments of anEnterpriseand Related
Information”, paragraph 39, a table disclosing the total amount of
revenues from any single customer that exceeds 10% of total revenues
follows:





For
      the Year Ended
                        February
      28, 2009
                      
                      
                      For
      the Year Ended
                        February
      29, 2008Project
                      Location
                      Product
                      Customer
                      
                      Revenue
                      
                      
                      Percentage
                      
                      
                      Revenue
                      
                      
                      PercentageEast
      Gilbertown
                      Alabama
                      Oil
                      Hunt
      Crude Oil Supply
                      
                      $
                      148,741
                      
                      
                      
                      73.7
                      %
                      
                      $
                      119,409
                      
                      
                      
                      61.5
                      %Krotz
      Springs
                      Louisiana
                      Gas
                      JP
      Oil Company
                      
                      $
                      22,944
                      
                      
                      
                      11.4
                      %
                      
                      $
                      37,121
                      
                      
                      
                      19.1
                      %Liquids
                      JP
      Oil Company
                      
                      $
                      26,122
                      
                      
                      
                      12.9
                      %
                      
                      $
                      30,591
                      
                      
                      
                      15.7
                      %





Title to
Properties





As is
customary in the oil and natural gas industry, we make only a cursory review of
title to undeveloped oil and natural gas leases at the time we acquire
them.  However, before drilling commences, we search the title, and
remedy material defects before we actually begin drilling the
well.  To the extent title opinions or other investigations reflect
title defects, we (rather than the seller or lessor of the undeveloped property)
typically are obligated to cure any such title defects at our
expense.  If we are unable to remedy or cure any title defects, so
that it would not be prudent for us to commence drilling operations on the
property, we could suffer a loss of our entire investment in the
property.  We believe that we have good title to our oil and natural
gas properties, some of which are subject to immaterial encumbrances, easements,
and restrictions.










5


Long Term
Success





Our
success depends on the successful acquisition, exploration and development of
commercial grade oil and gas properties as well as the prevailing prices for oil
and natural gas to generate future revenues and operating cash
flow.  Oil and natural gas prices have been extremely volatile in
recent years and are affected by many factors outside of our
control.  The volatile nature of the energy markets makes it difficult
to estimate future prices of oil and natural gas; however, any prolonged period
of depressed prices would have a material adverse effect on our results of
operations and financial condition.  Such pricing factors are largely
beyond our control, and may result in fluctuations in our
earnings.  We believe there are significant opportunities available to
us in the oil and gas exploration and development industry.





Regulation





The
exploration and development of oil and gas properties are subject to various
types of federal, state and local laws and regulations.  These laws
and regulations govern a wide range of matters, including the drilling and
spacing of wells, allowable rates of production, restoration of surface areas,
plugging and abandonment of wells and specific requirements for the operation of
wells.





Laws and
regulations relating to our business frequently change, and future laws and
regulations, including changes to existing laws and regulations, could adversely
affect our business.





Recent
Developments





During
May 2009, we drilled the Sunday #2 well at our East Slopes Project in Kern
County, California.  The well was drilled to 2,236 feet and
encountered 24 feet of oil pay in the Vedder sand.  This well will be
completed during the month of June 2009.  We also increased the
production in the Sunday #1 well to 80 barrels of oil per day ("BOPD") from 50
BOPD.





On March
10, 2009, we announced that the Bear #1 well at our East Slopes Project in the
San Joaquin Basin near Bakersfield, California had been drilled to a total depth
of 3,261 feet and encountered 26 feet of oil pay in the Vedder formation at
2,200 feet.  During May 2009, the well was completed and tested 50
BOPD.  Daybreak assumed the role of operator on March 1, 2009 for our
entire California project area.





On
December 5, 2008, we announced that the Sunday # 1 well at our East Slopes
Project in the San Joaquin Basin near Bakersfield, California had been drilled
to a total depth of 3,065 feet and encountered 24 feet of oil pay in the Vedder
formation at 2,000 feet.  On February 4, 2009 we announced that the
Sunday #1 well was completed and put on production at the rate of 52 BOPD and
that the Olancha # 1 and the Piute # 1 wells had been drilled and no
hydrocarbons were found in either well.  Both wells were plugged and
abandoned.





On
October 23, 2008, we announced that our Board of Directors, (or “the Board”),
had named James F. Westmoreland, 52, as President and Chief Executive Officer.
Timothy R. Lindsey, a Director, had held these offices on an interim basis since
December 2007.  Mr. Lindsey was appointed to the Board of Directors in
January 2007 and continues to serve on the Board.  Mr. Westmoreland
was also elected to the Company’s Board of Directors, effective
immediately.  The addition of Mr. Westmoreland expanded the size of
the Company’s Board of Directors to six members.









6


On August
1, 2008, we announced the election of Wayne G. Dotson to our Board of Directors,
effective July 31, 2008.  He is considered to be an independent
director and serves as a member of the Audit Committee, the Nominating and
Corporate Governance Committee and the Compensation Committee.  The
addition of Mr. Dotson as a Director expanded the size of the Company's Board of
Directors to five members.





On June
16, 2008, we announced that the Company signed the final closing documents on
June 12, 2008 to complete the sale of our Tuscaloosa Project properties located
in Tensas and Franklin Parishes, Louisiana.  At this closing, Daybreak
received $5,500,000 in exchange for the balance of its interests, having
previously received a total of $2,500,000 from partial closings in January and
April of 2008.





Employees and
Consultants





We
currently have eight employees.  We may hire more employees in the
next fiscal year as needed.  All other services are currently
contracted for with independent contractors.  The Company has not
obtained “key man” life insurance on any of its officers or
directors.





Availability of SEC
Filings





You may
read and copy any materials we file with the U.S. Securities and Exchange
Commission (the “SEC”) at the SEC’s Public Reference Room at 100 F Street, NE,
Washington, DC 20549, on official business days during the hours of 10:00
am to 3:00 pm.  You can obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC
maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC.  The address of that site is
http://www.sec.gov.





Website / Available
Information





Our
website can be found at www.daybreakoilandgas.com.  Our
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K and amendments to those reports filed with or furnished to the SEC,
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (“the
Exchange Act”) can be accessed free of charge on our web site at www.daybreakoilandgas.com
in the “Shareholder Information” section of our web site under the “SEC Filings”
button as soon as is reasonably practicable after we electronically file such
material with, or otherwise furnish it to, the SEC.





We have
adopted an Ethical Business Conduct Policy Statement to provide guidance to our
directors, officers and employees on matters of business conduct and ethics,
including compliance standards and procedures.  We also have adopted a
Code of Ethics for Senior Financial Officers that applies to our principal
executive officer, principal financial officer, principal accounting officer and
controller.  Our Ethical Business Conduct Policy Statement and Code of
Ethics for Senior Financial Officers are available in the “Shareholder
Information” section of our web site at www.daybreakoilandgas.com
under the heading “Corporate Governance.”  We intend to promptly
disclose via a Current Report on Form 8-K or via an update to our web site,
information on any amendment to or waiver of these codes with respect to our
executive officers and directors.  Waiver information disclosed via
the web site will remain on the web site for at least 12 months after the
initial disclosure of a waiver.










7


Our
Corporate Governance Guidelines and the charters of our Audit Committee,
Nominating and Corporate Governance Committee, and Compensation Committee are
also available in the “Shareholder Information” section of our web site at www.daybreakoilandgas.com
under the heading “Corporate Governance.”  In addition, copies of our
Ethical Business Conduct Policy Statement, Code of Ethics for Senior Financial
Officers, Corporate Governance Guidelines and the charters of the Committees
referenced above are available at no cost to any shareholder who requests them
by writing or telephoning us at the following address or telephone
number:




Daybreak
      Oil and Gas, Inc.601
      W. Main Ave., Suite 1012Spokane,
      WA 99201-0613Attention:
      Corporate SecretaryTelephone:
      (509) 232-7674





Information
contained on or connected to our web site is not incorporated by reference into
this Annual Report and should not be considered part of this report or any other
filing that we make with the SEC.














































8


ITEM 1A. RISK
FACTORS





As a
smaller reporting company, we are not required to provide the information
otherwise required by this Item.





































































9


ITEM 2. DESCRIPTION OF
PROPERTIES





We have
onshore oil and gas projects in California, Alabama and
Louisiana.  Unless otherwise noted, all of our discussion refers to
our continuing operations in these three project locations.  We have
not filed any estimates of total, proved net oil or gas reserves with any
Federal agency for the fiscal year ended February 28,
2009.  Throughout this 10-K annual report, oil is shown in barrels
(“Bbl”), and natural gas is shown in thousand cubic feet (“Mcf”).  The
project areas we are involved in are as follows:





California
(East Slopes Project and Expanded AMI Project)





Kern and Tulare
Counties.  In May 2005, we agreed to jointly explore an area of
mutual interest (“AMI”) in the southeastern part of the San Joaquin Basin near
Bakersfield, California. As our exploration work has continued, this project has
been divided into two major areas referred to as the “East Slopes Project” in
Kern County and the “Expanded AMI Project” in Tulare County. Drilling targets
are porous and permeable sandstone reservoirs which exist at depths of 1,200
feet to 4,000 feet.





Kern County,
California.  In June 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 Project
area.  By contributing 3,658 acres and paying the full cost of a 35
square mile, high resolution, 3-D seismic survey program over the entire acreage
block, referred to herein as the “Chevron AMI,” Chevron has earned a 50% working
interest in the lands contributed by Daybreak et al to the Chevron AMI project
area.  After paying 50% of the cost for drilling and completion of the
first four initial earning wells, Daybreak earned a 25% interest in the Chevron
lands that were contributed to the Chevron AMI project area.





Drilling
of the four earning wells commenced in November 2008 and was completed in March
2009.  Two successful wells were drilled, the Sunday #1 and the Bear #
1.  The Sunday # 1 well encountered 20 feet of oil pay in the Vedder
sand at 2,000 feet, was completed in January 2009.  It initially
produced 50 BOPD at approximately 14.7o API gravity oil into temporary
production facilities.  The Bear #1 well encountered 26 feet of oil
pay in the Vedder sands at 2,200 feet and tested at 50
BOPD.  Permanent production facilities are being engineered and
constructed to facilitate oil production from both wells.  A
developmental drilling program will be initiated in May 2009.  Further
exploration will continue following the completion of the development program
later in 2009.  We plan to spend approximately $1,000,000 in new
capital investments within the Chevron AMI in the upcoming twelve
months.





During
January 2009, Daybreak was notified by its partners, including the project
operator, that they could no longer financially continue in the
project.  As a result, these partners defaulted on a portion of the
financial obligation of their respective working interests.  On March
1, 2009, Daybreak became the operator.  During March 2009, the
defaulting partners assigned their 25% working interest to Daybreak, and we
assumed their $1.4 million liability.  Daybreak currently has a 50%
working interest in the East Slopes Project with a net revenue interest (“NRI”)
of 34.5%.





On May 1,
2009, we signed an Exchange Option Agreement with a third party, which gives
that party (i) a 30 day option to purchase a 25% working interest for $512,500,
(ii) commits to a payment in an amount equal to $700,000 to be payable out of
production from (a) 25% of the net revenue from the Sunday #1 and Bear # 1 wells
and (b) 50% of the net revenue from all future wells.












10


The third
party will also assign Daybreak a 25% interest in 14,100 acres in Kern County,
California.  This acreage is immediately north of our East Slopes
Project area.





Reserves





At March
1, 2009, we had net proved reserves of 17,250 barrels (“Bbls”) of oil in the
East Slopes Project according to SEC guidelines as determined by the certified
independent engineering firm, Huddleston & Co., Inc.





Tulare County,
California.  The Expanded AMI Project is also located in the
San Joaquin Basin in Tulare County and is a separate project area from the East
Slopes Project in Kern County. Since 2006, Daybreak and its partner have leased
approximately 9,000 acres.  Three prospect areas have been identified
to the north of the Chevron AMI area in Kern County.  A 3-D seismic
survey will have to be obtained over the prospect area before any exploration
drilling can be done.  As part of the default settlement with respect
to the Krotz Springs Field project, we were assigned the interest owned by our
partner in this area.  We now have a 100% working interest in this
project area.  We anticipate spending $50,000 in the next fiscal year
on lease rentals and brokerage fees.





Alabama
(East Gilbertown Field)





Choctaw
County.  In December 2006, we acquired a working interest in an
existing oil field project, the East Gilbertown Field that produces relatively
heavy oil (approximately 18o API).  This field has nineteen wellbores,
most of which have the potential to be productive.  For the year ended
February 28, 2009, we had commercial production from eight
wellbores.





From
December 2006 through March 2007, we incrementally increased our working
interest in this project from 2.5% to 12.5%.  On June 1, 2007, we
became the operator of the East Gilbertown Field.  Our original plans
were to increase production by working over non-producing
wellbores.  As of February 28, 2009, we had spent $420,615 in
leasehold, production and workover costs associated with this
field.  Because of the current low prices for oil, we have fully
impaired our capitalized cost in this property.





On April
29, 2009, we signed an agreement to sell our interest in the East Gilbertown
Field to a third party for $50,000 and other considerations.  The closing
date for this sale is scheduled for June 1, 2009.  This sale will
improve our cash reserves and allow us to focus on projects that better meet our
corporate goals and objectives.





Reserves





At March
1, 2009, using the current price for oil, the East Gilbertown Field was not
economic.  As a result, we have no proved reserves in the East
Gilbertown Field according to SEC guidelines as determined by the certified
independent engineering firm, Huddleston & Co., Inc.





Louisiana
(Tuscaloosa Project and Krotz Springs Field)





TuscaloosaProject.  On January 18, 2008 we signed a purchase and sale
agreement (“PSA”) for the sale of our Tensas and Franklin  Parish
interests (the “Tuscaloosa Project”) for $8 million in cash.  The
transaction closed in three tranches; the first closing for $2 million occurred
on January 18, 2008; the second closing for $500,000 occurred on April 30, 2008;
and the final closing for $5.5 million occurred on June 12, 2008 and was subject
to customary closing adjustments.


















11


The sale
included Daybreak's interests in the Tensas Farms et al F-1, F-3, B-1, A-1 and
F-2 wells; and all of our acreage and infrastructure in the project
area.  Under terms of the PSA, the effective date for each closing was
January 1, 2008. For more information on this project refer to the discussion
under discontinued operations in the MD&A section of this 10-K
report.





Reserves





As a
result of the sale of this property, on March 1, 2009 we had no proved
reserves.





St. Landry
Parish.The Krotz Springs Field is a gas play with current
production coming from a Cockfield Sands reservoir. We were the operator for
this project during the drilling and completion phases.  When
production commenced in May of 2007, the unitized field operator of the Krotz
Springs Field became the operator of this well.  Total project
drilling and completion costs were approximately $9.2 million.  We
have a 12.5% working interest in this project, with a net revenue interest
(“NRI”) of 9.125%.  As of February 28, 2009, we had spent $1.27
million in leasehold, drilling, completion and production costs associated with
this project. In December 2008, we participated in the installation of a gas
lift system.  The gas lift system did not increase the gas production
from the current producing reservoir and currently the well is shut
in.  We will attempt to farm out our interest in this
property.  We do not anticipate any further capital spending on this
property.  Because of the current low prices for gas and oil, we have
fully impaired our capitalized cost in this property.





Reserves





At March
1, 2009, we had no proved reserves in the Krotz Springs Field according to SEC
guidelines as determined by the certified independent engineering firm,
Huddleston & Co., Inc.





North Shuteston.The North
Shuteston Project, is a 3-D seismic supported shallow amplitude anomaly at a
depth of 2,300 feet.  This anomaly is related to a Miocene Age
Sand.  On April 23, 2008, we conveyed our interest in this project to
another party in exchange for a two percent (2.0%) overriding royalty interest
(ORRI) in the production revenue from the start of production. As of February
28, 2009, there has been no production established from this
property.





Avoyelles
Parish. The Avoyelles Parish Project is a Cretaceous target
positioned beneath an existing oilfield that has produced over 28 million
barrels of oil.  The project’s focus is on the broad northeast flank
of the Cretaceous structure, targeting the Massive Sand of the Lower Tuscaloosa
and the Fractured Lower (Austin) Chalk.  Plans call for a 3-D seismic
survey covering about 36 square miles.  Effective February 28, 2009,
we withdrew from this project due to an estimated large capital commitment and
assigned our interest to a third party.





Texas
(Saxet Deep Field)





Nueces
County.  In November 2005, we agreed to jointly participate in
a five well re-entry project in the Saxet Deep Field a previously produced
oilfield, on a developed 320 acre lease.  The project is located
within the city limits of Corpus Christi, Texas.  We had a variable
working interest in the project, with an average well working interest of 25.24%
and an NRI of 14.25% on all production from these wells.














12


During
the year ended February 28, 2009, we experienced increasing costs and declining
production, and as a result the field became uneconomic.  Effective
December 31, 2008, we assigned our interest to the operator in exchange for a
release of all future liability.





Reserves





As a
result of our assigning our interest to the Saxet Deep Field operator, we have
no proved reserves in the Saxet Deep Field as of March 1, 2009.





Total Reserves from all
Projects





At March
1, 2009, we had an aggregate amount of net proved reserves of 17,250 Bbls. of
oil from all of our projects according to SEC guidelines as determined by the
certified independent engineering firm, Huddleston & Co., Inc.





Summary
Operating Data





The
production and revenue shown in the following table is Daybreak’s net share of
annual production volume and revenue in each project as of February 28,
2009.  Oil is shown in barrels (“Bbl”), and natural gas is shown in
thousands of cubic feet (“Mcf”).




Oil
                                    
                                    
                                    Gas
                                    
                                    
                                    TotalState
                                    Field
                                    
                                    Net
      Bbl
                                    
                                    
                                    Net
      Revenue
                                    
                                    
                                    Net
      Mcf**
                                    
                                    
                                    Net
      Revenue
                                    
                                    
                                    RevenueCalifornia
                                    East
      Slopes
                                    
                                    
                                    44
                                    
                                    
                                    
                                    1,290
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    1,290Alabama
                                    East
      Gilbertown
                                    
                                    
                                    2,344
                                    
                                    
                                    $
                                    148,741
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    148,741Louisiana
                                    Krotz
      Springs
                                    
                                    
                                    24
                                    
                                    
                                    
                                    2,725
                                    
                                    
                                    
                                    14,743
                                    
                                    
                                    
                                    49,156
                                    
                                    
                                    
                                    51,8812,412
                                    
                                    
                                    $
                                    152,756
                                    
                                    
                                    
                                    14,743
                                    
                                    
                                    $
                                    49,156
                                    
                                    
                                    $
                                    201,912





** Gas
per Mcf (Thousand cubic feet) includes natural gas liquids (wet gas) if
any.





The
following table shows the average sales price per unit of oil and natural gas as
well as the average cost of production in barrels of oil equivalent (“BOE”)
conversion, for the past three fiscal years for continuing
operations.  One barrel of oil is roughly equivalent to 6,000 cubic
feet of natural gas.  Oil is shown in barrels (“Bbl”), and natural gas
is shown in thousands of cubic feet (“Mcf”).





Average
      Sales Price
                          
                          
                          Average
      CostOil (Bbl)
                          
                          
                          Gas (Mcf)**
                          
                          
                          BOE
                          
                          
                          of
      ProductionFebruary
      28, 2007
                          
                          $
                          35.40
                          
                          
                          
                          -
                          
                          
                          
                          35.40
                          
                          
                          $
                          26.47February
      29, 2008
                          
                          $
                          56.13
                          
                          
                          
                          3.00
                          
                          
                          
                          21.67
                          
                          
                          $
                          14.21February
      28, 2009
                          
                          $
                          63.31
                          
                          
                          
                          3.33
                          
                          
                          
                          41.47
                          
                          
                          $
                          26.01





** Gas
per Mcf (Thousand cubic feet) includes natural gas liquids (wet gas) if
any.





13


The
following table shows the developed and undeveloped oil and gas lease acreage
held by us as of February 28, 2009.  Undeveloped acres are acres on
which wells have not been drilled or completed to a point that would permit the
production of commercial quantities of oil and gas.  Gross acres are
the total number of acres in which we have an interest. Net acres are the sum of
our fractional interests owned in the gross acres.




Developed
      Acres
                      
                      
                      Undeveloped
      AcresLocation
                      
                      Gross
                      
                      
                      Net
                      
                      
                      Gross
                      
                      
                      NetCalifornia
                      
                      
                      1,514
                      
                      
                      
                      379
                      
                      
                      
                      27,777
                      
                      
                      
                      9,194Alabama
                      
                      
                      2,025
                      
                      
                      
                      253
                      
                      
                      
                      -
                      
                      
                      
                      -Total
                      
                      
                      3,539
                      
                      
                      
                      632
                      
                      
                      
                      27,777
                      
                      
                      
                      9,194




The
following table summarizes our productive oil and gas wells as of February 28,
2009. Productive wells are producing wells and wells capable of
production.  Gross wells are the total number of wells in which we
have an interest.  Net wells are the sum of our fractional interests
owned in the gross wells.




State
                Field
                
                Gross
                
                
                NetCalifornia
                East
      Slopes
                
                
                2
                
                
                
                0.50Alabama
                Gilbertown
                
                
                17
                
                
                
                2.13Louisiana
                Krotz
      Springs
                
                
                1
                
                
                
                0.38Total
                
                
                
                20
                
                
                
                3.01





The
following table shows our exploratory well drilling activity for the years ended
February 29, 2008 and February 28, 2009.




Fiscal
      Year 2009
                                  
                                  Fiscal
      Year 2008State
                                  
                                  Productive
                                  
                                  Dry
                                  
                                  Productive
                                  
                                  DryCalifornia
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Louisiana
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1
                                  
                                  
                                  
                                  1Total
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  2
                                  
                                  
                                  
                                  1
                                  
                                  
                                  
                                  1











14


ITEM 3. LEGAL
PROCEEDINGS




In a
lawsuit filed on January 12, 2008, in East Baton Rouge Parish, State of
Louisiana, entitled, “Daybreak Oil and Gas, Inc. v. California Oil & Gas
Corporation, Suit No. 562933, Section 24, 19th
Judicial District Court,” Daybreak sought judgment for the full balance of
$587,465 owed under a joint operating agreement for the Krotz Springs Field
project, together with legal interest thereon from the date of judicial demand
until paid, for reasonable attorney fees on both principal and interest, and all
costs of the proceedings.





Under the
Krotz Springs Field joint operating agreement, California Oil & Gas
Corporation (“COGC”) was responsible for twenty-five percent (25%) of the
working interest costs of the drilling and completion of the KSU # 59 ( formerly
Haas-Hirsch #1) well in the Krotz Springs Field project.  As part of
the drilling and completion of the KSU # 59 well, Daybreak incurred certain
costs and expenses on behalf of the various working interests associated with
the well.  COGC was periodically sent invoices for its 25% share of
these costs.  COGC has made partial payments pursuant to these
periodic invoices, but has not made full payment.





As a
result, Daybreak filed this lawsuit and service of this lawsuit was perfected on
COGC in Calgary, Alberta, Canada.  On November 17, 2008, a hearing was
held in which Daybreak requested a summary judgment against COGC. The request
was granted and on December 9, 2008, a written order for summary judgment
against COGC was entered by the court. Effective May 2, 2009, COGC assigned its
undeveloped interest in Dyer Creek and S.E. Edison Projects in Kern County,
California and undeveloped leases in Tulare County California, along with the
COGC interest in the Krotz Springs Field to satisfy the judgment. Daybreak has
received $166,891 from the net production revenue in the Krotz Springs Field as
of February 28, 2009.





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





During
the fourth quarter of the fiscal year ended February 28, 2009, we did not have
any matters submitted to a vote of our security holders of the
Company.





















15


PART II





ITEM 5. MARKET FOR COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASE OF EQUITY
SECURITIES





Our
Common Stock is quoted in the over-the-counter market on the OTC Bulletin Board
under the symbol “DBRM.OB”.  From July 2007 to December 13, 2007, our
stock was quoted in the OTC pink sheet market, due to SEC filing
delinquencies.  We returned to being quoted on the OTC Bulletin Board
market after the filing of our second fiscal quarter 2008 10-QSB
report.  The following table shows the high and low closing sales
prices for our Common Stock for the two most recent fiscal years.  The
quotations reflect inter-dealer prices, without retail mark-up, markdown or
commission and may not represent actual transactions.  The information
is derived from information received from online stock quotation
services.




Fiscal Year EndingFebruary 29, 2008
                                    
                                    High
      Closing
                                    
                                    
                                    Low
      ClosingFirst
      Quarter
                                    
                                    $
                                    0.95
                                    
                                    
                                    $
                                    0.48Second
      Quarter
                                    
                                    $
                                    0.70
                                    
                                    
                                    $
                                    0.39Third
      Quarter
                                    
                                    $
                                    0.62
                                    
                                    
                                    $
                                    0.35Fourth
      Quarter
                                    
                                    $
                                    0.45
                                    
                                    
                                    $
                                    0.25Fiscal Year EndingFebruary 28, 2009
                                    
                                    High
      Closing
                                    
                                    
                                    Low
      ClosingFirst
      Quarter
                                    
                                    $
                                    0.51
                                    
                                    
                                    $
                                    0.24Second
      Quarter
                                    
                                    $
                                    0.51
                                    
                                    
                                    $
                                    0.29Third
      Quarter
                                    
                                    $
                                    0.33
                                    
                                    
                                    $
                                    0.16Fourth
      Quarter
                                    
                                    $
                                    0.20
                                    
                                    
                                    $
                                    0.07





As of
February 28, 2009, the Company had 2,246 shareholders of record.  This
number does not include an indeterminate number of shareholders whose shares are
held by brokers in street name.





Dividend
Policy





The
Company has not declared or paid cash dividends or made distributions in the
past, and the Company does not anticipate that it will pay cash dividends or
make distributions in the foreseeable future.





Recent
Sales of Unregistered Securities





Common
Stock Warrants





During
the fiscal year ended February 28, 2009, Daybreak issued “goodwill” common stock
warrants to the participants of the two private placement offerings that were
held during 2006, which we refer to as the “Spring 2006” and “July 2006” private
placements.  The warrants were issued as a goodwill gesture to
investors in the private placements due to the inability to complete the
respective registration statements.








16


Each
participant from both the Spring 2006 and the July 2006 private placements was
offered one “goodwill” warrant for every unit that had been purchased in
exchange for waiving their rights under Registration Rights Agreement associated
with each private placement offering.  As of February 28, 2009, we
have received waiver letters from approximately 84% of the participants in these
two private placements.  The warrants will expire on February 14,
2010, have an exercise price of $0.65 and contain a cashless exercise
provision.  We have currently issued 4,478,198 goodwill warrants
valued at $997,733 to these investors.  A total of 5,413,367 warrants
could potentially be issued if we received waiver letters from all of the
investors in the two private placements.  The warrants were valued
using the Black-Scholes option pricing model.  The assumptions used in
the Black-Scholes valuation model varied depending on when the waiver letters
were received by the Company. The risk free interest rate of averaged 3.7 %;
with a declining term to expiration; average volatility of 121.67%; and dividend
yield of 0.0%.





Private
Placement Sale





On May
22, 2008, Daybreak closed an unregistered offering of its common stock through a
private placement under the securities transaction exemption Regulation D Rule
506 of the Securities Act of 1933.  Shares were offered at $0.25 per
share to “accredited investors” only as defined in Regulation D under the
Securities Act of 1933.  For the year ended February 28, 2009, a total
of 60,000 shares of unregistered common stock were sold directly by the Company
to two investors for $15,000. Net proceeds were used to meet leasehold expenses
in California and general and administrative expenses.





Securities
Authorized for Issuance under Equity Compensation Plan





The
following table provides information regarding outstanding restricted stock
awards for the fiscal year ended February 28, 2009.  The Company has
not awarded any restricted stock units.  The Company has no qualified
or nonqualified stock option plans and has no outstanding stock
options.




Equity
      Compensation Plan InformationPlan
      Category
                              Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
                              Weighted-average
      exercise price of outstanding options, warrants and rights
                              Number
      of securities remaining available for future issuance under equity
      compensation plansEquity
      compensation plans approved by security holders
                              -
                              -
                              -Equity
      compensation plans not approved by security holders(1)
                              -
                              -
                              2,100,000(2)Total
                              -
                              -
                              2,100,000(2)





(1)
            On
      April 6, 2009, the Board of Directors approved the 2009 Restricted Stock
      and Restricted Stock Unit Plan, as described in detail below, under the
      heading “2009 Restricted Stock and Restricted Stock Unit
      Plan”.




(2)
            Reflects
      initial 4,000,000 shares in the 2009 Restricted Stock and Restricted Stock
      Unit Plan, reduced by (i) 900,000 shares of restricted stock awarded to
      the Company’s non-employee directors in recognition of their leadership
      and contribution during the restructuring and transformation of the
      Company during the fiscal year ended February 28, 2009, and (ii) 1,000,000
      shares of restricted stock awarded to our current President and Chief
      Executive Officer and our former interim President and Chief Executive
      Officer in recognition of past service as executive
    officers.









17


2009
Restricted Stock and Restricted Stock Unit Plan





On April
6, 2009, the Board of Directors approved the 2009 Restricted Stock and
Restricted Stock Unit Plan (the “Plan”), allowing the executive officers,
directors, consultants and employees of the Company and its affiliates (“Plan
Participants”) to be eligible to receive restricted stock and restricted stock
units awards under our 2009 Restricted Stock and Restricted Stock Unit Plan (the
“2009 Plan”), as a means of providing management with a continuing proprietary
interest in the Company.  There are no predeterminations established
for restricted stock or restricted stock units to be awarded to our named
executive officers or employees.





We
believe that awards of this type further the mutuality of interest between our
employees and our shareholders by providing significant incentives for these
employees to achieve and maintain high levels of
performance.  Restricted stock and restricted stock units also enhance
our ability to attract and retain the services of qualified
individuals.





Under the
2009 Plan, we may grant up to 4,000,000 shares.  The Board delegated
the administration of the 2009 Plan to the Compensation
Committee.  The Compensation Committee will have the power and
authority to select Plan Participants and grant awards of restricted stock and
restricted stock units (“Awards”) to such Plan Participants pursuant to the
terms of the 2009 Plan.  Awards may be in the form of actual shares of
restricted common stock or hypothetical restricted common stock units having a
value equal to the fair market value of an identical number of shares of common
stock.  Unless otherwise provided by the Compensation Committee in an
individual Award agreement, Awards under the 2009 Plan vest 25% on each of the
first four anniversaries of the date of grant and the unvested portion of any
Award will terminate and be forfeited upon termination of the Plan Participant’s
employment or service.





Subject
to the terms of the 2009 Plan and the applicable Award agreement, the recipients
of restricted stock generally will have the rights and privileges of a
shareholder with respect to the restricted stock, including the right to vote
the shares and to receive dividends, if applicable.  The recipients of
restricted stock units will not have the rights and privileges of a shareholder
with respect to the shares underlying the restricted stock unit award until the
award vests and the shares are received.  The Compensation Committee
may, at its discretion, withhold dividends attributed to any particular share of
restricted stock, and any dividends so withheld will be distributed to the Plan
Participant upon the release of restrictions on such shares in cash, or at the
sole discretion of the Compensation Committee, in shares of common stock having
a fair market value equal to the amount of such dividends.  Awards
under the 2009 Plan may not be assigned, alienated, pledged, attached, sold or
otherwise transferred or encumbered by a Plan Participant other than by will or
by the laws of descent and distribution.





Change
in Control




Unless
otherwise provided in an Award agreement, in the event of a Change in Control
(as defined in the 2009 Plan) of the Company, the Compensation Committee may
provide that the restrictions pertaining to all or any portion of a particular
outstanding Award will expire at a time prior to the change in
control.  To the extent practicable, any actions taken by the
Compensation Committee to accelerate vesting will occur in a manner and at a
time which will allow affected Plan Participants to participate in the change in
control transaction with respect to the common stock subject to their
Awards.











18


Amendment
and Termination




The Board
at any time, and from time to time, may amend or terminate the 2009 Plan;
provided, however, that such amendment or termination shall not be effective
unless approved by the Company’s shareholders to the extent shareholder approval
is necessary to comply with any applicable tax or regulatory
requirements.  In addition, any such amendment or termination that
would materially and adversely affect the rights of any Plan Participant shall
not to that extent be effective without the consent of the affected Plan
Participant.  The Compensation Committee at any time, and from time to
time, may amend the terms of any one or more Awards; provided, however, that the
Compensation Committee may not effect any amendment which would materially and
adversely affect the rights of any Plan Participant under any Award without the
consent of such Plan Participant.





Common
Stock





The
Company is authorized to issue 200,000,000 shares of Common Stock with a par
value of $0.001 of which 44,293,299 were issued as of February 29,
2008.  At February 28, 2009, a total of 45,079,899 shares were
issued and outstanding.  All shares of Common Stock are equal to each
other with respect to voting, liquidation, dividend and other
rights.  Owners of shares of Common Stock are entitled to one vote for
each share of Common Stock owned at any shareholders'
meeting.  Holders of shares of Common Stock are entitled to receive
such dividends as may be declared by the Board of Directors out of funds legally
available therefor; and upon liquidation, are entitled to participate pro rata
in a distribution of assets available for such a distribution to
shareholders.





There are
no conversion, preemptive, or other subscription rights or privileges with
respect to any shares of our Common Stock.  Our stock does not have
cumulative voting rights, which means that the holders of more than fifty
percent (50%) of the shares voting in an election of directors may elect all of
the directors if they choose to do so.  In such event, the holders of
the remaining shares aggregating less than fifty percent (50%) would not be able
to elect any directors.





Preferred
Stock





The
Company is authorized to issue 10,000,000 shares of Preferred Stock with a par
value of $0.001 of which none had been issued as of February 28,
2006.  Our Preferred Stock may be entitled to preference over the
Common Stock with respect to the distribution of assets of the Company in the
event of liquidation, dissolution, or winding-up of the Company, whether
voluntarily or involuntarily, or in the event of any other distribution of
assets of the Company among its shareholders for the purpose of winding-up its
affairs.  The authorized but unissued shares of Preferred Stock may be
divided into and issued in designated series from time to time by one or more
resolutions adopted by the Board of Directors.  The directors in their
sole discretion shall have the power to determine the relative powers,
preferences, and rights of each series of Preferred Stock.





On June
30, 2006, in action by the Board of Directors, 2,400,000 of these preferred
shares were designated as Series A Convertible Preferred.  In July
2006, we completed a private placement of the Series A Convertible Preferred
that resulted in the issuance of 1,399,765 shares.  At February 28,
2009, there were 1,060,465 shares issued and outstanding.  There were
a total of 237,000 shares that were converted to our Common Stock during the
fiscal year.











19


Series
A Convertible Preferred Stock





The
following is a summary of the rights and preferences of the Series A Convertible
Preferred Stock.





Conversion:


The
preferred shareholder shall have the right to convert the Series A Convertible
Preferred Stock into the Company’s Common Stock at any time.  Each
share of Preferred Stock is convertible into three (3) shares of Common
Stock.





Automatic
Conversion:


The
Series A Convertible Preferred Stock shall be automatically converted into
Common Stock if the Common Stock into which the Series A Convertible Preferred
Stock are convertible are registered with the SEC and at any time after the
effective date of the registration statement the Company’s Common Stock closes
at or above $3.00 per share for twenty (20) out of thirty trading days (30)
days.





Dividend:


Holders
of Series A Convertible Preferred Stock shall be paid dividends, in the amount
of 6% of the Original Purchase price per annum. Dividends may be paid in cash or
Common Stock at the discretion of the Company. Dividends are cumulative from the
date of the Final Closing, whether or not in any dividend period or periods we
have assets legally available for the payment of such
dividends.  Accumulations of dividends on shares of Series A
Convertible Preferred Stock do not bear interest.  Dividends are
payable upon declaration by the Board of Directors.





Voting
Rights:


The
holders of the Series A Convertible Preferred Stock will vote together with the
Common Stock and not as a separate class except as specifically provided herein
or as otherwise required by law.  Each share of the Series A
Convertible Preferred Stock shall have a number of votes equal to the number of
shares of Common Stock then issuable upon conversion of such shares of Series A
Convertible Preferred Stock.





























20


ITEM 6. SELECTED FINANCIAL
INFORMATION





As a
smaller reporting company, we are not required to provide the information
otherwise required by this Item.































































21


ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATION





The
following management’s discussion and analysis (“MD&A”) is management’s
assessment of the historical financial and operating results of Daybreak during
the period covered by the financial statements. This MD&A should be read in
conjunction with the audited financial statements and the related notes and
other information included elsewhere in this 10-K report.





Safe Harbor
Provision





Certain
statements contained in our Management’s Discussion and Analysis of Financial
Condition or Plan of Operation are intended to be covered by the safe harbor
provided for under Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Exchange Act. All statements other than statements of
historical facts contained in this MD&A report, including statements
regarding our current expectations and projections about future results,
intentions, plans and beliefs, business strategy, performance, prospects and
opportunities, are inherently uncertain and are forward-looking statements. To
understand about forward looking statements, please refer to the section labeled
“Cautionary Statement About Forward-Looking Statements” at the beginning of this
10-K report.





Introduction
and Overview





We are an
independent oil and natural gas exploration, development and production
company.  Our basic business model is to increase shareholder value by
finding and developing oil and gas reserves through exploration and development
activities, and selling the production from those reserves at a
profit.  To be successful, we must, over time, be able to find oil and
gas reserves and then sell the resulting production at a price that is
sufficient to cover our finding costs, operating expenses, administrative costs
and interest expense, plus offer us a return on our capital
investment.





As an
exploration stage oil and gas company we have a limited operating history and
minimal proven reserves, production and cash flow.  To date, we have
had limited revenues and have not been able to generate sustainable positive
earnings.  Our management cannot provide any assurances that Daybreak
will ever operate profitably.  As a result of our limited operating
history, we are more susceptible to the numerous business, investment and
industry risks that have been described in Amendment No. 2 of our most recent
report on Form 10-KSB/A to our Annual Report on Form 10-KSB for the fiscal year
ended February 29, 2008 (Item 1. Description of Business – “Risk
Factors”).





Our
longer-term success depends on, among many other factors, the acquisition and
drilling of commercial grade oil and gas properties and on the prevailing sales
prices for oil and natural gas along with associated operating
expenses.





In the
year ended February 28, 2009, and currently, we are experiencing volatile oil
and gas prices that are affected by many factors outside of 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.











22


During
the second half of 2008, global economies began to experience a significant
slowdown sparked by a near-collapse in worldwide financial
markets.  This slowdown has continued to intensify into the first half
of 2009 and is currently being viewed by many economists as the most severe
recession in United States history, other than to the Great
Depression.  The United States government has taken significant steps
to support the financial markets and stimulate the economy in an effort to slow
or reverse the downward spiral of economic indicators, but the success of these
measures and the duration of the current recession cannot be
predicted.





Reduced
demand for energy caused by the current recession has resulted in a significant
deterioration in oil and gas prices, which in turn has led to a significant
reduction in drilling activity throughout the oil and gas
industry.  While the prices we pay for field services are beginning to
decline as a result of reduced demand for those services, the decline in these
prices is generally lagging behind the declines in oil and gas
prices.





As a
result of these lower oil and gas prices, we experienced reductions in operating
margins during the past fiscal year due to lower product prices and still
relatively high capital and operating costs.  The effects of lower
operating margins on our business are significant since they reduce our cash
flow from operations and diminish the present value of our oil and gas
reserves. Lower operating margins also offer us less incentive to assume
the drilling risks that are inherent in our business.





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 in the process of
developing a multi-well oilfield project in California.





During
the past two fiscal years, we have been involved in the drilling of eleven wells
in California and Louisiana.  We have achieved commercial production
in six of these projects.  Additionally, we have participated in a
five well workover project in Texas and achieved commercial production in three
of these wellbores.





Liquidity
and Capital Resources




Liquidity
is the ability to convert assets into cash or to obtain cash. Short-term
liquidity refers to the ability to meet short-term obligations of 12 months or
less. Liquidity is a matter of degree and is expressed in terms of a
ratio.  Two common liquidity ratios in financial statement analysis
are:  Working Capital and Current Ratio.




Our
working capital (current assets minus current liabilities) and current ratio
(current assets divided by current liabilities) are as follows:





February
      28, 2009
                
                
                February
      29, 2008Current
      Assets
                
                $
                2,784,213
                
                
                $
                1,049,217Current
      Liabilities
                
                $
                356,307
                
                
                $
                316,253Working
      Capital
                
                $
                2,427,906
                
                
                $
                732,964Current
      Ratio
                
                
                7.81
                
                
                
                3.32






23


The chart
below shows the corresponding current ratio for previous accounting periods by
quarter for the last two fiscal years.









While the
working capital and current ratio are important in looking at the financial
health of a business, numerous other factors may also affect the liquidity and
capital resources of a company.





Our
working capital increased $1,694,942, from $732,964 as of February 29, 2008 to
$2,427,906 as of February 28, 2009.  This increase was principally due
to the receipt of funds from the sale of our Tuscaloosa Project in
Louisiana.





Our
business is capital intensive.  Our ability to grow is dependent upon
favorably obtaining outside capital and generating cash flows from operating
activities to necessary to fund our investment activities.  As of
February 28, 2009, 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. This was a major factor in
our decision to accept an offer to sell our working interest in the Tuscaloosa
Project for $8 million.




During
the fiscal year ended February 28, 2009, we reported an operating loss of $4.3
million as compared with an operating loss of $4.5 million from the prior year.
The gain on the sale of our Tuscaloosa Project in Louisiana and the disposal of
the Saxet Deep Field in Texas resulted in a net loss for the year ended February
28, 2009 of $130,497 as compared to a net loss of $5.2 million from the prior
year. There is no assurance that we will be able to achieve profitability. Since
our future operations will continue to be dependent on successful exploration
and development activities and our ability to seek and secure capital from
exterior sources, should we be unable to achieve sustainable profitability this
could cause any equity investment in the Company to become
worthless.




We have
repositioned Daybreak during the years ended February 28, 2009 and February 29,
2008 to better meet our corporate goals and objectives by selling our Tuscaloosa
Project and the Saxet Deep Field.  We also have an agreement to sell
our East Gilbertown Field, which we expect to close on June 1,
2009.  These actions have allowed us to move forward with our drilling
and exploration program in California.




Our
sources of funds in the past have included the debt or equity markets and while
we have had cash flow from operations, we have not yet established sustainable
positive cash flow from those operations. We may again have to rely on the debt
or equity markets to fund future operations.  Our business model is
focused on acquiring exploration or development properties and also acquiring
existing producing properties.




24


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 may very likely require us to continue to raise equity or debt capital
from outside sources.




The net
funds provided by and used in each of our operating, investing and financing
activities are summarized in the following table:





For
      the Year EndedNet
      Cash Provided by or (Used in)
                                  
                                  February 28, 2009
                                  
                                  
                                  February 29, 2008Operating
      activities
                                  
                                  $
                                  (2,791,659
                                  )
                                  
                                  $
                                  (1,302,213
                                  )Investing
      activities
                                  
                                  
                                  5,000,636
                                  
                                  
                                  
                                  576,574Financing
      activities
                                  
                                  
                                  14,700
                                  
                                  
                                  
                                  406,815Net
      change in cash
                                  
                                  $
                                  2,223,677
                                  
                                  
                                  $
                                  (318,824
                                  )





Cash
Flow Used in Operating Activities





Substantially
all of our cash flow from operating activities is derived from the production of
our oil and gas reserves. For the year ended February 28, 2009 we had a negative
cash flow from operations of $2.8 million in comparison to a negative cash flow
of $1.3 million from the prior year.  This larger negative cash flow
was primarily caused by (1) lower depreciation, depletion, amortization
(“DD&A”) and impairment charges due to the disposal of our Tuscaloosa
Project and the Saxet Deep Field, (2) decrease in funds held as marketable
securities; and (3) lower accounts payable balances.  Additionally,
our accounts receivable from our working interest partners at our East
Gilbertown Field increased in comparison to the prior year due to the untimely
payments of their share of the monthly operating cost of the
field.  Variations in cash flow from operating activities can directly
impact our level of exploration and development expenditures.





Cash
Flow Provided by Investing Activities





Cash flow
provided by investing activities increased by $4.4 million to $5.0 million in
comparison to $0.6 million from the prior year.  This increase was due
directly to the sale of our Tuscaloosa Project property in Louisiana and the
Saxet Deep Field project in Texas.





Cash
Flow Provided by Financing Activities





Cash flow
provided by financing activities decreased by $392,115 to $14,700 in comparison
to $406,815 from the prior year.  This decrease was directly due to
the fact that for the year ended February 29, 2008, we conducted a private
placement sale of our common stock to raise funds for operating
capital.  The only financing activity that occurred in the year ended
February 28, 2009 was the last two transactions of the private placement
sale.





A major
source of funds for Daybreak in the past has been through the debt or equity
markets.  Since we have currently been unable to establish sustained,
profitable oil and gas operations this may also have to be a source of funds in
the future along with the sale of possible oil and gas assets as deemed
appropriate.  Our business model is focused on acquiring exploration
and developmental properties as well as existing
production.












25


Our
ability to generate future revenues and operating cash flow will depend on
successful exploration, and/or acquisition of profitable oil and gas producing
properties, which will very likely require us to continue to raise equity or
debt capital from sources outside of the Company.





Daybreak
has ongoing capital commitments to develop certain leases pursuant to their
underlying terms.  Failure to meet such ongoing commitments may result
in the loss of the right to participate in future drilling on certain leases or
the loss of the lease itself.  These ongoing capital commitments may
also cause us to seek additional capital from sources outside of the
Company.  The current uncertainty in the credit and capital markets,
and the potential economic downturn, may restrict our ability to obtain needed
capital.





Changes
in Financial Condition and Results of Operations





We
maintain our cash balance by increasing or decreasing our exploration and
drilling expenditures as limited by availability of cash from operations and
investments. The cash balance for the year ended February 28, 2009 was
$2,282,810.  The chart below shows the corresponding balances for
previous accounting periods by quarter for the last two fiscal
years.










The cash
balance declined during the fiscal year from a highpoint of $5,179,423 in the
second quarter to the fiscal year-end balance of $2,282,210.  This
decrease was primarily due to exploration and development expenditures in
California; plugging and abandonment activities in Alabama; on-going general and
administrative expenses; and lower revenues due to depressed energy
prices.





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











26


Selected Financial
Information





Since our
inception, we have incurred recurring losses from operations with negative cash
flow and have depended on external financing to sustain our
operations.  During the fiscal year ended February 28, 2009, we
reported losses from continuing operations of $4,266,377 with a net loss for the
year of $130,497.  There is no assurance that we will be able to
achieve profitability.  The chart below shows the corresponding net
loss for previous accounting periods by quarter for the last two fiscal
years.










Our
balance sheet on February 28, 2009 shows total assets of $3,538,523 comprised
primarily of cash of $2,282,810; accounts receivable (including trade and joint
interest participants) of $498,513; oil and gas properties (net of Depreciation,
Depletion, Amortization and Impairment) of $356,280.  This compares
with the February 29, 2008 balances for oil and gas properties (including assets
held for sale) of $1,804,192; cash and marketable securities of $214,578 and
accounts receivable of $1,313,697.  The above changes can be
attributed to the sale of both our Tuscaloosa Project property in Louisiana and
our Saxet Deep Field property in Texas.  Additionally, we have settled
an outstanding receivable with a working interest partner who was in default on
the Krotz Springs Field project in Louisiana.





At
February 28, 2009, we had total liabilities of $376,318, comprised of $356,307
in accounts payable and $20,011 in asset retirement obligation (ARO) as compared
with the February 29, 2008 balances for total liabilities of $435,460, comprised
of $316,253 in accounts payable and $119,207 in ARO, of which $104,093 is
reflected as “Liabilities associated with assets held for sale”.





Our
common stock issued and outstanding has increased by 786,600 shares during the
last fiscal year primarily as a result of conversions from our Series A
Convertible Preferred stock and a small private placement
sale.  Series A Convertible Preferred stock decreased by 237,000
shares to 1,060,465 as of February 28, 2009, compared to 1,297,465 as of
February 29, 2008.





Accumulated
Deficit





Our
financial statements for the year ended February 28, 2009 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. Our financial
statements also state that Company has incurred significant operating losses
that raise substantial doubt about our ability to continue as a going concern.
The accompanying financial statements do not include any adjustments that might
result from this uncertainty.










27


The
increase in the accumulated deficit during the exploration stage from
$18,064,765 as of February 29, 2008, to $18,195,262 was due to the $130,497 net
loss for the year ended February 28, 2009.  The loss from continuing
operations for the year decreased by $383,784 to $4,266,377 in comparison to the
$4,650,161 from the year ended February 29, 2008.





Management Plans to Continue as a
Going Concern





Implementation
of plans to enhance our ability to continue as a going concern are
underway.  On May 1, 2009, we signed an Exchange Option Agreement with
a third party, which gives that third party (i) a 30 day option to purchase a
25% working interest for $512,500, (ii) commits to a payment in an amount equal
to $700,000 to be payable out of production from (a) 25% of the net revenue from
the Sunday #1 and Bear #1 wells and (b) 50% of the net revenue from all future
wells.  The third party will also assign us a 25% working interest in
14,100 acres in Kern County, California that is immediately north of our East
Slopes project area. When this sale is completed, we plan to expand our
developmental drilling program at a rate that is compatible with our cash
flow.





On April
29, 2009, we signed an agreement to sell our interest in the East Gilbertown
Field to a third party for $50,000 and other considerations.  The closing
date for this sale is scheduled for June 1, 2009. After this sale is
complete, we will recover a $250,000 in cash collateral that was posted to
secure an operator bond in Alabama.  As a result of these two
transactions our liquidity will be substantially improved.  In
addition, we believe we have the ability to secure additional debt or equity
funding, if necessary.  We cannot offer any assurances that we will be
successful in executing the aforementioned plans to continue as a going
concern.





Fiscal
Year 2009 compared to Fiscal Year 2008 – Continuing Operations





This
discussion comparing the year ended February 28, 2009 (“2009”) results with year
ended February 29, 2008 (“2008”) results covers our continuing operations in the
East Slopes Project in California, the East Gilbertown Field in Alabama and the
Krotz Springs Field in Louisiana.





Revenues.Our
revenues are derived entirely from the sale of our share of oil and gas
production from our producing wells.  Prior to January 2007, we had no
revenues from continuing operations projects.





A table
of our revenues for the year 2009 compared to the year 2008
follows:





2009
                  
                  
                  2008California
      – East Slopes
                  
                  
                  1,290
                  
                  
                  
                  -Alabama
      – East Gilbertown
                  
                  $
                  148,741
                  
                  
                  $
                  119,740Louisiana
      – Krotz Springs
                  
                  
                  51,881
                  
                  
                  
                  74,209Total
      Revenues
                  
                  $
                  201,912
                  
                  
                  $
                  193,949




For the
year ended February 28, 2009, the East Slopes Project which realized its first
revenue in February 2009, represented 0.6% of total revenues.  The East
Gilbertown Field in Alabama revenues represented 73.7% of total
revenues.   The Krotz Springs Field in Louisiana revenues
represented 25.7% of total revenues.  For the year ended February 28,
2009, total revenues from continuing operations increased 4.1% in comparison
with the year ended February 29, 2008.




28


The
revenues we recorded for the year ended February 28, 2009 represented our
interests in ten producing wells.





Costs and
Expenses: Total operating expenses declined by 3.8% or $178,819 for
the fiscal year ended February 28, 2009 as compared to the year ended February
29, 2008.  The decreases in DD&A of $801,595 and G&A of
$40,866 were offset by increases in production costs of $13,513 and exploration
and drilling of $650,129.  The increase in exploration and drilling
was due to drilling activity in California and the recognition that two of the
four exploratory wells drilled were dry holes.





A table
of our costs and expenses for the year 2009 compared to the year 2008
follows:





Fiscal
      Year 2009
                        
                        
                        Fiscal
      Year 2008Production
      Costs
                        
                        $
                        158,413
                        
                        
                        $
                        144,900Exploration
      Costs
                        
                        
                        1,304,894
                        
                        
                        
                        654,765Depreciation,
      Depletion,Amortization & Impairment
                        
                        
                        556,651
                        
                        
                        
                        1,358,246General
      & Administrative
                        
                        
                        2,483,681
                        
                        
                        
                        2,524,547Total
      Operating Expenses
                        
                        $
                        4,503,639
                        
                        
                        $
                        4,682,458





Expenses
incurred by the Company include production costs associated directly with the
generation of oil and gas revenues (also including well workover projects and
plugging and abandonment activities); unsuccessful exploratory drilling; lease
rentals; depreciation, depletion, amortization and impairment charges; and,
general and administrative expenses (including legal and accounting expenses,
director and management fees, investor relations expenses, and other general and
administrative costs).





Production
costs increased $13,513 or 9.3% for the year ended February 28, 2009 and relates
directly to a remedial work project that was undertaken to improve production
volumes in the Krotz Springs Field.





Exploration
expenses increased $650,129 or 99.3% from the year ended February 29,
2008.  The majority of this increase was because two dry holes were
drilled in California.  For the year ended February 28, 2009, we
drilled two dry holes compared to one from the year ended February 29,
2008.





Depreciation,
depletion, amortization and impairment expenses decreased $801,595 or 59% from
the year ended February 29, 2008. This decrease was due to having fewer
producing assets because of the sales of both the Tuscaloosa and Saxet Deep
Field properties.  Additionally, the value of our California project
was partially impaired for $369,103 during the year ended February 28, 2009 due
to lower hydrocarbon prices affecting our proved reserves
estimates.





General
and administrative (“G&A”) costs decreased $40,866 or 1.6% from the year
ended February 29, 2008. This decrease was due to increased efforts to limit our
overall administrative costs.  Legal fees, a component of G&A, did
increase by $88,912 or 77.3% to $203,953 because of additional work done to
improve our Corporate Governance procedures and documentation and to update and
amend our Corporate By-Laws and Articles of Incorporation.












29


Additionally,
the two amended filings of our Annual Report on Form 10-KSB contributed to
the  increase in legal fees for the year ended February 29,
2008.  Accounting fees, another component of G&A, declined by
$50,174 or 15.9% to $264,549 as we continued to improve our financial reporting
capabilities.





Interest
and dividend income decreased $9,314 or 19.7% from the prior year due primarily
to lower interest rates being available for cash and investment
balances.





Interest
expense decreased by $206,316 or 98.8% from the prior year due primarily to an
aggressive program to pay off existing debt.





Due to
the nature of our business, as well as the relative immaturity of the business,
we expect 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 dependent
upon the amount of capital that we have to invest in future development
projects, as well as the success or failure of such
projects.  Likewise, the amount of depreciation, depletion,
amortization expense and impairment costs will depend upon the factors cited in
the prior sentence, as well as numerous other factors including general market
conditions.  An immediate goal for this current year is to improve
cash flow to cover the current level of general and administrative
expenses.





Fiscal
Year 2009 compared to Fiscal Year 2008 – Discontinued Operations





This
discussion comparing the year ended February 28, 2009 (“2009”) results with year
ended February 29, 2008 (“2008”) results covers our discontinued operations in
the Tuscaloosa Project in Louisiana and the Saxet Deep Field in
Texas.





On
January 18, 2008 we signed a purchase and sale agreement (“PSA”) for the sale of
our Tuscaloosa Project interests for $8 million dollars. The transaction closed
in three tranches; the first closing of $2 million occurred on January 18, 2008;
the second closing for $500,000 occurred on April 30, 2008; and the final
closing for $5.5 million occurred on June 12, 2008 and was subject to customary
closing adjustments. The sale included Daybreak's interests in the Tensas Farms
et al F-1, F-3, B-1, A-1 and F-2 wells; and all of its acreage and
infrastructure in the project area.  Under terms of the PSA, the
effective date for each closing was January 1, 2008.





On
December 31, 2008, we assigned our interest in the Saxet Deep Field in Corpus
Christi, Texas to the field Operator. This assignment was in exchange for the
release from all future liability of plugging and abandonment.  The
agreement included the release of all liability for any amounts currently owed
to the Operator.  Additionally, the Company agreed to give up any
right to production revenue that had not yet been distributed by the
Operator.











30


Revenues.A table of our
revenues for the year 2009 compared to the year 2008 follows:





Fiscal
      Year 2009
                        
                        
                        Fiscal
      Year 2008Louisiana
      – Tuscaloosa
                        
                        $
                        234,474
                        
                        
                        $
                        775,730Texas
      – Saxet Deep Field
                        
                        
                        77,728
                        
                        
                        
                        172,901Total
      Revenues
                        
                        $
                        312,202
                        
                        
                        $
                        948,631





Total
revenue from discontinued operations declined $636,429 or 67.1%.  The
Tuscaloosa Project revenue decreased by $541,256 or 70.0% and Saxet Deep Field
revenue declined $95,173 or 55.0%.  Revenues from the Tuscaloosa
Project represent the first three months and revenues from the Saxet Deep Field
represent the first ten months of the year ended February 28, 2009.





Costs and Expenses:Total
operating expenses from discontinued operations for both the Tuscaloosa Project
and Saxet Deep Field projects decreased by 1,262,022 or 84.2% for the fiscal
year ended February 28, 2009 as compared to the prior fiscal
year.  This was primarily due to the fact that we did not own these
properties for the entire fiscal year ended February 28, 2009.





A table
of our costs and expenses for the year 2009 compared to the year 2008
follows:





Fiscal
      Year 2009
                        
                        
                        Fiscal
      Year 2008Production
      Costs
                        
                        $
                        169,219
                        
                        
                        $
                        461,340Exploration
      Costs
                        
                        
                        -
                        
                        
                        
                        62,500Depreciation,
      Depletion. Amortization and Impairment
                        
                        
                        67,923
                        
                        
                        
                        975,324Total
      Operating Expenses
                        
                        $
                        237,142
                        
                        
                        $
                        1,499,164




Off-Balance
Sheet Arrangements





As of
February 28, 2009, 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.




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.











31


On an
ongoing basis, we evaluate our estimates, including those related to revenue
recognition, bad debts, cancellation costs associated with long term
commitments, investments, intangible assets, assets subject to disposal, income
taxes, service contracts, contingencies and litigation.  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 developmental 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.











32


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 February 28, 2009
and February 29, 2008.





Suspended
Well Costs





We
account for any suspended well costs in accordance with FASB Staff Position No.
19-1, “Accounting for
Suspended Well Costs” (FSP No. 19-1).  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





Share
based awards are accounted for under SFAS No. 123R, “Share Based Payment”and
related interpretations (“SFAS 123R”).  Under SFAS 123R, compensation
cost for all share based payments granted are based on the grant date fair value
estimated using an option pricing model.  The value of the portion of
the award that is ultimately expected to vest is recognized as expense ratably
over the requisite service periods.




































33


ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK





As a
smaller reporting company, we are not required to provide the information
otherwise required by this Item.








































































34


ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA








REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM











To the
Board of Directors and


Shareholders
of Daybreak Oil and Gas, Inc.


(An
Exploration Stage Company)








We have
audited the accompanying balance sheets of Daybreak Oil and Gas, Inc. (an
exploration stage company) as of February 28, 2009 and February 29, 2008 and the
related statements of operations, stockholders’ equity, and cash flows for the
years then ended and for the period from March 1, 2005 (inception) to February
28, 2009. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform an audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement.  The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Daybreak Oil and Gas, Inc. as of
February 28, 2009 and February 29, 2008 and the results of its operations and
cash flows for the years then ended and for the period from March 1, 2005
(inception) to February 28, 2009, in conformity with accounting principles
generally accepted in the United States of America.





The
accompanying financial statements have been prepared assuming that Daybreak Oil
and Gas, Inc. will continue as a going concern.  As discussed in Note
2 to the financial statements, Daybreak Oil and Gas, Inc. suffered losses from
operations and has negative operating cash flows, which raises substantial doubt
about its ability to continue as a going concern.  Management’s plans
regarding those matters also are described in Note 2.  The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.








/s/
Malone & Bailey PC


www.malone-bailey.com


Houston,
Texas





May 26,
2009





35


DAYBREAK OIL AND GAS, INC.
 (An
Exploration Stage Company, Date of Inception March 1, 2005)
 Balance
Sheets
 As of February 28, 2009 and February
29, 2008


2009
                              
                              
                              2008ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                              
                              $
                              2,282,810
                              
                              
                              $
                              59,133Investment
      in marketable securities, at market, cost of $155,445
                              
                              
                              -
                              
                              
                              
                              155,445Accounts
      receivable:Oil
      and gas sales
                              
                              
                              17,636
                              
                              
                              
                              311,277Joint
      interest participants, net of allowance for doubtfulaccounts
      of $15,103
                              
                              
                              480,877
                              
                              
                              
                              502,420Prepaid
      expenses and other current assets
                              
                              
                              2,890
                              
                              
                              
                              20,942Total
      current assets
                              
                              
                              2,784,213
                              
                              
                              
                              1,049,217OIL
      AND GAS PROPERTIES, net of accumulated depletion,
      depreciation,amortization
      and impairment, successful efforts methodProved
      properties
                              
                              
                              356,280
                              
                              
                              
                              46,499Unproved
      properties
                              
                              
                              -
                              
                              
                              
                              104,700VEHICLES
      AND EQUIPMENT, net of accumulated depreciation of $23,753and
      $13,310 respectively
                              
                              
                              7,576
                              
                              
                              
                              18,019Assets
      held for sale
                              
                              
                              -
                              
                              
                              
                              1,652,793Joint
      interest receivable - long term
                              
                              
                              -
                              
                              
                              
                              500,000OTHER
      ASSETS
                              
                              
                              390,454
                              
                              
                              
                              289,809Total
      assets
                              
                              $
                              3,538,523
                              
                              
                              $
                              3,661,037LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Accounts
      payable and other accrued liabilities
                              
                              $
                              356,307
                              
                              
                              $
                              316,253OTHER
      LIABILITIESAsset
      retirement obligation
                              
                              
                              20,011
                              
                              
                              
                              15,114Liabilities
      associated with assets held for sale
                              
                              
                              -
                              
                              
                              
                              104,093Total
      liabilities
                              
                              
                              376,318
                              
                              
                              
                              435,460COMMITMENTSSTOCKHOLDERS’
      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; 1,060,465 and1,297,465
      shares issued and outstanding respectively
                              
                              
                              1,061
                              
                              
                              
                              1,298Common
      stock- 200,000,000 shares authorized; $0.001 par value,
      45,079,899and
      44,293,299 shares issued and outstanding respectively
                              
                              
                              45,081
                              
                              
                              
                              44,294Additional
      paid-in capital
                              
                              
                              22,047,360
                              
                              
                              
                              21,980,785Accumulated
      deficit
                              
                              
                              (736,035
                              )
                              
                              
                              (736,035
                              )Deficit
      accumulated during the exploration stage
                              
                              
                              (18,195,262
                              )
                              
                              
                              (18,064,765
                              )Total
      stockholders’ equity
                              
                              
                              3,162,205
                              
                              
                              
                              3,225,577Total
      liabilities and stockholders' equity
                              
                              $
                              3,538,523
                              
                              
                              $
                              3,661,037





The
accompanying notes are an integral part of these financial
statements.
 36


DAYBREAK OIL AND GAS, INC.


(An
Exploration Stage Company)
 Statements
of Operations
 For
the Years ended February 28, 2009 and February 29, 2008 and for the
Period
 from
Inception (March 1, 2005) to February 28, 2009


From
      InceptionYears
      Ended
                                        
                                        
                                        ThroughFebruary
      28,
                                        
                                        
                                        February
      29,
                                        
                                        
                                        February
      28,2009
                                        
                                        
                                        2008
                                        
                                        
                                        2009REVENUE:Oil
      and gas sales
                                        
                                        $
                                        201,912
                                        
                                        
                                        $
                                        193,949
                                        
                                        
                                        $
                                        397,971OPERATING
      EXPENSES:Production
      costs
                                        
                                        
                                        158,413
                                        
                                        
                                        
                                        144,900
                                        
                                        
                                        
                                        308,644Exploration
      and drilling
                                        
                                        
                                        1,304,894
                                        
                                        
                                        
                                        654,765
                                        
                                        
                                        
                                        3,483,768Depreciation,
      depletion, amortization, andimpairment
                                        
                                        
                                        556,651
                                        
                                        
                                        
                                        1,358,246
                                        
                                        
                                        
                                        2,130,506General
      and administrative
                                        
                                        
                                        2,483,681
                                        
                                        
                                        
                                        2,524,547
                                        
                                        
                                        
                                        12,847,965Total
      operating expenses
                                        
                                        
                                        4,503,639
                                        
                                        
                                        
                                        4,682,458
                                        
                                        
                                        
                                        18,770,883OPERATING
      LOSS
                                        
                                        
                                        (4,301,727
                                        )
                                        
                                        
                                        (4,488,509
                                        )
                                        
                                        
                                        (18,372,912
                                        )OTHER
      INCOME (EXPENSE):Interest
      income
                                        
                                        
                                        7,671
                                        
                                        
                                        
                                        43,550
                                        
                                        
                                        
                                        153,280Dividend
      income
                                        
                                        
                                        30,256
                                        
                                        
                                        
                                        3,691
                                        
                                        
                                        
                                        39,493Interest
      expense
                                        
                                        
                                        (2,577
                                        )
                                        
                                        
                                        (208,893
                                        )
                                        
                                        
                                        (1,654,824
                                        )Total
      other income (expense)
                                        
                                        
                                        35,350
                                        
                                        
                                        
                                        (161,652
                                        )
                                        
                                        
                                        (1,462,051
                                        )LOSS
      FROM CONTINUING OPERATIONS
                                        
                                        
                                        (4,266,377
                                        )
                                        
                                        
                                        (4,650,161
                                        )
                                        
                                        
                                        (19,834,963
                                        )DISCONTINUED
      OPERATIONSIncome
      (loss) from discontinued operations(net
      of tax of $ -0-)
                                        
                                        
                                        75,060
                                        
                                        
                                        
                                        (550,533
                                        )
                                        
                                        
                                        (2,421,119
                                        )Gain
      from sale of oil and gas properties(net
      of tax of $ -0-)
                                        
                                        
                                        4,060,820
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        4,060,820INCOME
      (LOSS) FROM DISCONTINUEDOPERATIONS
                                        
                                        
                                        4,135,880
                                        
                                        
                                        
                                        (550,533
                                        )
                                        
                                        
                                        1,639,701NET
      LOSS
                                        
                                        
                                        (130,497
                                        )
                                        
                                        
                                        (5,200,694
                                        )
                                        
                                        
                                        (18,195,262
                                        )Cumulative
      convertible preferred stockdividend
      requirement
                                        
                                        
                                        (208,212
                                        )
                                        
                                        
                                        (237,752
                                        )
                                        
                                        
                                        (599,930
                                        )Deemed
      dividend - Beneficial conversion feature
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (4,199,295
                                        )NET
      LOSS AVAILABLE TO COMMONSHAREHOLDERS
                                        
                                        $
                                        (338,709
                                        )
                                        
                                        $
                                        (5,438,446
                                        )
                                        
                                        $
                                        (22,994,487
                                        )NET
      INCOME (LOSS) PER COMMON SHARELoss
      from continuing operations
                                        
                                        $
                                        (0.10
                                        )
                                        
                                        $
                                        (0.11
                                        )Income
      from discontinued operations
                                        
                                        
                                        0.09
                                        
                                        
                                        
                                        (0.01
                                        )NET
      LOSS PER COMMON SHARE - Basicand
      diluted
                                        
                                        $
                                        (0.01
                                        )
                                        
                                        $
                                        (0.13
                                        )WEIGHTED
      AVERAGE NUMBER OFCOMMON
      SHARES OUTSTANDING -Basic
      and diluted
                                        
                                        
                                        44,731,420
                                        
                                        
                                        
                                        41,292,659







The
accompanying notes are an integral part of these financial
statements.
 37


DAYBREAK OIL AND GAS, INC.


(An
Exploration Stage Company)


Statement
of Changes in Stockholders' Equity


For
the Period from Inception (March 1, 2005) through February 28, 2009




Series
      A Convertible
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            AccumulatedPreferred
      Stock
                                                            
                                                            Common
      Stock
                                                            
                                                            Additional
                                                            
                                                            
                                                            
                                                            During
      thePaid-In
                                                            
                                                            Accumulated
                                                            
                                                            ExplorationShares
                                                            
                                                            Amount
                                                            
                                                            Shares
                                                            
                                                            Amount
                                                            
                                                            Capital
                                                            
                                                            Deficit
                                                            
                                                            Stage
                                                            
                                                            TotalBALANCE,
      March 1, 2005 (Explorationstage
      date of inception)
                                                            
                                                            -
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            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
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            1,087,500Services
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            5,352,667
                                                            
                                                            
                                                            5,353
                                                            
                                                            
                                                            3,622,176
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            3,627,529Oil
      and gas properties
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            700,000
                                                            
                                                            
                                                            700
                                                            
                                                            
                                                            411,300
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            412,000Conversion
      of convertible debenturesand interest
payable
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            806,135
                                                            
                                                            
                                                            806
                                                            
                                                            
                                                            200,728
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            201,534Discount
      on convertible notes payable
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            1,240,213
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            1,240,213Net
      loss
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (4,472,041
                                                            )
                                                            
                                                            (4,472,041
                                                            )BALANCE,
      FEBRUARY 28, 2006
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            29,458,221
                                                            
                                                            
                                                            29,458
                                                            
                                                            
                                                            7,267,514
                                                            
                                                            
                                                            (736,035
                                                            )
                                                            
                                                            (4,472,041
                                                            )
                                                            
                                                            2,088,896Issuance
      of common stock for:
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            -Cash
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            8,027,206
                                                            
                                                            
                                                            8,027
                                                            
                                                            
                                                            5,180,230
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            5,188,257Services
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            1,270,000
                                                            
                                                            
                                                            1,270
                                                            
                                                            
                                                            2,606,430
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            2,607,700Oil
      and gas properties
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            222,500
                                                            
                                                            
                                                            223
                                                            
                                                            
                                                            528,527
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            528,750Conversion
      of convertible debentures
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            2,049,303
                                                            
                                                            
                                                            2,049
                                                            
                                                            
                                                            1,022,473
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            1,024,522Purchase
      and cancellation of common stock:
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (150,000
                                                            )
                                                            
                                                            (150
                                                            )
                                                            
                                                            (149,850
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (150,000
                                                            )Issuance
      of preferred stock for:Cash
                                                            
                                                            1,399,765
                                                            
                                                            
                                                            1,400
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            3,624,804
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            3,626,204Discount
      on convertible notes payable
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            25,000
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            25,000Extension
      warrants on convertible notespayable
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            119,283
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            119,283Discount
      on preferred stock
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            4,199,295
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            4,199,295Deemed
      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.
 38


DAYBREAK
OIL AND GAS, INC.


(An
Exploration Stage Company)


Statement
of Changes in Stockholders' Equity


For
the Period from Inception (March 1, 2005) through February 28, 2009,
continued





Issuance
      of common stock for:
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Cash
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            3,062,000
                                            
                                            
                                            3,062
                                            
                                            
                                            728,754
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            731,816Services
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            10,000
                                            
                                            
                                            10
                                            
                                            
                                            4,491
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            4,501Conversion
      of convertible debentures
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            37,169
                                            
                                            
                                            38
                                            
                                            
                                            27,840
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            27,878Extension
      warrants on convertible notespayable
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            60,973
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            60,973Conversion
      of preferred stock
                                            
                                            (102,300
                                            )
                                            
                                            (102
                                            )
                                            
                                            306,900
                                            
                                            
                                            307
                                            
                                            
                                            (205
                                            )
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -Issuance
      of goodwill warrants
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            934,521
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            934,521Net
      loss
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            (5,200,694
                                            )
                                            
                                            (5,200,694
                                            )BALANCE,
      FEBRUARY 29, 2008
                                            
                                            1,297,465
                                            
                                            
                                            1,298
                                            
                                            
                                            44,293,299
                                            
                                            
                                            44,294
                                            
                                            $
                                            21,980,785
                                            
                                            
                                            (736,035
                                            )
                                            
                                            (18,064,765
                                            )
                                            $
                                            3,225,577Issuance
      of common stock for:Cash
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            60,000
                                            
                                            
                                            60
                                            
                                            
                                            14,640
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            14,700Conversion
      of preferred stock
                                            
                                            (237,000
                                            )
                                            
                                            (237
                                            )
                                            
                                            711,000
                                            
                                            
                                            711
                                            
                                            
                                            (474
                                            )
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -Other
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            15,600
                                            
                                            
                                            16
                                            
                                            
                                            (16
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Issuance
      of goodwill warrants
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            52,425
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            52,425-
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Net
      loss
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            -
                                            
                                            
                                            (130,497
                                            )
                                            
                                            (130,497
                                            )BALANCE,
      FEBRUARY 28, 2009
                                            
                                            1,060,465
                                            
                                            $
                                            1,061
                                            
                                            
                                            45,079,899
                                            
                                            $
                                            45,081
                                            
                                            $
                                            22,047,360
                                            
                                            $
                                            (736,035
                                            )
                                            $
                                            (18,195,262
                                            )
                                            $
                                            3,162,205






















The
accompanying notes are an integral part of these financial
statements.
 39


DAYBREAK OIL AND GAS, INC.
 (An
Exploration Stage Company)
 Statements
of Cash Flows
 For
the Years ended February 28, 2009 and February 29, 2008 and for the
Period
 from
Inception (March 1, 2005) through February 28, 2009





FromInceptionMarch
      1, 2005Years
      Ended
                    
                    
                    
                    
                    
                    ThroughFebruary
      28,
                    
                    
                    February
      29,
                    
                    
                    February
      28,2009
                    
                    
                    2008
                    
                    
                    2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
                    
                    $
                    (130,497
                    )
                    
                    $
                    (5,200,694
                    )
                    
                    $
                    (18,195,262
                    )Adjustments
      to reconcile net loss to net cashused
      in operating activities:Common
      stock issued for services
                    
                    
                    -
                    
                    
                    
                    4,500
                    
                    
                    
                    6,239,729Gain
      on sale of oil and gas properties
                    
                    
                    (4,060,820
                    )
                    
                    
                    -
                    
                    
                    
                    (4,060,820
                    )Depreciation,
      depletion and impairment expense
                    
                    
                    624,575
                    
                    
                    
                    2,333,571
                    
                    
                    
                    5,356,194Exploration
      expense - dry wells
                    
                    
                    -
                    
                    
                    
                    33,233
                    
                    
                    
                    849,753Bad
      debt expense
                    
                    
                    326,707
                    
                    
                    
                    -
                    
                    
                    
                    326,707Non
      cash interest expense
                    
                    
                    -
                    
                    
                    
                    164,873
                    
                    
                    
                    1,470,051Non
      cash interest and dividend income
                    
                    
                    (5,427
                    )
                    
                    
                    (28,108
                    )
                    
                    
                    (62,120
                    )Non
      cash general and administrative expense
                    
                    
                    52,425
                    
                    
                    
                    934,521
                    
                    
                    
                    986,946Changes
      in assets and liabilities:Investment
      in marketable securities
                    
                    
                    155,445
                    
                    
                    
                    2,200,768
                    
                    
                    
                    -Accounts
      receivable - oil and gas sales
                    
                    
                    (135,598
                    )
                    
                    
                    (254,371
                    )
                    
                    
                    (446,876
                    )Accounts
      receivable - related party participants
                    
                    
                    -
                    
                    
                    
                    41,357
                    
                    
                    
                    -Accounts
      receivable - joint interest participants
                    
                    
                    216,013
                    
                    
                    
                    (202,450
                    )
                    
                    
                    (786,407
                    )Prepaid
      expenses and other current assets
                    
                    
                    18,052
                    
                    
                    
                    55,954
                    
                    
                    
                    (2,448
                    )Accounts
      payable and other accrued liabilities
                    
                    
                    147,466
                    
                    
                    
                    (1,385,367
                    )
                    
                    
                    950,009Other
      assets
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (77,177
                    )Net
      cash used in operating activities
                    
                    
                    (2,791,659
                    )
                    
                    
                    (1,302,213
                    )
                    
                    
                    (7,451,721
                    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of reclamation bond
                    
                    
                    (100,000
                    )
                    
                    
                    (250,000
                    )
                    
                    
                    (375,000
                    )Additions
      to note receivable
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (800,000
                    )Additions
      to oil and gas properties
                    
                    
                    (716,646
                    )
                    
                    
                    (2,036,888
                    )
                    
                    
                    (9,632,390
                    )Purchase
      of fixed assets
                    
                    
                    -
                    
                    
                    
                    (8,930
                    )
                    
                    
                    (31,841
                    )Proceeds
      from sale of oil and gas properties
                    
                    
                    5,812,500
                    
                    
                    
                    2,000,000
                    
                    
                    
                    7,812,500Proceeds
      from note receivable
                    
                    
                    -
                    
                    
                    
                    800,000
                    
                    
                    
                    800,000Additions
      to oil and gas prepayments
                    
                    
                    4,782
                    
                    
                    
                    72,392
                    
                    
                    
                    77,174Net
      cash provided by (used) in investing activities
                    
                    
                    5,000,636
                    
                    
                    
                    576,574
                    
                    
                    
                    (2,149,557
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from sales of preferred  stock, net
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,626,204Proceeds
      from sales of common stock, net
                    
                    
                    14,700
                    
                    
                    
                    731,816
                    
                    
                    
                    7,022,273Proceeds
      from related party notes payable
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    200,000Proceeds
      (repayments) from borrowings
                    
                    
                    -
                    
                    
                    
                    (325,001
                    )
                    
                    
                    1,035,520Net
      cash provided by financing activities
                    
                    
                    14,700
                    
                    
                    
                    406,815
                    
                    
                    
                    11,883,997NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                    
                    
                    2,223,677
                    
                    
                    
                    (318,824
                    )
                    
                    
                    2,282,719CASH
      AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
                    
                    
                    59,133
                    
                    
                    
                    377,957
                    
                    
                    
                    91CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
                    
                    $
                    2,282,810
                    
                    
                    $
                    59,133
                    
                    
                    $
                    2,282,810




The
accompanying notes are an integral part of these financial
statements.
 40


DAYBREAK
OIL AND GAS, INC.


(An
Exploration Stage Company)
 Statements
of Cash Flows
 For
the Years ended February 28, 2009 and February 29, 2008 and for the
Period
 from
Inception (March 1, 2005) through February 28, 2009, continued





CASH
      PAID FOR:Interest
                      
                      $
                      2,577
                      
                      
                      $
                      41,327
                      
                      
                      $
                      57,673Income
      taxes-SUPPLEMENTAL
      CASH FLOW INFORMATION:Common
      stock issued for services
                      
                      $
                      -
                      
                      
                      $
                      4,501
                      
                      
                      $
                      6,239,729Common
      stock issued for oil and gas properties
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      940,750Common
      stock repurchased and cancelled
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (150,000
                      )Common
      stock issued on conversion of convertible debenturesand
      interest
                      
                      
                      -
                      
                      
                      
                      27,878
                      
                      
                      
                      1,253,934Discount
      on convertible notes payable
                      
                      
                      -
                      
                      
                      
                      60,973
                      
                      
                      
                      1,326,186Extension
      warrants on convertible notes payable
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      119,283Conversion
      of preferred stock to common stock
                      
                      $
                      711
                      
                      
                      $
                      307
                      
                      
                      $
                      1,018





















































The
accompanying notes are an integral part of these financial
statements.
 41


NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION:





Organization





Originally
incorporated as Daybreak Uranium, Inc., (the “Company” or “Daybreak”), under the
laws of the State of Washington on March 11, 1955, the Company was organized to
explore for, acquire, and develop mineral properties in the Western United
States.  During 2005, management of the Company decided to enter the
oil and gas exploration industry.  On October 25, 2005, the
shareholders approved a name change to Daybreak Oil and Gas, Inc., to better
reflect the business of the Company.





All of
the Company’s oil and gas production is sold under contracts which are
market-sensitive. Accordingly, the Company’s financial condition, results of
operations, and capital resources are highly dependent upon prevailing market
prices of, and demand for, oil and natural gas.  These commodity
prices are subject to wide fluctuations and market uncertainties due to a
variety of factors that are beyond the control of the Company.  These
factors include the level of global demand for petroleum products, foreign
supply of oil and gas, the establishment of and compliance with production
quotas by oil-exporting countries, the relative strength of the U.S. dollar,
weather conditions, the price and availability of alternative fuels, and overall
economic conditions, both foreign and domestic.





Basis
of Presentation





The
accompanying audited financial statements of Daybreak have been prepared in
accordance with accounting principles generally accepted in the United States of
America and the rules of the SEC.





Exploration
Stage Company





On March
1, 2005 (the inception date), the Company commenced oil and gas exploration
activities. As of February 28, 2009, the Company has not produced a sustainable
positive cash flow from its oil and gas operations.  Accordingly, the
Company’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 the
Company’s financial statements be identified as those of an exploration stage
company. In addition, the statements of operations, stockholders equity and cash
flows are required to disclose all activity since the Company’s date of
inception.





The
Company will continue to prepare its financial statements and related
disclosures in accordance with SFAS No. 7 until such time that the Company’s oil
and gas properties have generated significant revenues. During the years ended
February 28, 2009 and February 28, 2008, the Company sold its largest revenue
producing wells.





Use
of Estimates and Assumptions





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 periods.  Actual results
could differ materially from those estimates.








42


The
accounting policies most affected by management’s estimates and assumptions are
as follows:


- The
  reliance on estimates of proved reserves to compute the provision for
  depreciation, depletion and amortization and to determine the amount of any
  impairment of proved properties;
- The
  valuation of unproved acreage and proved oil and gas properties to determine
  the amount of any impairment of oil and gas properties;
- Judgment
  regarding the productive status of in-progress exploratory wells to determine
  the amount of any provision for abandonment; and
- Estimates
  regarding abandonment obligations.

NOTE
2 — GOING CONCERN:





Financial
Condition





Daybreak’s
financial statements for the year ended February 28, 2009 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 has
incurred net losses since inception and has accumulated a deficit during the
exploration stage of $18,195,262, which raises substantial doubt about the
Company’s ability to continue as a going concern.





Management Plans to Continue as a
Going Concern





Implementation
of plans to enhance Daybreak’s ability to continue as a going concern are
underway.  On May 1, 2009, the Company signed an Exchange Option
Agreement with a third party, which gives that third party (i) a 30 day option
to purchase a 25% working interest for $512,500, (ii) commits to a payment in an
amount equal to $700,000 to be payable out of production from (a) 25% of the net
revenue from the Sunday #1 and Bear #1 wells and (b) 50% of the net revenue from
all future wells.  The third party will also assign Daybreak a 25%
working interest in 14,100 acres in Kern County, California that is immediately
north of the Company’s East Slopes project area.  When this sale is
completed, Daybreak plans to expand its developmental drilling program at a rate
that is compatible with its cash flow.





On April
29, 2009, Daybreak signed an agreement to sell its interest in the East
Gilbertown Field to a third party for $50,000 and other considerations.
 The closing date for this sale is scheduled for June 1, 2009. After
this sale is complete, Daybreak will recover $250,000 in cash collateral that
the Company had to post to secure an operator bond in Alabama.  In
addition, Daybreak plans to secure additional debt or equity funding, if
necessary.





Daybreak’s
financial statements as of February 28, 2009 do not include any adjustments that
might result from the inability to implement or execute Daybreak’s plans to
improve our ability to continue as a going concern.












43


NOTE 3
–SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES:





Cash
and Cash Equivalents





Cash
equivalents include demand deposits with banks and all highly liquid investments
with original maturities of three months or less.





The
Company routinely maintains balances in financial institutions where deposits
are guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) in excess
of the federally insured amount of $250,000. As of February 28, 2009, the
Company had approximately $1,657,867 of cash deposits in excess of FDIC insured
limits at various financial institutions.





Investment
in Marketable Securities





The
Company determines the appropriate classification of its investments in
marketable securities at the time of purchase and reevaluates such
determinations at each balance-sheet date. The Company classifies all
investments in marketable securities as trading securities as they are bought
and held principally for the purpose of selling them in the near
term.  These securities are reported at fair value, with realized and
unrealized gains and losses recognized in earnings. The fair value of all
securities is determined by quoted market prices.  These investments
are not insured by the FDIC.





Accounts
Receivable





The
Company routinely assesses the recoverability of all material trade and other
receivables.  The Company accrues a reserve on a receivable when,
based on the judgment of management, it is probable that a receivable will not
be collected and the amount of any reserve may be reasonably
estimated.  Actual write-offs may exceed the recorded
allowance.  For the years ended February 28, 2009 and February 29,
2008 the Company has recognized an allowance for doubtful accounts of $15,103
and $-0- respectively.





Oil
and Gas Properties





The
Company 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 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 the provisions of Statement of Financial Accounting Standards (“SFAS”) No.
144, “Accounting for
Impairment or Disposal of Long-Lived Assets”, the Company reviews proved
oil and natural gas properties and other long-lived assets for impairment.










44


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. The Company 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. These estimates of future product prices may differ from current market
prices of oil and gas. Any downward revisions to management’s estimates of
future production or product prices could result in an impairment of the
Company’s oil and gas properties in subsequent periods.  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.





Asset
impairments of $494,871 and $684,505 were recorded for the years ended February
28, 2009 and February 29, 2008, respectively which is included in depreciation,
depletion and amortization in the statement of operations.





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.





Property
and Equipment





Fixed
assets are stated at cost. Depreciation on vehicles is provided using the
straight line method over expected useful lives of three
years.  Depreciation on machinery and equipment is provided using the
straight line method over expected useful lives of three years.





Long
Lived Assets





The
Company reviews long-lived assets and identifiable intangibles whenever events
or circumstances indicate that the carrying amounts of such assets may not be
fully recoverable. The Company evaluates the recoverability of long-lived assets
by measuring the carrying amounts of the assets against the estimated
undiscounted cash flows associated with these assets.  If this
evaluation indicates that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the assets' carrying value, the
assets are adjusted to their fair values (based upon discounted cash
flows).





Fair
Value of Financial Instruments





The
amounts of financial instruments including cash, deposits, receivables, prepaid
expenses, accounts payable, and other accrued liabilities approximated their
fair values as of February 28, 2009 and February 29, 2008.





Share
Based Payments





Share
based awards are accounted for under SFAS No. 123R, “Share Based Payment” and
related interpretations (“SFAS 123R”). Under SFAS 123R, compensation costs for
all share based payments granted are based on the grant date fair value
estimated using an option pricing model.












45


The value
of the portion of the award that is ultimately expected to vest is recognized as
expense ratably over the requisite service periods.





The
Company uses the Black-Scholes option pricing model (“Black-Scholes Model”) as
its method of valuation for share-based awards granted during the
year.  The Company’s determination of fair value of share-based
payment awards on the date of grant using an option-pricing model is affected by
the Company’s stock price, as well as assumptions regarding a number of
subjective variables.  These variables include, but are not limited
to, the Company’s expected price volatility over the term of the awards, as well
as actual and projected exercise and forfeiture activity.





Loss
per Share of Common Stock





Basic
loss per share of Common Stock is calculated by dividing net loss available to
Common stockholders by the weighted average number of common shares issued and
outstanding during the year.  Common Stock equivalents are excluded
from the calculations when their effect is anti-dilutive.





Concentration
of Credit Risk





Substantially
all of the Company’s accounts receivable result from natural gas and crude oil
sales or joint interest billings to third parties in the oil and gas
industry.  This concentration of customers and joint interest owners
may impact the Company’s overall credit risk as these entities could be affected
by similar changes in economic conditions as well as other related
factors.  Accounts receivable are generally not
collateralized.





At each
of the Company’s three producing projects, there is only one buyer for the
purchase of oil or gas production.  At February 28, 2009, three
customers represented 100% of crude oil and natural gas sales receivable from
all projects in aggregate.





In
accordance with provisions of SFAS 131 “Disclosures about Segments of anEnterpriseand Related Information,” a table disclosing the
total amount of revenues from any single customer that exceeds 10% of total
revenues follows:





For
      the Year Ended
                      February
      28, 2009
                    
                    
                    For
      the Year Ended
                      February
      29, 2008Project
                    Location
                    Product
                    Customer
                    
                    Revenue
                    
                    
                    Percentage
                    
                    
                    Revenue
                    
                    
                    PercentageEast
      Gilbertown
                    Alabama
                    Oil
                    Hunt
      Crude Oil Supply
                    
                    $
                    148,741
                    
                    
                    
                    73.7
                    %
                    
                    $
                    119,409
                    
                    
                    
                    61.5
                    %Krotz
      Springs
                    Louisiana
                    Gas
                    JP
      Oil Company
                    
                    $
                    22,944
                    
                    
                    
                    11.4
                    %
                    
                    $
                    37,121
                    
                    
                    
                    19.1
                    %Liquids
                    JP
      Oil Company
                    
                    $
                    26,122
                    
                    
                    
                    12.9
                    %
                    
                    $
                    30,591
                    
                    
                    
                    15.7
                    %





Revenue
Recognition





The
Company 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.  The Company had no significant imbalances as of
February 28, 2009 and February 29, 2008.










46


Reclamation
Bonds





Included
in other assets as of February 28, 2009, are funds which have been pledged as
collateral in connection with asset retirement obligations for future plugging,
abandonment and site remediation in various states. The amounts pledged for
operator bonds in California, Alabama and Louisiana are $100,000, $250,000 and
$25,000 plus accrued interest respectively.  The pledging of these
funds was necessitated by the Company’s emerging status as an oil and gas
property operator.





Environmental
Matters and Asset Retirement Obligation





The
Company owns and has previously owned mineral property interests (which it has
explored for commercial mineral deposits) on public and private lands in various
states in the United States. The Company and its properties are subject to a
variety of federal and state regulations governing land use and environmental
matters.  Management believes it has been in substantial compliance
with all such regulations.  Management is also unaware of any pending
action or proceeding relating to regulatory matters that would effect the
financial position of the Company.





The
Company follows the provisions of SFAS No. 143 “Accounting for Asset Retirement
Obligations” (“SFAS 143”), as amended. SFAS 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement
costs.  This statement requires that the Company recognize the fair
value of a liability for an asset retirement obligation (ARO) in the period in
which it is incurred.  The ARO is capitalized as part of the carrying
value of the assets to which it is associated, and depreciated over the useful
life of the asset.  The ARO and the related asset retirement cost are
recorded when an asset is first drilled, constructed or
purchased.  The asset retirement cost is determined and discounted to
present value using a credit-adjusted risk-free rate.  After initial
recording, the liability is increased for the passage of time, with the increase
being reflected as accretion expense in the statements of
operations.  Subsequent adjustments in the cost estimate are reflected
in the ARO liability and the amounts continue to be amortized over the useful
life of the related long-lived assets.





Suspended
Well Costs





The
Company accounts for any suspended well costs in accordance with FSP No. 19-1,
“Accounting for Suspended Well
Costs”.  FSP 19-1 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, FSP 19-1 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.












47


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.





Income
Taxes





As
required under SFAS No. 109 “Accounting for Income
Taxes”, the
Company accounts for income taxes using an asset and liability approach, which
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the financial
statements and tax bases of assets and liabilities at the applicable tax
rates.  A valuation allowance is utilized when it is more likely than
not, that some portion of, or all of the deferred tax assets will not be
realized.  Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.





On March
1, 2007, the Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income
Taxes – An Interpretation of FASB Statement No. 109” (“FIN
48”).  FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected  to be taken in a tax
return.  Under FIN 48, the Company recognizes tax benefits only for
tax positions that are more likely than not to be sustained upon examination by
tax authorities.  The amount recognized is measured as the largest
amount of benefit that is greater than 50 percent likely to be realized upon
settlement.  A liability for “unrecognized tax benefits” is recorded
for any tax benefits claimed in our tax returns that do not meet these
recognition and measurement standards.





Recent
Accounting Pronouncements





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”(“SFAS No. 157”).  This standard defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles in the United States, and expands disclosures about fair
value measurements.  This standard does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the
information.  SFAS No. 157 is effective for fiscal years beginning
after November 15, 2007, and all interim periods within those fiscal
years.  The adoption of SFAS No. 157 did not have a material impact to
the Company’s financial statements.





In
February 2008, the FASB issued FASB Staff Position (FSP) FSP 157-2, Effective Date of FASB Statement No
157(FSP
157-2”).  FSP 157-2 delays the effective date of SFAS No. 157 for all
non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually), to fiscal years beginning after November 15, 2008 and
interim periods for those fiscal years.  The Company is currently
evaluating the impact that SFAS No,. 157 will have on the financial statements
when it is applied to non-financial assets and non-financial liabilities that
are not measured at fair value on a recurring basis beginning in the first
quarter of fiscal year 2009-2010.





In June
2008, FASB ratified EITF No. 07-05, Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock(“EITF
07-05”).  EITF 07-05 provides that an entity should use a two-step
approach to evaluate whether an equity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument’s
contingent exercise and settlement provisions.  EITF 07-05 is
effective March 1, 2009, and the Company is currently evaluating the impact of
the adoption of EITF 07-05 on its outstanding warrants at February 28,
2009.











48


In April
2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly”(FAS 157-4) to amend
SFAS No. 157, “Fair Value
Measurements”(SFAS 157).  FAS 157-4 provides additional
guidance for estimating fair value in accordance with SFAS 157 when the volume
and level of activity for an asset or liability has significantly
decreased.  In addition, FAS 157-4 includes guidance on identifying
circumstances that indicate a transaction is not orderly.  FAS 157-4
is effective for interim and annual reporting periods ending after June 15,
2009.  The Company is currently assessing the impact, if any, that the
adoption of this pronouncement will have on the Company’s operating results,
financial position or cash flows.





In
December 2008, the SEC released Final Rule, “Modernization of Oil and GasReporting.”  The new
disclosure requirements include provisions that permit the use of new
technologies to determine proved reserves if those technologies have been
demonstrated empirically to lead to reliable conclusions about reserve
volumes.  The new requirements also will allow companies to disclose
their probable and possible reserves to investors.  In addition, the
new disclosure requirements require that companies 1) report the independence
and qualifications of its reserves preparer or auditor, 2) file reports when a
third party is relied upon to prepare reserves estimates or conduct a reserves
audit, 3) report oil and gas reserves using an average price based upon the
prior 12-month period rather than year-end prices.  The new disclosure
requirements are effective for financial statements for fiscal years ending on
or after December 31, 2009.  Early adoption is not
permitted.  The Company is currently assessing the impact, if any,
that the adoption of the pronouncement will have on the Company’s operating
results, financial position or cash flows.





In May
2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted
Accounting Principles”(“SFAS 162”), whichidentifies a consistent
framework for selecting accounting principles to be used in preparing financial
statements for nongovernmental entities that are presented in conformity with
United States generally accepted accounting principles (GAAP).  The
current GAAP hierarchy was criticized due to its complexity, ranking position of
FASB Statements of Financial Accounting Concepts and the fact that is directed
at auditors rather than entities.  SFAS 162 will be effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
(PCAOB) amendments to AU Section 11 “The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles.”The
FASB does not expect that SFAS 162 will have a change in current practice, and
the Company does not believe that SFAS 162 will have an impact on operating
results, financial position or cash flows.





Reclassifications





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














49


NOTE
4 – INVESTMENTS IN MARKETABLE SECURITIES:





The
Company periodically invests excess cash on hand in marketable securities with
the intent to sell the securities in the near term as cash requirements
determine.  These securities were mutual fund investments in fixed
income securities with relatively low market risk and were 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 of February 28, 2009 and February 29, 2008 was $-0- and $155,445
respectively.








NOTE
5 – ACCOUNTS RECEIVABLE – JOINT INTEREST PARTICIPANTS:





In
January 2008, the Company instituted legal action against California Oil and Gas
Company (“COGC”), a 25% working interest participant, for their default in
meeting the financial commitments in the drilling and completion of the KSU #59
well in Louisiana.  On November 17, 2008, the Company requested a
summary judgment against COGC and on December 9, 2008, a written order for
summary judgment against COGC was entered by the court.  On March 2,
2009 COGC assigned its undeveloped interest in the Dyer Creek and S.E. Edison
Projects in Kern County California and undeveloped leases in Tulare County
California, along with COGC interest in the Krotz Springs Field to satisfy the
judgment.  As of February 28, 2009, the Company had received $166,891
from the net production revenue in the Krotz Springs Field in partial
satisfaction of the debt.  Receivables from COGC that were deemed to
be uncollectable amounting to $311,604 were written off during the
year.





In March
2009,the
Company became Operator of its California project and as such it is responsible
for collecting from its other working interest partners in California
reimbursement of lease rentals that have occurred during the fiscal year just
ended.  As of February 28, 2009, receivables related to these lease
rentals amounted to $152,427 and are included in accounts receivable – joint
interest participants in the balance sheets.


















50


NOTE
6 — OIL AND GAS PROPERTIES:





Oil and
gas properties, at cost:




February
      28, 2009
                  
                  
                  February
      29, 2008Proved
      leasehold costs
                  
                  $
                  299,571
                  
                  
                  $
                  299,571Unproved
      leasehold costs
                  
                  
                  104,700
                  
                  
                  
                  104,700Costs
      of wells and development
                  
                  
                  1,881,463
                  
                  
                  
                  1,157,447Capitalized
      asset retirement costs
                  
                  
                  13,880
                  
                  
                  
                  10,518Total cost of oil and gas
      properties
                  
                  
                  2,299,614
                  
                  
                  
                  1,572,236Accumulated
      depletion, depreciation,amortization
      and impairment
                  
                  
                  (1,943,334
                  )
                  
                  
                  (1,421,037
                  )Oil
      and gas properties, net
                  
                  $
                  356,280
                  
                  
                  $
                  151,199





Asset
Retirement Obligation





The
Company’s financial statements reflect the provisions of SFAS No. 143, “Accounting for Asset Retirement
Obligations.”  The asset retirement obligation (“ARO”)
primarily represents the estimated present value of the amount the Company will
incur to plug, abandon and remediate its producing properties at the end of
their productive lives, in accordance with applicable state laws. The Company
determines the ARO on its oil and gas properties by calculating the present
value of estimated cash flows related to the liability.  On February
28, 2009, and February 29, 2008, ARO obligations were considered to be long term
based on the estimated timing of the anticipated cash flows.  For the
years ended February 28, 2009 and February 29, 2008, the Company recognized
accretion expense of $2,739 and $1,374, respectively, which is included in
depreciation, depletion and amortization in the statement of
operations.





The
following table describes the changes in the asset retirement obligations for
the year ended February 28, 2009.




Asset
      retirement obligations, beginning of period
                  
                  $
                  119,207Accretion
      expense
                  
                  
                  2,739Asset
      retirement additions
                  
                  
                  3,368Asset
      retirement eliminations due to sale of assets
                  
                  
                  (105,303)Asset
      retirement obligations, end of period
                  
                  $
                  20,011





NOTE
7 — DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE:





The
Company finalized the disposal of two oil and gas properties during the year
ended February 28, 2009. The properties disposed of were the Tuscaloosa Project
in Louisiana and the Saxet Deep Field in Texas.





51


On
January 18, 2008, the Company signed a purchase and sale agreement (“PSA”)
for the sale of its Tuscaloosa Project interests in Louisiana for $8
million in cash.  The transaction closed in three tranches; the first
closing for $2 million closed on January 18, 2008; the second closing for
$500,000 occurred on April 30, 2008; and the final closing for $5.5 million
occurred on June 12, 2008 and was subject to customary closing
adjustments.  The sale included Daybreak's interests in the Tensas
Farms et al F-1, F-3, B-1, A-1 and F-2 wells; and all of its acreage and
infrastructure in the project area.  Under terms of the PSA, the
effective dates for each closing was January 1, 2008. The sale of the Tuscaloosa
Project resulted in a gain for the year ended February 28, 2009 of $3,998,632.
Prior period income statement amounts applicable to the Tuscaloosa Project have
been reclassified and included under Income (loss) from discontinued operations,
while related assets are classified as Assets held for sale in the balance
sheets.





The
following tables present the revenues and expenses related to the Tuscaloosa
Project for the years ended February 28, 2009 and February 29, 2008, and from
inception through February 28, 2009.





2009
                  
                  
                  2008
                  
                  
                  From
      Inception through
                    February
      28, 2009Oil
      and gas sales revenues – Tuscaloosa Project
                  
                  $
                  234,474
                  
                  
                  $
                  775,730
                  
                  
                  $
                  1,484,762Cost
      and Expenses
                  
                  
                  (115,092
                  )
                  
                  
                  (1,143,653
                  )
                  
                  
                  (3,420,252
                  )Income
      (loss) from discontinued operations
                  
                  $
                  119,382
                  
                  
                  $
                  (367,923
                  )
                  
                  $
                  (1,935,490
                  )





Oil and
gas properties held for sale, at cost – Tuscaloosa Project:





February
      28, 2009
                  
                  
                  February
      29, 2008Proved
      leasehold costs
                  
                  $
                  -
                  
                  
                  $
                  1,556,423Unproved
      leasehold costs
                  
                  
                  -
                  
                  
                  
                  310,657Costs
      of wells and development
                  
                  
                  -
                  
                  
                  
                  1,393,790Unevaluated
      capitalized exploratory well costs
                  
                  
                  -
                  
                  
                  
                  896,067Capitalized
      asset retirement costs
                  
                  
                  -
                  
                  
                  
                  57,567Total
      cost of oil and gas properties
                  
                  
                  -
                  
                  
                  
                  4,214,504Accumulated
      depletion, depreciation,amortization
      and impairment
                  
                  
                  -
                  
                  
                  
                  (2,580,033
                  )Oil
      and gas properties, net
                  
                  $
                  -
                  
                  
                  $
                  1,634,471





The
following table reflects the net changes in capitalized exploratory well costs
for discontinued operations - Tuscaloosa Project during the years ended February
28, 2009 and February 29, 2008, and does not include amounts that were
capitalized and subsequently expensed in the same period.





2009
                
                
                2008Beginning
      balance at March 1 of fiscal year
                
                $
                896,067
                
                
                $
                1,223,177Total
      exploration well additions
                
                
                -
                
                
                
                517,316Sales
      of exploratory wells
                
                
                (896,067
                )
                
                
                (844,426
                )Ending
      balance at February 28 of fiscal year
                
                $
                -
                
                
                $
                896,067










52


On
December 31, 2008, the Company assigned its interest in the Saxet Deep
Field in Corpus Christi, Texas to the field Operator.  This assignment
was in exchange for the release from all future liability of plugging and
abandonment liability.  The agreement included the release of all
liability for any amounts currently owed to the
Operator.  Additionally, the Company agreed to give up any right to
production revenue that had not yet been distributed by the
Operator.  The sale of the Saxet Deep Field resulted in a gain for the
year ended February 29, 2008 of $62,188.  Prior period income
statement amounts applicable to the Saxet Deep Field have been reclassified and
included under Income (loss) from discontinued operations, while related assets
are classified as Assets held for sale in the balance sheets.





The
following tables present the revenues and expenses related to the Saxet Deep
Field for the years ended February 28, 2009 and February 29, 2008, and from
inception through February 28, 2009.





2009
                  
                  
                  2008
                  
                  
                  From
      Inception through
                    February
      28, 2009Oil
      and gas sales revenues – Saxet Deep Field
                  
                  $
                  77,728
                  
                  
                  $
                  172,901
                  
                  
                  $
                  403,307Cost
      and expenses
                  
                  
                  (122,050
                  )
                  
                  
                  (355,511
                  )
                  
                  
                  (888,936
                  )Loss
      from discontinued operations
                  
                  $
                  (44,322
                  )
                  
                  $
                  (182,610
                  )
                  
                  $
                  (485,629
                  )




Oil and
gas properties held for sale, at cost – Saxet Deep Field:





February
      28, 2009
                  
                  
                  February
      29, 2008Proved
      leasehold costs
                  
                  $
                  -
                  
                  
                  $
                  -Unproved
      leasehold costs
                  
                  
                  -
                  
                  
                  
                  -Costs
      of wells and development
                  
                  
                  -
                  
                  
                  
                  575,511Unevaluated
      capitalized exploratory well costs
                  
                  
                  -
                  
                  
                  
                  -Capitalized
      asset retirement costs
                  
                  
                  -
                  
                  
                  
                  12,222Total
      cost of oil and gas properties
                  
                  
                  -
                  
                  
                  
                  587,733Accumulated
      depletion, depreciation,amortization
      and impairment
                  
                  
                  -
                  
                  
                  
                  (569,411
                  )Oil
      and gas properties, net
                  
                  $
                  -
                  
                  
                  $
                  18,322





The
following table reflects the net changes in capitalized exploratory well costs
for discontinued operations for the years ended February 28, 2009 and February
29, 2008, and does not include amounts that were capitalized and subsequently
expensed in the same period.





2009
                
                
                2008Beginning
      balance at March 1 of fiscal year
                
                $
                587,739
                
                
                $
                587,739Sales
      of exploratory wells
                
                
                (587,739
                )
                
                
                -Ending
      balance at end of fiscal year
                
                $
                -
                
                
                $
                587,739








53


NOTE
8 — RELATED PARTY TRANSACTIONS:





Office
Lease





The
Company leases space for its Corporate offices in Spokane, Washington from
Terrence J. Dunne & Associates, a company owned by Terrence J. Dunne (former
Chief Financial Officer, director and current 7.5% shareholder).  The
Company currently pays $1,000 per month on a month-to-month rental
basis.





Common
Stock and Cash for Services





Under
SFAS No. 123R the guidelines for recording stock issued for goods or services
require the fair value of the shares granted be based on the fair value of the
goods or services received or the publicly traded share price of the Company’s
stock on the date the shares were granted, whichever is more readily
determinable.  The Company has determined that the fair value of all
Common Stock issued for goods or services is more readily determinable based on
the publicly traded share price on the date of grant.





From
January 2, 2007 through February 29, 2008, the Company had a contract with
Timothy R. Lindsey (director and former interim CEO/President) to facilitate
long range strategic planning and advise the Company on business and exploration
matters in the oil and gas industry.  Under the terms of his contract,
Mr. Lindsey was granted 200,000 shares of unregistered Common Stock valued at
$260,000. For the fiscal year ended February 29, 2008, Mr. Lindsey was paid
$21,000 for services rendered.





NOTE
9 — STOCKHOLDERS’ EQUITY:





Series
A Convertible Preferred Stock





The
Company is authorized to issue up to 10,000,000 shares of $0.001 par value
preferred stock.  The Company has designated 2,400,000 shares of the
10,000,000 total preferred shares as “Series A Convertible Preferred Stock”
(“Series A Preferred”), with a $0.001 par value. During the year ended February
28, 2007, the Company conducted a private placement sale of Series A Preferred
(the “July 2006 Preferred Stock Private Placement”) to 100 accredited
investors.  Each sale unit consisted of one share of Series A
Preferred and two Common Stock purchase warrants.  The units were sold
for $3.00 per unit, with a total of 1,399,765 units sold; resulting in gross
proceeds of $4,199,295.  The Company received net proceeds of
$3,626,204 after placement agent fees, commissions and other offering costs of
$573,091.





The
Series A Preferred can be converted by the shareholder at any time into three
shares of the Company’s Common Stock.  If the Company’s Common Stock
is registered under the Securities Act of 1933, the Series A Preferred shall be
automatically converted into Common Stock at any time after the effective date
of the registration statement if the Company’s Common Stock closes at or above
$3.00 per share for twenty (20) out of thirty trading days (30)
days.  As of February 28, 2009 a total of 22 participants from the
July 2006 Preferred Stock private placement had converted their shares to the
Company’s Common Stock.









54


Holders
of Series A Preferred earn a dividend, in the amount of 6% of the original
purchase price per year.  Accumulated dividends do not bear interest
and as of February 28, 2009 amounted to $599,930.  Dividends can be
paid in cash or stock at the discretion of the Company and are payable upon
declaration by the Board of Directors.  Dividends are earned until the
Series A Preferred is converted to Common Stock. No dividends have been declared
as of February 28, 2009.





The table
below details the cumulative dividends earned for each fiscal year since
issuance:





Fiscal
      Period
                  
                  Shareholders
      at Period End
                  
                  
                  Accumulated
      DividendsYear
      Ended February 28, 2007
                  
                  
                  100
                  
                  
                  $
                  153,966Year
      Ended February 29, 2008
                  
                  
                  90
                  
                  
                  
                  237,752Year
      Ended February 28, 2009
                  
                  
                  78
                  
                  
                  
                  208,212Total
      Accumulated Dividends
                  
                  
                  
                  
                  
                  $
                  599,930





The
Warrants included in the private placement are exercisable for a period of five
years and expire on July 18, 2011 with an exercise price of $2.00 per share. In
accordance with EITF 98-5, the Company valued the warrants and the beneficial
conversion feature of the Series A Preferred.  Accordingly, the
Company recorded a discount for the warrants and beneficial conversion feature
(BCF) of $4,199,295.  The discount is attributable to the fair value
of the Warrants and the intrinsic value of the conversion feature of the Series
A Preferred.  The value of the BCF was recognized and measured
separately by allocating to additional paid-in capital the proceeds equal to the
$1,489,222 relative fair value of the warrants and the $2,710,073 intrinsic
value of the conversion feature.  The Company also recorded a deemed
dividend to reflect the full amortization of the discount of the value of the
warrants and conversion features of $4,199,295.  The fair value of
each Warrant granted was estimated using the Black-Scholes pricing
model.  The assumptions used in the Black-Scholes valuation model
were: a risk free interest rate of 4.99%; the current stock price at date of
issuance of $2.20 per share; the exercise price of the warrants at $1.00; an
expected term of five years; volatility of 113%; and dividend yield of
0.0%.  As of February 28, 2009, no subscriber warrants had been
exercised.





Bathgate
Capital Partners, of Denver, Colorado (“Bathgate”) was the placement
agent.  Joseph Lavigne, son of Dale B. Lavigne (the Chairman and a
director of Daybreak) is an employee of Bathgate. Bathgate was paid a sales
commission of 10% of the gross proceeds of the private placement and a
non-accountable expense allowance of 3% of the gross proceeds totaling $547,589.
For every $30.00 invested, Bathgate earned three common stock purchase warrants
exercisable at $1.00 per share.  The warrants are exercisable for a
period of seven years and expire on July 18, 2013. A total of 419,930 warrants
were issued to Bathgate from this private placement and were valued at
$816,374.  The placement agent warrants were valued using the
Black-Scholes option pricing model.  The assumptions used in the
Black-Scholes valuation model were: a risk free interest rate of 4.99%; the
current stock price at date of issuance of $2.20 per share; the exercise price
of the warrants at $1.00; an expected term of seven years; volatility of 113%;
and dividend yield of 0.0%.  As of February 28, 2009, no placement
agent warrants had been exercised.





Both the
subscriber warrants and the placement agent warrants contain customary
anti-dilution provisions.  The anti-dilution provisions permit an
adjustment for the number of shares issuable upon exercise of the warrants in
the event of stock splits, stock dividends, stock reversals and sales of
substantially all of the Company’s assets.  The placement agent
warrants also contain a cashless exercise provision.










55


The
cashless exercise provision allows for the holder of the warrants to receive a
number of shares equal to the quotient of a) the product of the number of
warrants held and the amount by which the Company’s market traded stock price
exceeds the exercise price of the warrants on the date of exercise, divided by
b) the market traded stock price.





The
Company agreed to register the Series A Preferred on a “best efforts”
basis.  If the Company was unable to file the registration statement
within the filing timeline, the Company agreed to issue 1,399,765 additional
warrants at an exercise price of $2.00 per share.  The Company was
required to file the Series A Preferred registration statement within sixty (60)
days after the registration statement for the common stock from the May of 2006
private placement became effective.  The Company did file the
registration statement for the May 2006 common stock on time and no additional
warrant issuances were required.





In
February 2008, the Company issued “goodwill” Common Stock warrants to the
participants of the July 2006 private placement.  The warrants were
issued as a goodwill gesture to investors in the two 2006 private placements due
to the May 2006 Common Stock private placement registration statement not being
declared effective. Each participant from the Series A Preferred private
placement was offered one “goodwill” warrant for every unit that had been
purchased in exchange for waiving any rights under the Registration Rights
Agreement.  The grant date of the “goodwill” warrants is determined by
when the Company receives the registration rights waiver letter from the
shareholder.  As of February 28, 2009, the Company had received
registration rights waiver letters from approximately 88% of the participants in
the Series A Preferred private placement.  The warrants will expire on
February 14, 2010, have an exercise price of $0.65 and contain a cashless
exercise provision.  As of February 28, 2009, the Company has issued
1,250,264 goodwill warrants valued at $279,397 to these investors.  A
maximum of 1,399,765 warrants potentially could be issued. The warrants
were valued using the Black-Scholes option pricing model.  The
assumptions used in the Black-Scholes valuation model were: an average risk free
interest rate of 3.7 %; a declining term to expiration; an average volatility of
121.67%; and dividend yield of 0.0%.





The
Company evaluated the application of SFAS No. 133 and EITF 00-19 with respect to
the conversion feature and the registration rights for consideration of embedded
derivatives and concluded that the preferred stock and registration rights
instruments did not have embedded derivatives.





The
relative fair values of the Series A Preferred and the Common Stock Purchase
Warrants are as follows:





Description
                                  
                                  Shares
                                  
                                  
                                  Relative Fair ValueSeries
      A Convertible Preferred
                                  
                                  
                                  1,399,765
                                  
                                  
                                  $
                                  2,710,073Common
      Stock Purchase Warrants
                                  
                                  
                                  2,799,530
                                  
                                  
                                  
                                  1,489,222Total
      Proceeds
                                  
                                  
                                  
                                  
                                  
                                  
                                  4,199,295Offering
      Costs
                                  
                                  
                                  
                                  
                                  
                                  
                                  (573,091
                                  )Net
      Proceeds
                                  
                                  
                                  
                                  
                                  
                                  $
                                  3,626,204












56


Common
Stock





The
Company is authorized to issue up to 200,000,000 shares of $0.001 par value
common stock of which 45,079,899 shares were issued and outstanding as of
February 28, 2009.





Commencing
on January 2, 2008, and closing on May 22, 2008, the Company conducted an
unregistered offering of common stock through a private placement under the
securities transaction exemption Regulation D Rule 506 of the Securities Act of
1933. Shares were offered at $0.25 per share to “accredited investors” only as
defined in Regulation D under the Securities Act of 1933. The shares were sold
either directly by the Company or by the placement agent, Newbridge Securities
Corporation (“Newbridge”) of Ft. Lauderdale, Florida.  A total of
625,000 shares of unregistered common stock were sold to eight investors
resulting in $156,250 in gross proceeds. Newbridge was paid a sales commission
of 10% of the gross proceeds of their firm’s sales of the private placement and
a non-accountable expense allowance of 3% of the gross proceeds of their firm’s
sales totaling $23,112.50. For every 100 shares sold by Newbridge in the private
placement, they earned seven common stock warrants exercisable at $0.25 per
share.  Newbridge earned a total of 39,550 warrants that were
determined to have a fair value of $10,442 and are exercisable for a period of
three years, expiring on January 31, 2011.  The placement agent
warrants were valued using the Black-Scholes option pricing
model.  The assumptions used in the Black-Scholes valuation model
were: a risk free interest rate of 2.44%; the stock price on the grant date of
$0.33; the exercise price of the warrants at $0.25; an expected term of three
years; volatility of 135.76%; and dividend yield of 0.0%.  The
placement agent warrants contain customary anti-dilution
provisions.  The anti-dilution provisions permit an adjustment for the
number of shares issuable upon exercise of the warrants in the event of stock
splits, stock dividends, stock reversals and sales of substantially all of the
Company’s assets.  As of February 28, 2009, no placement agent
warrants had been exercised.





Commencing
on October 19, 2007 and closing on December 28, 2007, the Company conducted an
unregistered offering of common stock through a private placement under the
securities transaction exemption Regulation D Rule 506 of the Securities Act of
1933.  Shares were offered at $0.25 per share to “accredited
investors” only as defined in Regulation D under the Securities Act of 1933. The
shares were sold directly by the Company and no placement agent was involved in
the offering. A total of 2,497,000 shares of unregistered common stock were sold
to thirteen investors resulting in $624,250 in gross
proceeds.  Offering expenses were approximately $6,500.





During
the year ended February 28, 2007, the Company conducted a private placement sale
of common stock from March 3, 2006 to May 19, 2006 (the “May 2006 Common Stock
Private Placement”).  Each sale unit consisted of two shares of Common
Stock and one Common Stock purchase warrant (warrant).  The units sold
for $1.50 per unit, with a total of 4,013,602 units sold; resulting in gross
proceeds of $6,020,404 (net proceeds of $5,188,257 after placement
costs).





The
warrants are exercisable for a period of five years and expire on May 20, 2011
with an exercise price of $2.00 per share.  The Company may call the
warrants for redemption if (a) the average of the closing sale price of the
common stock is at or above $3.00 for twenty (20) out of thirty (30) trading
days prior to the date the warrants are called, and (b) the warrant shares are
registered under the Securities Act.  The Warrants were valued using the
Black-Scholes option pricing model.  The assumptions used in the
Black-Scholes valuation model were: a risk free interest rate of 4.99%; the
current stock price at date of issuance of $2.70 per share; the exercise price
of the warrants; an expected term of five years; volatility of 112%; and
dividend yield of 0.0%.  As of
February 28, 2009, no subscriber warrants had been
exercised.










57





Bathgate
Capital Partners, of Denver, Colorado was the placement agent.  Joseph
Lavigne, son of Dale B.  Lavigne (the Chairman and a director of
Daybreak) is an employee of Bathgate Capital Partners.  The Placement
Agent was paid a sales commission of 10% of the gross proceeds of the private
placement and a non-accountable expense allowance of 3% of the gross proceeds
totaling $790,402.  Additionally, the Placement Agent was paid a due
diligence fee of $15,000.  For every ten units sold, the Placement
Agent earned three common stock warrants, two of which are exercisable at $0.75
per share and one of which is exercisable at $2.00 per share.  The
Placement Agent warrants are exercisable for a period of seven years, expiring
on May 20, 2013.  The placement agent earned 1,204,082 warrants, of
which 802,721 are exercisable at $0.75 per share and were determined to have a
fair value of $2,043,752.  The remaining 401,361 warrant shares are
exercisable at $2.00 per share and were determined to have a fair value of
$973,970.  The placement agent warrants were valued using the
Black-Scholes option pricing model.  The assumptions used in the
Black-Scholes valuation model were: a risk free interest rate of 4.99%; the
current stock price at date of issuance of $2.70 per share; the exercise price
of the warrants; an expected term of seven years; volatility of 112%; and
dividend yield of 0.0%.  As of February 28, 2009, no placement agent
warrants had been exercised.





The
placement agent warrants have a cashless exercise provision and contain
customary anti-dilution provisions.  The cashless exercise provision
allows for the holder of the warrants to receive a number shares equal to the
quotient of a) the product of the number of warrants held and the amount by
which the Company’s market traded stock price exceeds the exercise price of the
warrants on the date of exercise, divided by b) the market traded stock
price.  The anti-dilution provisions permit the adjustment of the
number of shares issuable upon exercise of the warrants in the event of stock
splits, stock dividends, stock reversals and sales of substantially all of the
Company’s assets.





The
Company agreed to register the Common Stock shares on a “best efforts”
basis.  If the Company was unable to file the registration statement
within the filing timeline, the Company would have had to issue 4,013,602
additional warrants at an exercise price of the lower of (a) the average closing
sale price of its common stock for twenty of the thirty trading days immediately
preceding the date the registration statement should have been filed, or (b)
$1.50 per common share.  The Company did file the registration
statement within the filing timeline and no additional warrants were required to
be issued by the Company.





In
February 2008, the Company issued “goodwill” common stock warrants to the
participants of the Spring 2006 private placement.  The warrants were
issued as a goodwill gesture to investors in the two 2006 private placements due
to the May 2006 common stock private placement registration statement not being
declared effective. Each participant was offered one “goodwill” warrant for
every unit that had been purchased in exchange for waiving any rights under the
Registration Rights Agreement.  The grant date of the “goodwill”
warrants is determined by when the Company receives the waiver letter from the
shareholder. As of February 28, 2009, the Company had received Registration
Rights waiver letters from approximately 81% of the participants in this private
placement.  The warrants will expire on February 14, 2010, have an
exercise price of $0.65 and contain a cashless exercise provision. As of
February 28, 2009, the Company has issued 3,227,934 goodwill warrants valued at
$718,336 to these investors. A total of 4,013,602 warrants potentially could be
issued. The issued warrants were valued using the Black-Scholes option
pricing model.












58


The
assumptions used in the Black-Scholes valuation model were: an average risk free
interest rate of 3.7 %; a declining term to expiration; an average volatility of
121.67%; and dividend yield of 0.0%.





Daybreak
evaluated the application of SFAS No. 133 and EITF 00-19 with respect to the
conversion feature and the registration rights for consideration of embedded
derivatives and concluded that the preferred stock and registration rights
instruments did not have embedded derivatives.





The
relative fair value of the Common Stock and the Common Stock Purchase Warrants
was as follows:





Description
                
                Shares
                
                
                Relative Fair ValueCommon
      Stock
                
                
                8,027,206
                
                
                $
                4,241,232Common
      Stock Purchase Warrants
                
                
                4,013,602
                
                
                
                1,779,172Total
      Proceeds
                
                
                
                
                
                
                6,020,404Offering
      Costs
                
                
                
                
                
                
                (832,147
                )Net
      Proceeds
                
                
                
                
                
                
                5,188,257





Common
Stock for Services





Under
SFAS No. 123R the guidelines for recording stock issued for goods or services
require the fair value of the shares granted be based on the fair value of the
goods or services received or the publicly traded share price of the Company’s
registered shares on the date the shares were granted, whichever is more readily
determinable.  This position has been further clarified by the
issuance of SFAS No. 157,”Fair
Value Measurements.”  The Company has determined that the fair
value of all Common Stock issued for goods or services is more readily
determinable based on the publicly traded share price on the date of
grant.





During
the year ended February 28, 2009, the Company did not have any issuances of
common stock paying for services.





During
the year ended February 29, 2008, the Company paid for services with 10,000
shares of unregistered common stock valued at $4,501.





Common
Stock Issued for Convertible Debentures and Interest Payable





During
the year ended February 28, 2009, the Company did not have any convertible debt
conversions, since it no longer has any debt nor were any interest payments made
with common stock.





During
the fiscal year ended February 29, 2008, non-related parties converted
debentures representing $25,000 in principal, resulting in 37,169 shares of
unregistered common stock being issued to satisfy the principal and interest
obligations.










59


NOTE
10 – WARRANTS:





Warrants
outstanding and exercisable as of February 28, 2009 are:





Exercise
                
                
                Remaining
                
                
                Exercisable
      WarrantsDescription
                
                Warrants
                
                
                Price
                
                
                Life
      (Years)
                
                
                RemainingSpring
      2006 Common Stock Private Placement
                
                
                4,013,602
                
                
                $
                2.00
                
                
                
                2.25
                
                
                
                4,013,602Placement
      Agent Warrants - Spring 2006 PP
                
                
                802,721
                
                
                $
                0.75
                
                
                
                4.25
                
                
                
                802,721Placement
      Agent Warrants - Spring 2006 PP
                
                
                401,361
                
                
                $
                2.00
                
                
                
                4.25
                
                
                
                401,361July
      2006 Preferred Stock Private Placement (PP)
                
                
                2,799,530
                
                
                $
                2.00
                
                
                
                2.50
                
                
                
                2,799,530Placement
      Agent Warrants - July 2006 PP
                
                
                419,930
                
                
                $
                1.00
                
                
                
                4.50
                
                
                
                419,930Convertible
      Debenture Term Extension
                
                
                150,001
                
                
                $
                2.00
                
                
                
                2.75
                
                
                
                150,001Convertible
      Debenture 2nd
      Term Extension
                
                
                112,000
                
                
                $
                0.53
                
                
                
                0.50
                
                
                
                112,000Convertible
      Debenture 3rd
      Term Extension
                
                
                90,000
                
                
                $
                0.25
                
                
                
                0.75
                
                
                
                90,000Spring
      2006 PP - Goodwill Warrants
                
                
                3,227,934
                
                
                $
                0.65
                
                
                
                1.00
                
                
                
                3,227,934July
      2006 PP - Goodwill Warrants
                
                
                1,250,264
                
                
                $
                0.65
                
                
                
                1.00
                
                
                
                1,250,264Placement
      Agent Warrants - January 2008 PP
                
                
                39,550
                
                
                $
                0.25
                
                
                
                2.00
                
                
                
                39,55013,306,893
                
                
                
                
                
                
                
                
                
                
                
                13,306,893





For the
year ended February 28, 2009, a total of 397,547 warrants were issued as part of
the Company’s goodwill warrant program and to the placement agent from the
January 2008 private placement. There were no warrants exercised during the
year.  The intrinsic value of all warrants as of February 28, 2009 was
$-0-.





For the
year ended February 29, 2008, there were 4,120,201 warrants issued as part of
the Company’s goodwill warrant program and for convertible debenture extensions.
A total of 12,909,346 warrants were issued and outstanding as of February 29,
2008.  The intrinsic value of all warrants as of February 29, 2008 was
$5,400.





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:







2009Computed
      at U.S. and State statutory rates (40%)
                  
                  $
                  (52,196
                  )Permanent
      differences
                  
                  
                  25,731Changes
      in valuation allowance
                  
                  
                  26,465Total
                  
                  $
                  -










60


Tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred liabilities are presented
below:




Deferred
      tax assets:
                
                2009
                
                
                2008Net
      operating loss carryforwards
                
                $
                4,130,040
                
                
                $
                2,574,000Oil
      and gas properties
                
                
                216,245
                
                
                
                1,745,820Less
      valuation allowance
                
                
                (4,346,285
                )
                
                
                (4,319,820
                )Total
                
                $
                -
                
                
                $
                -





At
February 28, 2009, the Company had a net operating loss carryforwards for
federal and state income tax purposes of approximately $10,325,100, which will
begin to expire, if unused, beginning in 2024.  The valuation
allowance increased by approximately $26,465 for the fiscal year ended February
28, 2009 and by 2,011,828 for the fiscal year ended February 29,
2008.  Section 382 Rule will place annual limitations on the Company’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.





NOTE
12 – SUBSEQUENT EVENTS:





During
May 2009, the Company drilled the Sunday #2 well at its East Slopes Project in
Kern County, California.  The well was drilled to 2,236 feet and
encountered 24 feet of oil pay in the Vedder sand.  This well will be
completed during the month of June 2009.  The Company also increased
the production in the Sunday #1 well to 80 BOPD from 50 BOPD.





On April
29, 2009, the Company agreed to sell its interest in the East Gilbertown
Field in Alabama to a third party $50,000 and other considerations.  The
closing date for this sale is set for June 1, 2009.





On April
6, 2009, the Board of Directors of the Company approved the 2009 Restricted
Stock and Restricted Stock Unit Plan (the “2009 Plan”), allowing the executive
officers, directors, consultants and employees of the Company and its affiliates
(“Plan Participants”) to be eligible to receive restricted stock and restricted
stock units awards under the 2009 Plan, as a means of providing management with
a continuing proprietary interest in the Company.





On April
6, 2009, the Compensation Committee of the Board of Directors approved awards of
restricted shares of common stock of the Company, with a grant date of April 7,
2009, to a current and a former executive officer of the Company of 500,000
shares each (the “Restricted Shares”).  The Restricted Shares were
granted pursuant to the 2009 Plan and vest over three years at a rate of 331/3% each
year.  The Restricted Shares were granted to the current executive
officer as compensation for his past services as Executive Vice President and
Chief Financial Officer of the Company, and to the former executive officer as
compensation for his past services as interim President and Chief Executive
Officer of the Company.





Additionally,
on April 6, 2009, the Compensation Committee of the Board of Directors approved
awards of restricted shares of Common Stock of the Company, with a grant date of
April 7, 2009, to certain members of the Board of
Directors.






61


A total
of 900,000 Restricted Shares were granted to five different members of the Board
in recognition of their leadership and contribution during the restructuring and
transformation of the Company in fiscal year 2009.





NOTE
13 - SUPPLEMENTARY INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)





All of
the Company’s continuing operations are directly related to oil and natural gas
producing activities located in California, Alabama and Louisiana.





Capitalized
Costs Relating to Oil and Gas Producing Activities





As
      ofFebruary
      28, 2009
                      
                      
                      February
      29, 2008Proved
      propertiesMineral
interests
                      
                      $
                      299,571
                      
                      
                      $
                      1,855,994Wells, equipment and
      facilities
                      
                      
                      1,895,343
                      
                      
                      
                      3,207,055Total
      proved properties
                      
                      
                      2,194,914
                      
                      
                      
                      5,063,049Unproved
      propertiesMineral
interests
                      
                      
                      104,700
                      
                      
                      
                      415,357Uncompleted wells, equipment and
      facilities
                      
                      
                      -
                      
                      
                      
                      896,067Total
      unproved properties
                      
                      
                      104,700
                      
                      
                      
                      1,311,424Less
      accumulated depreciation, depletion, amortization and
      impairment
                      
                      
                      (1,943,334
                      )
                      
                      
                      (4,570,481
                      )Net
      Capitalized Costs
                      
                      $
                      356,280
                      
                      
                      $
                      1,803,992





Costs
Incurred in Oil and Gas Producing Activities




Twelve
      Months EndedFebruary
      28, 2009
                            
                            
                            February
      29, 2008Acquisition
      of proved properties
                            
                            $
                            2,839
                            
                            
                            $
                            119,235Acquisition
      of unproved properties
                            
                            
                            -
                            
                            
                            
                            7,043Development
      costs
                            
                            
                            468,701
                            
                            
                            
                            921,334Exploration
      costs
                            
                            
                            1,322,852
                            
                            
                            
                            1,264,784Total
      Costs Incurred
                            
                            $
                            1,794,392
                            
                            
                            $
                            2,312,396






62


Results
of Operations from Oil and Gas Producing Activities





Twelve
      Months EndedFebruary
      28, 2009
                    
                    
                    February
      29, 2008Oil
      and gas revenues
                    
                    $
                    514,114
                    
                    
                    $
                    1,017,604Production
      costs
                    
                    
                    (327,632
                    )
                    
                    
                    (606,240
                    )Exploration
      expenses
                    
                    
                    (1,304,894
                    )
                    
                    
                    (717,265
                    )Depletion,
      depreciation, and impairment
                    
                    
                    (624,574
                    )
                    
                    
                    (2,314,160
                    )Result
      of oil and gas producing operations before income taxes
                    
                    
                    (1,742,986
                    )
                    
                    
                    (2,620,061
                    )Provision
      for income taxes
                    
                    
                    -
                    
                    
                    
                    -Results
      of Oil and Gas Producing Operations
                    
                    $
                    (1,742,986
                    )
                    
                    $
                    (2,620,061
                    )





Proved
Reserves





The
Company’s proved oil and natural gas reserves have been estimated by the
certified independent engineering firm, Huddleston & Co.,
Inc.  Proved reserves are the estimated quantities that geologic and
engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions. Proved developed reserves are the quantities expected to be
recovered through existing wells with existing equipment and operating
methods.  Due to the inherent uncertainties and the limited nature of
reservoir data, such estimates are subject to change as additional information
becomes available.  The reserves actually recovered and the timing of
production of these reserves may be substantially different from the original
estimate. Revisions result primarily from new information obtained from
development drilling and production history; acquisitions of oil and natural gas
properties; and changes in economic factors.  Our proved reserves are
summarized in the table below:





Oil (Bbl)
                        
                        
                        Gas (Mcf)**
                        
                        
                        BOEProved
      reserves:February
      28, 2007
                        
                        
                        29,425
                        
                        
                        
                        211,800
                        
                        
                        
                        64,725Revisions(1)
                        
                        
                        (15,775
                        )
                        
                        
                        (104,264
                        )
                        
                        
                        (33,152
                        )Extensions
      and discoveries
                        
                        
                        9,776
                        
                        
                        
                        18,148
                        
                        
                        
                        12,801Production
                        
                        
                        (6,792
                        )
                        
                        
                        (49,584
                        )
                        
                        
                        (15,056
                        )Purchases
      (sales) of minerals-in-place
                        
                        
                        (3,522
                        )
                        
                        
                        (10,600
                        )
                        
                        
                        (5,289
                        )February
      29, 2008
                        
                        
                        13,112
                        
                        
                        
                        65,500
                        
                        
                        
                        24,029Revisions(2)
                        
                        
                        (68
                        )
                        
                        
                        (31,257
                        )
                        
                        
                        (5,278
                        )Extensions
      and discoveries
                        
                        
                        17,250
                        
                        
                        
                        -
                        
                        
                        
                        17,250Production
                        
                        
                        (4,119
                        )
                        
                        
                        (27,220
                        )
                        
                        
                        (8,656
                        )Purchases
      (sales) of minerals-in-place
                        
                        
                        (8,925
                        )
                        
                        
                        (7,023
                        )
                        
                        
                        (10,095
                        )February
      28, 2009
                        
                        
                        17,250
                        
                        
                        
                        -
                        
                        
                        
                        17,250





** Gas
per Mcf (Thousand cubic feet) includes natural gas liquids (wet gas) if
any.





(1)
              The
      revisions of previous estimates for the year ended February 29, 2008
      resulted from two sources.  In the Tuscaloosa Project in
      Louisiana, the F-1 and F-3 wells were shut in for the majority of the
      fiscal year resulting in a marked decline in field performance. This
      decline then resulted in the previous estimates of proved reserves being
      decreased.




63






(2)
              The
      revisions of previous estimates for the fiscal year ended February 28,
      2009, resulted from a revised lower estimate of reserve value due to
      depressed hydrocarbon prices in the energy
  markets.





Standardized
Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas
Reserves





The
following information is based on the Company’s best estimate of the required
data for the Standardized Measure of Discounted Future Net Cash Flows as of
February 28, 2009 and February 29, 2008 in accordance with SFAS No. 69, “Disclosures About Oil and Gas
Producing Activities” which requires the use of a 10% discount
rate.  This information is not the fair market value, nor does it
represent the expected present value of future cash flows of the Company’s
proved oil and gas reserves.




Twelve
      Months EndedFebruary
      28,2009
                          
                          
                          February
      29,2008Future
      cash inflows
                          
                          $
                          597,368
                          
                          
                          $
                          1,876,287Future
      production costs (1)
                          
                          
                          (151,111
                          )
                          
                          
                          (632,786
                          )Future
      development costs
                          
                          
                          (12,500
                          )
                          
                          
                          -Future
      income tax expenses (2)
                          
                          
                          -
                          
                          
                          
                          -Future
      net cash flows
                          
                          
                          433,757
                          
                          
                          
                          1,243,50110%
      annual discount for estimated timing of cash flows
                          
                          
                          (77,478
                          )
                          
                          
                          (113,236
                          )Standardized
      measure of discounted future net cash flows at the end of the
      year
                          
                          $
                          356,279
                          
                          
                          $
                          1,130,265




(1)
              Production
      costs include oil and gas operations expense, production ad valorem taxes,
      transportation costs and general and administrative expense supporting the
      Company’s oil and gas
operations.




(2)
              The
      Company has sufficient tax deductions and allowances related to proved oil
      and gas reserves to offset future net
revenues.




Future
cash inflows are computed by applying year-end prices, adjusted for location and
quality differentials on a property-by-property basis, to year-end quantities of
proved reserves, except in those instances where fixed and determinable price
changes are provided by contractual arrangements at year-end.  The
discounted future cash flow estimates do not include the effects of the
Company’s derivative instruments, if any.  See the following table for
average prices.




Average
      PriceYear
      Ended
                          
                          Oil (Bbl)
                          
                          
                          Gas (Mcf)**February
      28, 2009
                          
                          $
                          35.40
                          
                          
                          $
                          -February
      29, 2008
                          
                          
                          56.13
                          
                          
                          
                          3.00February
      28, 2007
                          
                          
                          63.31
                          
                          
                          
                          3.33





** Gas per Mcf (Thousand cubic feet)
includes natural gas liquids (wet gas) if any.




64


Future
production and development costs, which include dismantlement and restoration
expense, are computed by estimating the expenditures to be incurred in
developing and producing the Company’s proved crude oil and natural gas reserves
at the end of the year, based on year-end costs, and assuming continuation of
existing economic conditions.




Future
income tax expenses are computed by applying the appropriate year-end statutory
tax rates to the estimated future pretax net cash flows relating to the
Company’s proved crude oil and natural gas reserves, less the tax bases of the
properties involved.  The future income tax expenses give effect to
tax credits and allowances, but do not reflect the impact of general and
administrative costs and exploration expenses of ongoing operations relating to
the Company’s proved crude oil and natural gas reserves.




Sources
of Changes in Discounted Future Net Cash Flows





Principal
changes in the aggregate standardized measure of discounted future net cash
flows attributable to the Company’s proved crude oil and natural gas reserves,
as required by SFAS No. 69, at year end are set forth in the table
below.




Twelve
      Months EndedFebruary
      28, 2009
                  
                  
                  February
      29, 2008Standardized
      measure of discounted future net cash flows at the beginning of the
      year
                  
                  $
                  1,130,265
                  
                  
                  $
                  1,940,367Extensions,
      discoveries and improved recovery, less related costs
                  
                  
                  -
                  
                  
                  
                  644,889Revisions
      of previous quantity estimates
                  
                  
                  (37,959
                  )
                  
                  
                  (1,559,345
                  )Changes
      in estimated future development costs
                  
                  
                  (464,940
                  )
                  
                  
                  (185,701
                  )Purchases
      of minerals in place
                  
                  
                  370,671
                  
                  
                  
                  -Sales
      of minerals in place
                  
                  
                  (954,039
                  )
                  
                  
                  (330,401
                  )Net
      changes in prices and production costs
                  
                  
                  (116,325
                  )
                  
                  
                  283,361Accretion
      of discount
                  
                  
                  113,027
                  
                  
                  
                  194,037Sales
      of oil and gas produced, net of production costs
                  
                  
                  (186,482
                  )
                  
                  
                  (411,365
                  )Development
      costs incurred during the period
                  
                  
                  464,939
                  
                  
                  
                  356,463Change
      in timing of estimated future production and other
                  
                  
                  37,122
                  
                  
                  
                  197,959Net
      change in income taxes
                  
                  
                  -
                  
                  
                  
                  -Standardized
      measure of discounted future net cash flows at theend
      of the year
                  
                  $
                  356,279
                  
                  
                  $
                  1,130,265














65


ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE





None.




































































66


ITEM 9A(T). CONTROLS AND
PROCEDURES





Management’s
Evaluation of Disclosure Controls and Procedures





As of the
end of the reporting period, February 28, 2009, an evaluation was conducted by
Daybreak management as to the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-15(e) of the Exchange
Act. Such disclosure controls and procedures are designed to ensure 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 SEC 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 disclosures.





Management
(with the participation of our Chief Executive Officer and interim principal
finance and accounting officer) determined that as of February 28, 2009, these
disclosure controls and procedures are effective ensuring that information that
is required to be disclosed by the Company in reports filed or submitted with
the SEC is recorded, processed, summarized and reported within the time periods
specified in the rules and forms established by the SEC.





Internal
Control Over Financial Reporting





The
Company’s internal 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 principles.





Our
internal controls over financial reporting include those policies and procedures
that:




1)
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;


2)
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that our receipts and expenditures are being
      made in accordance with authorizations of management and our Board of
      Directors; and


3)
              provide
      reasonable assurance regarding prevention or timely detection of any
      unauthorized acquisition, use or disposition of assets that could have a
      material effect on the financial
statements.





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.





Management’s
Report on Internal Control Over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act. Management assessed the effectiveness of our internal
control over financial reporting as of February 28, 2009. In making this
assessment, management used certain criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework.










67


A
material weakness is a significant deficiency, or combination of significant
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 by the entity’s internal control over financial reporting.
Management identified the following material weakness that occurred during the
year ended February 28, 2009:


- In
  December 2008, the Audit Committee of the Board of Directors determined that
  it was necessary to restate the Company’s financial statements for the fiscal
  year ended February 29, 2008, included in our Annual Report as filed on Form
  10-KSB filed on May 27, 2008.This
  determination was made after consideration was given to a series of comments
  made by the Staff of the SEC regarding certain financial valuation and
  disclosure items in our Amendment No. 1 on Form 10-KSB/A to our Annual Report
  on Form 10-KSB for the fiscal year ended February 29, 2008.  In
  response to comments and a review by the SEC, the Company determined that it
  should follow the guidance of Statement of Financial Accounting Standards No.
  123R (“FAS 123R”) “Share-Based Payment”and
  related interpretations and FSP EITF 00-19-2
  “Accounting for Registration
  Payment Arrangements” in its accounting treatment of goodwill warrants
  offered by the Company in February 2008 to participants of certain private
  placement offerings (the “Warrants”) and recognize a non-cash general and
  administrative expense for the recordable valuation of the Warrants which
  resulted in an increase to the net loss of $934,521 on the Statement of
  Operations for the fiscal year ended February 29, 2008.

Solely as
a result of the aforementioned material weakness, management has concluded that,
as of February 28, 2009, the Company’s internal control over financial reporting
was not effective.





This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the SEC that permit the
company to provide only management’s report in this annual report.





Changes
in Internal Control over Financial Reporting





As a
result of our evaluations described above, the Company is initiating the
following changes described below in our internal control over financial
reporting:


- we are
  developing an additional level of authoritative accounting resource and review
  to be used in the recognition of extraordinary non-cash
  transactions;
- additional
  training is being designed to reinforce existing resources;
- management
  is adding a further level of  oversight for approval of non-routine
  non-cash transactions, and
- we have
  engaged a third party to assist in efforts to document and test financial
  reporting controls.













68


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.





ITEM 9B. OTHER
INFORMATION





None
















































69


PART III





Certain
information required by Part III is omitted from this Annual Report on Form 10-K
because we will file a definitive proxy statement pursuant to Regulation 14A
(the “Proxy Statement”), not later than 120 days after the end of the fiscal
year covered by this Form 10-K, and certain information to be included therein
is incorporated herein by reference.





ITEM 10. DIRECTORS, EXECUTIVE
OFFICERS, AND CORPORATE GOVERNANCE





Information
regarding our Ethical Business Conduct Policy Statement and the Code of Ethics
for Senior Financial Officers is described in the introductory pages of this
Annual Report under the caption “Website / Available
Information.”  The information required by Item 10 that relates to our
directors and executive officers is incorporated by reference from the
information appearing under the captions “Proposal Number 1: Election of
Directors,” “Executive Officers,” “Corporate Governance,” “Section 16(a)
Beneficial Ownership Reporting Compliance” and “Report of the Audit Committee of
the Board of Directors” in our Proxy Statement.





ITEM 11. EXECUTIVE
COMPENSATION





The
information required by Item 11 that relates to compensation of our principal
executive officers and our directors is incorporated by reference from the
information appearing under the captions “Executive Compensation” and “Director
Compensation” in our Proxy Statement.





ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS





The
information required by Item 12 that relates to the ownership of securities by
management and others is incorporated by reference from the information
appearing under the caption “Security Ownership” in our Proxy
Statement.





ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE





The
information required by Item 13 that relates to business relationships and
transactions with our management and other related parties is incorporated by
reference from the information appearing under the captions “Corporate
Governance” and “Transactions Between the Company and Management” in our Proxy
Statement.





ITEM 14. PRINCIPAL ACCOUNTANT
FEES AND SERVICES





The
information required by Item 14 that relates to services provided by our
registered public accounting firm and the fees incurred for services provided
during fiscal years 2009 and 2008 is incorporated by reference from the
information appearing under the captions “Fees Billed by Independent Public
Accountants” in our Proxy Statement.










70


PART IV





ITEM 15. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES





The
following Exhibits are filed as part of the report:





3.01
                Articles
      of Incorporation, as amended(1)


3.02
              Amended
      and Restated Bylaws(2)


4.01
                Specimen
      Stock Certificate(14)


4.02
                  Designations
      of Series A Convertible Preferred Stock (filed as Articles of Amendment to
      the Articles of Incorporation of Daybreak Oil & Gas, Inc. dated June
      30, 2006 and filed as part of Exhibit
3.01.)


4.03
                Warrant
      for the purchase shares of common stock, March 2006 private
      placement(3)


4.04
              Registration
      rights agreement, March 2006 private placement(3)


4.05
                Warrant
      for the purchase shares of common stock, July 2006 private
      placement(4)


4.06
              Registration
      rights agreement, July 2006 private placement(4)


4.07
                      Form
      of agreement whereby recipients of goodwill warrants waived rights under
      registration rights agreement associated with the Spring 2006 and the July
      2006 private placement offerings.(14)


4.08
              2009
      Restricted Stock and Restricted Stock Unit Plan(5)


4.09
                Form
      of Restricted Stock Award Agreement(5)


4.10
              Form
      of Restricted Stock Unit Award Agreement(5)


10.01
                Development
      agreement with Chicago Mill Joint Venture for Louisiana
      project(6)


10.02
              Prospect
      review and non-competition agreement for California project(6)


10.03
                Joint
      Venture Agreement with Nomad Hydrocarbons, Ltd. for California
      project(6)


10.04
              Prospect
      review agreement for California project(6)


10.05
                Development
      agreement with Vision Exploration for Krotz Springs 3D
      Prospect(6)


10.06
              Subscription
      agreement and letter of investment intent, March 2006 private
      placement(3)


10.07
                Pipeline
      license agreement for Tuscaloosa project in Louisiana(6)


10.08
              Subscription
      agreement and letter of investment intent, July 2006 private
      placement(4)


10.09
                Purchase
      of additional mineral interest in Tuscaloosa project in
      Louisiana(7)


10.10
              Farmout
      agreement with Monarch Gulf Exploration, Inc.(8)


10.11
                Oil
      and gas lease with Anadarko E&P Company, L.P.(9)


10.12
              Drilling
      contract with Energy Drilling for two wells in Louisiana(10)


10.13
                Seismic
      Option Farmin Agreement with Chevron U.S.A.(11)


10.14
              Joint
      Development Participation Agreement for Tuscaloosa project in
      Louisiana(12)


10.15
                Purchase
      and Sale Agreement with Lasso Partners, LLC(1)


10.16
              Letter
      of Agreement to amend the Purchase and Sale Agreement with Lasso Partners,
      LLC(13)


10.17
                Purchase
      of Tuscaloosa interest from Kirby Cochran(1)


10.18
                  Purchase
      of Tuscaloosa interest from 413294 Alberta Ltd. (Robert N.
      Martin)(1)


10.19
                Purchase
      of Tuscaloosa interest from Tempest Energy, Inc (Eric L. Moe)(1)


10.20
              Letter
      of Agreement on North Shuteston Assignment of Interest(1)


23.1
                    Consent of Huddleston & Co., Inc. (14)


23.2
                Consent of Malone & Bailey, PC (14)


31.1
                  Certification of principal executive and
      principal financial officer as required pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002(14)


32.1
                Certification of principal executive and
      principal financial officer as required pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002 (14)





71


(1)
            Previously
      filed as exhibit to Form 10-KSB filed on May 27, 2008, and incorporated by
      reference herein.


(2)
            Previously
      filed as exhibit to Form 8-K on April 9, 2008, and incorporated by
      reference herein.


(3)
            Previously
      filed as exhibit to Form SB-2 on July 18, 2006, and incorporated by
      reference herein.


(4)
            Previously
      filed as exhibit to Form 10-KSB on September 21, 2007, and incorporated by
      reference herein.


(5)
            Previously
      filed as exhibit to Form S-8 filed on April 7, 2009 and incorporated by
      reference herein.


(6)
            Previously
      filed as exhibit to Form SB-2/A on December 28, 2006, and incorporated by
      reference herein.


(7)
            Previously
      filed as exhibit to Form 8-K on September 28, 2006, and incorporated by
      reference herein.


(8)
            Previously
      filed as exhibit to Form 8-K on October 26, 2006, and incorporated by
      reference herein.


(9)
            Previously
      filed as exhibit to Form 8-K on November 7, 2006, and incorporated by
      reference herein.


(10)
            Previously
      filed as exhibit to Form 8-K on November 17, 2006, and incorporated by
      reference herein.


(11)
            Previously
      filed as exhibit to Form 8-K on July 16, 2007, and incorporated by
      reference herein.


(12)
            Previously
      filed as exhibit to Form 8-K on July 20, 2007, and incorporated by
      reference herein.


(13)
            Previously
      filed as exhibit to Form 8-K on May 2, 2008, and incorporated by reference
      herein.


(14)
            Filed
      herewith.












































72


SIGNATURES





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/
      JAMES F. WESTMORELANDJames
      F. Westmoreland, itsPresident,
      Chief Executive Officerand
      interim principal finance and accounting officerDate:  May
      27, 2009




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.




By:
                                                  /s/
      JAMES F. WESTMORELAND
                                                  
                                                  By:
                                                  /s/
      DALE B. LAVIGNEJames
      F. Westmoreland
                                                  
                                                  
                                                  Dale
      B. LavigneDirector/
      President and Chief Executive Officer
                                                  
                                                  
                                                  Director
      / ChairmanDate:  May
      27, 2009
                                                  
                                                  
                                                  Date: May
      27, 2009By:
                                                  /s/
      TIMOTHY R. LINDSEY
                                                  
                                                  By:
                                                  /s/
      WAYNE G. DOTSONTimothy
      R. Lindsey
                                                  
                                                  
                                                  Wayne
      G. DotsonDirector
                                                  
                                                  
                                                  DirectorDate: May
      27, 2009
                                                  
                                                  
                                                  Date: May
      27, 2009By:
                                                  /s/
      RONALD D. LAVIGNE
                                                  
                                                  By:
                                                  /s/
      JAMES F. MEARARonald
      D. Lavigne
                                                  
                                                  
                                                  James
      F. MearaDirector
                                                  
                                                  
                                                  DirectorDate: May
      27, 2009
                                                  
                                                  
                                                  Date: May
      27, 2009






















73