##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-QSB 
 (AMENDMENT NO 1)
 
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period
from to to 
 Commission File Number :
001-32228 
 O2DIESEL CORPORATION  Delaware
(State or Other
Jurisdiction of Incorporation)
    
    91-2023525
(IRS Employer
Identification No.)
 100 COMMERCE DRIVE, Suite 301
NEWARK, DELAWARE 19713
(Address of Principal Executive Offices) (302) 266-6000
(Issuers telephone number)
Not Applicable o þ
 (Former name, former address and former fiscal year, if changed since last report)
APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuers classes of common
equity, as of the latest practicable date: As of May 10, 2005, the registrant had 31,085,966 shares of Common Stock,
$0.0001 par value per share, issued and outstanding Transitional Small Business Disclosure Format (check one) Yes o No þ




---



##### 



02DIESEL CORPORATION
FOR THE QUARTER ENDED March 31, 2005 INDEX TO FORM 10-QSB PART I FINANCIAL INFORMATION PAGEItem 1. Financial Statements
    
    
    F-1Item 2. Managements Discussion and Analysis or Plan of Operation
    
    
    1Item 3. Controls and Procedures
    
    
    8PART IIItem 1. Legal Proceedings
    
    
    8Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    8Item 3. Defaults Upon Senior Securities
    
    
    8Item 4. Submission of Matters to a Vote of Security Holders
    
    
    9Item 5. Other Information
    
    
    9Item 6. Exhibits and Reports on Forms 8-K
    
    
    9Signatures
    
    
    9
 NOTE REGARDING FORWARD LOOKING STATEMENTS This quarterly report on Form 10-QSB contains forward-looking statements concerning O2Diesel
Corporation (O2Diesel, the Company or the Registrant) and its future operations, plans and
other matters. Any statements that involve discussions with respect to predictions, expectations,
beliefs, plans, projections, objectives, assumptions or future events or performance (often, but
not always, using phrases such as expects, or does not expect, is expected, anticipates or
does not anticipate, plans, estimates or intends, or stating that certain actions, events
or results may, could, might, or will be taken or occur or be achieved) are not statements
of historical fact and may be forward looking statements which include statements relating to,
among other things, the ability of O2Diesel to successfully compete in the fuel additive and fuel
distribution business. O2Diesel cautions readers not to place undue reliance on any such forward-looking statements, which
speak only as of the date made. Such forward-looking statements are based on the beliefs of
O2Diesels management as well as on assumptions made by and information currently available to
O2Diesel at the time such statements were made. Forward-looking statements are subject to a variety
of risks and uncertainties which could cause actual events or results to differ from those
reflected in the forward-looking statements, including, without limitation, the failure to obtain
adequate financing on a timely basis and other risks and uncertainties. Actual results could differ
materially from those projected in the forward-looking statements, as a result of either the
matters set forth or incorporated in this report generally or certain economic and business
factors, some of which may be beyond the control of O2Diesel. These factors include adverse
economic conditions, entry of new and stronger competitors, inadequate capital, unexpected costs,
failure to gain product approval in the United States or foreign countries for the
commercialization and distribution of our products and failure to capitalize upon access to new
markets. O2Diesel disclaims any obligation subsequently to revise any forward-looking statements to
reflect events or circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events.




---



##### 



O2Diesel Corporation
(A Development Stage Company) PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Balance Sheet
March 31, 2005 ASSETSCURRENT ASSETSCash
    
    $
    1,105,586Accounts receivable
    
    
    3,427Due from
related parties
    
    
    29,607Other receivables
    
    
    77,641Inventory
    
    
    74,064Prepaid expenses and deposits
    
    
    180,788Total current assets
    
    
    1,471,113FURNITURE AND EQUIPMENTOffice furniture equipment
    
    
    157,565Fuel and test equipment
    
    
    172,598330,163Less accumulated depreciation
    
    
    (84,463
    )245,700TOTAL ASSETS
    
    $
    1,716,813LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    499,607Accrued expenses
    
    
    941,002Due to related party
    
    
    227,806Deferred grants
    
    
    211,139Other current liabilities
    
    
    125,752Total current liabilities
    
    
    2,005,306Long Term Liabilities
    
    
    8,438TOTAL LIABILITIES
    
    
    2,013,744STOCKHOLDERS EQUITYPreferred stock: par value of $0.0001; 20,000,000 shares
authorized; 1,550,000 issued and outstanding.
    
    
    155Common stock: par value of $0.0001; 100,000,000 shares
authorized; 29,150,823 issued and outstanding.
    
    
    2,915Common stock
subscribed; 2,803,428 shares at March
31, 2005
    
    
    1,796,053Additional
paid-in capital
    
    
    18,760,144Common stock subscriptions receivable
    
    
    (546,000
    )Accumulated other comprehensive income
    
    
    2,843Deficit accumulated during the development stage
    
    
    (20,313,041
    )Total stockholders equity
    
    
    (296,931
    )TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,716,813
 See Notes to Financial Statements F - 1




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##### 



O2Diesel Corporation
(A Development Stage Company) Consolidated Statements of Operations October 14, 2000(inception)Three months ended March 31,
    
    
    through2005
    
    
    2004
    
    
    March 31, 2005Revenue
    
    $
    15,244
    
    
    
    20,062
    
    
    $
    154,899Expenses:Cost of goods sold
    
    
    9,501
    
    
    
    16,819
    
    
    
    115,164Selling and marketing
    
    
    434,210
    
    
    
    434,509
    
    
    
    5,075,796Product testing and government
grants, net
    
    
    160,724
    
    
    
    78,186
    
    
    
    1,095,403General and administrative
    
    
    1,093,916
    
    
    
    1,217,780
    
    
    
    14,757,310Total operating expense
    
    
    1,698,351
    
    
    
    1,747,294
    
    
    
    21,043,673Operating loss
    
    
    (1,683,107
    )
    
    
    (1,727,232
    )
    
    
    (20,888,774
    )Other income (expense):Interest expense
    
    
    (6,298
    )
    
    
    (2,730
    )
    
    
    (109,977
    )Interest income
    
    
    2,938
    
    
    
    973
    
    
    
    39,415Foreign currency gain (loss), net
    
    
    
    
    
    
    (5,935
    )
    
    
    152,660Other income, net
    
    
    (454
    )
    
    
    
    
    
    
    347,993Total other income (expense)
    
    
    (3,814
    )
    
    
    (7,692
    )
    
    
    430,091Loss before provision (benefit) for
income
taxes
    
    
    (1,686,921
    )
    
    
    (1,734,924
    )
    
    
    (20,458,683
    )Benefit for income taxes
    
    
    
    
    
    
    
    
    
    
    (145,642
    )Net loss
    
    $
    (1,686,921
    )
    
    $
    (1,734,924
    )
    
    $
    (20,313,041
    )Net loss per share (basic and
diluted)
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (1.25
    )Weighted average shares of common
shares
outstanding
    
    
    29,150,823
    
    
    
    28,525,072
    
    
    
    54,292,816Recapitalization resulting from the
AAE
Technologies International PLC
acquisition
    
    
    
    
    
    
    
    
    
    
    (38,081,080
    )Weighted average shares of common
shares
outstanding - giving effect to the
recapitalization
    
    
    29,150,823
    
    
    
    28,525,072
    
    
    
    16,211,736
 See Notes to Financial Statements F -2




---



##### 



O2Diesel Corporation
(A Development Stage Company)Statement of Changes in Stockholders(Deficit) Equity
October 14, 2000 (Inception) through March 2005 Common
    
    
    AdditionalPreferred Stock
    
    
    Common Stock
    
    
    Stock
    
    
    Paid - InShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Subscribed
    
    
    CapitalBalance at October
14, 2000
(Inception)Common stock issued
in exchange for
interest in wholly
owned subsidiaries
    
    
    
    
    
    
    
    
    
    
    43,008,772
    
    
    $
    430,088
    
    
    $
    
    
    
    $
    3,603,415Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Common stock issued
on various dates
during 2001
    
    
    
    
    
    
    
    
    
    
    24,181,038
    
    
    
    241,810
    
    
    
    
    
    
    
    1,268,031Balance at December
31, 2001
    
    
    
    
    
    
    
    
    
    
    67,189,810
    
    
    
    671,898
    
    
    
    
    
    
    
    4,871,446Net lossForeign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Common stock issued
at $0.225 per share
on various
dates during 2002
    
    
    
    
    
    
    
    
    
    
    703,282
    
    
    
    7,033
    
    
    
    
    
    
    
    515,657Balance at December
31, 2002
    
    
    
    
    
    
    
    
    
    
    67,893,092
    
    
    
    678,931
    
    
    
    
    
    
    
    5,387,103Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Common stock issued
on various dates
during 2003
    
    
    
    
    
    
    
    
    
    
    555,556
    
    
    
    5,556
    
    
    
    
    
    
    
    119,444Common stock issued
for consulting
services
    
    
    
    
    
    
    
    
    
    
    200,000
    
    
    
    2,000
    
    
    
    
    
    
    
    43,000Common stock issued
for remaining
interest in
subsidiaries on
July 15, 2003
    
    
    
    
    
    
    
    
    
    
    4,356,200
    
    
    
    43,562
    
    
    
    
    
    
    
    46,323Common stock issued
upon exercise of
stock options on
various dates
during 2003
    
    
    
    
    
    
    
    
    
    
    8,670,881
    
    
    
    86,709
    
    
    
    
    
    
    
    1,131,595Recapitalization
resulting from AAE
acquisition on July
15, 2003
    
    
    
    
    
    
    
    
    
    
    (56,928,690
    )
    
    
    (814,283
    )
    
    
    
    
    
    
    814,283Common stock issued
at $1.50 per share
on various
dates during 2003
    
    
    
    
    
    
    
    
    
    
    3,333,333
    
    
    
    333
    
    
    
    
    
    
    
    4,999,667Expenses related to
2003 issuance of
common stock and
recapitalization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (795,650
    )Subscriptions for
754,900 shares of
common stock at
$1.50 per share on
various dates
during 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,132,350
    
    
    
    Balance at December
31, 2003
    
    
    
    
    
    
    
    
    
    
    28,080,372
    
    
    
    2,808
    
    
    
    1,132,350
    
    
    
    11,745,765Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Common stock issued
at $1.50 per share
on various
dates in 2004
    
    
    
    
    
    
    
    
    
    
    1,070,451
    
    
    
    107
    
    
    
    (1,132,350
    )
    
    
    1,535,770Preferred stock
issued on various
dates during 2004
    
    
    1,550,000
    
    
    
    155
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,478,609Balance at December
31, 2004
    
    
    1,550,000
    
    
    $
    155
    
    
    
    29,150,823
    
    
    $
    2,915
    
    
    
    
    
    
    $
    18,760,144Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss:Subscriptions for
2,803,428 shares of
common stock at
$.70 per share on
various dates
during 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,796,053
    
    
    
    Balance at March
31, 2005
    
    
    1,550,000
    
    
    $
    155
    
    
    
    29,150,823
    
    
    $
    2,915
    
    
    
    1,796,053
    
    
    $
    18,760,144
 See Notes to Financial Statements F-3




---



##### 



O2Diesel Corporation
(A Development Stage Company)Statement of Changes in Stockholders (Deficit) Equity
October 14, 2000 (Inception) through March 31, 2005 DeficitCommon
    
    
    Accumulated
    
    
    Accumulated
    
    
    TotalStock
    
    
    Other
    
    
    During the
    
    
    StockholdersSubscriptions
    
    
    Comprehensive
    
    
    Development
    
    
    EquityReceivable
    
    
    Income (Loss)
    
    
    Stage
    
    
    (Deficit)Balance at October
14, 2000
(Inception)Common stock issued
in exchange for
interest in wholly
owned subsidiaries
    
    $
    
    
    
    $
    
    
    
    $
    (4,138,684
    )
    
    $
    (105,181
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (1,406,709
    )
    
    
    (1,406,709
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    (4,476
    )
    
    
    
    
    
    
    (4,476
    )Comprehensive Loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,411,185
    )Common stock issued
on various dates
during 2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,509,841Balance at December
31, 2001
    
    
    
    
    
    
    (4,476
    )
    
    
    (5,545,393
    )
    
    
    (6,525
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (1,712,803
    )
    
    
    (1,712,803
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    (74,085
    )
    
    
    
    
    
    
    (74,085
    )Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,786,888
    )Common stock issued
at $0.225 per share
on various
dates during 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    522,690Balance at December
31, 2002
    
    
    
    
    
    
    (78,561
    )
    
    
    (7,258,196
    )
    
    
    (1,270,723
    )Net loss
    
    
    
    
    
    
    
    
    
    
    (4,230,296
    )
    
    
    (4,230,296
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    179,689
    
    
    
    
    
    
    
    179,689Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,050,607
    )Common stock issued
on various dates
during 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125,000Common stock issued
for consulting
services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,000Common stock issued
for remaining
interest in
subsidiaries on
July 15, 2003
    
    
    
    
    
    
    
    
    
    
    (409,614
    )
    
    
    (319,729
    )Common stock issued
upon exercise of
stock options on
various dates
during 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,218,304Recapitalization
resulting from AAE
acquisition on July
15, 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued
at $1.50 per share
on various
dates during 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000,000Expenses related to
2003 issuance of
common stock and
recapitalization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (795,650
    )Subscriptions for
754,900 shares of
common stock at
$1.50 per share on
various dates
during 2003
    
    
    (180,000
    )
    
    
    
    
    
    
    
    
    
    
    952,350Balance at December
31, 2003
    
    
    (180,000
    )
    
    
    101,128
    
    
    
    (11,898,106
    )
    
    
    903,945Net loss
    
    
    
    
    
    
    
    
    
    
    (6,728,014
    )
    
    
    (6,728,014
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    (97,446
    )
    
    
    
    
    
    
    (97,446
    )Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,825,460
    )Common stock issued
at $1.50 per share
on various
dates in 2004
    
    
    180,000
    
    
    
    
    
    
    
    
    
    
    
    583,527Preferred stock
issued on various
dates during 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,478,764Balance at December
31, 2004
    
    
    
    
    
    $
    3,682
    
    
    $
    (18,626,120
    )
    
    $
    140,776Net loss
    
    
    
    
    
    
    
    
    
    
    (1,686,921
    )
    
    
    (1,686,921
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    (839
    )
    
    
    
    
    
    
    (839
    )Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,687,760
    )Subscriptions for
2,803,428 shares of
common stock at
$.70 per share on
various dates
during 2005
    
    
    (546,000
    )
    
    
    
    
    
    
    
    
    
    
    1,250,053Balance at March
31, 2005
    
    
    (546,000
    )
    
    $
    2,843
    
    
    $
    (20,313,041
    )
    
    $
    (296,931
    )
 See Notes to Financial Statements F-4




---



##### 



O2Diesel Corporation
(A Development Stage Company)Consolidated Statements of Cash Flows October 14, 2000Three Months Ended March 31,
    
    
    (inception) through2005
    
    
    2004
    
    
    March 31, 2005Cash
flows from operating activitiesNet loss
    
    $
    (1,686,921
    )
    
    $
    (1,734,924
    )
    
    $
    (20,313,041
    )Adjustments
to reconcile loss to net cash used in operating activities:Depreciation
    
    
    16,110
    
    
    
    10,600
    
    
    
    140,190Amortization
    
    
    
    
    
    
    
    
    
    
    7,786Write off of patent
    
    
    
    
    
    
    
    
    
    
    337,329Common stock issued for consulting services
    
    
    
    
    
    
    
    
    
    
    45,000Write off of equipment
    
    
    
    
    
    
    
    
    
    
    1,538Changes in
operating assets and liabilities:Accounts receivable
    
    
    12,717
    
    
    
    (11,636
    )
    
    
    (3,427
    )Due to/(from) related parties
    
    
    61,700
    
    
    
    (32,142
    )
    
    
    198,199Other receivables
    
    
    63,529
    
    
    
    206,715
    
    
    
    (77,641
    )Inventory, prepaid expenses and other current assets
    
    
    45,812
    
    
    
    (74,725
    )
    
    
    (254,852
    )Accounts payable
    
    
    (90,139
    )
    
    
    218,343
    
    
    
    499,607Accrued expenses
    
    
    3,350
    
    
    
    336,115
    
    
    
    780,663Deferred grants
    
    
    73,097
    
    
    
    28,750
    
    
    
    211,139Other current liabilities
    
    
    141,306
    
    
    
    5,927
    
    
    
    225,469Cash flows used in operating activities
    
    
    (1,359,439
    )
    
    
    (1,046,977
    )
    
    
    (18,202,041
    )Cash flows from investing activitiesRestricted cash
    
    
    
    
    
    
    750,000
    
    
    
    Purchase of furniture and equipment
    
    
    (3,395
    )
    
    
    (42,669
    )
    
    
    (387,428
    )Purchase of Patent
    
    
    
    
    
    
    
    
    
    
    (345,115
    )Cash flows (used in) provided by investing activities
    
    
    (3,395
    )
    
    
    707,331
    
    
    
    (732,543
    )Cash flows from financing activitiesNet proceeds from issuance of preferred stock
    
    
    
    
    
    
    2,675,277
    
    
    
    5,478,764Net proceeds from private placement
    
    
    1,299,517
    
    
    
    
    
    
    
    4,215,544Net proceeds from issuance of common stock
    
    
    
    
    
    
    540,511
    
    
    
    10,323,423(Repayments) / borrowings of bank debt
    
    
    (2,508
    )
    
    
    
    
    
    
    19,596Cash flows provided by financing activities
    
    
    1,297,009
    
    
    
    3,215,788
    
    
    
    20,037,327Effect of exchange rate changes on cash
    
    
    (839
    )
    
    
    (1,513
    )
    
    
    2,843Net (decrease) increase in cash
    
    
    (66,664
    )
    
    
    2,874,629
    
    
    
    1,105,586Cash at beginning of period
    
    
    1,172,250
    
    
    
    1,084,876
    
    
    
    -Cash at end of period
    
    $
    1,105,586
    
    
    $
    3,959,505
    
    
    $
    1,105,586Cash paid for interest
    
    $
    1,878
    
    
    $
    2,730
    
    
    $
    98,578Cash paid for income taxes
    
    None
    
    None
    
    None
 Non-cash transactions: Conversion of Bridge loan to common stock at 9/30/2003, $2,322,500. See Notes to Financial Statements F-5




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##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements 1. The Company and Basis of Presentation The Company O2Diesel Corporation (O2Diesel or the Company) is in the development stage and has developed a
proprietary additive product designed to enable distillate liquid transportation fuels to burn
cleaner by facilitating the addition of ethanol as an oxygenate to these fuels. To date, the
Companys operations have continued to be focused on raising capital, performing research and
development, and bringing its product to market. O2Diesel Corporations predecessor, Dynamic Ventures, Inc., was incorporated in the State of
Washington on April 24, 2000. Dynamic Ventures, Inc. changed its name to O2Diesel Corporation
effective June 10, 2003, in contemplation of the reverse acquisition of AAE Technologies
International Plc (AAE). On July 15, 2003, O2Diesel Corporation acquired all of the issued and
outstanding shares of AAE in exchange for 17,847,039 shares of its common stock. As a result of
this transaction, the former shareholders of AAE acquired control of the combined companies. The
acquisition of AAE has been accounted for as a capital transaction followed by a recapitalization.
AAE was considered to be the accounting acquirer. Accordingly, the historical financial statements
of AAE are considered to be those of O2Diesel Corporation for all periods presented. In conjunction with the reverse acquisition, the Company completed a private placement of its
common stock whereby it issued 3,333,333 shares of common stock at $1.50 per share. Of the $5.0
million raised, approximately $800,000 was used to pay the costs of the reverse acquisition and private
placement, $1.0 million was used to repay a bridge loan that was made in contemplation of the
transaction, and the balance of $3.2 million was used to fund the ongoing developmental activities
of the Company. O2Diesel was reincorporated in the state of Delaware in a transaction that became effective on
December 31, 2004. Basis of presentation The Companys unaudited consolidated financial statements for the three months ended March 31,
2005, have been prepared on a going concern basis, which contemplates the realization of assets and
the settlement of liabilities and commitments in the normal course of business. At March 31, 2005,
the Company has a working capital deficiency of $534,193 and has accumulated losses of $20,313,041.
Further, management has received notice that the Company is not in compliance with the listing
standards of the American Stock Exchange,( AMEX or the Exchange). Management has concluded
that additional equity must be raised in order for the Company to have sufficient cash to execute
its business plan and to be in compliance with the AMEXs listing standards. In January 2005, the Company retained a third party to raise $5.0 million in two private placements
of the Companys common stock at a price of $0.70 per share. This offering price per share
represents a discount from the market value of the Companys common stock of approximately 10%.
The first private placement is for approximately $2.0 million ($2.0 million Private Placement)
and the second is for just over $3.0 million ($3.0 million Private Placement). As part of the
understanding by which these funds are to be raised, the Company is obligated to comply with
certain conditions in connection with the $2.0 million Private Placement and is obligated to
satisfy still other conditions applicable to the $3.0 million Private Placement. Pursuant to the $2.0 million Private Placement, the Company, as of March 31, 2005, has received
qualified subscriptions for 2,803,428 shares of its common stock at a price of $0.70 per share. The
total proceeds to be received for these subscriptions are $1,962,400, before payment of an 8%
commission and other expenses. As of the end of March 2005, the Company had received cash of
$1,416,400, leaving $546,000 as a subscription receivable. As of the
date of this Report, the Company had received $196,000 of the
subscription receivable. Parties subscribing to the
2,803,428, shares agreed to waive certain of the conditions to permit the transaction to be closed as to
their respective subscriptions. An initial closing for this
transaction was held on March 17, 2005 for 1,915,143 shares, and
these shares were issued on April 26, 2005. A final
closing for the remaining 888,255 shares shall be held following
collection of the subscription receivable of $350,000, or, if such
amount is  not received, at such time as determined by the Company. In addition, the Company has received additional subscriptions under the terms of the $3.0 million
Private Placement for which the conditions have not yet been satisfied, or waived. F - 6




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) The Company and Basis of Presentation (continued) Management believes that
equity of at least $11.0 million, inclusive of the two private
placements totaling $5.0 million, will need to be raised in
order for the Company to be able to execute its business plan for the remainder of 2005 and to be
in compliance with the listing standards of the AMEX by June 2006. It is the Companys intention
to raise $11.0 million in equity during 2005, but there can be no assurance that it will be able to
do so. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all affiliated
subsidiaries. All significant inter-company balances and transactions have been eliminated in
consolidation. Cash and Cash Equivalents The Company considers all highly liquid instruments with a maturity of three months or less at the
time of issuance to be cash equivalents. Restricted Cash Restricted cash consisted of cash held in the Companys bank account pursuant to the provisions set
forth in documents to the acquisition of AAE on July 15, 2003. The restricted funds were released
in equal amounts on October 15, 2003 and January 15, 2004. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, accounts receivable, due to/from related
parties, other receivables, accounts payable, accrued expenses and deferred grants approximate fair
value because of their short-term nature. Concentration of Credit Risk and Allowance for Doubtful Accounts The Company provides an allowance for doubtful accounts for estimated losses resulting from the
inability of customers to make required payments. The Company does not require collateral and it
does not charge finance fees on outstanding trade receivables. The allowance is determined by
analyzing historical data and trends, as well as specific customers financial conditions.
Past-due or delinquency status is based upon the credit terms for that specific customer from the
date of delivery. Charges for doubtful accounts are recorded in selling and marketing expenses.
Trade accounts receivables are written off to the allowance for doubtful accounts when collection
appears unlikely. Specific accounts receivable of $6,750 were written-off during the three months
ending March 31, 2005. Inventories Inventories, consisting of fuel additive held at third party locations, are stated at the lower of
cost as determined using the first in, first out (FIFO) method, or market value. Furniture and Equipment and Depreciation Furniture and equipment are stated at cost, less accumulated depreciation. Depreciation is provided
over the estimated useful lives of the assets using the straight-line method. The estimated useful
lives of fixed assets are as follows: Office furniture and equipment: 3 to 5 years
Fuel and test equipment: 5 years Depreciation expense recorded in the accompanying Consolidated Statement of Operations was $16,110,
$10,600 and $140,190 for the three months ending March 31, 2005 and 2004 and the period October 14,
2000 (inception) through March 31, 2005. F - 7




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Accounting for Impairment of Long-Lived Assets The carrying value of intangible assets and other long-lived assets are reviewed on a regular basis
for the existence of facts or circumstances that may suggest impairment. The Company recognizes
impairment when the sum of the expected undiscounted future cash flows is less than the carrying
amount of the asset. Impairment losses, if any, are measured as the excess of the carrying amount
of the asset over its estimated fair value. Financial Instruments The carrying value of cash, accounts receivable, due to/from related parties, and accounts payable
approximate fair value due to the relatively short maturity of these instruments. Revenue Recognition 
 The Company sells its products directly to
customers and through its non-exclusive sales agent for the United States and Canada. On
sales through its non-exclusive sales agent, the Company is paid its
manufacturers
cost plus a share of the gross profit realized by the non-exclusive sales agent on sales to
the end user. The sales agent is obligated to pay the Company a price utilizing a formula
based upon the selling price to the end user. Revenue on such sales are recorded gross at
the price determined by this formula. In both types of sales transactions, revenue from the
sales of product is recognized and recorded upon the passage of title of the product to the
customer and following confirmation that the customer is utilizing
the final blended fuel. 
 In certain sales transactions, the Company may enter into contracts to provide its O2Diesel fuel
to municipal transit agencies at less than full price for specified periods of time. Gross revenue
from sales attributable to these contracts is recognized and recorded upon the passage of title of
the product to the customer. As part of these transactions, the Company sells sponsorships to
corporate sponsors who pay an amount to subsidize that part of the fuel price not charged to the
municipality and to cover other costs associated with the contract. Sponsorship fees are amortized
to revenue over the period of the respective contract associated with a particular municipality. At
the time the Company enters into a binding contract with a municipal transit agency, it compares
the product revenue and known sponsorship fees to be earned against the costs to be incurred for
such contract. If the total expected costs for a contract exceed the total anticipated product
revenue and known sponsorship fees, the Company will record a loss at the time the contract becomes
effective. As of March 31, 2005, the Company had entered into one contract for the sale of fuel to
a municipal transit agency. The Company has recorded a loss of $144,786, which is the estimated
amount by which the total costs are estimated to exceed the total sales revenue and known
sponsorship fees for this contract. In cases where sponsorship fees do not relate to a contract with a municipality, the sponsorship
fees will be amortized to revenue over the life of the sponsorship agreement. Shipping and Handling Costs The Company classifies costs associated with shipping and handling activities within cost of goods
sold in the consolidated statements of operations. Shipping and handling costs were $1,967, $4,175
and $28,406 respectively for the three months ended March 31, 2005 and 2004 and for the period
October 14, 2000 (inception) through March 31, 2005. Advertising Expenses Advertising costs are expensed as incurred. Advertising expense was nil for the three months ended
March 31, 2005 and 2004. Advertising costs were $450,000 for the period October 14, 2000
(inception) to March 31, 2005. Research and Development Costs Research and development costs are expensed as incurred. F - 8




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Product Test and Demonstration Appropriations The Company receives appropriations from U.S. governmental agencies to fund certain of its product
testing and demonstration programs. The Company evaluates the conditions of the appropriation and
either increases revenue,
decreases expenses or reduces the cost of furniture and equipment depending upon the attributes of
the underlying grant. Appropriations are not recognized until there is reasonable assurance that
the Company will comply with the conditions
of the grant and that the monies under the grant will be received. Net Loss Per Common Share (Basic and Diluted) Basic net loss per common share is computed by dividing the net loss available to common
stockholders by the weighted average number of common shares outstanding during the period.
Diluted net loss per share gives effect to all dilutive potential common shares outstanding during
the period using the if-converted method. Diluted net loss per share excludes all potential
dilutive common shares if their effect is anti-dilutive. The weighted average number of shares
used to compute basic and diluted loss per share is the same since the effect of the dilutive
securities is anti-dilutive. Accounting for Stock-Based Compensation Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS
123) provides companies with a choice to follow the provisions of SFAS 123 in determination of
stock-based compensation expenses or to continue with the provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The Company continues to follow
APB 25. Pro forma effects of SFAS 123 were immaterial for the three months ended March 31, 2005 and
2004 and for the period October 14, 2000 (inception) through March 31, 2005. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No.
123(R)), which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No 123(R) requires all
share-based payments to employees, including grants of employee stock options, to be recognized in
the financial statements based on their fair values beginning with the first interim period after
June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted
under SFAS No. 123 will no longer be an alternative to financial statement recognition. The
Company is required to adopt SFAS No. 123(R) in the third quarter of 2005. Under SFAS No. 123(R),
the Company must determine the appropriate fair value model to be used for valuing share-based
payments, the amortization method for compensation cost and the transition method to be used at the
date of adoption. The permitted transition methods include either retrospective or prospective
adoption. Under the retrospective option, prior periods may be restated either as of the beginning
of the year of adoption or for all periods presented. The prospective methods requires that
compensation expense be recorded for all unvested stock options at the beginning of the first
quarter of adoption of SFAS No.123(R), while the retrospective methods would record compensation
expense for all unvested stock options beginning with the first period presented. The Company is
currently evaluating the requirements of SFAS No. 123(R) and expects that adoption of SFAS No.
123(R) may have a material impact on the Companys consolidated financial position and consolidated
results of operations. The Company has not yet determined the method of adoption or the effect of
adopting SFAS No. 123(R), and it has not determined whether the adoption will result in amounts
that are similar to the current pro forma disclosures under SFAS No. 123(R). Income taxes Income taxes are accounted for using the liability method in accordance with SFAS No. 109,
Accounting for Income Taxes. Under SFAS 109, deferred tax assets or liabilities are computed
based upon the difference between the financial statement and income tax bases of assets and
liabilities using the enacted marginal tax rate applicable when the related asset or liability is
expected to be realized or settled. Deferred income tax expense or benefits are based on the
changes in the asset or liability from period to period. If available evidence suggests that it is
more likely than not that some portion or all of a deferred tax asset will not be realized, a
valuation allowance is recorded to reduce the deferred tax assets to the amount that is more likely
than not to be realized. Future changes in such valuation allowance would be included in the
provision for deferred income taxes in the period of change. F - 9




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates 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
periods. Actual results could differ from those estimates. Foreign Subsidiaries The Company has foreign subsidiaries whose local currency has been determined to be the functional
currency. For these foreign subsidiaries, the assets and liabilities have been translated using the
current exchange rates, and the income and expenses have been translated using the weighted average
of historical exchange rates during the reporting period. The adjustments resulting from
translation have been recorded separately in shareholders (deficit) equity as other comprehensive
income (loss) and are not included in determining the consolidated net loss. As of March 31, 2005,
other comprehensive income included $839 of cumulative income from foreign currency translation. The Company began operations in Brazil in March of 2004 by establishing a 75% owned subsidiary.
During the three months ending March 31, 2005, the Brazilian subsidiary recognized nil revenue and
at March 31, 2005, had net assets of $44,414. Transactions in Brazil are denominated in and the
functional currency is the Brazilian Real. Accordingly, no currency exchange rate gains or losses
are recorded in the accompanying consolidated statement of operations for Brazilian operations. At
March 31, 2005, the Brazilian operations had aggregate losses of $871,340. The minority
stockholders portion of aggregate losses is not recorded in the consolidated balance sheet since
reimbursement of this amount from the minority stockholders is not assured. Segment Reporting The Company is a development stage company and has not made sales of its products in commercial
volumes. Management believes that the Company currently operates and manages the business as one
business segment. Interim Financial Statements The unaudited interim consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States for interim financial
information. In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary to present fairly the financial position of the Company as of
March 31, 2005 and the results of operations and cash flows presented herein from inception
(October 14, 2000) through March 31, 2005 have been included in the financial statements. Interim
results are not necessarily indicative of results of operations that may be expected for the year
ending December 31, 2005. 3. Government Appropriations Appropriation from the U.S. Department of Energy In 2002, the Company received an appropriation of $1,107,734, which was increased to $2,039,650 as
of September 15, 2004, from the U.S. Department of Energy (DOE) to test the Companys fuel
additive as well as its blended fuel, O2Diesel. This appropriation is managed for the DOE by the
National Renewable Energy Laboratory (NREL) under a contract which, as amended, continues until
December 31, 2005. Under the terms of the contract, the Company is reimbursed by NREL for 80% of
the costs incurred to complete the Statement of Work as set forth in the contract. The Company
charges all expenses as incurred to operations and accrues all
amounts receivable under the
contract as a reduction to contract expenses. As of March 31, 2005, the Company had incurred costs
of $1,044,549 towards completion of the contract, leaving a balance of $995,102 in costs to
complete the contract. From the inception of the contract in December 2002 through March 31, 2005,
the Company billed NREL $835,694 of which $43,759 is included in other receivables as of March 31,
2005. F - 10




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) 3. Government Appropriations (continued) Appropriation (1) from the U.S. Department of Defense In 2003, the Company received an appropriation of $1,000,000 from the U.S. Department of Defense to
test O2Diesel fuel in non-strategic military vehicles operated by the U.S. Air Force at Nellis Air
Force Base in Las Vegas, Nevada. Under the terms of this Appropriation, a third party is to be paid
$200,000 to administer this program on behalf of the Department of Defense. The remaining $800,000
is to be used to fund purchases of O2Diesel fuel, certain capital equipment and to reimburse the
Company for its labor, overhead and out-of-pocket costs required to complete this project. Under
this program, the Company is required to meet certain milestones as a condition to receiving
reimbursements for its costs. Thus, upon achieving a milestone, the Company accrues the amount due
and submits an invoice for reimbursement. All amounts are expensed as incurred, and all amounts
receivable for work done are treated as a reduction to expense over the period earned. The period
of performance for this program ran from October 7, 2003 to December 31, 2004. The third party
administrator has agreed that the Company through December 31, 2004, had achieved five milestones.
Since inception, the Company has billed $360,000 related to this appropriation, of which $160,000
was billed in January 2005. Through March 31, 2005, the Company has received cash in excess of
costs incurred of $298,040, and has included this amount in Deferred Grants recorded at March 31,
2005 in the Consolidated Balance Sheet. All amounts billed had been received as of March 31, 2005.
By its terms, this contract expired on December 31, 2004, and it has not been extended. The work
required to achieve the milestones not completed as of December 31, 2004, has been included as part
of the Statement of Work for Appropriation (2) from the U.S. Department of Defense. Appropriation (2) from the U.S. Department of Defense On January 11, 2005, the Company entered into a contract with a value of $1,085,000 from the U.S.
Department of Defense. Under this contract, the Companys O2Diesel fuel is to be tested in a
maximum of forty (40) non-tactical vehicles at US Air Force bases in Nevada for an 18 month period.
In addition, the Company is to complete certain engine testing and other work required for the
acceptance of O2Diesel as a viable alternative fuel for use by the Air Force. Work on this
contract commenced on November 1, 2004 and is to continue through November 30, 2006.
Notwithstanding that this contract was signed in January 2005, the Company was asked to begin work
in 2004 and, by a letter from the contract administrator, was authorized to incur costs in an amount not to
exceed $75,000 during the pre-contract period. This is a time and materials contract that is
administered for the U.S. Department of Defense by a third party contractor. The Company charges
all costs as incurred to expense and accrues all amounts receivable under the contract as a
reduction to contract expenses. As of March 31, 2005, costs totaling $125,066 had been incurred,
and, of this amount, $38,165 had been billed and collected. The excess of the costs over the
amount billed, or $86,901, is recorded in Deferred Grants. 4. Other Receivables March 31, 2005Other ReceivablesNREL Appropriation
    
    $
    43,759Kansas Corn Commission
    
    
    32,500Reimbursement due from Cognis
    
    
    1,382ITC Appropriation
    
    
    $
    77,641
 F - 11




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) 5. Accrued Expenses March 31, 2005Accrued LiabilitiesLegal and
professional
    
    $
    510,683Investor
Relations*
    
    
    289,568Other
    
    
    140,751$
    941,002
 
 * NOTE: Within Investor Relations, the Company recorded
an accrual for both an investor relation outsourcing contract ($150,000) and costs associated
with raising capital ($139,568). 
 6. Deferred Financing and Business Acquisition Costs During 2003, management began
the public listing process on the Alternative Investment Market (AIM)
in London, England. All legal, accounting, and other related costs incurred in connection with the
AIM listing were capitalized as deferred financing costs. In December 2003, management determined
that the Company would terminate its plan to seek an AIM listing. Accordingly, deferred financing
costs of $517,000, were charged to expense for the year ended December 31, 2003. The Company records the cost of equity financings as a reduction of the associated proceeds. 7. Income Taxes No provision for Federal and state income taxes has been recorded during the periods presented due
to the Companys significant operating losses in each year. The income tax benefit reflected in the
accompanying consolidated statement of operations is the current benefit recognized in Ireland for
the periods presented. Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income
tax reporting purposes. Significant components of the Companys deferred tax asset as of March 31,
2005 are as follows: Income taxesNet operating loss carryforwards
    
    $
    4,910,000Deferred revenue
    
    
    116,000Accrued expenses
    
    
    141,000Total deferred tax assets
    
    
    5,167,000Valuation allowance
    
    
    (5,167,000
    )Net deferred tax assets
    
    $
    
 Management has determined that a valuation allowance equal to 100% of the existing deferred tax
assets is appropriate given the uncertainty regarding the ultimate realization of these assets. At
March 31, 2005, the Company had Federal and state net operating loss carryforwards of approximately
$11.4 million for income tax purposes. If not used, these F - 12




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) carryforwards begin to expire in 2021 for
Federal and state tax purposes. Federal tax rules impose limitations on the use of net operating
losses following certain changes in ownership. If such a change occurs, the limitation would reduce
the amount of the benefits that would be available to offset future taxable income each year,
starting with the year of ownership change. As of March 31, 2005, the Company had an Irish net
operating loss carryforward of approximately $340,000 which can be carried forward indefinitely,
and a Brazilian net operating loss of approximately $674,000 that may be carried forward
indefinitely, but which is subject to annual usage limitations. 8. Stockholders Equity Recapitalization On July 15, 2003, O2Diesel Corporation and AAE Technologies International Plc (AAE) entered into a
merger transaction whereby O2Diesel acquired all of the issued and outstanding share capital of AAE
in exchange for the issuance of 17,847,039 shares of common stock of O2Diesel. Although O2Diesel
was the legal acquirer, AAE was deemed to be the accounting acquirer. The transaction was accounted
for as an AAE capital transaction, accompanied by a recapitalization. As a result of the transaction, the historical financial statements of AAE are deemed to be those
of the Company for financial reporting purposes. The equity accounts of AAE have been adjusted for
the recapitalization to reflect the equity structure of O2Diesel, the legal acquirer. Specifically,
the historical stockholders equity of AAE prior to the transaction has been effected for the
equivalent number of shares of O2Diesel common stock received in the transaction, with an offset to
paid-in capital; the accumulated deficit of AAE has been carried forward after the transaction; and
the loss per share for all periods prior to the transaction has been restated to reflect the number
of equivalent common shares received by AAE in the transaction. Issuances of Common Stock In connection with the merger between O2Diesel and AAE in July 2003, the Company completed a
private placement of 3,333,333 shares of common stock at $1.50 per share. The private placement was
partially effectuated through the
issuance of a $4 million convertible note that was convertible into the Companys common stock at
$1.50 per share. In October 2003, the Company repaid $1,677,500 of the note and the $2,322,500
balance was converted into 1,548,333
shares of common stock. The remaining 1,785,000 shares of common stock issuable under the private
placement were issued to other parties in exchange for cash proceeds of $2,677,500. The expenses
associated with the merger and subsequent issuances of shares were $795,650 and have been reflected
as a reduction of paid-in capital. Pursuant to the $2.0 million Private Placement, the Company, as of March 31, 2005, has received
qualified subscriptions for 2,803,428 shares of its common stock at a price of $0.70 per share, for
total proceeds of $1,962,400, before payment of an 8% commission and other expenses, which together
total $166,347. As of March 31, 2005, the Company had received cash of $1,416,400 and has
recorded a subscription receivable of $546,000. Subsequent to
March 31, 2005, but prior to the date of this Report, the
Company collected $196,000 of the subscription receivable, leaving an amount
due of $350,000. None of the common stock to be issued for these
subscriptions had been issued as of March 31, 2005. An initial
closing for the $2.0 million Private Placement was held on March 17,
2005 for 1,915,143 shares, which were issued on April 26, 2005. A
final closing for the remaining 888,255 shares shall be held
following collection of the subscription receivable of $350,000, or,
if such amount is not received, at such time as determined by the
Company. Subscribers to the $2.0 million Private Placement are to receive for each two shares of common
stock purchased one warrant to purchase one additional share of common stock. The warrant expires
twenty-four months following the closing of the $2.0 million Private Placement. Each warrant is
exercisable at a price of $0.70 per share during the first twelve months following the close of the
$2.0 million Private Placement, or at an exercise price of $1.05 per share in the second twelve
months following the close of the $2.0 million Private Placement. Issuances of Preferred Stock: In March 2004, the Company approved the designation of two new series of preferred shares. The new
preferred shares, which consist of one million five hundred and fifty thousand (1,550,000) shares
of Preferred Stock, are Series A and B 0%
Convertible Preferred Stock, par value $.0001 (the Series A Preferred Stock and Series B
Preferred Stock). Subsequent to approving the new Series A and Series B Preferred Stock, the
Company immediately completed a transaction with a publicly traded investment trust on the London
Stock Exchange in which it received approximately $2.8 million, net of all expenses including a
finders fee, in exchange for all of the 800,000 shares of its Series A Preferred Stock. Effective
March 29, 2004, the Company completed a second transaction with another publicly traded investment
trust on the London Stock Exchange in which it received in May 2004 approximately $2.1 million, net
of all expenses including a finders fee, in exchange for 600,000 shares of its Series B Preferred
Stock. As part of the Series B transaction, the remaining 150,000 shares of Series B Preferred
Stock were issued and placed in an escrow account. In May 2004,
the 150,000 shares of Series B Preferred Stock were released from F - 13




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##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) escrow to the same publicly traded investment trust, for which
the Company received approximately $536,000, net of all expenses including a finders fee. 8. Stockholders Equity (continued) Warrants A wholly-owned subsidiary of the Company entered into a supply and distribution agreement (the
Agreement) with a distributor dated July 10, 2001 that granted the distributor the right to
purchase up to 10% of the outstanding common stock of the Company for $1.00 should certain sales
targets be achieved. The warrant expires on July 10, 2006. None of the sales targets have been
achieved under the Agreement. As of December 10, 2004 this Agreement was terminated and replaced by
a New Agreement. Under this New Agreement, the distributor received a warrant to purchase 600,000
shares of O2Diesel Corporations common stock at a price of $2.00 per share. The Holder may
exercise this warrant in whole or in part at any time before 5:00 pm
Eastern Standard time on May 5, 2007. 9. Related Party Transactions A company controlled by the Chairman of the Board provides office space, accounting and other
services to the Company at a cost of approximately $2,300 per month. For the three months ending
March 31, 2005 and 2004 and for the period October 14, 2000 (inception) through March 31, 2005 the
Company paid $8,235, $6,698, and $141,533, respectively to the company controlled by the Chairman.
At March 31, 2005, the Company recorded $2,744 which is payable to this related party. Included in receivables due from related parties at March 31, 2005 is $21,269 which is related to
travel advances made to employees. 10. Commitments Operating leases The Company leases office space and certain office equipment under agreements that are accounted
for as operating leases. As of March 31, 2005, future minimum lease payments under non-cancelable
operating leases expiring through 2008, were as follows: Operating Leases2005
    
    
    
    59,4642006
    
    
    
    81,5302007
    
    
    
    83,7752008
    
    
    
    78,680Total
    
    $
    303,449
 Rent expense under the leases from unrelated parties for the three months ended March 31, 2005 and
2004 and the period October 14, 2000 (inception) through March 31, 2005 was $19,583, $18,441 and
$100,116 respectively. The leases did not exist prior to 2003. F - 14




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##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Financial Statements (continued) Truck Loan On November 4, 2004 the Company purchased a diesel truck to be used for product testing and
analysis. The cost of this vehicle was $26,545. Subsequent to this purchase, the Company financed
$23,000 with a local bank. The loan is secured by the truck. The note bears interest at 7.00 % and
is payable in 24 monthly installments of $1,031 with the final payment due in November of 2006. 10. Commitments (continued) Options The Company has made a
commitment to grant two of its Directors the right to purchase
750,000 shares, each, of the Companys common stock at $1.50 per share. The options will
vest over three years and will expire 10 years from the effective date. The Company will record a
compensation charge for the difference between the fair value of the common stock and the exercise
price of the option on the date of issuance if the fair value of the common stock exceeds the
exercise price of the option on that date. On October 15, 2004, a third Director was granted an incentive stock option for 200,000 shares of
common stock at an exercise price of $1.50 per share. This option vests over two years and expires
ten years from the date of the grant. On January 5, 2005, a director was granted a non-statutory
option for 500,000 shares of common stock at an exercise price of $1.50 per share and this option
is fully vested. Each of these grants is subject to approval by the Board of Directors. The
Companys stock option plan was approved by the Companys shareholders on August 17, 2004. 11. Subsequent Event As of the date of this
Report, the Company had received subscriptions under the terms of the $3.0
million Private Placement for 4,648,738 shares of its common stock at
$0.70 per share, for total proceeds of $3,254,116. This
offering price per share represents a discount from the market value
of the Companys common stock of
approximately 10%. The Company has received cash of $3,134,094, which is held in an escrow
account, leaving funds of $120,022 to be received. As part of the terms for the $3.0 million
Private Placement, the Company must satisfy two conditions in order to close the transaction. With respect to one of the conditions, the AMEX requires stockholder approval as a prerequisite to
list newly issued shares if (i) the aggregate number of shares to be issued would result in the
issuance of twenty-percent (20%) or more of the amount of common stock issued and outstanding, and
(ii) the sale price of the shares would be less than the greater of book or market value of the
common stock. The number of shares to be issued in the $2.0 million Private Placement is less than twenty percent
(20%) of the Companys issued and outstanding common stock, and as such, the Company is not
required to seek shareholder approval for this transaction. The number of shares to be issued in the $3.0 Private Placement, when combined with the $2.0
million Private Placement, will exceed twenty percent (20%) of issued and outstanding common stock,
and these shares will be sold for less than market value. As a consequence, the Company is required
to seek shareholder approval to issue shares attributable to the $3.0 million Private Placement.
The Company will seek shareholder approval at its annual general
meeting, which is scheduled to be held on May 31, 2005, for the
issuance of these shares. The second condition to closing the $3.0 million Private Placement requires that the Company expand
its senior management team. Neither of the two closing conditions has been satisfied as of date of this Report, and there can be no
assurance that the Company will be able to fulfill the conditions. F - 15




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION OVERVIEW Business Plan: Overview: The Company is classified as a development stage company as shown on our unaudited consolidated
financial statements for the period from inception (October 14, 2000) through March 31, 2005.
However, we do anticipate having sales of our additive in sufficient volumes during 2005 so that a
change in our status as a development stage company may occur by the end of 2005. O2Diesels predecessor, Dynamic Ventures, Inc., was incorporated in the State of Washington on
April 24, 2000. Dynamic Ventures, Inc. changed its name to
O2Diesel Corporation effective June 10, 2003, in contemplation of the
reverse acquisition of AAE. On July 15, 2003, O2Diesel acquired
all of the issued and outstanding share capital of AAE in exchange for 17,847,039 shares of its
common stock. As a result of this transaction, the former shareholders of AAE acquired control of
the combined companies. The acquisition of AAE has been accounted for as a capital transaction
followed by a recapitalization as AAE was considered to be the accounting acquirer. Accordingly,
the historical consolidated financial statements of AAE are considered to be those of O2Diesel for
all periods presented. In conjunction with the reverse acquisition, the Company completed a private placement of its
common stock whereby it issued 3,333,333 shares of common stock at $1.50 per share. Of the $5.0
million raised, approximately $800,000 was used to pay the costs of the reverse acquisition and
private placement, $1.0 million was used to repay a bridge loan that was made in contemplation of
the transaction, and the balance of $3.2 million was used to fund the ongoing developmental
activities of the Company. On June 15, 2004, the American Stock Exchange (AMEX OR EXCHANGE) approved an application to
list 46,518,898 shares of our common stock under the symbol OTD. Our shares began to trade on the
exchange on July 1, 2004. On December 29, 2004, the Company consummated a merger (the Reincorporation Merger) with and into
its wholly owned subsidiary, O2Diesel Delaware Corporation, a Delaware corporation (O2Diesel
Delaware) in order to reincorporate in the State of Delaware (the Reincorporation). As a result
of the Reincorporation, the legal domicile of the Company is now Delaware. Our audited consolidated financial statements for the year ended December 31, 2004, were prepared
on a going concern basis, which contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. Our independent registered public
accounting firm included an explanatory paragraph in their report on the December 31, 2004 audited
consolidated financial statements to highlight that the Companys accumulated losses and working
capital deficit raised substantial doubt about the Companys ability to continue as a going
concern. At December 31, 2004, the Company had a working capital deficiency of $106,693 and had
accumulated losses of $18,626,120. Our unaudited consolidated
financial statements for the three months ended March 31, 2005, have been
prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. At March 31, 2005, the Company
had a working capital deficiency of $534,193 and had accumulated losses of $20,313,041. Further, the Company was notified in December 2004, by the AMEX that it was no longer in compliance
with the listing standards of the Exchange. AMEX requires that minimum levels of shareholder equity
be maintained. O2Diesel was not in compliance because its shareholders equity had dropped below
the required minimums, and it had experienced continuing losses for the past four years. In order
to return to full compliance, O2Diesel must have shareholders equity of $6.0 million by June 2006. Management believes that
equity of at least $11.0 million must be raised in order for the
Company to have sufficient cash to execute its business plan, and to be in compliance with the
AMEXs listing requirements. Of the $11.0 million in new equity, approximately $8.2 million is expected to
be needed in 2005 for use as working capital and the remaining $2.8 million is needed to allow us
to regain compliance with the AMEXs listing standards by June 2006. 1




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 If the Company should fail to
achieve the operating results it anticipates from the $11.0 million that it
intends to raise, then it is likely that we will require an amount in
excess of $11.0 million in order for
us to execute our business plan and be compliant with the listing standards of the AMEX. If the Company were to fail to return to full compliance with the Exchanges listing
standards, the AMEX would likely initiate procedures to de-list its common stock . If the
Companys common stock was de-listed by the AMEX, its shares could continue to be traded as a
bulletin board stock. As part of our efforts to
raise $11.0 million in new equity, we retained a third party in
January 2005, to raise, in a series of two private placements of our
common stock, $5.0 million at a price of $0.70 per share. This offering price per share represents
a discount from the market value of our common stock of approximately ten-percent (10%). The first
private placement is for just under $2.0 million ($2.0 million Private Placement) and the second
is for just over $3.0 million ($3.0 million Private Placement). As part of these transactions,
we are obligated to comply with certain conditions in connection with the $2.0 million Private
Placement, and we are also obligated to satisfy still other conditions applicable to the $3.0
million Private Placement. Further, the AMEX requires that shareholder approval be obtained by the Company for the sale of
common stock in a transaction if the price of the shares to be sold is less than the greater of
book or market value, and the number of shares equal twenty-percent (20% or more of the presently
outstanding common stock. In order to comply with this requirement, we will seek shareholder
approval for the $3.0 million Private Placement. No shareholder approval is required for the shares
to be issued in conjunction with the $2.0 million Private Placement. Pursuant to the $2.0 million Private Placement, we have received qualified subscriptions for
2,803,428 shares of our common stock for total proceeds of $1,962,400, before
payment of an 8% commission and other expenses. As of the date of
this Report, we have received cash proceeds of $1,612,400, and we have
a subscription receivable of $350,000 for the remaining proceeds of
this transaction. The parties subscribing to these shares agreed to
waive certain of the conditions to permit the transaction to be
closed as to their respective subscriptions. An initial closing for
the $2.0 million Private Placement was held on March 17, 2005 for
1,915,143 shares. A final closing for the remaining 888,255 shares
shall be held following receipt of the subscription receivable of
$350,000, or, if such amount is not collected, at such time as
determined by the Company. In addition, as of May 10, 2005, we had received subscriptions under the $3.0 million Private
Placement for 4,648,738 shares of our common stock, for total proceeds of $3,254,116, before
payment of an 8% commission. In conjunction with these subscriptions, we have received cash of
$3,134,094, which is held in an escrow account, leaving funds of $120,022 to be received. As part
of the terms for the $3.0 Private Placement, we must satisfy two conditions in order to close the
transaction. As indicated above, the first condition requires that we obtain shareholder approval
to issue these shares, and we will seek this approval at our annual general meeting, which is
scheduled to be held on May 31, 2005. Pursuant to the second condition, we are required to expand
our senior management team. Neither of these two closing conditions has been satisfied as of date of this
Report, and there can be no assurance that the Company will be able to fulfill the conditions. Subscribers to both the $2.0 million Private Placement and $3.0 million Private Placement are to
receive for each two shares of common stock purchased one warrant to purchase one additional share
of common stock. The warrant expires twenty-four months following the closing of the $2.0 million
Private Placement and $3.0 million Private Placement, respectively. Each warrant is exercisable at
a price of $0.70 per share during the first twelve months following the close of each Private
Placement, or at an exercise price of $1.05 per share in the second twelve months following the
close of each Private Placement. During the first three months of 2005, we continued our efforts to generate sales to our targeted
customers in the U.S. and Brazil. At the same time, we devoted more resources to our CityHome
marketing program as a means of accelerating sales under this initiative. CityHome is a marketing
and sales initiative directed at municipal transit agencies across the United States. This program
stresses the environmental benefits of our fuel and is designed to allow transit authorities to
purchase O2Diesel for the same price that they pay for regular diesel fuel. All additional costs
of the program are intended to be funded by corporate sponsors who wish to have their brands
associated with a clean air campaign. We are continuing our efforts to establish and improve the logistics network required for the
delivery of O2Diesel. In addition, we are also continuing a series of product tests and
demonstrations that relate directly to our sales initiatives and which are designed to meet the
needs of our targeted customers. In particular, these tests include completing the necessary 2




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 test
protocols and making the appropriate submissions to allow O2Diesel to be designated as a Diesel
Emissions Control Strategy fuel in California and a TxLed equivalent fuel for Texas United States and Canada: Initially, our focus for the U.S. and Canada is to target key geographical areas and specific
diesel markets based upon:  Ø Current and projected quantity of diesel fuel consumption;Ø High-population centers under strict air quality regulations;Ø Large concentrations of urban-based, centrally fueled fleets of trucks and buses;Ø Off-road construction equipment;Ø Diesel equipment used by port facilities and large-scale mining operations; andØ Marketing opportunities centered on public policy and a positive environmental image (CityHome Programs). For the remainder of 2005, we intend to concentrate on the U.S. market and will not devote
significant resources to developing business in Canada. In the U.S., O2Diesels initial sales and
marketing efforts have been focused on the states of California, Nevada and, Texas and, to a lesser
extent, on the northeastern states of New York, New Jersey, Pennsylvania, and Delaware. Taken
together, these three areas account for about one-third of all diesel fuel used in the U.S. Based
on our experience gained to date, our sales force is seeking to identify potential customers that
fit the profile for the use of our additive and O2Diesel. As part of the process of identifying potential customers and conducting product demonstrations, we
have encountered a number of challenges. In general, these challenges fall into the following
categories: (1) logistics of delivering and dispensing O2Diesel (2) sourcing and installation of
flame arrestors and other devices in vehicles and storage facilities, (3) sourcing fuel grade
ethanol, and (4) ensuring that fuel tanks are appropriately cleaned. O2Diesel has devised parallel
strategies to meet these challenges, as well as to position O2Diesel as a premium clean fuel. Under the first element of our strategy, we are working to create a network of diesel fuel jobbers,
who in turn have centrally fueled fleets as their customers. To date, we have signed supply and
distribution agreements with ten jobbers located in the states of California, Nevada and Texas. We
plan to sell additive to the jobbers and assist them in purchasing ethanol by locating ethanol
suppliers or, in limited cases, purchasing and reselling ethanol to them. The jobbers will blend
the additive and ethanol with diesel fuel and then sell O2Diesel to their customers. Our sales
force and technical staff will work jointly with a jobber and the jobbers customers to assist in
the transition from the use of regular diesel fuel to O2Diesel. A key part of working with each
jobber and its customers is to provide safety and training materials covering the use of the fuel.
In addition, O2Diesels technical staff plans to work closely with each customer to install flame
arrestors in all vehicles, to install fuel cooling devices in certain vehicles, as well as
reviewing the customers fueling facilities for compatibility with O2Diesel. In some cases, we
will be responsible for sourcing and installing the flame arrestors and fuel cooling devices,
arranging tank cleaning and filtering systems as necessary, and in cases where a customer may
choose to perform these tasks, we will have an oversight role to ensure that all parts and
installation work comply with O2Diesels specifications. Pursuant to the second part
of our strategy, our sales force plans to market and sell O2Diesel
directly to companies,
governmental municipalities, port facilities and others that operate large centrally fueled fleets.
These customers may include large truck and bus fleets, construction and mining companies as well
as port cargo handling facilities and agricultural users. In these cases, we will likely be
responsible for all logistics required to deliver O2Diesel to the customer. To achieve this goal,
we intend to work with fuel distributors that have the ability to blend diesel fuel, ethanol and
additive for delivery to a customers central fueling location. We will arrange for the purchase of
ethanol and will supply additive and, in some cases, we may even arrange for the purchase of diesel
fuel by the customer. Under our business model, we do not intend to purchase either ethanol or
diesel fuel for sale to our customers because to do so would likely involve significant amounts of
working capital. However, we also recognize that in certain limited circumstances we may be
required to do so as a condition to obtaining a customer. These situations will be considered on a
case by case basis, giving due regard to the amount of working capital needed. In the process of
transitioning a customers fleet to O2Diesel, we need to put in place the logistical support to
ensure that fuel is delivered on a timely basis. To accomplish this, O2Diesel is working to create
a network of transportation providers, ethanol suppliers and in limited cases, wholesalers of
diesel fuel. With large fleet customers, our technical staff will work closely with the customer to
prepare the vehicles or other equipment to use O2Diesel. This will include a review of the
customers fueling facilities for cleanliness and compatibility
to O2Diesel, arranging for the cleaning of tanks and filtering
systems as necessary, and purchasing and installing flame arrestors
and fuel cooling devices or assisting the customer to do so. 3




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 
 As a part of our CityHome marketing strategy, we have developed a marketing concept which, at the
outset, is being directed primarily to municipal transit agencies. Under this concept, the
municipality will incorporate into its environmental policy the
benefits to the community of using O2Diesel in its transit fleet. Marketing efforts have shown
that an initiative encouraging municipalities to use O2Diesel as part of a commitment to improve
air quality may be a significant driver for the sale of O2Diesel. As part of this concept, we
will assist municipalities to defray the cost of using O2Diesel by arranging for corporate
sponsors to participate with the municipalities in the cost and benefits of being associated with
using a clean burning fuel. Companies that participate in this program will pay sponsorship fees in
return for the use of advertising space on a municipalitys bus fleet. Sponsors will be able to
have their brands identified with a clean air program and enjoy the added benefit of being seen as
good corporate citizens. 
 
 Sponsorship fees will become additional revenue for us
and will be recognized as such when a sponsorship agreement is signed and the fees have been
invoiced. Costs that are intended to be supported by the sponsorship fees are recorded
separately in the related expense line in our statement of operations. 
 
 With regard to the advertising space, since the
CityHome program is still in its beginning phase and since we have been unable to assess the
fair market value of the advertising space received, we assign no value to the space at the
time of the receipt. We are recognizing the value associated with the advertising space when
we enter into a contractual arrangement with a third party. The Company will consider
assigning a fair value to the advertising space received at the time of the initial sale
when such fair value is more readily determinable, based upon a history of cash transactions. 
 
 We believe that CityHome will become one of the
mainstays of our sales and marketing strategy. Following its launch in several smaller
cities, CityHome will be marketed to larger municipalities throughout the U.S. 
 In the near term, CityHome programs are being marketed mostly to municipal fleets in smaller cities
in the Midwestern states. To date, we have found that larger cities are reluctant to commit their
transit fleets to a new fuel until the fuel has been used in a wide array of commercial
applications for long periods of time. As of the end of March 2005, one city was operating substantially all of its fleet on O2Diesel as
part of a CityHome program designed for its transit authority. A second city is testing O2Diesel
in about 10% of its fleet before making a decision to fully participate in a CityHome program. For a more detailed
description of CityHome, see Note 2 to the unaudited financial
statements on page F-8. Following the launch and acceptance of CityHome programs for municipal fleets in smaller cities, we
hope to begin testing this program in larger municipal fleets. We anticipate that CityHome will
gain the most traction in those states, such as California, Texas and Nevada that mandate the use
of clean-burning alternative fuels. Brazil: In Brazil, O2Diesel has targeted customers similar to those in the U.S. To do so, we have
established our own sales and technical capabilities in Brazil to substantially mirror what has
been done in the U.S. In addition, we have joined with a Brazilian commodity firm that trades sugar
and alcohol for the purpose of obtaining a local partner that can provide assistance to help
introduce our products into the Brazilian market. The Brazilian commodity firm owns 25% of our
Brazilian subsidiary. Together with our partner, we initially targeted some of Brazils largest sugar growers and millers
as potential customers for O2Diesel. We have also created programs to market our fuel to
municipalities and large fleets in Brazil using environmental initiatives similar to those we are
designing for use in the U.S. Penetration of the Brazilian market has been slower than we had planned. Moreover, our partner in
Brazil has not performed to our expectations in so far as assisting us to obtain customers in
certain market segments. As of the end of March 2005, we had only tested our fuel with one
customer, which was from the miller segment. As a result of funding restraints and slower than
expected progress in Brazil, we have taken a decision to reduce our operating expenses and to
follow a focused sales strategy to gain customers. Cash Requirements, Liquidity and Risk Factors: To date, we have not had any bank trade facilities, except an overdraft line in the U.K. used to
meet operating needs. This overdraft facility was repaid and canceled during 2003. However if the
Company achieves significant sales, we plan to apply for trading lines with banks in the U.S. and
Brazil as a means to finance our working capital needs. The Company has had very favorable trade
terms with its supplier, Cognis Deutschland GmbH (Cognis) for the supply of additive. However, we
have been informed by Cognis that it wishes to renegotiate both the purchase price of the additive
as well as the payment terms. At this time, we do not know what the new terms will be, except that
we understand that Cognis will increase the price of the additive and will ask for shorter payment
terms. Significant technical and logistical issues in the first quarter of 2005 continued to affect our
ability to generate sales. In addition, as we have started to bring customers onto the fuel, we
have had to incur significant up-front implementation costs to prepare the vehicles and storage
facilities to use O2Diesel. This has placed greater demands on
our working capital. 4




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 As part of the terms by which O2Diesel was approved for sale in California, the California Air
Resources Board set a number of conditions to which we must adhere on an ongoing basis. One of the
conditions is that all storage tanks in which O2Diesel is stored and all vehicles that use the
fuel must be fitted with devices known as flame arrestors. Flame arrestors are safety devices which
are intended to prevent a fire in the case that a spark or other type of ignition might
inadvertently enter the fill inlet of a fuel tank. Imposing this requirement has negatively impacted our ability
to efficiently commercialize our technology in the U.S. Even though flame arrestor technology has
been used for many years in other applications, flame arrestors in the required sizes and designs
are not yet available as an off the shelf item for all of the vehicle types that may use
O2Diesel. During most of 2004 and into
2005, we have had an active research and development effort underway to
design flame arrestors and adaptors for vehicles and other equipment that use O2Diesel. Some of
these devices have undergone and passed tests to ensure that they comply with all required
specifications. As other flame arrestors are perfected, they will be subjected to the required
tests. However, we have now learned that the time and cost of designing and fitting flame arrestors
is greater than what we previously thought. Even though we have gained a significant amount of
technical knowledge during the last fifteen months, we have still not obtained sufficient
experience with sourcing, purchasing and fitting flame arrestors for all types of vehicles and
storage tanks to be able to accurately project the availability and cost of these devices.
Moreover, there is insufficient history for us to be able to predict with certainty the manpower
required to accomplish the work to install flame arrestors. In addition, we have learned
that certain engines require the fitting of a primer pump to ensure
that the vehicle starts and runs properly in hot weather. These devices are simple and readily
available. However, the necessity of adding these devices to certain vehicles will increase our
costs and is likely to increase the time required to transition a fleet from using regular diesel
fuel to the use of O2Diesel. Lastly, for some buses, we have had to install safety fueling
devices in the fuel inlet that serve the function of flame arrestors, but are generally more
expensive. These particular devices are readily available in the market. We are developing and are
testing an alternative device which, if successful, will be significantly cheaper than what is
currently available. All of these issues have led to a greater lead time than expected to convert a fleet from using
regular diesel to O2Diesel. In fact, the time it takes to do the conversion work may be the most
limiting factor to efficiently bring new fleets onto the fuel. As a means of mitigating this
timing issue, we want our customers to do much of this work under our direction. However, this
policy is dependent upon obtaining an agreement from the customer to do the work. The actual time
required to convert a fleet to use O2Diesel is further limited by making arrangements for the
customers vehicles to be in one place long enough to affect the required changes. In some cases
for safety, insurance or union reasons, customers will require that they do all of the work
necessary for their vehicles and diesel powered equipment to use
O2Diesel, as well as ensuring that their storage and dispensing facilities are compatible with the use of the fuel. Another concern we have relates to the logistics and storage of O2Diesel for fleets and other
diesel equipment that use our fuel. To date, we have not completed the required logistics
arrangements to identify and finalize the best infrastructure to ensure that we can arrange for a
supply of ethanol to blend with our additive and then arrange for the timely delivery of O2Diesel
to potential customers and its proper storage once delivered. This has proven to the true in
connection with our Urban Marketing program, wherein we have had to locate and train new fuel
distributors and jobbers to deliver O2Diesel. In some cases, this has been complicated by the
small volume of fuel used by a customer and by existing fuel contracts that a customer may have in
place. These same issues exist for centrally fueled fleets. Turning to other technical issues, it is very important that storage tanks be cleaned prior to the
introduction of O2Diesel into the customers refueling station. We have made important strides in
working with customers to make certain that their storage facilities are compatible with O2Diesel. Even
with the experience we have gained, we have not fully completed the necessary research and
logistics studies to be able to determine with certainty that the storage facilities of all users are capable of meeting
the standards necessary to store and dispense an ethanol based diesel fuel such as O2Diesel. This
important work is on-going. We have also confirmed that it is important to carefully select ethanol suppliers. There is a wide
range of fuel grade ethanol in the marketplace. It is critical that the ethanol component of
O2Diesel be of a consistently high quality and that it meet certain other specifications.
Selection of ethanol suppliers and creating a relationship with those that can provide the quality
of product we require is an important need, and is a task to which we will devote considerable time
during the remainder of 2005. 5




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##### 



O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 In order to ensure quality, we have established a quality control function that constantly monitors
and tests the ethanol and O2Diesel used by our customers, both as part of test demonstrations and
in commercial applications. We have also learned that it is necessary to test the quality of diesel
blended with our additive and ethanol. Establishing our own laboratory facility has been a
significant help to us in developing quality control standards and procedures. Moreover, this
facility is playing an important role in carrying out the quality assurance measures that are necessary to
prepare a fleet to use O2Diesel. None of the procedures are technically difficult, but they have
proven to be both time-consuming and critical to ensuring that our product functions as intended.
As we gain more experience, it may not be necessary to conduct the level and frequency of tests
that we expect to do for the remainder of this year. Technical challenges have presented significant hurdles to commercializing our technology. In most
cases, we have overcome these obstacles by the application of technical resources, payments to
support our customers and a high level of customer service. To do this, we have developed a team
of qualified technicians that are becoming more and more familiar with these issues and which have
the ability to respond quickly and solve problems as they arise. All of this has been
time-consuming and has slowed down our ability to bring our product to market. But it has also
created a base of knowledge which should prove helpful as we continue efforts to commercialize
our technology. Given our projected level of operating costs and the cash of $1.1 million on hand as of March 31,
2005, it is clear we must raise additional cash to be able to fund our operations for the remainder
of 2005. Moreover, we also need new investment to allow us to become compliant with the listing
standards of the AMEX. In total, we believe we need to raise at least $11.0 in new equity, of
which $8.2 million is expected to be needed in 2005 for use as working capital with the remaining
$2.8 million to be raised either in 2005 or prior to June 2006 to allow us to regain compliance
with the AMEXs listing standards. If we fail to execute our business plan as intended, we may
require more than $11.0 million to meet our stated needs. As part of our
efforts to raise $11.0 million in new equity, we have received qualified
subscription agreements from investors in the $2.0 million Private
Placement who have subscribed to 2,803,428 shares of our common stock
at $0.70 per share. The total proceeds to be received for these subscriptions are $1,962,400, before
payment of expenses, which to date total $166,347. As of the date of this Report, the Company had received
cash of $1,612,400 leaving $350,000 to be collected.  An initial closing for
this transaction was held on March 17, 2005 for 1,915,143 shares. A
final closing for the remaining 888,255 shares shall be held
following collection of the subscription receivable of $350,000, or,
if such amount is not received, at such time as determined by the
Company. In addition, as of May 10, 2005, we had received subscriptions under the $3.0 million Private
Placement for 4,648,738 shares of our common stock, for total proceeds of $3,254,116, before
payment of an 8% commission, In conjunction with these subscriptions, we have received cash of
$3,134,094, which is held in an escrow account, leaving funds of $120,022 to be received. Two
conditions must be satisfied in order to close this $3.0 million Private Placement. The first
condition requires the Company to obtain shareholder approval to issue these shares. Such approval
will be sought at the Companys annual general meeting, which is scheduled to be held on May 31,
2005. Pursuant to the second condition, we are required to expand our senior management team.
Neither of these two closing conditions had been satisfied as of the date of this Report, and there can be
no assurance that they will be fulfilled. The Company has undertaken to prepare and file at its own expense a registration statement within
sixty days following the close of the $2.0 million and the $3.0 Private Placement transactions. In
addition, the Company has agreed to use its reasonable best efforts to cause such registration
statements to become effective within six months from the initial filings. In connection with our efforts to attract new investment, there can be no assurance that we will be
successful in doing so. Nor can there be any assurance that the Company will generate sales and
sponsorship fees followed by the collection of cash to offset our operating expenses. As of March
31, 2005, the Company has generated only $15,244 in product sales and had signed one sponsorship
agreement for $32,500 associated with one Urban Marketing program. Lastly, there can be no
assurance that actual events will not differ from those anticipated, or that general economic
conditions will not vary significantly in ways that could negatively impact the operations and cash
position of the Company. Research & Development: As part of our cooperation agreement with Cognis, we, along with Cognis, are the joint owners of
all patents covering both the use and composition of our additive, O2D05. Patent applications have been filed in
twelve countries for O2D05, including the U.S., Canada, Brazil, and Europe. For this purpose,
Europe is counted as one country. As such, the patent application for Europe covers 20 countries,
including the more populous countries of the U.K., France, Germany, Italy and Spain. The patent
applications for the U.S., Brazil and Canada are pending. 6




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O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 All legal costs associated with preparing, filing and administering the jointly owned patents are
shared equally by the Company and Cognis. We also have a number of patents that have been issued
that relate to the predecessor technology of O2D05. As a strategic measure, we continue to fund all costs necessary to maintain some of these
patents. O2Diesel is the sole owner of these latter patents, which in general, cover the use and
composition of its prior generation technology. We have filed trademark registration applications in the U.S. and the European Union for a mark
which includes the words and numbers O2Diesel as well as a figurative logo of the words. As mentioned earlier, we have developed a new marketing initiative which is styled as CityHome.
To protect this trademark, we have filed applications for the trademark CityHome (and design) in
eight classes of goods and services. An application has also been filed for the trademark TODAYS
CLEAN AIR SOLUTION TOMORROWS BRIGHTER FUTURE covering one class of goods and services. At the start of 2005, we had governmental test programs in progress with total remaining costs to
complete of approximately $1.9 million. Under these programs a wide array of engine tests and
product demonstrations are to be conducted to further prove the emissions benefits of O2Diesel and
to show that the fuel performs well in specific applications. Included in the foregoing programs
are product demonstrations in Nevada to test O2Diesel in non-tactical military equipment, and to
test O2Diesel in a fleet of refuse trucks in California. Still other tests that may be undertaken
will include using O2Diesel in mining equipment as well as seeking to obtain a military
procurement specification for the fuel. Other programs underway include conducting the required tests to allow O2Diesel to be designated
as a TxLed equivalent fuel for Texas. Once the TxLed tests are completed, additional testing and
protocols will be commenced to permit O2Diesel to be classified as a Diesel Emissions Control
Strategy fuel by the California Air Resources Board. These latter two tests are complicated and
may take considerable time to complete. At this point, we are at an early stage so that it is not
possible to predict when this work will be completed, or if we will obtain the desired results. Based on the government funding in place and funds which have been appropriated, we believe that
approximately 80% of the costs to conduct these tests may be funded by appropriations from the U.S.
Departments of Energy and Defense. For a more detailed description of government appropriations, see Note 3 to the unaudited financial
statements on page F-10. We will also continue to devote considerable time and resources to the design and development of
flame arrestor technology. Most of the design work will be performed by our own personnel and
consultants with the actual fabrication work contracted out to specialized manufacturers. We
expect this work to continue through the remainder of 2005. For the remainder of 2005, we anticipate spending about $15,000 for various fuel and vehicle tests
in Brazil. Employees: At present, O2Diesel has fifteen full-time employees of which twelve are in the U.S. and three are
in Brazil. We have no part-time employees. Currently, we rely extensively on consultants to assist
us with business development, commercializing our technology and to provide help in key technical
areas. At present, we use eighteen consultants; three in marketing; two for investor relations; two
in business development; six as field technicians, three laboratory technicians and two in
government contracts. For the remainder of the year, we will add new personnel based on the pace of our
commercialization. Under our plan, we may add nine full-time employees in the U.S., but none in
Brazil, bringing our total employee count to twenty-four by the year-end. In the U.S., we plan to
hire one person in a management position, two for sales/marketing, four as field technicians, one
for accounting and one for office support. We anticipate continuing to employ sixteen to eighteen
consultants serving in the same capacities for the remainder of 2005. 7




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O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 ITEM 3. CONTROLS AND PROCEDURES. 
 EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. O2Diesels Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of O2Diesels disclosure
controls and procedures (as such term is defined in Rules13a-15 and
15d-15 under the Exchange Act of 1934, as amended)
as of the end of the period covered by this quarterly report (the Evaluation Date). Based on such
evaluation, such officers have concluded that, as of the Evaluation Date, O2Diesels disclosure controls and procedures are effective. 
 
 CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the most recent fiscal quarter,
there have not been any changes in the Companys internal controls over financial
reporting or in other factors that have materially affected, or are reasonably likely to materially
affect internal controls over financial reporting. 
 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. Changes to Common Stock: Pursuant to the $2.0 million Private Placement, we have received qualified subscriptions for
2,803,428 shares of our common stock at a price of $0.70 per share, for total proceeds of
$1,962,400, before the payment of an 8% commission and other expenses, which together total
$166,347. As of the end of March 2005, the Company had received cash of $1,416,400, leaving
$546,000 to be collected. Subsequent to March 31, 2005, we
received $196,000 of the subscription receivable, leaving an amount due of
$350,000. All parties subscribing to these shares agreed to waive certain of the conditions to
permit the transaction to be closed as to their respective subscriptions. None of the shares to be
issued in conjunction with the $2.0 Private Placement were issued as of March 31, 2005. On April
26, 2005, we issued 1,915,143 shares of common stock in connection with a partial closing of this
transaction, which was held on March 17, 2005. The remaining
888,285 shares of common stock for this transaction will be issued subsequent to the
final closing, which will occur following the collection of the
$350,000 subscription receivable, or, if such amount is not received,
at a time to be determined by the Company. There was no underwriter involved in the $2.0 million Private Placement. Sales of common stock
under the $2.0 million Private Placement were exempt from registration pursuant to Section 4(2) of
the Securities Act, and Regulation D promulgated under the Securities Act. Subscribers to the $2.0 million Private Placement are to receive for each two shares of common
stock purchased one warrant to purchase one additional share of common stock. The warrant expires
twenty-four months following the closing of the $2.0 million Private Placement. Each warrant is
exercisable at a price of $0.70 per share during the first twelve months following the close of the
$2.0 million Private Placement, or at an exercise price of $1.05 per share in the second twelve
months following the close of the $2.0 million Private Placement. SUBSEQUENT CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. 8




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O2Diesel Corporation
(A Development Stage Company)
March 31, 2005 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 5. OTHER INFORMATION. None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. The following exhibits are filed herewith. 31.1
    
    Certification by Chief Executive
Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the
Securities and Exchange Act of 1934, as amended31.2
    
    Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the
Securities and Exchange Act of 1934, as amended32.1
    
    Rule 13a-14(b) Certifications by
Chief Executive Officer and Chief Financial Officer pursuant to Rule
13a-14(b) of the Securities and Exchange Act of 1934, as amended.
 12. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized. O2DIESEL CORPORATION
(Registrant)Date: May 16, 2005
    

By:  /s/ Alan RaeAlan RaeChief Executive Officer
(Principal Executive Officer) Date: May 16, 2005
    

By:  /s/ David KoontzDavid KoontzChief Financial Officer
(Principal Financial Officer) 9