HNO International, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Over the next twelve months, we plan to expand our existing biomass generating capacity in India from 19.5 megawatt per hour (“MW/h”) to 66.8 MW/h. We are in current negotiations to enter into a fifteen year lease to operate a 27.3 MW/h power plant located in Kancheepuram, Tamilnadu, India (the “27.3 MW/h power plant”). The 27.3 MW/h power plant is located near the 18MW/h plant that we currently operate (the “18.0 MW/h power plant”). We have been operating the plant since March 15, 2011 and have achieved an average 65% Plant Load Factor (PLF), which is a measurement of the optimum efficiency of which the plant can operate. We also intend to upgrade the 1.5 MW/h anaerobic digestion biomass power plant in Namakkal, Tamilnadu, India that we also will be operating (the “1.5 MW/h power plant”) by adding a 1.0 MW/h Jenbacher gas turbine engine. We anticipate such upgrade to be completed by end of the Company’s third fiscal quarter of 2011. During the past quarter, we have conducted tests on the bi–product (compost) produced from the anaerobic digestion process and determined an estimated market value of $55 per ton. At the site of the 1.5 MW/h plant, we intend to install a 2 MW/h gasification biomass power plant, for which we will source local agricultural waste as biomass feedstock prior to the cultivation of our own energy crops at plantations we intend to develop in areas close to the 1.5 MW/h plant. We are currently conducting tests on the use of dried chicken litter as a source of biomass for the gasification power plant. We are still performing due diligence on the purchase and/or lease a 15 MW/h bagasse power plant located in Kancheepuram. This 15.0 MW/h power plant is located near our 18.0 MW/h power plant and uses bagasse as a source of biomass for generating electricity. The 15 MW/h plant is not currently operational and will need refurbishment work to be completed before it is capable of generating electricity. We have entered into a non-binding Memorandum of Agreement on May 30, 2011 to purchase an 8.5 MW/h biomass power plant located at Kaklaiyarkovil in Sivaganga District, Tamilnadu, along with its factory land estimated at 50 acres, factory building, plant and machinery. The cost of the acquisition is $11.5 million of which $3.3 million is paid in equity and $8.2 million will be in the form of the assumption of debt financing with State Bank of India (“SBI”). We have placed an advance deposit of approximately $226,000 on the plant and expect to close the acquisition prior to the completion of our current fiscal year, which ends on October 31, 2011 (“our 2011 fiscal year”). The plant location is in close proximity to local suppliers of biomass feedstock year-round (Prosopis Julia Flora), which averages $40 per ton delivered to the power plant. We have a memorandum of understanding with a third party to install a 4.0 MW/h gasification biomass power plant at the third party’s new manufacturing facilities in Whitefield, Karnataka, India. The agreement contemplates that we will own and operate the plant, provide to the third party 1.5 MW/h of the plant’s electrical output at market rates with the ability to sell any surplus electricity generated to the local state government. We have an agreement with National Power Corporation in the Philippines to build, own and operate a 2.0 MW/h gasification power plant on Romblon Island which we intend to increase its generating capacity to 4 MW/h in 2012. Four hundred acres of suitable land within 3 kilometres of the power plant have been identified and a lease is currently under negotiation. This power plant will be sited on land owned by The Romblon University where there is connectivity to the national power grid within a 2 kilometer distance. We have an agreement with Ghana Manganese Company Limited to build, own and operate a 2.0 MW/h gasification power plant at their mining site in Tarkwa, Ghana which will supply electricity directly to its mining operations. In addition, we are planning two additional 2.0 MW/h gasification power plant installations in Ghana on behalf of a mining and construction company. 10 Results of Operations Three Months Ended April 30, 2011 and 2010 Our result of operations for the subject three month periods are summarized below: Three Months Ended April 30, 2011 2010 Revenue $ 2,543,350 $ Nil Cost of services 2,158,988 Nil Operating expenses 687,378 5,419,513 Interest 541,926 96,412 Net loss 844,942 5,515,361 We did not recognize any revenues for the three months ended April 30, 2010. We commenced generating revenues in October 2010. Our sole source of revenues for the three months ended April 30, 2011 was generated through our operating the 18.0 MW/h power plant. The 18.0 MW/h power plant was operated for approximately 80% of the period at an average 65% PLF and we anticipate revenues from the 18.0 MW/h plant to be greater in future periods. We anticipate that the 1.5 MW/h plant will begin generating revenues before the conclusion of our 2011 fiscal year. For the three months ended April 30, 2011, we incurred cost of services totaling $2,158,988 relating to various direct expenses incurred in connection with the generation of power at the 18.0 MW/h biomass power plant. Such expenses include fuel inputs of biomass and other fuels, electricity charges paid to the state electricity board as open access charges for using the state’s power grid to supply power to third party customers and water charges, as well as maintenance costs relating to the plant and machinery. We do not anticipate costs of services for the 18.0 MW/h plant to increase in future periods, except in proportion to revenues, although costs of services will increase as other operations are brought online. General and administrative expenses for the three months ended April 30, 2011, decreased by $4,732,135 as compared to the comparative period in 2010, notwithstanding that we began incurring some research and development charges in connection with our agronomy program. The decrease is primarily due to the lack of stock-based compensation charges during the three month period ended April 30, 2011, as compared to significant stock-based compensation charges of $4,615,802 incurred in the three months ended April 30, 2010, as we retained numerous consultants during the 2010 period, to assist us in developing and implementing our business plan. During the three month period ending April 30, 2011, we incurred interest charges in the amount of $541,926 as compared to an interest expense of $96,412 in the period ending April 30, 2011. The increase in interest charges on the IDBI bank loan for the 18.0 MW/h plant for in the amount of $468,633. Foreign Currency Transaction We are exposed to exchange rate fluctuations due to the fact that we are and are planning on operating in multiple foreign jurisdictions, including India, Ghana and Philippines. Since most of the company’s revenues and costs are paid in the local currency of the subject country of operation, variations in the currency exchange rate between the country of operation and the United States impacts both positively and negatively the reporting results. 11 Six Months Ended April 30, 2011 and 2010 Our result of operations for the subject six month periods are summarized below: Six Months Ended April 30, 2011 2010 Revenue $ 4,441,192 $ Nil Cost of services 3,757,069 Nil Operating expenses 1,485,128 6,846,225 Interest 1,388, 711 96,412 Net loss 2,189,716 6,942,073 We did not recognize any revenues for the six months ended April 30, 2010. We commenced generating revenues in October 2010. Our sole source of revenues from the six months ended April 30, 2011 was generated through our operating the 18.0 MW/h power plant. The 18.0MW/h plant was operated for approximately 80% of the period and we anticipate revenues from the 18.0 MW/h plant to be greater in future periods. We anticipate that the 1.5MW/h plant will begin generating revenues before the conclusion of our 2011 fiscal year. During the six months ended April 30, 2011, we incurred cost of services totaling $3,757,069 relating to various direct expenses incurred in connection with the generation of power at the 18.0 MW/h biomass power plant. Such expenses include fuel inputs of biomass and other fuels, electricity charges paid to the state electricity board as open access charges for using the state’s power grid to supply power to third party customers and water charges, as well as maintenance costs relating to the plant and machinery. General and administrative expenses for the six months ended April 30, 2011, decreased by $5,361,097 as compared to the comparative period in 2010, notwithstanding that the Company has started incurring some costs on R&D for development of its agronomy business. The decrease is primarily due to the limited use of stock-based compensation during six months ended April 30, 2011, as compared to significant stock-based compensation charges of $5,116,651 incurred in the six months ended April 30, 2011. During the six months period ended April 30, 2011, we incurred interest charges in the amount of $1,388,711 as compared to an interest expense of $96,412 for a comparative period in 2010. The interest charges have risen mainly on account of the Company bearing the interest charges on the IDBI bank loan for the 18.0 MW/h plant for an amount of $946,874. As of April 30, 2011, we had loans outstanding totaling $3,460,882 in principal amount with an aggregate weighted interest rate of 8.00% per annum. Such loans are due affiliates and stockholders. We have entered into an agreement to acquire the 18.0 MW/h power plant from its current owners. The agreement requires, as a condition to consummating the acquisition that the bank-lender to the plant, IDBI Bank Ltd., approve such acquisition and the assumption of the debt owed to the bank-lender. We are in discussions with the bank-lender. However, the bank-lender has stated that it will not approve the acquisition until such time as we provide sufficient collateral in the form of cash deposits with the bank-lender as required under Indian banking laws. We currently do not have available the funds necessary to make such a deposit and are seeking additional capital to make the deposit. No assurance can be given that the Company will not be successful in obtaining such additional capital, nor, if successful, the terms and costs of additional capital will be advantageous to the Company. We have an oral arrangement with the owners of the plant to the effect that we are operating the plant, retaining all revenues generated from such operations and paying all costs associated with operating the plant. This oral arrangement can be terminated at any time. We expect to operate the 18.0 MW/h plant at 80% capacity by the completion of our fiscal year ending October 31, 2011 (our “Fiscal Year 2011”). We have also acquired operational control of the 1.5 MW/h power plant and are presently conducting renovations to the plant and anticipate commencing revenue generation once the repairs to its gas engines are completed. We operated neither the 18.0 MW/h power plant nor the 1.5 MW/h power plant during the three and six months ended April 30, 2010. We do not anticipate generating revenues during our Fiscal Year 2011 from our proposed operations in Ghana and the Philippines. 12 We hired additional staff and management to operate the 1.5MW/h anaerobic digestion power plant in Namakkal, India in order to operate and maintain the facility. We incurred costs in repairing the power plant and, initially, were not able to operate to generate electricity at the 1.5 MW/h plant for more than four hours a day due to the stabilization process of the digesters. We are required to hire specialist engineers for maintenance and service the gas engines on an annual basis, during such time the plant is required to be closed. We anticipate the plant to be closed for two weeks on an annual basis and the costs for such engineers to be $5,000 for the first year’s maintenance and service. We have conducted tests on the bi-product (chicken litter compost) and believe that if the plant is operated at full capacity, the sale of the bi-product would result in additional revenues of $525,600 based on estimation of 30 tons generated per 1 MW/h of power generated at 80% PLF, at an an estimated market value of $40 per ton. Repair work on the 1.5 MW/h power plant has been scheduled for July 2011 and we expect to start operating at full capacity prior to the completion of our 2011 Fiscal Year. We have hired additional staff and management for the 18.0 MW/h biomass power plant. The plant requires regular maintenance and service which should result in the plant being closed down for an anticipated one month period in order to conduct such service. We have been operating the plant since March 15, 2011 and have achieved on average 65% PLF. We have established a medical centre onsite and engage full time qualified medical service teams to operate the medical centre and provide free medical services to our employees and their related family members. The costs relating to this center will be included in general and administrative expenses on our Statement of Operations. We have rented new office premises in Chennai, India in order to accommodate additional administrative, accounting and management staff. This has resulted in additional overhead costs and general operating expenses, estimated at $5000 per month as compared to the office rental costs of $1,800 per month. In April 2010, we retained four consultants in Ghana to develop projects with the mining companies and local, state and countrywide governments. We have submitted proposals to build and operate/or transfer two 2.0 MW/h gasification power plants in Ghana. In November 2009, we retained three consultants in the Philippines to conduct feasibility studies for supplying off-grid electricity on certain islands to a number of mining companies. Additional office staff has been retained in the Philippines in April 2010. We entered into a non-binding Memorandum of Agreement with National Power Corporation for the supply of 10.0 MW/h of renewable energy at designated sites throughout the Philippines, which is revolving once the first 10.0 MW/h have been installed. We expect to build and operate 2.0 MW/h on Romblon Island, Philippines and an additional 2.0 MW/h in our Fiscal Year 2012. We are exposed to exchange rate fluctuations due to the fact that we are and are planning on operating in multiple foreign jurisdictions, including India, Ghana and Philippines. Since most of the company’s revenues and costs are paid in the local currency of the subject country of operation, variations in the currency exchange rate between the country of operation and the United States impacts both positively and negatively the reporting results. Liquidity and Financial Condition Net cash used in operating activities decreased by $776,248 for the six months period ended April 30, 2011 when compared with the same period in 2010, notwithstanding that there was a higher net loss during the six months period ended April 30, 2010 of $6,942,073 compared to a net loss of $2,189,716 for the six month period ended April 30, 2011, primarily due to higher non-cash expenses such as share-based compensation of $5,116,651 incurred in the six months period ended April 30, 2010. Also the net working capital has increased by $183,331 in 2011 as compared to a decrease of $648,739 in 2010. Net cash used in investing activities was $14,654 for the six months ended April 30, 2011 as compared to $10,010 for the comparable six month period in 2010. These investing activities were primarily incurred in connection with the purchase of office equipment for our new Chennai office in India. Net cash used in investing activities 2010 was also primarily incurred in connection with acquisition of office equipment and furniture. 13 We sold 300,000 shares of common stock in aggregate for legal and investor relations services, and borrowed approximately $500,000 which was applied to repayment of the principal amounts due on the IDBI loan on the 18.0 MW/h power plant. The decrease in financing activities between the comparable six month periods is mainly because the Company has borrowed lesser funds from its affiliates and shareholders in 2011 compared to 2010 for working capital purposes. Cash flows from financing activities for the six months period ended April 30, 2011 was $1,458,270 as compared to $3,003,155 for a similar period in 2010. The effect of the exchange rate adjustment was a benefit $18,869 for the six months period ended April 30, 2011. The exchange rate adjustment is caused by the differences in the exchange rates from period to period between our functional currency(s) versus our reporting currency and the translation of various items of the financials at different rates depending on their nature. For the comparative period in 2010 , the exchange rate adjustment was $356,017. We expect to benefit from or incur charges for exchange rate adjustments in all future periods as we will be operating in various countries and exchange rates between the currencies of such countries and the US dollar will continue to fluctuate due to factors beyond our control. We have no current intentions to hedge against currency fluctuations. As of April 30, 2011, our company had a working capital deficit of approximately $4,221,000. We estimate our operating expenses and working capital requirements for the next twelve month period to be as follows: Operating expenses $ 4,540,000 Management and consulting fees 1,210,000 General and administrative charges 950,000 Total $ 6,700,000 Our estimated operating expenses do not reflect the cost of feedstock for the 18.0MW/h power plant, 27.3MW/h power plant and 1.5MW power plant, which feedstock costs are considered costs of services. We project entering into a lease agreement for the 27.3MW/h power plant in July 2011, subject to satisfactory completion of a testing period. The estimated cost of feedstock, which are not included in operating expenses, but are treated as cost of services, for the three power plants over the next twelve months is approximately $25.5 million. Such estimated feedstock cost is based on anticipated revenues of $42.5 million. The above table does not include additional operating expenses which we may incur as a result of acquisitions or new constructions of power plants over the next twelve months. We will need additional funds to meet our working capital requirements over next twelve months. We anticipate that we will be required to raise additional funds through private sales of debt and equity securities of our company and certain of our wholly- and majority-owned subsidiaries, to fund our operations and execute our business plan. There is no assurance that the financing will be completed on terms advantageous to us, or at all. If we are not successful in raising additional funding, we may be forced to curtail or cease some of all of our operations and/or curtail or elect not to proceed with certain aspects of our business plan. Our business plan contemplates acquisitions of a significant amount of equipment over the next twelve months for the purpose of increasing our generating capacity in India from 19.5MW/h to 66.8/MW/h, along with the installations of gasification power plants in Philippines and Ghana, which are anticipated to generate 8.0MW/h of renewable electricity. We will have to fund the start-up costs and operations of these plants until, if ever, the plants generate sufficient cash flow from their operations. We also will make expenditures in connection with purchases of farm equipment and other machinery for approximately 1,600 acre plantation to supply feedstock for our planned gasification power plants that we intend to build and operate, which we estimate will cost approximately $6 million. We may also encounter unforeseen costs that could also require us to seek additional capital. As a result, we will need to raise additional debt and/or equity funding. However, no assurance can be given that we will be able to sell any of such securities. An inability to obtain such funding would prevent us from constructing any biomass/gasification plants or set up feedstock plantations. Furthermore, our power plants may not produce revenues even if successfully funded. Our ability to obtain additional capital also will depend on market conditions, national and global economies and other factors beyond our control. The terms of any future debt or equity funding that we may obtain may be unfavorable to us and to our stockholders. Furthermore, we can not guarantee the anticipated yields from the planting of energy crops as a source of biomass feedstock for our power plants, nor can we ensure against fire and other natural disasters that would inversely impact to supply of biomass feedstock to our power plants. 14 Critical Accounting Policies Our significant accounting policies are described in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K, for our fiscal year ended October 31, 2010, filed with the Securities and Exchange Commission on Febuary 15, 2011. A discussion of our critical accounting policies and estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations (the “MD&A”) in such Annual Report. There have been no material changes to the critical accounting policies or estimates reported in the MD&A section of our audited financial statements for the year ended October 31, 2010 as filed with the SEC. Item 3. Quantitative and Qualitative Disclosures about Market Risk. This item is not applicable to smaller reporting companies.