HNO International, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations We believe the following selected sales and expense data, the percentage relationship between sales and major categories in our condensed consolidated statements of operations and the percentage change in the dollar amounts of each of the items presented is important in evaluating the performance of our business operations. ($ in Thousands) Three Months Ended July 31, 2010 2009 2010 vs 2009 Amount Percentage of Revenues Amount Percentage of Revenues Amount of Increase (Decrease) Percentage Increase (Decrease) Sales $ 0 N/A $ 0 N/A $ 0 N/A Cost of sales N/A 0 N/A 0 N/A General and administrative expenses 6,275 N/A 11 N/A 6,264 56,945.5 Research and development 0 N/A 0 N/A 0 N/A Operating loss 6,275 N/A 11 N/A 6,264 56,945.5 Interest expense 401 N/A 0 N/A 401 N/A Other income 9 N/A 0 N/A 9 N/A Provision for income taxes 0 N/A 0 N/A 0 N/A Net loss 6,667 N/A 11 N/A 6,656 60,509.1 Foreign currency translation (loss)/income 544 N/A 0 N/A 544 N/A Comprehensive loss 6,123 N/A 11 N/A 6,134 58,609.1 Nine Months Ended July 31, 2010 2009 2010 vs 2009 Amount Percentage of Revenues Amount Percentage of Revenues Amount of Increase (Decrease) Percentage Increase (Decrease) Sales $ 0 N/A $ 0 N/A $ 0 N/A Cost of sales 0 N/A 0 N/A 0 N/A General and administrative expenses 14,170 N/A 69 N/A 14,101 20,436.2 Research and development 74 N/A 0 N/A 74 N/A Operating loss 14,244 N/A 69 N/A 14,175 20,546.4 Interest expense 497 N/A 0 N/A 497 N/A Other income 9 N/A 0 N/A 9 N/A Provision for income taxes 0 N/A 0 N/A 0 N/A Net loss 14,731 N/A 69 N/A 14,662 21,249.3 Foreign currency translation (loss)/income 187 N/A 0 N/A 187 N/A Comprehensive loss 14,543 N/A 69 N/A 14,474 21,460.9 10 Three Months Ended July 31, 2010 and 2009 Sales We did not recognize any sales for the three months ended July 31, 2010 (the “2010 Third Quarter”) and 2009 (the “2009 Third Quarter”). We are in the process of migrating from the advanced development stage to an operating company that offers strategic clean energy generation and sustainable fuel supply projects to address the requirement of renewable and sustainable source of power. In December 2009, we entered into an agreement to acquire a biomass power plant located in Salem, Tamilnadu, India (the “Salem Plant”) and, during the 2010 Third Quarter, we entered into an agreement to acquire a second biomass power plant located near Chennai, India (the “Chennai Plant”). We are in the process of tendering final purchase price payments to the sellers of the Salem Plant, which we anticipate will be completed prior to the end of our current fiscal year, which ends on October 31, 2010 (the “2010 Fiscal Year”). The Salem Plant has a current capacity to generate 1.5 megawatts per hour (“MWe”) of electrical power from the use of anaerobic digestive biomass (in the case of the Salem Plant, chicken litter). We have been refurbishing the Salem Plant in anticipation of commencing power generation operations. Such refurbishing efforts are expected to be completed prior to the end of the 2010 Fiscal Year and we anticipate commencing power generation operations at the Salem Plant also prior to the end of the 2010 Fiscal Year. We believe the Salem Plant will generate gross revenues of approximately $150,000 per month when operating at its current full capacity. We are in the process of completing the necessary steps in order to secure the bank financing necessary to consummate the acquisition of the Chennai Plant. The Chennai Plant has the capacity to generate 18 MWe of power utilizing biomass as a feedstock (in the case of the Chennai Plant, dry agricultural wood waste). We anticipate consummating the acquisition prior to the end of the 2010 Fiscal Year, after which we anticipate the commencement of power generation operations at the Chennai Plant. We believe the Chennai Plant will generate gross revenues of approximately $1.2 million per month when operating at its anticipated initial power generation rate of 80% of plant capacity. Cost of Sales We had no cost of sales during both the 2010 Third Quarter and 2009 Third Quarter, as we had no operations during either of such fiscal periods. We anticipate that our cost of sales for our two anticipated plant operations will primarily relate to the costs of purchasing feedstock chicken litter for the Salem Plant and dry agricultural waste for the Chennai Plant. We anticipate that cost of [services] for the Salem Plant and Chennai Plant will be approximately 50% of anticipated gross revenues, based on operations at current anticipated capacities and typical cost of [sales] within the biomass power generation industry. General and Administrative Expenses General and administrative expenses for the 2010 Third Quarter increased by approximately $6,265,000, or 56,945.5%, as compared to the 2009 Third Quarter, primarily as a result of incurring increased commissions consulting fees, finance costs and share-based compensation of $3,039,000 in the 2010 Third Quarter. There were no share-based compensation expenses incurred in the 2009 Third Fiscal Quarter. The 2010 Third Quarter share-based compensation was incurred in connection with our retention of three consultants to perform business development and capital raising services. We do not intend to continue to rely upon compensating our directors, officers, consultants, employees and other service providers with share-based compensation to the extent we have done so over the prior twelve month period; but do anticipate increased compensation charges in future fiscal periods as we commence operations at the Salem Plant and Chennai Plant. We anticipate employment costs and other operating expenses for each of the Salem Plant and Chennai Plant, once operating at anticipated capacities, will be between 10% and 15% of the sales generated by such plant. Research and Development We incurred $29,408 in research and development expenses during our 2010 Third Quarter and zero for the 2009 Third Quarter. From inception on October 2005 through March 2009, we incurred a total of approximately $2,349,000 of research and development expenses relating to the development of certain genetically-engineered feedstocks which we intend to utilize at our biomass power generating plants and for sale to third parties, including the Paulownia species of tree which we license on an exclusive basis from Star Biotechnology Limited and Arbour Technologies Pty Ltd. 11 We intend to continue to conduct research on the genetical engineering of a species of tree (Melia dubia) and bamboo (Beema Bamboo) in view of increasing its growth rate by up to 40% per annum. We further intend to allocate funds to the cultivation of improved strains (clones) of Melia dubia as well as conducting research into organic fertilizers and pesticides to complement the species of tree and grass we have selected for use as biomass feedstocks. In addition, we also intend to conduct research into the conversion to liquid fertilizer of the by-product that will be generated by the Salem Plant during the processing of chicken litter as the feedstock for power generation at the plant, with the view of increasing the value and application of such for use as organic fertilizer for biomass feedstock plantations. Interest Expense and Other Income Interest expense increased between the comparable three-month periods due to the costs of servicing debt in the 2010 Third Quarter, which aggregated in principal amount to $497,111 at July 31, 2010, while there was nominal or no debt serviced in the 2009 Third Quarter. We will require further borrowings as we commence operations of the Salem Plant and Chennai Plant. These loans are anticipated to be approximately $1.5 million for the Salem Plant and $15 million for the Chennai Plant. We are in discussions with banks on the terms of such loans, although no assurance can be given that such borrowings will be consummated on terms favorable to us, or at all, nor whether the borrowings will be sufficient for the commencement and continued operations of the two plants. We further anticipate that we will incur additional debt as we continue to expand by purchasing existing biomass power generating plants or build such type of plants on our own. Any increase in debt will result in our debt servicing obligations. No assurance can be given that we will be able to obtain additional debt financing (or equity financing) for our maintenance and expansion needs on terms advantageous to us or at all. Provision for Income Taxes We did not make a provision for income taxes for either the 2010 Third Quarter nor the 2009 Third Quarter, as we had no tax liability for either of the comparative periods. Net Loss For the above stated reasons, our net loss increased by approximately $6,656,000, or 58,609.1%, between the 2009 Third Quarter and 2010 Third Quarter. We expect to continue to incur quarterly net losses until such time as we are operating a sufficient number of biomass power plants and feedstock plantations that generate revenues in excess of the costs incurred in operating such facilities and the administration of our Company. We expect to achieve such level of revenues by the end of our fiscal year ending October 31, 2011 (the “2011 Fiscal Year”). Nine Months Ended July 31, 2010 and 2009 Sales We did not recognize any sales for the nine months ended July 31, 2010 (the “2010 Nine Month Period”) and 2009 (the “2009 Nine Month Period”). As we noted in the three month comparison above, we are in the process of migrating from the advanced development stage to an operating company that offers strategic clean energy generation and sustainable fuel supply projects to address the requirement for renewable and sustainable source of power. In December 2009, we entered into an agreement to acquire the Salem Plant and, during the 2009 Third Quarter, we entered into an agreement to acquire the Chennai Plant. We are in the process of tendering final purchase price payments to the sellers of the Salem Plant, which we anticipate will be completed prior to the end of the 2010 Fiscal Year. We have been refurbishing the Salem Plant in anticipation of commencing power generation operations. Such refurbishing efforts are expected to be completed prior to the end of the 2010 Fiscal Year and we anticipate commencing power generation operations at the Salem Plant also prior to the end of the 2010 Fiscal Year. We believe the Salem Plant will generate gross revenues of approximately $150,000 per month when operating at its current full capacity. 12 We are in the process of completing the necessary steps in order to obtain the financing necessary to consummate the acquisition of the Chennai Plant. We anticipate consummating the acquisition prior to the end of September 2010, after which we anticipate the commencement of power generation operations at the Chennai Plant. We believe the Chennai Plant will generate gross revenues of approximately $1,200,000 per month when operating at its anticipated initial power generation rate of 80% of plant capacity. Cost of Sales We had no cost of sales during both the 2010 Nine Month Period and 2009 Nine Month Period, as we had no operations during either of such fiscal periods. We anticipate that our cost of sales for our two anticipated plant operations will primarily relate to the costs of purchasing feedstock chicken litter for the Salem Plant and dry agricultural waste for the Chennai Plant. We anticipate that cost of sales for the Salem Plant and Chennai Plant will be approximately 50% of anticipated gross revenues, based on operations at current anticipated capacities and typical cost of sales within the biomass power generation industry. General and Administrative Expenses General and administrative expenses for the 2010 Nine Month Period increased by approximately $14,100,000, or 20,436.2%, as compared to the 2009 Nine Month Period, primarily as a result of incurring share-based compensation of $9,265,000 and significant commission, consulting and financing costs in the 2010 Nine Month Period. There were no share-based compensation expenses incurred in the 2009 Nine Month Period. The share-based compensation for the 2010 Nine Month Period was incurred at a time when we had little cash available to pay our service providers and we were attempting to build the necessary corporate infrastructure necessary to put our business plan into operation. We do not intend to continue to rely upon compensating our directors, officers, consultants, employees and other service providers with share-based compensation to the extent we have done so over the prior twelve month period; but do anticipate increased compensation charges in future fiscal periods as we commence operations at the Salem Plant and Chennai Plant, as well as expand our operations through acquisitions or internal growth. Due to lower employment costs for operations in India, we anticipate employment costs at each of the Salem Plant and Chennai Plant, once operating at anticipated capacities, will be between 10% and 15%of the revenues generated by such plant. Research and Development We incurred approximately $74,000 in research and development expenses during our 2010 Nine Month Period primarily related to agronomy research. We did not incur any research and development expenses during our 2009 Nine Month Period. From inception on October 2005 through October 31, 2009, we incurred a total of approximately $2,349,000 of research and development expenses relating to the development of certain genetically-engineered feedstocks which we intend to utilize at our biomass power generating plants and for sale to third parties, including the Pavlownia species of tree which we license on an exclusive basis from Star Biotechnology Limited and Arbour Technologies Pty Ltd. As noted in our discussion of our results for the 2010 Third Quarter, we intend to conduct research and development on additional species of trees and grasses and on uses of byproducts resulting from our power generation operations. Interest Expense During the nine months ended July 2010, the Company incurred approximately $497,111 in interest expense relating to notes payable that were outstanding during the period, none of which were outstanding during the nine months ended July 2009. We will require further borrowings as we commence operations of the Salem Plant and Chennai Plant. These loans are anticipated to be approximately $1.5 million for the Salem Plant and $15 million for the Chennai Plant. We are in discussions with banks on the terms of such loans, although no assurance can be given that such borrowings will be consummated on terms favorable to us, or at all, nor whether the borrowings will be sufficient for the commencement and continued operations of the two plants. 13 We further anticipate that we will incur additional debt as we continue to expand by purchasing existing biomass power generating plants or build such type of plants on our own. Any increase in debt will result in our debt servicing obligations. No assurance can be given that we will be able to obtain additional debt financing (or equity financing) for our maintenance and expansion needs on terms advantageous to us or at all. Other Income The Company realized approximately $580 in other income during the 2010 Nine Month Period, relating to the forgiveness of debt incurred in a prior period of $300 and interest in the amount of $280 earned on cash balances in our bank accounts. Provision for Income Taxes We did not make a provision for income taxes for either the 2010 Nine Month Period or the 2009 Nine Month Period, as we had no tax liability for either of the comparative periods. We have a loss carry-forward of approximately $19,694,655 as of July 31, 2010. The utilization of any loss carryforward is dependent on our ability to generate taxable income against which any resulting tax liability can be offset by such loss carryforward, to the extent permissible under federal and applicable state tax laws. Net Loss For the above stated reasons, our net loss increased by approximately $14,662,000, or 21,249.3%, between the 2009 Nine Month Period and 2010 Nine Month Period. We expect to continue to incur quarterly net losses until such time as we are operating a sufficient number of biomass power plants and feedstock plantations that generate revenues in excess of the costs incurred in operating such facilities and the administration of our Company. We expect to achieve such level of revenues by the end of the 2011 Fiscal Year. Liquidity and Financial Condition As of July 31, 2010, we had a working capital deficit of approximately $1,943,000, calculated as follows: At July 31, 2010 At October 31, 2009 Percentage Increase/Decrease Current assets $ 964,294 $ 16,511 18,566.8 Current liabilities 4,568,894 551,257 826.1 Working capital $ (3,604,600 ) $ (534,746 ) 278.4 Our working capital deficit has increased over the nine month period ending July 31, 2010 by approximately $3,070,000. Such increase is primarily due to the increase in business development activities, including the increase in staff and consulting costs. We had approximately $121,000 of subscriptions receivable at July 31, 2010. This amount represents funds held in escrow pending our acceptance of related subscriptions. Such amount was paid as of August 31, 2010. On July 30, 2010, we entered into an agreement with our chief executive officer whereby the officer has irrevocably paid to us the sum of ₤175,000, which is to be retained by us regardless of whether milestones are met. We have entered into various consulting agreements pursuant to which we have issued our common stock as share-based compensation for services rendered or to be rendered. We are amortizing the value of the compensation over the terms of the individual consulting agreements and are carrying the unearned portion as prepaid expense. As of July 31, 2010, the amount of prepaid consulting services is approximately $817,000. While the amortization of such compensation value will impact our operating results, such amortization should not affect cash flow or our financial position. 14 The following summarizes our cash flows for the nine months ended July 31, 2010 and 2009: Nine Months Ended July 31, 2010 2009 Net cash used in operating activities $ (3,851,862 ) $ (58,867 ) Net cash used in investing activities (1,673,078 ) - Net cash provided by financing activities 5,356,738 - Effect of exchange rate changes on cash 187,514 - Net increase (decrease) in cash during the period $ 19,312 $ (58,867 ) Net cash used in operating activities was approximately $3,852,000 for the nine months ended July 31, 2010, as compared to $59,000 for the nine months ended July 31, 2009. The changes in cash flows from operating activities between the corresponding nine month periods were primarily due to increases to prepaid consulting and finance costs. Over the past nine months, we have been transitioning from an advanced development stage entity towards being an operating company. During the nine months ending July 2010, we have primarily been financed through advances and notes payable and use of our common stock; through sales to third parties and others and by the issuance of stock as share-based compensation. We currently have 68 highly qualified individuals as consultants and employees, located in six different geographic areas, providing services to our company. In part by preserving cash flow through compensating, in whole or part, our services providers, consisting of employees and consultants, through issuances of stock rather than cash payments, we believe that we have acquired assets, including what we hope to be valuable intellectual property rights, and have begun to create the infrastructure required to generate revenues in the near future. Net cash used in investing activities was approximately $1,673,000 for the nine months ended July 31, 2010, as compared to none for the nine months ended July 31, 2009. The changes in cash flows from investing activities between the corresponding nine month periods were primarily incurred in connection with refurbishing and other costs relating to the Salem Plant that we are in the process of acquiring. Net cash provided by financing activities was approximately $5,357,000 for the nine months ended July 31, 2010, as compared to none for the nine months ended July 31, 2009. The changes in cash flows from financing activities between the corresponding nine month periods include $1,194,000 in cash from the sale of stock, $2,383,000 in cash received from affiliates and shareholders and $1,779,000 in cash received on notes payable. We received a loan (the “Rootchange Loan”) in the principal amount of $607,461 from Rootchange Limited, an affiliate of two of our directors and executive officers, Mark L.M. Quinn and Jessica Hatfield, on August 5, 2010, subsequent to the end of the 2010 Third Quarter. The Rootchange Loan is evidenced by two promissory notes, each in the principal amount equal to one-half of the loan amount, $303,730.50. The maturity date of each of the promissory notes is November 1, 2011, with acceleration of such maturity date limited to non-payment and bankruptcy events. The promissory notes each provide for interest at the below-market rate of 1.00% per annum (20.00% following an acceleration event), payable semi-annually, commencing on February 1, 2011. The principal amount (but not accrued and unpaid interest) of one of such notes is convertible into our common stock at the rate of one share for each $0.50 of principal converted. The closing market price of our common stock on the date we received the proceeds of the Rootchange Loan was $0.50 per share. We intend to use the proceeds of the Rootchange Loan to fund our business and development plan, including our planned acquisition, development, expansion and construction of biomass power plants and biomass feedstock plantations, as well as to fund the start-up costs operations of these plants until, if ever, the plants generate sufficient cash flow from their operations to fund the plants’ ongoing costs and expenses. We intend to seek additional capital, either through equity or debt funding, to further fund our business and development plan. Any equity financing could result in substantial dilution to our then current stockholders. Further, any equity or debt financing may not be on terms favorable to us, may be on terms onerous to us or may not be obtainable on any terms whatsoever. 15 Future Financings We will require additional capital to fund our business and development plan, including its planned acquisition, development, expansion and/or construction of biomass power plants and biomass feedstock plantations. In addition, once the power plants have been acquired or constructed, we will need to fund the start-up costs of operating these plants until such time, if ever, when the plants generate sufficient cash flow from their operations to fund the plants’ ongoing costs and expenses. We also may encounter unforeseen costs that could also require us to seek additional capital. Accordingly, our business plan and growth strategy anticipates that we obtain significant additional financial resources, including resources obtained through debt and/or equity financing. We may not be able to obtain the funding necessary to implement its growth strategy on favorable terms or at all. An inability to obtain such funding would prevent us from acquiring, developing, expanding and/or constructing any plants or plantations. Furthermore, our business development strategy may not result in significant revenues even if successfully funded. We have not yet identified all of the sources for the additional financing it requires, although we have discussed possible private equity financing by institutional and other investors located in London, Frankfurt, Munich, Dubai and Abu Dhabi over the past three months and have, in the past, been able to raise equity capital through the sale of our stock. Our ability to obtain additional capital will depend on market conditions, national and global economies, demand for electricity in countries in which we intend to operate power plants, environmental and legal issues affecting power plant operations, weather and other conditions affecting our biomass plantations and other factors beyond our control. Critical Accounting Policies The Company’s significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements included in the Company’s amended Annual Report on Form 10-K/A for the year ended October 31, 2009, filed with the Securities and Exchange Commission on March 19, 2010. A discussion of the Company’s critical accounting policies and estimates is included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of such Form 10-K/A. There have no material changes to such critical accounting policies or estimates as reported in such amended Annual Report section.