##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-QSB [X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 [  ]      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: 000-32217 O2DIESEL CORPORATION  WASHINGTON
    
    91-2023525(State or Other
    
    (IRS EmployerJurisdiction of Incorporation)
    
    Identification No.)
 100 COMMERCE DRIVE
NEWARK, DELAWARE 19713
(Address of Principal Executive Offices) (302) 266-6000
(Issuers telephone number)
Not Applicable (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 July 17, 2004, the registrant had 29,106,156 shares of Common Stock,
$0.0001 par value per share, issued and outstanding Transitional Small Business Disclosure Format (check one)     Yes [   ]    No [X]




---



##### 



02DIESEL CORPORATION
FOR THE QUARTER ENDED June 30, 2004 INDEX TO FORM 10-QSB PAGEPART I FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    F-1Item 2. Plan of Operation
    
    
    1Item 3. Controls and Procedures
    
    
    4PART IIItem 1. Legal Proceedings
    
    
    5Item 2. Changes in Securities
    
    
    5Item 3. Defaults Upon Senior Securities
    
    
    5Item 4. Submissions of Matters to a Vote of Security Holders
    
    
    5Item 5. Other Information
    
    
    6Item 6. Exhibits and Reports on Forms 8-K and 8-A
    
    
    6Signatures
    
    
    8
 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
effectively integrate the business of AAE Technologies International Plc into
its operations and 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 risks detailed in O2Diesels
Annual Report on Form 10-KSB, filed with the SEC on March 29, 2004 and other
filings with the SEC. 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, unanticipated challenges in
commercially deploying our products, failure to gain product approval in the
United States or foreign countries for the commercialization and distribution
of its products and failure to capitalize upon access to new markets. The
statements made in this quarterly report are made as of the date of this
quarterly report and O2Diesel undertakes no obligation to update any of the
forward-looking statements to reflect events or circumstances after the date of
such statements made herein, whether as a result of new information, future
events, changes in expectations or otherwise.




---



##### 



PART I. FINANCIAL INFORMATION 
  02Diesel Corporation
    (A Development Stage Company)
    Consolidated Balance Sheets
    (unaudited) June 30, 2004
        
        December 31, 2003ASSETSCURRENT ASSETSCash
        
        $
        4,521,530
        
        
        $
        1,084,876Restricted cash
        
        
        
        
        
        
        750,000Accounts receivable
        
        
        49,978
        
        
        
        12,204Due from related
            parties
        
        
        67,809
        
        
        
        65,309Other receivables
        
        
        55,307
        
        
        
        276,659Inventory
        
        
        74,827
        
        
        
        57,988Prepaid expenses
            and deposits
        
        
        167,951
        
        
        
        81,380Total current assets
        
        
        4,937,402
        
        
        
        2,328,416FURNITURE AND
            EQUIPMENTOffice furniture
            equipment
        
        
        157,489
        
        
        
        115,948Fuel and test equipment
        
        
        132,607
        
        
        
        52,731290,096
        
        
        
        168,679Less accumulated
            depreciation
        
        
        (52,409
        )
        
        
        (29,296
        )237,687
        
        
        
        139,383TOTAL ASSETS
        
        $
        5,175,089
        
        
        $
        2,467,799LIABILITIES
            AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
        
        $
        679,403
        
        
        $
        529,923Accrued expenses
        
        
        966,039
        
        
        
        884,078Due to related party
        
        
        
        
        
        
        29,642Deferred grants
        
        
        88,933
        
        
        
        65,872Other current liabilities
        
        
        70,127
        
        
        
        54,339Total current liabilities
        
        
        1,804,502
        
        
        
        1,563,854**STOCKHOLDERS
            EQUITY**Preferred stock:
            par value of $0.0001; 20,000,000 shares authorized; 1,550,000 issued
            and outstanding.
        
        
        155
        
        
        
        Common stock: par
            value of $0.0001; 100,000,000 shares authorized; 29,106,156 and 28,080,372 issued
            and outstanding respectively.
        
        
        2,911
        
        
        
        2,808Common stock subscribed;
            754,900 shares at December 31, 2003
        
        
        
        
        
        
        1,132,350Additional paid-in
            capital
        
        
        18,765,463
        
        
        
        11,745,765Common stock subscriptions
            receivable
        
        
        
        
        
        
        (180,000
        )Accumulated other
            comprehensive income
        
        
        113,899
        
        
        
        101,128Deficit accumulated
            during the development stage
        
        
        (15,511,841
        )
        
        
        (11,898,106
        )Total Stockholders
            Equity
        
        
        3,370,587
        
        
        
        903,945TOTAL LIABILITIES
            AND STOCKHOLDERS EQUITY
        
        $
        5,175,089
        
        
        $
        2,467,799
 F - 1




---



##### 



02Diesel Corporation
(A Development Stage Company)
Consolidated Statements of Operations
(unaudited) October 14, 2000(inception)Six months ended June 30,
        
        Three months ended June 30,
        
        through2004
        
        2003
        
        2004
        
        2003
        
        June 30, 2004Revenue
        
        $
        104,584
        
        
        $
        
        
        
        $
        84,522
        
        
        $
        
        
        
        $
        116,788Expenses:Cost of goods sold
        
        
        76,276
        
        
        
        
        
        
        
        59,458
        
        
        
        
        
        
        
        87,547Selling and marketing
        
        
        946,461
        
        
        
        191,184
        
        
        
        511,952
        
        
        
        150,200
        
        
        
        3,696,003Product testing and
            government grants, net
        
        
        120,211
        
        
        
        8,556
        
        
        
        42,026
        
        
        
        8,556
        
        
        
        749,447General and administrative
        
        
        2,636,603
        
        
        
        1,125,018
        
        
        
        1,394,224
        
        
        
        727,819
        
        
        
        11,555,764Total operating
            expense
        
        
        3,779,551
        
        
        
        1,324,758
        
        
        
        2,007,660
        
        
        
        886,575
        
        
        
        16,088,761Operating loss
        
        
        (3,674,967
        )
        
        
        (1,324,758
        )
        
        
        (1,923,138
        )
        
        
        (886,575
        )
        
        
        (15,971,973
        )Other income (expense):Interest expense
        
        
        (3,849
        )
        
        
        (34,275
        )
        
        
        (1,704
        )
        
        
        (19,534
        )
        
        
        (94,372
        )Interest income
        
        
        9,722
        
        
        
        183
        
        
        
        8,745
        
        
        
        149
        
        
        
        22,904Foreign currency
            gain (loss), net
        
        
        (26,661
        )
        
        
        26,480
        
        
        
        (20,726
        )
        
        
        (46,916
        )
        
        
        37,957Other income, net
        
        
        82,020
        
        
        
        
        
        
        
        82,020
        
        
        
        
        
        
        
        348,001Total other income
            (expense)
        
        
        61,232
        
        
        
        (7,612
        )
        
        
        68,335
        
        
        
        (66,301
        )
        
        
        314,490Loss before benefit for income taxes
        
        
        (3,613,735
        )
        
        
        (1,332,370
        )
        
        
        (1,854,803
        )
        
        
        (952,876
        )
        
        
        (15,657,483
        )Benefit for
            income taxes
        
        
        
        
        
        
        (49,415
        )
        
        
        
        
        
        
        (49,415
        )
        
        
        (145,642
        )Net loss
        
        $
        (3,613,735
        )
        
        $
        (1,282,955
        )
        
        $
        (1,878,575
        )
        
        $
        (903,461
        )
        
        $
        (15,511,841
        )Net loss per share
            (basic and diluted)
        
        
        (0.12
        )
        
        
        (0.09
        )
        
        
        (0.06
        )
        
        
        (0.06
        )
        
        
        (0.68
        )Weighted average
            shares of common stock
        
        
        28,985,594
        
        
        
        68,081,981
        
        
        
        29,079,745
        
        
        
        68,270,870
        
        
        
        58,481,478Recapitalization
            resulting from the AAE Technologies International PLC acquisition
        
        
        
        
        
        
        (53,203,926
        )
        
        
        
        
        
        
        (53,351,537
        )
        
        
        (35,513,816
        )Weighted average
            shares of common stock outstanding  giving effect to the recapitalization
        
        
        28,985,594
        
        
        
        14,878,055
        
        
        
        29,079,745
        
        
        
        14,919,333
        
        
        
        22,967,661
 F - 2




---



##### 



02Diesel Corporation
(A Development Stage Company)
Statement of Changes in Stockholders (Deficit) Equity
October 14, 2000 (Inception) through June 30, 2004 Preferred Stock
    
    Common Stock
    
    CommonStock
    
    AdditionalPaid - 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
    
    
    
    
    
    
    $
    3,603,415Common stock issued on various dates
during 2001
    
    
    
    
    
    
    
    
    
    
    24,181,038
    
    
    
    241,810
    
    
    
    
    
    
    
    1,268,031Comprehensive Loss:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2001
    
    
    
    
    
    
    
    
    
    
    67,189,810
    
    
    
    671,898
    
    
    
    
    
    
    
    4,871,446Common stock issued at $0.225 per share
on various dates during 2002
    
    
    
    
    
    
    
    
    
    
    703,282
    
    
    
    7,033
    
    
    
    
    
    
    
    515,657Comprehensive loss:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net lossBalance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    67,893,092
    
    
    
    678,931
    
    
    
    
    
    
    
    5,387,103Common 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
    
    
    
    Comprehensive loss:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2003
    
    
    
    
    
    
    
    
    
    
    28,080,372
    
    
    
    2,808
    
    
    
    1,132,350
    
    
    
    11,745,765Common stock issued at $1.50 per share
on various dates during 2004
    
    
    
    
    
    
    
    
    
    
    1,025,784
    
    
    
    103
    
    
    
    (1,132,350
    )
    
    
    1,535,770Preferred stock issued on various dates
during 2004
    
    
    1,550,000
    
    
    
    155
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,483,928Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,550,000
    
    
    $
    155
    
    
    
    29,106,156
    
    
    $
    2,911
    
    
    
    
    
    
    $
    18,765,463
   [Continued from above table, first column(s) repeated] DeficitCommon
    
    Accumulated
    
    Accumulated
    
    TotalStock
    
    Other
    
    During the
    
    StockholdersSubscriptions
    
    Comprehensive
    
    Development
    
    EquityReceivable
    
    Income
    
    Stage
    
    (Deficit)Balance at October 14, 2000 (Inception)Common stock issued in exchange for
interest in wholly owned subsidiaries
    
    
        
    
    
    
    
    
    
    
    
    
    
    $
    (4,138,684
    )
    
    $
    (105,181
    )Common stock issued on various dates
during 2001
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,509,841Comprehensive Loss:Foreign currency translation adjustment
    
    
        
    
    
    
    
    
    
    
    (4,476
    )
    
    
    
    
    
    
    (4,476
    )Net loss
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    (1,406,709
    )
    
    
    (1,406,709
    )Balance at December 31, 2001
    
    
        
    
    
    
    
    
    
    
    (4,476
    )
    
    
    (5,545,393
    )
    
    
    (6,525
    )Common stock issued at $0.225 per share
on various dates during 2002
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    522,690Comprehensive loss:Foreign currency translation adjustment
    
    
        
    
    
    
    
    
    
    
        (74,085
        )
    
    
            
    
    
    (74,085
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,712,803
    )
    
    
    (1,712,803
    )Balance at December 31, 2002
    
    
        
    
    
    
    
    
    
    
    (78,561
    )
    
    
    (7,258,196
    )
    
    
    (1,270,723
    )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
    )
    
    
    
    
    
    
    
    
    
    
    952,350Comprehensive loss:Foreign currency translation adjustment
    
    
        
    
    
    
    
    
    
    
    179,689
    
    
    
    
    
    
    
    179,689Net loss
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    (4,230,296
    )
    
    
    (4,230,296
    )Balance at December 31, 2003
    
    
        
    
    
    
    (180,000
    )
    
    
    101,128
    
    
    
    (11,898,106
    )
    
    
    903,945Common stock issued at $1.50 per share
on various dates during 2004
    
    
        
    
    
    
    180,000
    
    
    
    
    
    
    
    
    
    
    
    583,523Preferred stock issued on various dates
during 2004
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,484,083Comprehensive loss:
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
        
    
    
    
    
    
    
    
    12,771
    
    
    
    
    
    
    
    12,771Net loss
    
    
        
    
    
    
    
    
    
    
    
    
    
    
    (3,613,735
    )
    
    
    (3,613,735
    )
    
    
    $
    113,899
    
    
    $
    (15,511,841
    )
    
    $
    3,370,587
 F - 3




---



##### 



02Diesel Corporation
(A Development Stage Company)
Consolidated Statements of Cash Flows
(unaudited) October 14, 2000Six months ended June 30,
    
    Three months ended June 30
    
    (inception) through2004
    
    2003
    
    2004
    
    2003
    
    June 30, 2004Cash
flows from operating activitiesNet loss
    
    $
    (3,613,735
    )
    
    $
    (1,282,955
    )
    
    $
    (1,878,575
    )
    
    $
    (903,461
    )
    
    $
    (15,511,841
    )Adjustments
to reconcile loss to net cash used in operating activities:Depreciation
    
    
    23,113
    
    
    
    13,772
    
    
    
    12,512
    
    
    
    22,712
    
    
    
    108,136Amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,786Write off of patent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    337,329Common stock issued for consulting services
    
    
    
    
    
    
    45,000
    
    
    
    
    
    
    
    45,000
    
    
    
    45,000Write off of telephone system
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,538Changes in
operating assets and liabilities:Accounts receivable
    
    
    (37,774
    )
    
    
    
    
    
    
    (26,138
    )
    
    
    
    
    
    
    (49,978
    )Due to/from related parties
    
    
    (2,500
    )
    
    
    (27,286
    )
    
    
    
    
    
    
    25,988
    
    
    
    (38,167
    )Other receivables
    
    
    221,352
    
    
    
    (113,817
    )
    
    
    14,637
    
    
    
    (34,791
    )
    
    
    (55,307
    )Inventory, prepaid expenses and deposits
    
    
    (103,410
    )
    
    
    (362,947
    )
    
    
    (28,685
    )
    
    
    (402,626
    )
    
    
    (242,778
    )Accounts payable
    
    
    149,480
    
    
    
    307,016
    
    
    
    (68,863
    )
    
    
    191,264
    
    
    
    679,403Accrued expenses
    
    
    81,961
    
    
    
    311,985
    
    
    
    (254,154
    )
    
    
    280,619
    
    
    
    966,039Deferred grants
    
    
    23,061
    
    
    
    
    
    
    
    (5,689
    )
    
    
    
    
    
    
    88,933Other current liabilities
    
    
    (13,854
    )
    
    
    54,340
    
    
    
    9,861
    
    
    
    54,340
    
    
    
    40,485Cash flows used in operating activities
    
    
    (3,272,306
    )
    
    
    (1,054,892
    )
    
    
    (2,225,094
    )
    
    
    (720,955
    )
    
    
    (13,623,422
    )Cash flows from investing activitiesRestricted cash
    
    
    750,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Purchase of furniture and equipment
    
    
    (121,417
    )
    
    
    (62,489
    )
    
    
    (78,748
    )
    
    
    (41,347
    )
    
    
    (347,361
    )Purchase of Patent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (345,115
    )Cash flows provided by (used in) investing activities
    
    
    628,583
    
    
    
    (62,489
    )
    
    
    (78,748
    )
    
    
    (41,347
    )
    
    
    (692,476
    )Cash flows from financing activitiesBridge Loan from DVI
    
    
    
    
    
    
    1,000,000
    
    
    
    
    
    
    
    
    
    
    
    Net proceeds from issuance of preferred stock
    
    
    5,484,083
    
    
    
    
    
    
    
    2,803,246
    
    
    
    
    
    
    
    15,807,506Net proceed from follow-on private placement of common stock
    
    
    583,523
    
    
    
    
    
    
    
    48,221
    
    
    
    
    
    
    
    583,523Net proceeds from issuance of common stock
    
    
    
    
    
    
    125,000
    
    
    
    
    
    
    
    125,000
    
    
    
    Increase of bank debt.
    
    
    
    
    
    
    16,773
    
    
    
    
    
    
    
    16,773
    
    
    
    2,332,500Cash flows provided by financing activities
    
    
    6,067,606
    
    
    
    1,141,773
    
    
    
    2,851,467
    
    
    
    141,773
    
    
    
    18,723,529Effect of exchange rate changes on cash
    
    
    12,771
    
    
    
    (32,142
    )
    
    
    14,400
    
    
    
    (241,570
    )
    
    
    113,899Net increase (decrease) in cash
    
    
    3,436,654
    
    
    
    (7,750
    )
    
    
    562,025
    
    
    
    (862,099
    )
    
    
    4,521,530Cash at beginning of period
    
    
    1,084,876
    
    
    
    119,139
    
    
    
    3,959,505
    
    
    
    973,488
    
    
    
    Cash at end of period
    
    $
    4,521,530
    
    
    $
    111,389
    
    
    $
    4,521,530
    
    
    $
    111,389
    
    
    $
    4,521,530Supplemental Disclosures:Cash paid for interest:
    
    
    3,849
    
    
    
    34,275
    
    
    
    1,704
    
    
    
    19,534
    
    
    
    92,849Cash paid for income taxes:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 F - 4




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##### 



02Diesel Corporation
(A Development Stage Company) 1. Nature of Operations O2Diesel Corporation (O2Diesel or the Company) is in the development stage
and has developed a proprietary additive product designed to improve the
performance of distillate liquid transportation fuels by facilitating the
addition of ethanol as an oxygenate to these fuels. The additive stabilizes and
enhances the blending of fuel grade ethanol with diesel fuel. Blending the
Companys additive with ethanol and various grades of diesel fuel in turn
creates a proprietary clean burning fuel called O2Diesel. The Companys
products are designed for use by diesel powered vehicles including centrally
fueled truck and bus fleets, railroads, municipal fleets, and various types of
diesel equipment used for on and off-road construction, mining and agriculture,
as well as in stationary generators and port logistics facilities. The Company has co-developed its additive technology with Cognis Deutschland
GmbH (Cognis), a German based manufacturer of specialty chemicals. Under its
arrangement with Cognis, the Company has world-wide marketing and sales rights
and Cognis has world-wide manufacturing rights. Cognis performs research and
development work in conjunction with O2Diesel, and produces O2Diesels additive
products for all of the regions targeted by the Company for commercialization
of
its additive technology. To date, the Companys operations have been primarily focused on raising
capital, performing product tests and demonstrations, and bringing its products
to market in the U.S., Canada and Brazil. In April 2004, the Company signed
a Supply and Distribution Agreement with a Saudi Arabian company for the sale
of its product in Saudi Arabia and other Middle-Eastern countries. Additional
studies must be completed to determine if the Companys product is compatible
with diesel fuels used in the region and to verify that it will perform
adequately in the temperature ranges found in the harsh desert climates of the
Middle East. 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 Technologies International Plc (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 approved an application to list
46,518,898 shares of the Companys common stock under the symbol OTD. Trading
of the Companys shares on the exchange began July 1, 2004. 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 intercompany balances and
transactions have been eliminated in consolidation. Concentration of Credit Risk and Allowance for Doubtful Accounts Due to the limited volume of sales, concentrations of credit risk with respect
to accounts receivable are limited. No allowance for doubtful accounts
receivable was deemed necessary at June 30, 2004 or December 31, 2003. F - 5




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##### 



02Diesel Corporation
(A Development Stage Company) 2. Summary of Significant Accounting Policies (continued) Inventories Inventories, consisting of fuel additive and cetane held at a third party
location, are stated at the lower of cost as determined using the first in,
first out (FIFO) method or market value. Furniture and Equipment 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 furniture and equipment
are as follows: Office furniture and equipment: 3 to 5 years
Fuel and test equipment: 5 years Long-Lived Assets Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long Lived Assets was issued in August 2001 and
adopted by the Company on January 1, 2002. In accordance with SFAS No. 144, the
carrying values 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 an 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 Revenue from the sales of product by the Company is recognized and recorded
upon the passage of title to the customer. Sales of the Companys product may
also be made by its exclusive sales agent for the United States and Canada. On
these sales, the Company will be paid a share of the gross profit realized from
each sale to the end user. The Company will record
revenue earned in these cases upon notification of a completed sale to the end
user. F - 6




---



##### 



02Diesel Corporation
(A Development Stage Company) 2. Summary of Significant Accounting Policies (continued) 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 $3,770 and $7,945 for the three and six
months ended June 30, 2004, respectively, and were $9,886 for the period
October 14, 2000 (inception) through June 30, 2004. No shipping and handling
costs were incurred for the three and six months ended June 30, 2003. Advertising Expenses Advertising costs are expensed as incurred. Advertising expense was nil for the
three and six months ended June 30, 2004 and were nil and $62,500 for the three
and six months ended June 30, 2003, respectively. Advertising costs were
$500,000 for the period October 14, 2000 (inception) to June 30, 2004. Research and Development Costs Research and development costs are expensed as incurred. 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 shareholders 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. Stock Based Compensation The Company accounts for stock option grants in accordance with APB Opinion 25,
Accounting for Stock Issued to Employees (APB 25) and related
interpretations. Under APB 25, because the exercise price of the stock options
equaled the fair value of the underlying common stock on the date of grant, no
compensation cost is recognized. In accordance with SFAS 123, Accounting for
Stock-Based Compensation, the Company does not recognize compensation cost
based on the fair value of the options granted at grant date. If the Company
had elected to recognize compensation cost based on the fair value of the
options granted at grant date, net loss and net loss per share would not have
been materially different. F - 7




---



##### 



02Diesel Corporation
(A Development Stage Company) 2. Summary of Significant Accounting Policies (Continued) Income taxes Income taxes are accounted for using the liability method whereby deferred tax
assets or liabilities are computed based upon the difference between the
financial statement and income tax basis 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 expenses 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 the deferred tax assets will not be realized, a valuation allowance
is required 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. 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 Currency Translation 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 current exchange rates, and the income
and expenses have been translated using historical exchange rates. The
adjustments resulting from translation have been recorded separately in
stockholders (deficit) equity as other comprehensive income (loss) and are
not included in determining consolidated net income (loss). As of June 30,
2004, other comprehensive income included $113,899 of cumulative income from
foreign currency translation. 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 June 30, 2004 and the
results of operations and cash flows presented herein from inception (October
14, 2000) through June 30, 2004 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, 2004. F - 8




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##### 



02Diesel Corporation
(A Development Stage Company) 3. Government Appropriations Appropriation from the Department of Energy: In 2002, the Company received an appropriation of $1,107,734 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 November 30, 2004. 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 June 30, 2004, the Company
had incurred $753,950 towards completion of the contract, leaving a balance of
$353,784 in costs to complete the contract. From the inception of the contract
in December 2002 through June 30, 2004, the Company has billed NREL $603,160,
of which $46,460 is included in other receivables as of June 30, 2004. Appropriation from the Department of Defense: In 2003, the Company received an appropriation of $1,000,000 from the
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 runs from October 7, 2003 to December 31, 2004. As of June 30,
2004, the Company had incurred $105,129 leaving a balance of $694,871 in costs
to complete the program. Through June 30, 2004, the Company had achieved two
milestones and, since inception, has billed $200,000 related to this
Appropriation. All amounts billed had been received as of June 30, 2004. 4. Other Receivables Other receivables consisted of the following: June 30, 2004
    
    December 31, 2003NREL Appropriation
    
    $
    46,460
    
    
    
    $184,850Reimbursement due from Cognis
    
    
    8,847
    
    
    
    11,809CTC Appropriation
    
    
    
    
    
    
    80,000$
    55,307
    
    
    
    $276,659
 5. Accrued Expenses Accrued expenses consisted of the following: June 30, 2004
    
    December 31, 2003Legal and professional fees
    
    $
    466,400
    
    
    $
    728,984Financing fees
    
    
    175,723
    
    
    
    Marketing
    
    
    50,000
    
    
    
    50,000Other
    
    
    273,915
    
    
    
    105,094$
    966,038
    
    
    $
    884,078
 F - 9




---



##### 



02Diesel Corporation
(A Development Stage Company) 6. 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
period. 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 purposes. Significant components
of the Companys deferred tax assets as of June 30, 2004 are as follows: Net operating loss carryforwards
    
    $
    2,915,000Accrued expenses and deferred revenue
    
    
    162,000Total deferred tax assets
    
    $
    3,077,000Valuation allowance
    
    
    (3,077,000
    )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 June 30, 2004, the Company had Federal
and state net operating loss carryforwards of approximately $6.9 million for
income tax purposes. If not used, these 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 these benefits that
would be available to offset future taxable income each year, starting with the
year of ownership change. As of June 30, 2004, the Company had an Irish net
operating loss carryforward of approximately $187,000, that may be carried
forward indefinitely, and a Brazilian net operating loss carryforward of
approximately $287,000 that may be carried forward indefinitely, but which is
subject to annual usage limitations. 7. 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. F - 10




---



##### 



02Diesel Corporation
(A Development Stage Company) 7. Stockholders Equity (continued) 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. During the later half of 2003, the Company received subscriptions for the
issuance of 754,900 additional shares of common stock in conjunction with a
follow-on private placement. The Company received $952,350 in gross proceeds
related to the subscriptions for 634,900 shares and has recorded a subscription
receivable of $180,000 related to the subscriptions for the remaining 120,000
shares. In the first quarter of 2004, the Company received subscriptions for
the issuance of 390,884 shares of common stock pursuant to the follow-on
private placement. The Company received $386,325 in gross proceeds related to
the subscriptions for 390,884 shares, and it collected gross proceeds of
$150,000 for subscriptions that it received in calendar year 2003. A
subscription receivable of $230,001 was recorded as of March 31, 2004 to
reflect balances of $30,000 for subscriptions received in calendar year 2003
and $200,001 for subscriptions received in the first quarter of 2004. In the
second quarter of 2004, the Company received gross proceeds of $50,001 related
to subscriptions received in the first quarter of 2004, and cancelled and reversed the
remaining balance of $180,000 in the subscription receivable account as of June
30, 2004. 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
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. Warrants A wholly-owned subsidiary of the Company entered into a supply and distribution
agreement (the Supply and Distribution 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 subsidiary for $1.00 provided certain sales
targets are achieved. The warrant expires on July 10, 2006. To date, none of
the sales targets have been achieved under the Supply and Distribution
Agreement. 8. 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 six and three months ended June 30, 2004 and 2003, and for
the period from October 14, 2000 (inception) through June 30, 2004 the Company
paid $14,430, $7,732, $13,587, $6,830 and $116,396, respectively to the company
controlled by the Chairman. Included in receivables due from related parties at June 30, 2004 is $49,709
due from Directors for the individual tax liability in Ireland attributable to
certain consultancy fees paid during 2003 and $18,100 related to travel
advances made to certain employees. F - 11




---



##### 



02Diesel Corporation
(A Development Stage Company) 9. Commitments Operating leases The Company leases certain office equipment under agreements that are accounted
for as operating leases. As of June 30, 2004, future minimum lease payments
under non-cancelable operating leases expiring through 2008, were as follows: 2004
    
    $
    39,2932005
    
    
    79,2852006
    
    
    81,5302007
    
    
    83,7752008
    
    
    78,680Total
    
    $
    362,563
 Rent expense under the leases was $39,962 and $18,521 for the six and three
months ended June 30, 2004 and was $41,224 for the period October 14, 2000
(inception) through June 30, 2004. The leases did not exist prior to December
2003. Options The Company has commitments to grant to certain of its Officers and Directors
options to purchase 3.7 million shares 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. These options will not be issued until the Companys
proposed stock incentive plan, which has been approved by the Companys Board
of Directors, is also approved by the stockholders. 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. 10. Saudi Arabian Supply and Distribution Agreement On April 20, 2004, the Company signed a Supply and Distribution Agreement
(Saudi Agreement) with a Saudi Arabian company (Distributor) under which the
Distributor has been granted the exclusive rights for the sale and distribution
of the Companys additive and O2Diesel for three countries in the Middle East.
As part of the Saudi Agreement, the Distributor has committed to order and
take a minimum amount of additive during each year of the Saudi Agreement,
which by its terms, is to continue for an initial period of five years with a
right of renewal by the Distributor for two successive three year terms. In
the event the Distributor fails to order and take delivery of the minimum
amount required under the Saudi Agreement, the Company may invoice the
Distributor for 75% of the quantity by which the actual amounts fall short of
the required minimum. If the Distributor orders and takes more than the
required minimum in a year, such excess may be carried over to subsequent years
and counted towards the required minimums in future periods. It is important
to note that the Companys products have not yet been tested or proven in the
harsh desert climates of the Middle East, nor have they been adequately tested
with the grades of diesel fuel and ethanol produced and used in the region. To
date, the Company has undertaken some preliminary research which has indicated
that its product may only be compatible with certain diesel fuels used in the
Middle East and may be capable of performing satisfactorily in the hot desert
environment. The Company expects to assemble a team and develop a plan to
carry out more in-depth tests in order to prove that its products are suitable
for the climates and conditions existing in these countries. In addition, the
Company will need to do extensive work to determine the types of vehicles and
equipment in which the fuel can be used, as well as to do further work to
understand the distribution facilities available for storing and dispensing
O2Diesel. The Companys success in this region will also be dependent upon
the Companys ability to liaise closely with the Distributor to insure that
there is an adequate supply of fuel grade ethanol available to blend with its
additive and local diesel fuel. Lastly, as part of the sales and technical
support to be provided to the Distributor, the Company will supply training and
safety materials to persons and organizations to be identified by the
Distributor. F - 12




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 
 ITEM 2. 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 June 30,
2004. In the second half of 2004, the Company expects to have sales of its
additive and O2Diesel in sufficient volumes to cause the Companys status as a
development stage company to terminate. During the second six months of 2004, we intend to continue our focus on
generating sales to our targeted customers in the U.S., Canada and Brazil. In
line with our sales initiatives, we have expanded our marketing efforts to
target large municipalities and certain truck fleets to encourage these
entities to use clean fuel as part their environmental strategies.
We now also believe that opportunities for the sale and distribution for our
products may exist in the Middle East and we intend to aggressively investigate
this emerging market. As set forth in Item 5 of this report, we signed a
Supply and Distribution Agreement with a Saudi Arabian company in April 2004,
for the sale of our product in Saudi Arabia and other Middle-Eastern countries.
Additional studies must be completed to determine if the Companys product is
compatible with diesel fuels used in the region and to verify that it will
perform adequately in the temperature ranges found in the harsh desert climates
of the Middle East. Perhaps most importantly, we are continuing our efforts to establish and
improve the logistics networks required for the delivery of our products.
Finally, we will continue 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. These tests are intended to confirm the
integrity of our product for use in multiple vehicle types, various kinds of
diesel equipment, and in different environments. 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 O2
Diesel 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 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. 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. 1




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 In the U.S., O2Diesels initial sales and marketing efforts have been focused
on the states of California, Nevada and, Texas as well as the northeastern
states of New York, New Jersey, Pennsylvania, Delaware and Connecticut. Taken
together, these three areas account for about one-third of all diesel fuel used
in the U.S. In Canada, we intend to concentrate our efforts on the countrys
large population centers in the Eastern and Western provinces. In each of these
regions, our sales force will seek to identify potential customers that fit the
profile for the use of O2Diesels products. In selling into the U.S. and Canadian markets, the Company faces several
challenges, centered around the logistics of delivering and dispensing
O2Diesel to potential customers and on the need to install flame arrestors and
other devices in vehicles and storage facilities. 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 intend 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 nine
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 will be 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 in the process of
purchasing and installing flame arrestors in all vehicles, fuel cooling devices
in some 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, the Company will have an oversight role to
insure that all parts and installation work comply with O2Diesels
specifications. As part of the second leg of our strategy, our sales force plans to market and
sell O2Diesel directly to companies,
governmental municipalities 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 facilities, railroads, 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. O2Diesel will arrange for the
purchase of ethanol and will supply additive and, in some cases, may even
arrange for the purchase of diesel fuel by the customer. In the process of
transitioning a customers fleet to O2Diesel, we need to put in place the
logistical support to insure that fuel is delivered on a timely basis. To
accomplish this, O2Diesel is seeking 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 tank cleaning and filtering systems as
necessary, as well as either purchasing and installing flame arrestors and fuel
cooling devices or assisting the customer to do so. As a part of our marketing strategy of targeting large municipal and certain
company fleets, we have developed and are testing a marketing concept based on
the customer incorporating into its environmental statements the benefits that
using O2Diesel brings to the fuel user and the community. Preliminary
marketing efforts have shown that an initiative encouraging companies and
municipalities to integrate the use of O2Diesel into their environmental
mission statements as part of their 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 the
benefits of being associated with using a clean burning fuel. Brazil: In Brazil, O2Diesel plans to target customers similar to those in the U.S. For
Brazil, we are establishing our own sales and technical capabilities to
substantially mirror what has been done in the U.S. We have joined with a
Brazilian commodity firm that trades sugar and alcohol for the purpose of
obtaining local assistance in our efforts to introduce our products into the
Brazilian market. This Brazilian commodity firm owns 25% of O2Diesels
Brazilian subsidiary. O2Diesel has targeted some of Brazils largest sugar
growers and millers as potential customers for O2Diesel, and we anticipate
that our equity partner will play a significant role in selling to this sector.
We also intend 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. and Canadian markets. 2




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 Brazils fuel distribution system is more concentrated than it is in the U.S.
As a consequence, O2Diesel must join with one or more large fuel distributors
who can deliver and distribute O2Diesel in Brazil. Failure to attract one or
more distribution partners would likely set back our timetable for achieving
market penetration in Brazil. Potential distribution partners have been
identified but discussions are in the preliminary stages, and, as of the date
of this report, there can be no assurance that we will reach a definitive
agreement with any of these companies. Cash Requirements and Liquidity: Based on current projected level of operations and expected sales, we fully
anticipate that we will need to raise additional funds by the end of the first
quarter in 2005. In the first quarter of 2004, we completed two financings in
which the Company issued newly-created preferred stock in exchange for
approximately $5.5 million in net proceeds. These funds were received in March
and May of 2004. In addition, during the first quarter of 2004, we received net
proceeds of approximately $536,000 in a private placement of shares of our
common stock. As of March 31, 2004, the Company closed the private placement
and had a subscription receivable of approximately $230,001 as of that date.
Subsequent to March 31, 2004, we collected gross proceeds of $50,001 and wrote
off the remaining balance of $180,000 in the subscription receivable account. 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 favorable trade terms with
Cognis for the supply of additive. Under these terms, we expect to be able to
purchase and sell our additive product and match the receipt of sales proceeds
with payment for our additive inventory. There are significant technical and logistical issues that are affecting our
ability to generate sales, and these, in turn, will likely impact our ability
to meet projected cash needs over the next twelve months. First, as part of the
process by which O2Diesel was approved for sale in California, the California
Air Resources Board (ARB) set a number of conditions that must be adhered to 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. This is a serious
issue and has negatively impacted the Companys ability to efficiently
commercialize our products 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
use with O2Diesel. However, we are designing flame arrestors for use with
O2Diesel and these are now undergoing tests to insure that they are capable of
complying with all required specifications. Consequently, we have not obtained
sufficient experience with sourcing, purchasing and fitting flame arrestors to
vehicles and storage tanks to be able to accurately project the cost and time
of completing these tasks. Moreover, there is insufficient history for the
Company to be able to predict with certainty the manpower required to
accomplish this work. In addition, we have learned that certain vehicles
require the fitting of a fuel cooling device to insure that the vehicle runs
properly in hot weather. These devices are simple and readily available and the costs are
known, but the necessity of adding these devices to certain vehicles will
increase our costs and is likely to complicate the sales process. The second concern relates to the logistics, storage and maintenance of
O2Diesel for fleets that are direct customers of the Company and customers of
jobbers in the U.S., Canada and Brazil. To date, we have not completed the
required logistics arrangements to identify and finalize the necessary
infrastructure to insure that we can arrange for a supply of ethanol to blend
with our additive and then arrange for the timely delivery and proper storage
of O2Diesel to potential customers. In this regard, the Company has not fully
completed the necessary research and logistics studies to make certain that the
storage facilities of users are capable of meeting the standards necessary to
store and dispense O2Diesel. Given our projected level of operating costs, the continuation of favorable
trade terms from our major supplier and cash on hand as of the date of this
report, we expect to have sufficient cash to fund our operations for the
remainder of 2004. However, because of the delays in our ability to procure
flame arrestors and because the logistics and storage tank issues have not been
fully resolved, it is highly likely that additional funding will be needed
during the first quarter of 2005 if we are to have sufficient operating capital
to carry out our business plan. At the Companys Board of Directors meeting
in June 2004, our Board agreed and authorized management to raise additional
capital. We have begun the process to do so. In connection with our efforts to
attract new investment, there can be no assurance that we will be successful in
our efforts to raise additional funds. Nor can there be any assurance that the
Company will generate sales and collect cash to offset our operating expenses.
As of June 30, 2004, the Company has generated only $104,584 in product sales
and has only minimal orders for either our additive or O2Diesel. Lastly, there can be no assurance
that actual events will not differ from those anticipated, or that general
economic conditions may vary significantly in ways that could negatively impact
the operations and cash position of the Company. 3




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 Research & Development: O2Diesel has an agreement with Cognis Deutschland GmbH (Cognis) for the joint
development of co-solvency additive products as well as the joint ownership of
patents covering such products. Under this agreement, O2Diesel has worldwide
rights to market and sell the additive products and Cognis has the worldwide
rights to manufacture such products. Under the terms of this agreement,
O2Diesel is not required to incur any research and development expenditures,
but we are required to share equally in all of the legal costs to file and
maintain all patent applications and issued patents. O2Diesel is responsible for the costs of testing our products. To date, these
tests have generally been specific to the jurisdictions in which we intend to
do business. For the remainder of 2004, we expect to pursue an ambitious
program of testing O2Diesel products both in the laboratory and in field
trials. In 2004 we plan to carryout the necessary testing to obtain both ARB
and EPA verifications for the broadest possible array of engine families and
uses. Other projected tests include using O2Diesel in large mining operations
within the United States. We have initiated talks with two large mining
companies in the western United States to begin the planning for use of
O2Diesel in selected equipment at each mine. All of the above tests, which
could cost as much as $2.0 million, will be conducted within the framework of
existing grants received from the U.S. government. The completion of these
tests should further validate the benefits of using O2Diesel, and should
assist in the marketing of our product. Based on government funding that we
have received and additional government funding that we believe may be
appropriated for these specific purposes, we estimate that as much as 80% of
the costs for such laboratory tests and field trials may be funded by U.S.
government agencies such as the Department of Energy and the Department of
Defense. In addition to testing O2Diesel, the Company is continuing the process of
assisting in the design and testing of new flame arrestor technologies for a
wide range of vehicle applications. [For a more detailed explanation, see Note
3 to the Financial Statements on page F-9.] In Brazil, we expect to spend approximately $60,000 in 2004 on testing
protocols. The test protocols will be undertaken to insure that our additive
and fuel complies with the governments fuel and environmental laws and
regulations. In addition, we expect that these tests will help to validate the
use of O2Diesel in the various types of vehicles and the different grades of
diesel fuel found in Brazil. Employees: At present, we have nineteen full-time employees of which fifteen are in the
U.S. and four are in Brazil. For the remainder of the year, we plan to add
seven full-time employees in the U.S. and three in Brazil which would bring our
total employee count to twenty-nine by the year-end. In the U.S., we plan to
hire one person for marketing support, five persons as field technical
representatives, and one in accounting. Of the three new staff planned for
Brazil, we anticipate that two will work in technical sales, and one in office
administration. 
 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
Rules 13a-15 and 15d-15 under the Exchange Act) 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 in alerting them on
a timely basis to material information relating to O2Diesel required to be
included in its reports filed or submitted under the Exchange Act. CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the most recent
fiscal quarter, there have not been any significant 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. 4




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. None. 
 ITEM 2. CHANGES IN SECURITIES. During the quarter ended on March 31, 2004, O2Diesel received subscriptions for
390,884 shares of its common stock in the Private Placement at $1.50 per share
for a total of $586,326. We received cash payments of $386,250 for these shares
in the first quarter, and had a subscriptions receivable of $230,001 at March
31, 2004. We collected additional proceeds of $50,001 in the quarter ended
June 30, 2004, and wrote off the remaining balance of $180,000 in the
subscriptions receivable account as of June 30, 2004. Of which $30,000 was
applicable to subscriptions received during 2003. On March 12, 2004, the Company filed a Certificate of Designation with the
Secretary of State of the State of Washington defining the rights of holders of
750,000 shares of O2Diesel Series B 0% Convertible Preferred Stock, par value
$.0001 (Series B Preferred Stock). Pursuant to a Convertible Preferred Stock
Purchase Agreement between the Company and the purchaser named therein (the
Series B Purchaser) dated as of March 29, 2004, the Company issued to the
Series B
Purchaser, 600,000 shares of Series B Preferred Stock and placed 150,000 shares
in escrow. The offering of the 600,000 Series B shares resulted in gross
proceeds of $2.3 million to the Company. After deduction of fees and
commissions, the Company received net proceeds of approximately $2.1 million
for the 600,000 Series B shares. Under the Series B Purchase Agreement, as
amended, the Company released the remaining 150,000 Series B Preferred shares
in May 2004 and received gross proceeds of $572,000 which, after the payment of
all expense, fees and commissions, resulted in net proceeds of approximately
$536,000. The sale of the Series B Preferred Stock was exempt from
registration pursuant to Regulation S promulgated under the Securities Act of
1933. The Series B Preferred Stock is convertible into the Companys common stock at
a variable conversion ratio which is the lesser of (a) $3.65 as adjusted as
provided in the Series B Certificate of Designation (the Series B
Fixed Conversion Price) or (b) eighty percent (80%) of the lowest closing bid
price for the Common Stock in the ten business days preceding the date of
conversion, but, in no case, less than 50% of the Series B Fixed Conversion
Price. In no
event will the Series B Purchaser receive more than approximately 4,109,589 nor
less than 2,054,795 shares of the Companys common stock upon conversion of the
Series B Preferred Stock. The Series B Preferred Stock is subject to a two-year
restriction on transfer. The Series B Preferred Stock Certificate of
Designation and the Convertible Preferred Stock Purchase Agreement with the
Series B Purchaser were filed as exhibits to Form 10-KSB on March 30, 2004 and
are incorporated herein by reference. SUBSEQUENT CHANGES IN SECURITIES None 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 
 ITEM 5. OTHER INFORMATION. On April 20, 2004 we signed a Supply and Distribution Agreement (Saudi
Agreement) with a Saudi Arabian company (Distributor) under which the
Distributor has been granted the exclusive rights for the sale and distribution
of the Companys additive and O2Diesel for three countries in the Middle East.
As part of the Saudi Agreement, the Distributor has committed to order and take a minimum amount of additive 5




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 during each year of
the Saudi Agreement, which by its terms, is to continue for an initial period
of five years with a right of renewal by the Distributor for two successive
three year terms. In the event the Distributor fails to order and take
delivery of the minimum amount required under the Saudi Agreement, the Company
may invoice the Distributor for 75% of the quantity by which the actual amounts
fall short of the required minimum. If the Distributor orders and takes more
than the required minimum in a year, such excess may be carried over to
subsequent years and counted towards the required minimums in future periods.
It is important to note that the companys products have not yet been tested or
proven in the harsh desert climates of the Middle East, nor have they been
adequately tested with the grades of diesel fuel and ethanol produced and used
in the region. To date, we have undertaken some preliminary research which has
indicated that our products may only be compatible with certain diesel fuels
used in the Middle East and may be capable of operating satisfactorily in the
hot desert environment. We intend to assemble a team and develop a plan to
carry out more in-depth tests in order to prove that our products are suitable
for the climates and conditions existing in these countries. In addition, we
will need to do extensive work to determine the types of vehicles and equipment
in which our fuel can be used, as well as to do further work to understand the
distribution facilities available for storing and dispensing O2Diesel. It
will also be imperative that we liaise closely with the Distributor to insure
that there is an adequate supply of fuel grade ethanol available to blend with
its additive and local diesel fuel. Lastly, as part of the sales and technical
support to be provided to the Distributor, we will supply training and safety
materials to persons and organizations to be identified by the Distributor. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K and 8-A. (a) Exhibits Exhibits included or incorporated by reference in this document are set forth
in the Exhibit Index below. EXHIBIT INDEX3.1(1)
    
    Articles of Incorporation3.2(3)
    
    Articles of Amendment to change the Companys name to O2Diesel
Corporation (previously filed as Exhibit 1)3.3(1)
    
    Bylaws4.1(1)
    
    Specimen Stock Certificate4.2(1
    
    Stock Subscription Agreement4.3(2)
    
    $100,000 Promissory Note10.1(1)
    
    License Agreement10.2(1)
    
    Assignment of License10.3(4)
    
    Support Agreement (previously filed as Exhibit 1)10.4(4)
    
    Indemnity Escrow Agreement (previously filed as Exhibit 2)10.5(4)
    
    Option and Escrow Agreement (previously filed as Exhibit 3)10.6(4)
    
    Contribution and Cancellation Agreement (previously filed as
Exhibit 4)10.7(4)
    
    Waiver Agreement (previously filed as Exhibit 5)10.8(4)
    
    Loan Agreement (previously filed as Exhibit 6)10.9(4)
    
    Form of Convertible Note (previously filed as Exhibit 7)10.10(4)
    
    Form of Employment Agreement between O2Diesel and Alan Rae
(previously filed as Exhibit 8)10.11(4)
    
    Form of Employment Agreement between O2Diesel and David Koontz
(previously filed as Exhibit 9)10.12(4) (5)
    
    Cooperation agreement between Cognis and AAE (previously filed as
Exhibit 10)10.13(6)
    
    Form of Agreement to Amendment Loan Agreement and Convertible
Debenture10.14(7)
    
    Letter dated September 23, 2003 from the California Air Resources
Board (previously filed as Exhibit 10.13)
 6




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 10.15(7)
    
    Memorandum of Understanding between BASF Aktiengesellschaft and
O2Diesel Corporation dated August 18, 2003 (previously filed as Exhibit 10.14)10.16
    
    Supply and Distribution Agreement between the Company and ALOBAYYA Corporation
dated April 20, 2004 (filed herewith)16.1(8)
    
    Letter from Manning Elliot to the Securities and Exchange
Commission dated January 23, 200416.2(8)
    
    Letter from Cremin McCarthy & Company to the Securities and
Exchange Commission dated February 2, 200431.1
    
    Certification by Chief Executive Officer pursuant to Rule 13a-14(a) of the
Securities and Exchange Act of 1934, as amended (filed herewith)31.2
    
    Certification by Chief Financial Officer pursuant to Rule 13a-14(a) of the
Securities and Exchange Act of 1934, as amended (filed herewith)32.1
    
    Rule 13a-14(b) Certifications by Chief Executive Officer and Chief Financial Officer
pursuant to Rule 13a-14(b) the Securities and Exchange Act of 1934, as amended (filed herewith)99.1(9)
    
    Certificate of Designation of the Rights and Preferences of
Series A 0% Convertible Preferred Stock of O2Diesel Corporation
filed with the Secretary of State of the State of Washington on
March 2, 200499.2(9)
    
    Convertible Preferred Stock Purchase Agreement by and among
O2Diesel Corporation and the Purchaser named therein, dated as
of March 3, 200499.3(10)
    
    Certificate of Designation of the Rights and Preferences of
Series B 0% Convertible Preferred Stock of O2Diesel Corporation
filed with the Secretary of State of the State of Washington on
March 12, 200499.4(11)
    
    Convertible Preferred Stock Purchase Agreement by and among
O2Diesel Corporation and the Purchaser named therein, dated as
March 29, 2004(1)
    
    Previously filed as an exhibit to the Companys registration statement on
Form SB-2 on June 30, 2000, as amended September 19, 2000, November
3, 2000 and
December 22, 2000 and incorporated herein by reference.(2)
    
    Previously filed as an exhibit to the Companys annual report on Form
10-KSB on March 29, 2002 and incorporated herein by reference.(3)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K
on June 9, 2003 and incorporated herein by reference.(4)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K
on July 30, 2003 and incorporated herein by reference.(5)
    
    O2Diesel applied for, and was granted on February 25, 2004, confidential
treatment with respect to certain portions of this Agreement, which
have been
omitted, pursuant to Rule 24b-2 of the Securities Exchange Act of
1934, as amended.(6)
    
    Previously filed as an exhibit to the Companys quarterly report on Form
10-QSB for the quarter ended June 30, 2003 on August 14, 2003 and
incorporated
herein by reference.(7)
    
    Previously filed as an exhibit to the Companys quarterly report on Form
10-QSB for the quarter ended September 30, 2003 on November 19, 2003
and
incorporated herein by reference.(8)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K
on February 6, 2004 and incorporated herein by reference.(9)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K
on March 12, 2004 and incorporated herein by reference.(10)
    
    Previously filed as an exhibit to the Companys annual report on Form
10-KSB on March 30, 2004 and incorporated herein by reference.(11)
    
    Previously filed as an exhibit to the Companys annual report on Form
10-KSB on March 30, 2004 and incorporated herein by reference.
 7




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##### 



02Diesel Corporation
(A Development Stage Company)
June 30, 2004 (b) Reports on Forms 8-K and 8-A. O2Diesel filed the following current reports
on Forms 8-K and 8-A during the quarter ended June 30, 2004: Current report on Form 8-K filed on April 16, 2004, relating to
the appointment of Rick Roger to the Board of Directors. Current report on Form 8-A filed on June 23, 2004, relating to
the registration and listing of the companys common stock on
the American Stock Exchange. 
 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: August 13, 2004
    By:
    /s/ Alan RaeAlan RaeChief Executive Officer
(Principal Executive Officer) Date: August 13, 2004
    By:
    /s/ David KoontzDavid KoontzChief Financial Officer
(Principal Financial Officer) 8