##### 



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 MARCH 31, 2004 [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934For the transition period from to . . . . . . . . . .to. . .
.. . . . . . . . . .
 Commission File Number: 000-32217 O2DIESEL CORPORATION  WASHINGTON
(State or Other
Jurisdiction of Incorporation)
    
    91-2023525
(IRS Employer
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 May 11, 2004, the registrant had 29,083,156 shares of Common Stock,
$0.0001 par value per share, issued and outstanding Transitional Small Business
Disclosure Format (check one) Yes [X] No [   ]




---



##### 



O2DIESEL CORPORATION
FOR THE QUARTER ENDED March 31, 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
    
    
    4Item 2. Unregulated Sales of Equity Securities and Use of Proceeds
    
    
    5Item 3. Defaults Upon Senior Securities
    
    
    5Item 4. Submissions of Matters to Vote of Security Holders
    
    
    6Item 5. Other Information
    
    
    6Item 6. Exhibits and Reports on Form 8-K
    
    
    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 02Diesel
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 and other risks detailed in
O2Diesels Annual Report on Form 10-KSB, filed with the SEC on March 30, 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, 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 
 ITEM 1. O2Diesel Corporation
(A Development Stage Company)
Consolidated Balance Sheet
March 31, 2004
(unaudited) ASSETSCURRENT ASSETSCash
    
    $
    3,959,505Account receivable
    
    
    23,840Due from related parties
    
    
    67,809Other receivables
    
    
    69,944Inventory
    
    
    95,578Prepaid expenses and deposits
    
    
    118,515Total current assets
    
    
    4,335,191FURNITURE AND EQUIPMENTOffice furniture equipment
    
    
    132,143Fuel and test equipment
    
    
    79,205211,348Less accumulated depreciation
    
    
    (39,896
    )171,452TOTAL ASSETS
    
    $
    4,506,643LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    748,266Accrued expenses
    
    
    1,220,193Deferred grants
    
    
    94,622Other current liabilities
    
    
    60,266Total current liabilities
    
    
    2,123,347STOCKHOLDERS 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; 28,969,772 issued and outstanding.
    
    
    2,897Common stock
subscribed; 256,384 shares
    
    
    384,576Additional paid in capital
    
    
    18,580,426Preferred stock subscriptions receivable
    
    
    (2,821,342
    )Common stock subscriptions receivable
    
    
    (230,001
    )Accumulated other comprehensive income
    
    
    99,615Deficit accumulated during the development stage
    
    
    (13,633,030
    )Total stockholders equity
    
    
    2,383,296TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    4,506,643
 (The accompanying notes are an integral part of the Financial Statements) F-1




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Consolidated Statements of Operations
(unaudited) October 14, 2000(inception)Quarter ended March 31,
    
    through2004
    
    2003
    
    March 31, 2004Revenue
    
    $
    20,062
    
    
    $
    
    
    
    $
    32,266Expenses:Cost of goods sold
    
    
    16,819
    
    
    
    
    
    
    
    28,090Selling and marketing
    
    
    434,509
    
    
    
    40,984
    
    
    
    3,184,051Product testing and government grants, net
    
    
    78,186
    
    
    
    
    
    
    
    707,422General and administrative
    
    
    1,241,552
    
    
    
    397,199
    
    
    
    10,160,713Total operating expense
    
    
    1,771,066
    
    
    
    438,183
    
    
    
    14,080,276Operating loss
    
    
    (1,751,004
    )
    
    
    (438,183
    )
    
    
    (14,048,010
    )Other income (expense):Interest expense
    
    
    (2,730
    )
    
    
    (14,741
    )
    
    
    (93,253
    )Interest income
    
    
    973
    
    
    
    34
    
    
    
    14,155Foreign currency gain (loss), net
    
    
    (5,935
    )
    
    
    73,396
    
    
    
    58,683Other income, net
    
    
    
    
    
    
    
    
    
    
    265,981Total other income (expense)
    
    
    (7,692
    )
    
    
    58,689
    
    
    
    245,566Loss before minority interest and
provision (benefit) for income taxes
    
    
    (1,758,696
    )
    
    
    (379,494
    )
    
    
    (13,802,444
    )Provision (benefit) for income taxes
    
    
    
    
    
    
    
    
    
    
    (145,642
    )Loss before minority interest
    
    
    (1,758,696
    )
    
    
    (379,494
    )
    
    
    (13,656,802
    )Minority interest
    
    
    23,772
    
    
    
    
    
    
    
    23,772Net loss
    
    $
    (1,734,924
    )
    
    $
    (379,494
    )
    
    $
    (13,633,030
    )Net loss per share (basic and diluted)
    
    $
    (0.06
    )
    
    $
    (0.03
    )
    
    $
    (0.84
    )Weighted average shares of common stock
outstanding
    
    
    28,525,072
    
    
    
    67,893,092
    
    
    
    54,292,816Recapitalization resulting from the AAE
Technologies International PLC acquisition
    
    
    
    
    
    
    (53,056,315
    )
    
    
    (38,081,080
    )Weighted average shares of common stock
outstanding - giving effect to the
recapitalization
    
    
    28,525,072
    
    
    
    14,836,777
    
    
    
    16,211,736
 (The accompanying notes are an integral part of the Financial Statements) F-2




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Statement of Changes in Stockholders (Deficit) Equity
October 14, 2000 (Inception) through March 31, 2004 Preferred Stock
        
        Common Stock
        
        CommonStockShares
        
        Amount
        
        Shares
        
        Amount
        
        SubscribedBalance at October 14, 2000 (Inception)
        
        
        
        
        
        $
        
        
        
        
        
        
        
        $
        
        
        
        $
        Common stock issued
            in exchange for interest in wholly owned subsidiaries
        
        
        
        
        
        
        
        
        
        
        43,008,772
        
        
        
        430,088
        
        
        
        Common stock issued
            on various dates during 2001
        
        
        
        
        
        
        
        
        
        
        24,181,038
        
        
        
        241,810
        
        
        
        Comprehensive Loss:Foreign currency
            translation adjustment
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Balance at December 31,
            2001
        
        
        
        
        
        
        
        
        
        
        67,189,810
        
        
        
        671,898
        
        
        
        Common stock issued
            at $0.225 per share on various dates during 2002
        
        
        
        
        
        
        
        
        
        
        703,282
        
        
        
        7,033
        
        
        
        Comprehensive Loss:Foreign currency
            translation adjustment
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Balance at December 31,
            2002
        
        
        
        
        
        
        
        
        
        
        67,893,092
        
        
        
        678,931
        
        
        
        Common stock issued
            on various dates during 2003
        
        
        
        
        
        
        
        
        
        
        555,556
        
        
        
        5,556
        
        
        
        Common stock issued
            for consulting services
        
        
        
        
        
        
        
        
        
        
        200,000
        
        
        
        2,000
        
        
        
        Common stock issued
            for remaining interest in subsidiaries on July 15, 2003
        
        
        
        
        
        
        
        
        
        
        4,356,200
        
        
        
        43,562
        
        
        
        Common stock issued
            upon exercise of stock options on various dates during 2003
        
        
        
        
        
        
        
        
        
        
        8,670,881
        
        
        
        86,709
        
        
        
        Recapitalization
            resulting from the AAE acquisition on July 15, 2003
        
        
        
        
        
        
        
        
        
        
        (56,928,690
        )
        
        
        (814,283
        )
        
        
        Common
            stock issued at $1.50 per share on various dates during 2003
        
        
        
        
        
        
        
        
        
        
        3,333,333
        
        
        
        333
        
        
        
        Expenses related
            to 2003 issuance of common stock and recapitalization
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Subscriptions for
            754,900 shares of common stock at $1.50 per share on various dates
            during 2003
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        1,132,350Comprehensive Loss:Foreign currency
            translation
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Balance at December 31,
            2003
        
        
        
        
        
        
        
        
        
        
        28,080,372
        
        
        
        2,808
        
        
        
        1,132,350Common
            stock issued at $1.50 per share on various dates in 2004
        
        
        
        
        
        
        
        
        
        
        889,400
        
        
        
        89
        
        
        
        (1,102,350
        )Subscriptions
for 750,000 shares of
preferred stock on various dates in 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Subscriptions for
            236,384 shares of common stock at $1.50 per share on various dates
            in 2004
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        354,576Preferred stock issued
            on various dates in 2004
        
        
        1,550,000
        
        
        
        155
        
        
        
        
        
        
        
        
        
        
        
        Comprehensive Loss:Foreign currency
            translation
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Net loss
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Balance at
            March 31, 2004
        
        
        1,550,000
        
        
        $
        155
        
        
        
        28,969,772
        
        
        $
        2,897
        
        
        $
        384,576
   [Continued from above table, first column(s) repeated] DeficitPreferred
    
    Common
    
    Accumulated
    
    Accumulated
    
    TotalAdditional
    
    Stock
    
    Stock
    
    Other
    
    During the
    
    StockholdersPaid - In
    
    Subscriptions
    
    Subscriptions
    
    Comprehensive
    
    Development
    
    EquityCapital
    
    Receivable
    
    Receivable
    
        Income (Loss)
    
    Stage
    
    (Deficit)Balance at October 14, 2000 (Inception)Common stock issued in exchange for
interest in wholly owned subsidiaries
    
    $
    3,603,415
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (4,138,684
    )
    
    $
    (105,181
    )Common stock
issued on various dates in
2001
    
    
    1,268,031
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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
    
    
    4,871,446
    
    
    
    
    
    
    
    
    
    
    
    (4,476
    )
    
    
    (5,545,393
    )
    
    
    (6,525
    )Common stock issued at $0.225 per share
 on various dates throughout
2002
    
    
    515,657
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    522,690Comprehensive Loss:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (74,085
    )
    
    
    
    
    
    
    (74,085
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,712,803
    )
    
    
    (1,712,803
    )Balance at December 31, 2002
    
    
    5,387,103
    
    
    
    
    
    
    
    
    
    
    
    (78,561
    )
    
    
    (7,258,196
    )
    
    
    (1,270,723
    )Common stock issued on
            various dates in 2003
    
    
    119,444
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125,000Common stock issued for consulting
services
    
    
    43,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,000Common stock issued for remaining
interest in subsidiaries on July 15, 2003
    
    
    46,323
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (409,614
    )
    
    
    (319,729
    )Common stock issued upon exercise of
stock options on various dates in 2003
    
    
    1,131,595
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,218,304Recapitalization resulting from AAE
acquisition on July 15, 2003
    
    
    814,283
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued at $1.50 per
share on various dates during 2003
    
    
    4,999,667
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000,000Expenses related to 2003 issuance
            of common stock.
    
    
    (795,650
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179,689
    
    
    
    
    
    
    
    179,689Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,230,296
    )
    
    
    (4,230,296
    )Balance at December 31, 2003
    
    
    11,745,765
    
    
    
    
    
    
    
    (180,000
    )
    
    
    101,128
    
    
    
    (11,898,106
    )
    
    
    903,945Common stock issued at $1.50 per
share on various dates in 2004
    
    
    1,338,196
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    235,935Subscriptions for 750,000
            shares of preferred stock on various dates in 2004
    
    
    
    
    
    
    (2,821,342
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,821,342
    )Subscriptions for 236,384
            shares of common stock at $1.50 per share on various dates in 2004
    
    
    
    
    
    
    
    
    
    
    (50,001
    )
    
    
    
    
    
    
    
    
    
    
        304,575Preferred stock issued on various dates in 2004
    
    
    5,496,465
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,496,620Comprehensive Loss:Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,513
    )
    
    
    
    
    
    
    (1,513
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,734,924
    )
    
    
    (1,734,924
    )$
    18,580,426
    
    
        $
    (2,821,342
    )
    
        $
    (230,001
    )
    
        $
    99,615
    
    
        $
    (13,633,030
    )
    
        $
    2,383,296
 (The accompanying notes are an integral part of the Financial Statements) F-3




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Consolidated Statements of Cash Flows
(unaudited) October 14, 2000Quarter Ended March 31,
    
    (inception) through2004
    
    2003
    
    March 31, 2004Cash
flows from operating activitiesNet loss
    
    $
    (1,734,924
    )
    
    $
    (379,494
    )
    
    $
    (13,633,030
    )Adjustments
to reconcile loss to net cash used in operating activities:Depreciation
    
    
    10,600
    
    
    
    13,684
    
    
    
    95,623Amortization
    
    
    
    
    
    
    
    
    
    
    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
    
    
    (11,636
    )
    
    
    
    
    
    
    (23,840
    )Due to/from related parties
    
    
    (32,142
    )
    
    
    
    
    
    
    (67,809
    )Other receivables
    
    
    206,715
    
    
    
    (178,219
    )
    
    
    (69,944
    )Inventory, prepaid expenses and other current assets
    
    
    (74,725
    )
    
    
    39,679
    
    
    
    (214,093
    )Accounts payable
    
    
    218,343
    
    
    
    115,751
    
    
    
    748,266Accrued expenses
    
    
    336,115
    
    
    
    31,366
    
    
    
    1,220,193Deferred grants
    
    
    28,750
    
    
    
    45,919
    
    
    
    94,622Other current liabilities
    
    
    5,927
    
    
    
    
    
    
    
    60,266Cash flows used in operating activities
    
    
    (1,046,977
    )
    
    
    (311,314
    )
    
    
    (11,398,093
    )Cash flows from investing activitiesRestricted cash
    
    
    750,000
    
    
    
    
    
    
    
    Purchase of furniture and equipment
    
    
    (42,669
    )
    
    
    (16,399
    )
    
    
    (268,613
    )Purchase of patent
    
    
    
    
    
    
    
    
    
    
    (345,115
    )Cash flows provided by (used in) investing activities
    
    
    707,331
    
    
    
    (16,399
    )
    
    
    (613,728
    )Cash flows from financing activitiesNet proceeds from issuance of preferred stock
    
    
    2,675,277
    
    
    
    
    
    
    
    2,675,277Net proceeds from issuance of common stock
    
    
    540,511
    
    
    
    
    
    
    
    10,863,934Borrowings of debt, net
    
    
    
    
    
    
    1,000,000
    
    
    
    2,332,500Cash flows provided by financing activities
    
    
    3,215,788
    
    
    

    1,000,000
    
    
    
    15,871,711Effect of exchange rates on cash
    
    
    (1,513
    )
    
    
    182,062
    
    
    
    99,615Net increase in cash
    
    
    2,874,629
    
    
    
    854,349
    
    
    
    3,959,505Cash at beginning of period
    
    
    1,084,876
    
    
    
    119,139
    
    
    
    Cash at end of period
    
    $
    3,959,505
    
    
    $
    973,488
    
    
    $
    3,959,505Supplemental Disclosures:Cash paid for interest:
    
    $
    2,730
    
    
    $
    14,741
    
    
    $
    93,253Cash paid for income taxes:
    
    $
    
    
    
    $
    
    
    
    $
    Preferred
Stock Subscribed:
    
    $
    2,821,342
    
    
    $
    
    
    
    $
    2,821,342Common Stock Subscribed:
    
    $
    230,001
    
    
    $
    
    
    
    $
    230,001
 (The accompanying notes are an integral part of the Financial Statements) F-4




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 1. Nature of Operations O2 Diesel 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. 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 O2 Diesel 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. 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 March 31, 2004. F-5




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 yearsFuel 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 are 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




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 are $4,175 and nil for the three months ended March
31, 2004 and 2003, respectively, and are $6,116 for the period October 14, 2000
(inception) through March 31, 2004. Advertising Expenses Advertising costs are expensed as incurred. Advertising expense was nil for the
three months ended March 31, 2004 and 2003, respectively, and was $500,000 for
the period October 14, 2000 (inception) to March 31, 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 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 was 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




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 the 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 equity as other comprehensive income (loss) and are
not included in determining consolidated net income (loss). As of March 31,
2004, other comprehensive income included $99,615 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 interim financial statements present the consolidated balance sheet,
statements of operations, statement of changes in stockholders (deficit)
equity and statements of cash flows of the Company, and have been prepared in
accordance with accounting principles generally accepted in the United States.
The interim financial information is unaudited. In the opinion of management,
all adjustments necessary to present fairly the financial position of the
Company as of March 31, 2004 and the
results of operations and cash flows presented herein from October
14, 2000, (inception)
through March 31, 2004, have been included in the financial
statements. Interim results are not necessarily indicative of results of
operations for the full year. F-8




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 March 31, 2004, the Company
incurred costs of $693,711 towards completion of the contract, leaving a
balance of $414,023 in costs to complete the contract. From the inception of
the contract in December 2002 through March 31, 2004, the Company has billed
NREL $554,969, of which $56,696 is included in other receivables as of March
31, 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 March 31,
2004, the Company had incurred costs of $50,506 leaving a balance of $749,494
in costs to complete the program. Through March 31, 2004, the Company had
achieved two milestones and had billed $120,000 related to this Appropriation.
All amounts billed had been received as of March 31, 2004. 4. Other Receivables Other receivables consisted of the following at March 31, 2004: NREL Appropriation
    
    $
    56,696Reimbursement due from Cognis
    
    
    13,248$
    69,944
 5. Accrued Expenses Accrued expenses consisted of the following at March 31, 2004: Legal and professional fees
    
    $
    536,920Financing fees
    
    
    360,132Other
    
    
    323,141$
    1,220,193
 F-9




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 March 31, 2004 are as follows: Net operating loss carryforwards
    
    $
    2,040,000Accrued professional fees
    
    
    210,000Advertising costs
    
    
    127,000Accrued expenses and deferred revenue
    
    
    79,000Total deferred tax assets
    
    $
    2,456,000Valuation allowance
    
    
    (2,456,000
    )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, 2004, the Company had
Federal and state net operating loss carryforwards of approximately $4.9
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 March 31, 2004, the
Company had an Irish net operating loss carryforward of approximately $115,000,
that may be carried forward indefinitely, and a Brazilian net operating loss
carryforward of approximately $ 40,000 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




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 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 latter 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 at December 31,
2003 had 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. In addition, the Company collected gross
proceeds of $150,000 for subscriptions that it received in calendar year 2003.
A subscription receivable of $230,001 is 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. The
shares are reflected as common stock subscribed in the accompanying financial
statements as of March 31, 2004 because the shares had not been issued as of
the balance sheet date. Issuances of Preferred Stock: In March 2004, the Company approved the designation of two new series of
preferred stock. The new preferred stock, which consists 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 $2.9 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 April 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
expects to receive approximately $530,000, 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 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 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 three months ended March 31, 2004 and 2003, and for the
period from October 14, 2000 (inception) through March 31, 2004 the Company
paid $6,698, $6,830, and $108,664, respectively to the company controlled by
the Chairman. Included in receivables due from related parties at March 31, 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




---



##### 



O2Diesel Corporation
(A Development Stage Company)
Notes to Consolidated Financial Statements 9. Commitments Operating leases The Company leases certain office equipment under agreements that are accounted
for as operating leases. As at March 31, 2004, future minimum lease payments
under non-cancelable operating leases expiring in 2008, were as follows: 2004
    
    $
    58,5192005
    
    
    79,2852006
    
    
    81,5302007
    
    
    83,7752008
    
    
    78,680Total
    
    $
    381,789
 Rent expense under the leases was $18,441 for the quarter ended March 31, 2004
and was $22,703 for the period October 14, 2000 (inception) through March 31,
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 4.4 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. F-12




---



##### 



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 quarter ended March 31,
2004. In 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 remainder of 2004, we intend to focus our
efforts on generating sales to our targeted customers in the U.S., Canada and
Brazil The Company believes that sales and distribution opportunities may
exist for our products in the Middle East and we intend to aggressively
investigate this emerging market. In line with its sales initiatives, the
Company intends to expand its marketing efforts to target large municipalities
and trucking firms to encourage these entities to use clean fuel as part their
environmental strategies and mission statements. Perhaps most importantly, we
plan to continue our efforts to establish and improve the logistics networks
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. 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. 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 size 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 in large-scale mining operations; andØ
    
    Marketing opportunities centered on public policy and positive environmental image. In the U.S., O2Diesels initial sales and marketing efforts will be focused on
the states of Texas and California, 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. Our sales force will identify
potential customers that fit the profile for use of O2Diesel products. 1




---



##### 



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 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 are in the process of signing
distribution agreements with major jobbers, who in turn have centrally fueled
fleets as their customers. To date, we have signed distribution agreements with
nine jobbers located in the states of California, Nevada and Texas. O2Diesel
plans 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. O2Diesels 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 customer 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 customer
vehicles, as well as reviewing the customers fueling facilities for
compatibility with O2Diesel. In some cases, O2Diesel will be responsible for
sourcing and installing the flame arrestors, arranging tank cleaning and
filtering systems as necessary, and in other cases the Company will have an
oversight role for these tasks. As part of the second leg of our strategy, O2Diesels sales force plans to
market and sell O2Diesel directly to companies,
government 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,
O2Diesel will likely be responsible for all logistics required to deliver
O2Diesel to the customer. To achieve this goal, O2Diesel intends 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, the Company
needs to put in place the logistical support to insure that fuel is delivered
on a timely basis. In this regard, O2Diesel is seeking to create a network of
transportation providers, ethanol suppliers and in limited cases, wholesalers
of diesel fuel. With large fleet customers, O2Diesels 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 or assisting the customer to do so. As a part of our marketing strategy of targeting large municipal and company
fleets, the Company has developed a marketing concept based on the user of
O2Diesel incorporating into its environmental statements the benefits that the
fuel brings to the company and to the community. We believe that a two tiered
initiative that encourages companies and municipalities to integrate the use of
O2Diesel into their environmental mission statements publicizing the use of
O2Diesel fuel as part of their commitment to improve air quality standards
will be a significant statement for the use of O2Diesel. Brazil: In Brazil, O2Diesel plans to target customers similar to those in the U.S. For
Brazil, we are in the process of establishing our own sales force and technical
team to mirror what has been done in the U.S. The Company has joined with a
Brazilian commodity firm that trades sugar and alcohol to assist the Company to
introduce its products into the Brazilian market. This Brazilian company 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. The Company also intends to market its fuel to municipalities and
large fleets in Brazil using the same environmental initiatives that we are
designing for use in the U.S. and Canadian markets. 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 products in Brazil. Failure to attract
one or more distribution partners would likely set back the Companys timetable
for achieving market penetration in Brazil. 2




---



##### 



Cash Requirements and Liquidity: Based on current projected levels of operations and expected sales, the Company
may need to raise additional funds over the next twelve months. In the first
quarter of 2004, the Company completed two financings in which the Company
issued newly-created preferred stock in exchange for approximately $5.5 million
in net proceeds to be received in April and May of 2004. In addition it
received net proceeds of approximately $536,000 in a private placement of its
shares of common stock. Subsequent to March 31, 2004, the Company received
additional net proceeds of $50,000 from the private placement. As of March 31,
2004, the Company closed the private placement and it has a subscription
receivable of approximately $180,000 outstanding as of the date of this Report. To date, the Company has 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, the Company
expects 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 two significant risks that may affect the Companys ability to
generate sales, and this in turn may impact our ability to adequately meet our
cash needs. 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 its products in the U.S. The
Company has not obtained sufficient experience with sourcing, purchasing and
fitting flame arrestors to vehicles and storage tanks in the U.S. to be able to
accurately project the cost and time of completing this task. Moreover, there
is insufficient history for the Company to be able to predict with certainty
the manpower required to accomplish this work. The second concern relates to the logistics and maintenance issues for fleets
that are direct customers of the Company and customers of jobbers in the U.S.,
Canada and Brazil. To date, the Company has not completed the required
logistics arrangements to 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 to determine in each case that the storage facilities of users
meet the standards necessary to store and dispense O2Diesel Given our projected level of expenses, the cash on hand, the continuation of
favorable trade terms from our major supplier and the $6.1 million raised in
2004, the Company believes it will have sufficient cash to fund our operations
for the remainder
of 2004. However, additional funding will be needed if the Company is unable to
successfully manage the flame arrestor issue and/or establish adequate
financial and logistics arrangements to insure the timely delivery and storage
of O2Diesel. If one or both of these issues are not resolved in a satisfactory
and timely manner, there can be no assurance that the Company will have
sufficient operating capital to carry out our business plan. Moreover, there
can be no assurance that the
Company will be successful in our efforts to raise additional funds, if we need
to do so. Nor can there be any assurance that the Company will generate sales
and collect cash to offset our operating expenses. For the three
months ended March 31, 2004, the
Company has generated only $19,582 in 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. 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. 3




---



##### 



O2Diesel is responsible for the costs of testing our products. To date, these
tests have generally been specific to the jurisdictions in which the Company
intends to do business. For the remainder of 2004, the Company expects to
pursue an ambitious program of testing O2Diesel products both in the laboratory
and in field trials. In 2004 the Company intends to carryout the necessary
testing to obtain both ARB and EPA verifications for the broadest possible
array of engine families and uses. Part of the projected tests includes using
O2Diesel in large mining operations within the United States. The completion
of these tests should further validate the benefits of using O2Diesel, and
should assist in the marketing of the product. The costs to complete these
tests could reach as much as $2.0 million. Based on government funding that we
have received and additional government funding that we believe may be
appropriated for these specific purposes, the Company estimates 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 in the process of
assisting in the design and testing of new flame arrestor technologies for a
wide range of vehicle applications and storage tank uses. Lastly the Company is
in the planning stages to initiate tests of its O2Diesel fuel in large
mining equipment at two mines in the U.S. These latter tests will be conducted
within the framework of existing grants received from the U.S. government. [For a more detailed explanation, see Note 3 to the Financial Statements on
page F-9.] In Brazil, we expect to spend about $120,000 in 2004 on testing protocols to
insure that our additive and fuel complies with the Brazilian governments fuel
and environmental laws and regulations. Employees: At present, O2Diesel has 19 full-time employees of which 13 are in the U.S. and
6 are in Brazil. For the remainder of the year, the Company plans to add 10
full-time employees in the U.S. and 2 in Brazil which would bring our total
employee count to 31 by the year-end. In the U.S., the Company plans to hire 1
person in a management position, 2 persons for logistics, 1 in marketing, 3 as
technical representatives, and 3 in accounting. Of the 2 new staff planned for
Brazil, the Company anticipates that 1 will work in logistics, 1 in technical
sales, and 1 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 02Diesel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. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. None. 4




---



##### 



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. The Company received cash payments of $386,325 for
these shares in the first quarter, and $50,001 following March 31, 2004. As disclosed in our current report on Form 8-K filed with the SEC 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 O2Diesel Series A 0% Convertible Preferred Stock, par
value $.0001 (Series A Preferred Stock). Pursuant to a Convertible Preferred
Stock Purchase Agreement between the Company and the purchaser named therein
(the Series A Purchaser) dated as of March 3, 2004, the Company issued to the
Series A Purchaser, 800,000 shares of Series A Preferred Stock. The offering
resulted in gross proceeds to the Company of approximately $3.2 million. After deduction of fees and
commissions, the Company received net proceeds of approximately $2.9 million.
The sale of the Series A Preferred Stock was exempt from registration pursuant
to
Regulation S promulgated under the Securities Act of 1933. The Series A Preferred Stock is convertible into the Companys common stock at
a variable conversion ratio which is the lesser of (a) $4.00 as adjusted as
provided in the Series A Certificate of Designation (the Series A 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 45.5% of the Series A Fixed Conversion Price. In no
event will the Series A Purchaser receive more than approximately 4,395,604 nor
less than 2,000,000 shares of the Companys common stock upon conversion of the
Series A Preferred Stock. The Series A Preferred Stock is subject to a two-year
restriction on transfer. The Series A Preferred Stock Certificate of
Designation and the Convertible Preferred Stock Purchase Agreement with the
Series A Purchaser were filed as exhibits to Form 8-K and are incorporated herein
by reference. 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 $2.4 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 expects to receive approximately $530,000 in net proceeds,
after payment of fees and commissions. 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. 5




---



##### 



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. (a) Exhibits Exhibits included or incorporated by reference in this document are set forth
in the Exhibit Index below. EXHIBIT INDEX 3.1(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)10.15(7)
    
    Memorandum of Understanding between BASF Aktiengesellschaft and
O2Diesel Corporation dated August 18, 2003 (previously filed as
Exhibit 10.14)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)
 6




---



##### 



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. (b) Reports on Form 8-K. O2Diesel filed the following current reports
on Form 8-K during the quarter ended March 31, 2004: Current report on Form 8-K filed on July February 04, 2004 related to
changes in the Registrants Certifying Accountant Current report on Form 8-K filed on March 12, 2004 related to the
issuance of 800,000 shares of its Series A 0% Convertible Preferred
Stock, par value $.0001. 7




---



##### 



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 17, 2004
    
    By: /s/ Alan RaeAlan Rae
Chief Executive Officer
(Principal Executive Officer)Date: May 17, 2004
    
    By: /s/ David KoontzDavid Koontz
Chief Financial Officer
(Principal Financial Officer)
 8