Notes
to Financial Statements
(Unaudited)
1.
The Company and Basis of Presentation
The
Company
O2Diesel
Corporation (“O2Diesel” or the “Company”) is in the development stage and has
developed a proprietary additive product designed to enable distillate liquid
transportation fuels to burn cleaner by facilitating the addition of ethanol
as
an oxygenate to these fuels. To date, the Company's operations have continued
to
be focused on raising capital, performing research and development, and bringing
its product to market.
O2Diesel
Corporation's predecessor, Dynamic Ventures, Inc., was incorporated in the
State
of Washington on April 24, 2000. Dynamic Ventures, Inc. changed its name to
O2Diesel Corporation effective June 10, 2003, in contemplation of the
reverse acquisition of AAE Technologies International Plc (“AAE”). On
July 15, 2003, O2Diesel Corporation acquired all of the issued and
outstanding shares of AAE in exchange for 17,847,039 shares of its common stock.
As a result of this transaction, the former shareholders of AAE acquired control
of the combined companies. The acquisition of AAE has been accounted for as
a
capital transaction followed by a recapitalization. AAE was considered to be
the
accounting acquirer. Accordingly, the historical financial statements of AAE
are
considered to be those of O2Diesel Corporation for all periods
presented.
In
conjunction with the reverse acquisition, the Company completed a private
placement of its common stock whereby it issued 3,333,333 shares of common
stock
at $1.50 per share. Of the $5.0 million raised, approximately $800,000 was
used
to pay the costs of the reverse acquisition and private placement,
$1.0 million was used to repay a bridge loan that was made in contemplation
of the transaction, and the balance of $3.2 million was used to fund the
ongoing developmental activities of the Company. Subsequent to its first private
placement, the Company undertook to raise an additional $3.5 million
through a follow-on private placement of our common stock (the “Follow-On
Private Placement”). In the Follow-On Private Placement, we raised $1,535,770,
before expenses, and issued 1,025,784 shares of our common stock at a price
of
$1.50 per share.
O2Diesel
was reincorporated in the state of Delaware in a transaction that became
effective on December 31, 2004.
On
June 15, 2004, the American Stock Exchange (“AMEX” or “Exchange”) approved
an application to list 46,518,898 shares of our common stock under the symbol
OTD. Subsequent to this date, the Exchange has approved additional applications
to list 72,830,013 shares of the Company's common stock so that the total number
of shares approved for listing is now 119,348,911. Our shares began to trade
on
the Exchange on July 1, 2004.
Basis
of Presentation
The
Company's unaudited consolidated financial statements for the three and nine
months ended September 30, 2007, have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business.
We
have
reclassified certain prior-year amounts to conform to the current year’s
presentation.
At
September 30, 2007, the Company had working capital of $1,959,349 and had
accumulated losses of $40,500,079. However, $2,898,550 of the working capital
is
restricted in use to operational costs associated with developing markets in
Europe. The lack of adequate working capital and continuing losses, as well
as
the uncertain conditions regarding the Company’s AMEX listing status as stated
below, create an uncertainty about the Company’s ability to continue as a going
concern. However, as discussed below, management has developed a plan to bring
the Company into compliance with AMEX standards and to commence profitable
operations. The financial statements do not include any adjustments that might
be necessary if the Company is unable to continue as a going concern.
The
Company was notified by the AMEX in December 2004 that it was not in
compliance with AMEX Company Guide Section 1003(a)(iii) which requires listed
companies to have at least $6.0 million of stockholders' equity when it has
sustained
losses from continuing operations and/or net losses in its five most recent
fiscal years
.
AMEX
indicated that, in order to return to full compliance, O2Diesel needed to
have
stockholders' equity of $6.0 million by June 2006 and to maintain this
level going forward.
In
accordance with the procedures of the Exchange, we filed a plan (“Plan”) with it
to demonstrate the steps we would take to return to full compliance. On
February 15, 2005, the AMEX notified us that it had accepted our Plan, and
that we would be given until June 2006 in which to regain compliance with
the Exchange's listing rules. To achieve that level of stockholders' equity,
we
anticipated having to raise a total of approximately $10.0 million in new
equity during 2005. In December 2005 the Company determined that it could
not meet certain conditions of the Plan and met with representatives of the
AMEX
to discuss the need to develop an amended plan to demonstrate how the Company
would be in compliance by June 2006.
The
Company believed it needed to raise an additional $7.0 million in new
capital prior to June 2006 to allow it to return to full compliance with
the listing standards of the AMEX. In addition, the Company believed it needed
to raise an additional $3.5 million in equity in the second half of 2006 to
allow it to execute its business plan for the year and to remain in compliance
with the AMEX standards.
The
Company collected $592,692 (after expenses) and $865,452 (net of expenses)
in
two warrant exercises and closed three private placements totaling $7.5 million
as part of this effort in 2006.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
On
July
17, 2006, the Company received a letter from the AMEX indicating that the
Company had regained compliance with AMEX listing requirements. At December
31,
2006, the Company was in compliance with AMEX listing requirements but, for
the
period ended March 31, 2007, the Company was not able to meet the listing
requirements. On June 29, 2007, the Company was notified by AMEX that it was
not
in compliance with the listing standards of the Exchange because it lacked
the
requisite amount of stockholders' equity. The Company was asked to submit a
plan
by July 27, 2007 advising AMEX of actions the Company would be taking to bring
it into compliance with the continued listing standards by December 29,
2008.
On
July
27, 2007, the Company filed a plan with the Exchange describing the steps it
plans to take to return to full compliance. The Company has entered into a
common stock purchase agreement with Fusion Capital
Fund
II,
LLC
to raise
up to $10 million in new equity over a twenty-five month period starting on
February 16, 2007. Also, the Company announced a private placement in which
we
raised an additional $2.52 million in July and August 2007. As noted below,
the
Company intends to raise additional new equity in conjunction with the
acquisition of the ProEco Energy Company, Inc. (“ProEco”). We believe these
actions will enable us to meet or exceed the equity requirements of the
Exchange.
On
September 13, 2007, the Company received a written notice from the AMEX
indicating that AMEX had reviewed and accepted the Company’s plan to regain
listing qualifications compliance. With the acceptance of the plan, the Company
will be able to continue its listing during the plan period pursuant to an
extension granted until December 29, 2008. The AMEX notice also advised the
Company that, in addition to the previously disclosed deficiency with respect
to
Section 1003(a)(iii) of the AMEX Company Guide, it had triggered an additional
deficiency with respect to Section 1003(a)(ii) of the AMEX Company Guide
which
requires listed companies to have at least $4.0 million of stockholders'
equity
when it has
sustained
losses from continuing operations and/or net losses in its four most recent
fiscal years
.
During
the interim period until December 29, 2008, the Company must continue to provide
AMEX staff with updates regarding initiatives set forth in its plan of
compliance. The Company will be subject to periodic review by AMEX staff during
the interim period. If the Company is not in compliance with the continued
listing standards on December 29, 2008, or the Company does not make progress
consistent with the plan during the interim period,
the
AMEX
would likely initiate procedures to de-list the Company's common stock. If
the
Company's common stock were to be de-listed by the AMEX, its shares would
continue to be traded as a bulletin board stock.
The
consolidated financial statements in this report do not include any adjustments
to reflect the anticipated private placements or the possible future effects
on
the recoverability and classification of assets or the amounts and
classification of liabilities that may result should management be unsuccessful
in obtaining financing on terms acceptable to the Company.
Since
July 2003, the Company has raised approximately $36 million for its operations.
2.
Summary of Significant Accounting Policies
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and all
affiliated subsidiaries. All significant inter-company balances and transactions
have been eliminated in consolidation. Based on Financial Accounting Standards
Board (“FASB”) Interpretation No. 46R,
Consolidation
of Variable Interest Entities
”
(“FIN
46R”), the Company is the holder of the majority of the risks and rewards
relating to ProEco Energy Company, Inc. (“ProEco”). As such, the Company is
considered to be the “primary beneficiary” of ProEco, deemed to be a variable
interest entity (“VIE”), and has included ProEco’s assets, liabilities and
operating results in its consolidated financial statements.
Variable
Interest Entity (VIE)
In
general, a VIE is a corporation, partnership, limited-liability corporation,
trust or any other legal structure used to conduct activities or hold assets
that either (i) has an insufficient amount of equity to carry out its principal
activities without additional subordinated financial support; (ii) has a group
of equity owners that are unable to make significant decisions about its
activities; or (iii) has a group of equity owners that do not have the
obligation to absorb losses or the right to receive returns generated by its
operations. Based on these guidelines, the Company has determined that ProEco
is
a VIE beginning with the third quarter of 2007. Prior to that period, activity
with ProEco was not material.
Cash
and Cash Equivalents
The
Company considers all highly liquid instruments with a maturity of three months
or less at the time of issuance to be cash equivalents. As of September 30,
2007, cash deposits exceeded federally insured limits which are generally
$100,000 per financial institution.
Restricted
Cash
On
December 16, 2005, the Company completed a private placement of its common
stock, whereby it received approximately $3.6 million USD which is
restricted to operational costs associated with developing markets in Europe.
Prior to 2005, restricted cash consisted of cash held in the Company's bank
account pursuant to the provisions set forth in documents to the acquisition
of
AAE on July 15, 2003. The restricted funds associated with the acquisition
of AAE were released in equal amounts on October 15, 2003, and
January 15, 2004.
Fair
Value of Financial Instruments
The
carrying amounts of cash and cash equivalents, accounts receivable, due to/from
related parties, other receivables, accounts payable, accrued expenses and
deferred grants approximate fair value because of their short-term
nature.
Concentration
of Credit Risk and Allowance for Doubtful Accounts
The
Company provides an allowance for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. The Company
does not require collateral and it does not charge finance fees on outstanding
trade receivables. The allowance is determined by analyzing historical data
and
trends, as well as specific customers' financial conditions. Past-due or
delinquency status is based upon the credit terms for that specific customer
from the date of delivery. Charges for doubtful accounts are recorded in selling
and marketing expenses. Trade accounts receivables are written off against
the
allowance for doubtful accounts when collection appears unlikely.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
Inventories
Inventories,
consisting of fuel additive held at third party locations, are stated at the
lower of cost as determined using the first in, first out (FIFO) method, or
market value.
Furniture,
Equipment, Construction in Progress
and
Depreciation
Furniture
and equipment are stated at cost, less accumulated depreciation. Depreciation
is
provided over the estimated useful lives of the assets using the straight-line
method.
Construction
in progress primarily includes payments to third parties for land options,
submission of permits for construction, negotiation of EPC, supply and
transportation contracts, and the development of marketing agreements for sale
of the ethanol to be produced at the Ethanol Plant. It also includes
payroll-related costs attributable to personnel working directly on the project.
The
estimated useful lives of fixed assets are as follows:
Office
furniture and equipment: 3 to 5 years
Fuel
and
test equipment: 5 years
Depreciation
expense recorded in the accompanying Consolidated Statements of Operations
was
$21,124 and $62,820 for the three and nine months ended September 30, 2006,
respectively, and was $20,713, $64,728 and $348,492 for the three and nine
months ended September 30, 2007 and for the period October 14, 2000
(inception) through September 30, 2007, respectively.
Accounting
for Impairment of Intangible and Long-Lived Assets
The
carrying values of intangible and long-lived assets are reviewed on a
regular basis for the existence of facts or circumstances that may suggest
impairment. The Company recognizes impairment when the sum of the expected
undiscounted future cash flows is less than the carrying amount of the asset.
Impairment losses, if any, are measured as the excess of the carrying amount
of
the asset over its estimated fair value.
Revenue
Recognition
The
Company sells its product directly to its customers and revenue is recognized
and recorded upon the passage of title of the product to the customer and
following confirmation that the customer is utilizing the final blended
fuel.
The
Company has developed the CityHome™ program to serve as an
important element of its sales/marketing and product demonstration
strategy. This program involves the sale of our additive, the receipt of
sponsorship fees and the potential sale of advertising space. As with other
customers, revenue from the sales of product is recognized and recorded upon
the
passage of title of the product to the customer and following confirmation
that
the customer is utilizing the final blended fuel. Sponsorship fees will become
additional revenue for us and will be recognized as such over the period of
the
contract when a sponsorship agreement is signed and the fees have been invoiced.
Costs that are intended to be supported by the sponsorship fees are recorded
separately in the related expense line in our statement of operations. With
regard to the advertising space, since the CityHome™ program is still in its
beginning phase and since we have been unable to assess the fair market value
of
the advertising space received, we assign no value to the space at the time
of
receipt. We are recognizing the value associated with the advertising space
when
we enter into a contract arrangement with a third party. The Company will
consider assigning a fair value to the advertising space received at the time
of
the initial sale when such fair value is more readily determinable, based upon
a
history of cash transactions.
The
Company has supported certain fleet equipment conversion costs in these
CityHome™ initiatives and has also been required to bear the incremental costs
of the blended fuel, where it is experienced. Whenever the expected costs of
the
program are determined to be in excess of the contracted sponsorship fees and
related fuel additive revenue, the Company records the loss for the contract
as
an expense and a deferred liability to be amortized over the life of the
contract. As of September 30, 2007, costs remaining to be amortized for
CityHome™ programs were recorded on the balance sheet as Deferred Marketing
Program in the amount of $67,833. The Company recorded $23,779 and $112,532
in
costs for the CityHome™ initiatives in excess of sponsorship fees during the
three and nine months ended September 30, 2006 and ($22,497), $63,896 and
$1,185,632 of costs in excess of sponsorship fees (fees in excess of costs)
for
CityHome™ initiatives for the three and nine months ended September 30, 2007 and
for the period October 14, 2000 (inception) through September 30,
2007, respectively.
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.
Advertising
Expenses
Advertising
costs are expensed as incurred. Advertising expense was $0 for the three and
nine months ended September 30, 2007 and 2006, and was $450,000 for the period
October 14, 2000 (inception) to September 30, 2007.
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
stockholders by the weighted average number of common shares outstanding during
the period. Diluted net loss per share gives effect to all dilutive potential
common shares outstanding during the period using the if-converted method.
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.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
Accounting
for Stock-Based Compensation
Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of Statement of Financial Accounting Standard ("SFAS") No. 123(R)
Share-Based
Payment
,
using
the modified prospective transition method. SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the financial statements based on their fair values
beginning with the first annual reporting period that begins after
December 15, 2005, with early adoption encouraged.
The
Company implemented a Stock Incentive Plan (the “Incentive Plan”) in 2004 for
which the Board of Directors has authorized 9,750,000 shares of common stock
to
be reserved for future issuance under the Plan. Stock options generally vest
over three years and will expire 10 years from the effective date. However,
the Company has the latitude under the Incentive Plan to issue options at
various stages of vesting.
Once
these options are granted by the Board under the provisions of the plan, the
Company records a compensation charge for the difference between the fair value
of the common stock and the exercise price of the options on the date of
issuance if the fair value of the common stock exceeds the exercise price of
the
option on that date. The fair value of each option granted is estimated on
the
date of grant using the Black-Scholes option-pricing model. There were no
options granted by the Board in the nine months ended September 30, 2007. The
assumptions used with this model for 2006 were an expected life of three years,
a zero dividend yield, volatility ranging from 72% to 209% (depending on date
of
grant), and risk free interest rates ranging from 4.64% to 5.09% (depending
on
date of grant). The assumptions used with this model for 2005 were an expected
life of 3 years, a zero dividend yield, volatility ranging from 59% to 120%
(depending on date of grant), and risk free interest rates ranging from 3.39%
to
3.96% (depending on date of grant). The estimated fair value of an option is
amortized over the option's vesting period. During the nine months ended
September 30, 2007, no additional options were granted and 1,475,000 options
expired unexercised.
Income
Taxes
Income
taxes are accounted for using the liability method in accordance with SFAS
No. 109,
Accounting
for Income Taxes
.
Under
SFAS 109, deferred tax assets or liabilities are computed based upon the
difference between the financial statement and income tax bases of assets and
liabilities using the enacted marginal tax rate applicable when the related
asset or liability is expected to be realized or settled. Deferred income tax
expense or benefits are based on the changes in the asset or liability from
period to period. If available evidence suggests that it is more likely than
not
that some portion or all of a deferred tax asset will not be realized, a
valuation allowance is recorded to reduce the deferred tax assets to the amount
that is more likely than not to be realized. Future changes in such valuation
allowance would be included in the provision for deferred income taxes in the
period of change.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those
estimates.
Foreign
Subsidiaries
The
Company has foreign subsidiaries whose local currency has been determined to
be
the functional currency. For these foreign subsidiaries, the assets and
liabilities have been translated using the period-end exchange rates, and the
income and expenses have been translated using the weighted average of
historical exchange rates during the reporting period. The adjustments resulting
from translation have been recorded separately in shareholders' equity as “other
comprehensive income (loss)” and are not included in determining the
consolidated net loss. As of September 30, 2007, accumulated other comprehensive
income included $8,419 of cumulative income from foreign currency
translation.
The
Company began operations in Brazil in March of 2004 by establishing a 75% owned
subsidiary. The Brazilian subsidiary recognized revenue of $0 for the three
and
nine months ended September 30, 2006, and $0, $0 and $7,682 for the three and
nine months ended September 30, 2007, and the period October 14, 2000
(inception) through September 30, 2007, respectively. Brazil also had total
assets less current liabilities (exclusive of intercompany amounts eliminated
in
consolidation) of $77,546 at September 30, 2007. Transactions in Brazil are
denominated in, and the functional currency is, the Brazilian Real. Accordingly,
no Brazilian operations currency exchange rate gains or losses are recorded
in
the accompanying consolidated statement of operations. At September 30, 2007,
the Brazilian operation had aggregate losses of $1,932,556. The minority
stockholder's portion of aggregate losses is not recorded in the consolidated
balance sheet since reimbursement of this amount from the minority stockholders
is not assured.
On
December 31, 2004, the Company ceased operations at two of its wholly-owned
subsidiaries in the United Kingdom. In connection with the cessation, the
Company recorded an exchange gain in the 2004 consolidated statement of
operations of $94,396 to recognize cumulative translation gains previously
recorded in other comprehensive income (loss). The subsidiaries were primarily
holding companies and had no assets or liabilities as of December 31, 2004.
For the year ended December 31, 2005 and December 31, 2006 and for the three
and
nine months ended September 30, 2007, these subsidiaries incurred no activity
and therefore had no profit or loss.
The
company began operations in Spain in April of 2006 by establishing a 100%
subsidiary. The Spanish subsidiary recognized $6,799 of revenue for the
three and nine months ended September 30, 2007, and for the period of April
2006 through September 30, 2007. At September 30, 2007 the Spanish subsidiary
had total assets less current liabilities (exclusive of intercompany amounts
eliminated in consolidation) of $91,279. Transactions in Spain are denominated
in and the functional currency is the Euro. At September 30, 2007, the Spanish
operation had aggregate losses of $1,414,104.
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.
Impairment
of Intellectual Property Rights
Prior
to
the fourth quarter of 2002, the Company was pursuing the marketability of a
technology it had acquired for $424,659. In December, 2002, the Company
determined that the related product was no longer commercially viable and would
no longer be pursued. As a result of this decision, it was determined that
the
asset would not be recoverable as there was no alternative market for the
technology. Accordingly, the net book value of $345,115 was charged to general
and administrative expenses during 2002.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
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
September 30, 2007 and the results of operations and cash flows presented herein
for the three and nine month periods ended September 30, 2007 and 2006 and
from
inception (October 14, 2000) through September 30, 2007 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,
2007. It is recommended that this financial information be read with the
complete financial statements included in the Company's Form 10-KSB dated
December 31, 2006 previously filed with the SEC on March 27,
2007.
3.
ProEco Transaction
On
January 12, 2007, the Company entered into a share exchange agreement (the
“Share Exchange Agreement”) with ProEco and its shareholders (“ProEco
Shareholders”) to acquire shares equal to 80% of the outstanding capital stock
of ProEco in exchange for approximately 9.2 million shares of the Company's
common stock (the “Transaction Shares”) valued at $0.872 per share for a total
purchase price of $8.0 million.
ProEco,
which has had limited operations to date, has been in the process of
developing a new fuel-grade ethanol plant (the “Ethanol Plant”) with planned
capacity of at least 100 million gallons per year to be built in two 50 million
gallon trains (each a “Train”). Under the terms of the Shareholder Exchange
Agreement, ProEco Shareholders would receive 60% of the Transaction Shares
at
the time of the closing and would receive the remaining 40% of the Transaction
Shares in two equal installments upon the completion of construction of the
first Train (20%) and the commencement of construction of the final Train (20%).
The remaining 40% of the Transaction Shares would be held in escrow until the
conditions for their release have been met. The parties intend the transaction
to qualify as a tax-free reorganization under Section 368(a) of the U.S.
Internal Revenue Code of 1986, as amended (the “Code”).
The
Share
Exchange Agreement requires ProEco to complete a number of steps toward
completion of the Ethanol Plant project in order for the closing of the share
exchange to occur. At the time of the closing, ProEco must have entered into
a
definitive engineering, procurement and construction (“EPC”) contract, with a
reputable firm with extensive experience in implementing and completing projects
similar to the Ethanol Plant project, and executed marketing agreements for
the
sale of the production of the Ethanol Plant. Under the terms of the Share
Exchange Agreement, ProEco is responsible for having the Ethanol Plant
designated as a facility nameplated, or certified, as producing ethanol at
a
level of at least 100 million gallons of production a year.
As
a
condition to the closing of the ProEco share exchange, the Company would
be obligated to secure the financing necessary to complete the construction
costs to build the Ethanol Plant. Accordingly, the Company would be required
to
raise $60 to $70 million in debt and between $30 and $40 million in equity
in
the first quarter of 2008 for each train.
Prior
to
closing, the Company and the ProEco Shareholders will enter into a stockholder
agreement that will, among other things, impose restrictions on the transfer
of
the Transaction Shares.
The
Common Stock will be issued to the ProEco shareholders in a transaction that
will be exempt from the registration requirement pursuant to Section 4(2) of
the
Securities Act of 1933, as amended (the “Securities Act”) and under Regulation D
promulgated under the Securities Act.
Under
the
terms of the letter of intent for the share exchange agreement, the Company
agreed to enter into a secured loan agreement with ProEco for the purposes
of
financing the purchase options for the land to be used for the ethanol plant
and
certain engineering and permitting work required for the closing of the ProEco
share exchange. The annual interest rate on the loan is 7% and the maturity
date
of the loan is December 15, 2007.
Current
trends in the ethanol industry have seen increases in the price of corn and
other feedstocks as well as a decline in the average selling price of ethanol.
For a number of new plant construction projects, the lack of EPC contractor
availability has resulted in increased costs and delays in completion dates.
We
are continuing our review of both the timing and scope of this project in light
of the present industry environment. Our estimated timetable to obtain the
financing and start construction has now shifted to the first half of
2008.
Based
on
FIN
46R,
the Company is the holder of the majority of the risks and rewards relating
to
ProEco Energy Company, Inc. (“ProEco”). As such, the Company is considered to be
the “primary beneficiary” of ProEco, deemed to be a VIE, and has included
ProEco’s assets, liabilities and operating results in its consolidated financial
statements. (
In
general, a VIE is a corporation, partnership, limited-liability corporation,
trust or any other legal structure used to conduct activities or hold assets
that either (i) has an insufficient amount of equity to carry out its principal
activities without additional subordinated financial support; (ii) has a group
of equity owners that are unable to make significant decisions about its
activities; or (iii) has a group of equity owners that do not have the
obligation to absorb losses or the right to receive returns generated by its
operations.) Based on these guidelines, the Company has determined that ProEco
is a VIE beginning with the third quarter of 2007. Prior to that period,
activity with ProEco was not material.
The
following table summarizes the significant assets and liabilities of ProEco
as
of September 30, 2007:
Cash
|
|
$
|
35,554
|
|
Construction
in progress
|
|
|
994,008
|
|
Accounts
payable
|
|
|
341,904
|
|
Accrued
expenses
|
|
|
74,978
|
|
ProEco
operating expenses of $327,216, after elimination of inter-company
transactions, are also reflected in the Company’s consolidated
statements of operations.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
4.
Common Stock and Warrant Activity During 2007
$10.0
Million Private Placement
On
February 16, 2007, the Company entered into a common stock purchase agreement
(the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
Company's discretion, the Company may sell up to $10.0 million of the Company's
common stock to Fusion Capital from time to time over a 25-month period. The
Company has reserved for issuance up to 12,000,000 shares of the Company's
common stock for sale to Fusion Capital under this agreement. Subject to earlier
termination at the Company's discretion, Fusion Capital's purchases commenced
after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
effective the registration statement related to the transaction. The Company
has
issued to Fusion Capital 805,987 shares of the Company's common stock as a
commitment fee for entering into the Purchase Agreement.
Concurrently
with entering into the Purchase Agreement, the Company entered into a
registration rights agreement with Fusion Capital (the “Registration Rights
Agreement”). Under the Registration Rights Agreement, the Company agreed to file
a registration statement with the SEC covering the shares that have been issued
or may be issued to Fusion Capital under the Purchase Agreement. After the
SEC
has declared effective the registration statement, generally the Company has
the
right but not the obligation from time to time to sell shares of the Company's
common stock to Fusion Capital in amounts between $100,000 and $1 million
depending on certain conditions. The Company has the right to control the timing
and amount of any sales of the Company's shares to Fusion Capital. The purchase
price of the shares will be determined based upon the market price of the shares
of common stock without any fixed discount. Fusion Capital shall not have the
right or the obligation to purchase any shares of the Company's common stock
on
any business day that the price of the Company's common stock is below either
$0.50 or $0.60, depending on the transaction size of the purchase. The agreement
may be terminated by the Company at any time at its discretion without any
cost
to the Company.
During
the quarter ended September 30, 2007, the Company did not execute any
transactions under this agreement. During the nine months ended September 30,
2007, the Company executed five separate transactions under this agreement,
selling a total of 970,994 shares of common stock at an average price of $0.515
per share for total proceeds of $500,000.
$2.52
Million Private Placement
Between
June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
European institutional and private investors for the sale of 6,123,346 shares
of
the Company’s common stock at a purchase price of approximately $0.41 per share
in a private placement, for total proceeds of $2,517,710 before commissions.
As
a condition to the enforceability of these agreements against the Company,
the
investors were required to fund the purchase price in an escrow account, which
funds were received between June 19, 2007 and July 31, 2007.
As
part
of the sale, the Company issued warrants to purchase 1,530,827 shares of common
stock at an exercise price of $0.62 per share during the period of six months
to
sixty-six months subsequent to issuance. The warrants expire sixty-six months
after the date of issuance.
The
Company was obligated to file a registration statement with the SEC including
the common stock and the shares issuable upon exercise of the warrants within
90
days of the closing date. A Form S-3 registration statement, including these
shares and shares issuable upon exercise of the warrants, was filed by the
Company on October 18, 2007 and declared effective by the SEC on October 31,
2007. All the costs and expenses incurred in connection with the registration
of
the common stock and warrants are paid by the Company. The Company closed this
transaction on July 20, 2007 and August 20, 2007.
Stock
Repurchase
On
July
17, 2007, the Company repurchased 100,000 shares of its common stock for
treasury for an aggregate purchase price of $40,100. The purchase price was
$0.401 per share, which was the daily volume weighted average for the five
trading days prior to the day the Company’s board of directors approved the
repurchase.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
5.
Government Appropriations
Appropriation
from the U.S. Department of Energy (1)
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™. The appropriation was increased to $2,039,651 as of
September 15, 2004. This appropriation is managed for the DOE by the
National Renewable Energy Laboratory (“NREL”) under a contract which, as
amended, continued until June 30, 2007. As of September 30, 2007, NREL has
not yet closed this contract. 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 when the Company is reasonably certain all
conditions of the reimbursement are satisfied. As of September 30, 2007, the
Company had incurred the full cumulative costs of $2,039,651 towards completion
of the contract therefore leaving no balance of costs left to spend in order
to
complete the contract. From the inception of the contract in December 2002
through September 30, 2007, the Company billed NREL $1,631,720 of which $23,924
is included in other receivables as of September 30, 2007.
Appropriation
from the U.S. Department of Energy (2)
In
2003,
the Company received an appropriation of $1,123,834 to test the Company's fuel
additive under the California Air Resources Board (CARB) Diesel Emissions
Control Strategy (DECS) verification rules. The Company is eligible to
receive reimbursements of 80% of costs incurred under a contract up to the
appropriation amount. This appropriation is managed for the DOE by NREL, the
National Renewable Energy Laboratory. As of September 30, 2007, the Company
had
incurred cumulative costs of $921,609 towards completion of the contract,
leaving a balance of $202,225 in costs to complete the contract. From the
inception of the contract through September 30, 2007, the Company billed NREL
$737,287 of which $173,493 is included in other receivables as of September
30,
2007.
Appropriation
from the U.S. Department of Energy (3)
During
2004 and 2005, Congress approved appropriations aggregating $1,000,000 for
the
purpose of continued testing and verification of our fuel additive. The Company
will submit a proposal to NREL, and expects to have these funds under contract,
by the end of the fourth quarter of 2007. These projects would be eligible
for
80% reimbursement.
Appropriation
from the U.S. Department of Defense (1)
In
2003,
the Company received an appropriation of $1,000,000 from the U.S. Department
of
Defense (“DoD”) 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 completed are treated as a
reduction to expense over the period earned. The period of performance for
this
program ran from October 7, 2003 to December 31, 2004. Through
December 31, 2004, the Company had achieved five milestones and, since
inception, has billed $360,000 related to this appropriation, of which $160,000
was billed in January, 2005. By its terms, this contract expired on
December 31, 2004 and will not be extended. No activity under this
appropriation has taken place subsequent to March 31, 2005. The work
required to achieve the milestones not completed as of December 31, 2004,
has been included as part of the Statement of Work for Appropriation
(2) from the DoD as is permitted under that contract. However, the funds
from Appropriation (1) cannot be applied to Appropriation (2). Through
December 31, 2005, the Company has received cash in excess of costs incurred
of
$296,097 and has recorded Deferred Grants at December 31, 2005 in the
Consolidated Balance Sheet. All amounts billed had been received as of December
31, 2005. No additional reimbursements are expected from this appropriation.
During the fourth quarter of 2006 the Company was notified from the
subcontractor that the contract was officially closed and O2Diesel has no
further requirements. Based on this information, the Company applied the
previously recorded liability of $296,097 for this contract as an offset to
2006
grant expenses for the year ended December 31, 2006.
Appropriation
from the U.S. Department of Defense (2)
On
January 11, 2005, the Company entered into a contract with a value of
$1,085,000 with the DoD. Under this contract, the Company's O2Diesel™ fuel is to
be tested in a maximum of forty (40) non-tactical vehicles at US Air Force
bases in Nevada for an 18 month period. Furthermore, the Company is to
complete certain engine testing and other work required for the acceptance
of
O2Diesel™ as a viable alternative fuel for use by the Air Force. Work on this
contract commenced on November 1, 2004 and is to continue through
November 30, 2006. Notwithstanding that the agreement for this contract was
signed in January 2005,
The
Company was asked to begin work in 2004 and, by a letter from Innovative
Technologies Corporation (ITC), was authorized to incur costs in an amount
not
to exceed $75,000. This is a time and materials contract that is administered
for the DoD by a third party contractor. The Company charges
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
all
costs
as incurred to expense and accrues all amounts receivable under the contract
as
a reduction to contract expenses. The contract amount was amended in May 2006
to
$1,012,564. The amount of the reduction will be added to a future contract
through the Air Force. Billings under this contract are made monthly. As of
December 31, 2006, costs totaling $1,011,215 had been incurred, billed, and
received. As of September 30, 2007, there is a balance of $1,349 in the
contract, but no further activity is expected. The contract will be officially
closed out in the fourth quarter of 2007.
Appropriation
from the U.S. Department of Defense (3)
The
Company received a contract during 2005 of approximately $910,000 from the
DoD.
Concurrent Technologies Corporation (CTC) manages this appropriation on
behalf of the Department of Defense. This contract contains a payment schedule
based on meeting performance milestones. Six milestones were achieved by
September 30, 2007. The primary objective of this contract is to create
potential fuels using the Company additive that contain no more than 80%
petroleum. If this project is successful, an application will be made to DOE
for
“alternative fuel” status, creating an incentive for federal customers to use
the fuel. Part of this research entails conducting demonstrations in various
climates at three Air Force bases, including Nellis Air Force Base (expanded
fleet) in Nevada. As of September 30, 2007, the Company has recorded expenses
of
$768,505 against this contract, leaving a balance of $141,495. The Company
invoiced and collected $630,000 for the six milestones on this project through
September 30, 2007. The Company also recorded $138,505 as an unbilled receivable
under this appropriation as of September 30, 2007.
Appropriation
from the U.S. Department of Defense (4)
Congress
approved appropriations aggregating $1,100,000 in 2006 (DoD-4) and $1,000,000
in
2007 (DoD-5) for continued testing and verification of O2Diesel™. Instead of
executing two separate contracts, DoD amended the funds and activities from
DoD-5 into the existing DoD-4 contract.
As of
September 30, 2007, the Company has executed one contract for $1,106,895 to
carry out theses activities. As of September 30, 2007, the Company has recorded
expenses of $101,197 to this contract, leaving a balance of $1,005,698. The
Company invoiced and collected $418,633 for four milestones on this project
through September 30, 2007. In addition, the Company recorded $317,436 as a
deferred grant on the balance sheet at September 30, 2007.
Contract
payments are based on milestones and do not require matching funds from
O2Diesel. It is expected that approximately $168,000 will be added to this
contract during the fourth quarter of 2007.
6.
Other Receivables
Significant
components of the Company’s Other Receivables at September 30, 2007 are as
follows:
|
|
|
|
NREL
Appropriation
|
|
$
|
197,417
|
|
Reimbursement
of expenses and services performed
|
|
|
28,787
|
|
Travel
advances to employees
|
|
|
24,923
|
|
|
|
$
|
251,127
|
|
7.
Accrued Expenses
Significant
components of the Company’s Accrued Expenses at September 30, 2007 are as
follows:
|
|
|
|
Legal
and professional fees
|
|
$
|
131,095
|
|
Salaries
and
benefits
|
|
|
38,978
|
|
Investor
relations fees
|
|
|
10,000
|
|
Severance
payments
|
|
|
282,604
|
|
Minority
interest
|
|
|
35,000
|
|
Other
|
|
|
123,775
|
|
|
|
$
|
621,452
|
|
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
8.
Deferred Financing and Business Acquisition Costs
During
2003, management began the public listing process on the Alternative Investment
Market (AIM) in London, England. All legal, accounting, and other related costs
incurred in connection with the AIM listing were capitalized as deferred
financing costs. In December 2003, management determined that the Company
would terminate its plan to seek an AIM listing. Accordingly, deferred financing
costs of $517,000, were charged to expense for the year ended December 31,
2003.
The
Company records the cost of equity financings as a reduction of the associated
proceeds.
9.
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. The income
tax benefit reflected in the accompanying consolidated statement of operations
is the current benefit recognized in Ireland for the periods
presented.
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and
the amounts used for income tax reporting purposes. Significant components
of
the Company's deferred tax asset as of September 30, 2007:
Net
operating loss carryforwards
|
|
$
|
11,303,000
|
|
Deferred
revenue
|
|
|
524,500
|
|
Accrued
expenses
|
|
|
206,800
|
|
Total
deferred tax assets
|
|
|
12,034,300
|
|
Valuation
allowance
|
|
|
(12,034,300
|
)
|
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 September 30, 2007, the Company had Federal
and
state net operating loss carryforwards of approximately $27.5 million for
income tax purposes. If not used, these carryforwards expire through 2021 for
Federal and state tax purposes. Federal tax rules impose limitations on the
use
of net operating losses following certain changes in ownership. If such a change
occurs, the limitation would reduce the amount of the benefits that would be
available to offset future taxable income each year, starting with the year
of
ownership change. As of September 30, 2007, the Company had an Irish net
operating loss carryforward of approximately $637,000 which can be carried
forward indefinitely, cumulative Spanish losses of approximately $1,450,000
and
a Brazilian net operating loss of approximately $1,675,000 that may be carried
forward indefinitely, but which is subject to annual usage
limitations.
In
July
2006, the FASB issued FASB Interpretation No. 48,
Accounting
for Uncertainty in Income Taxes
-
an
interpretation of FASB Statement No. 109
”
(“FIN
48”). FIN 48 clarifies the accounting and disclosure for uncertainty in tax
positions, as defined and prescribes the measurement process and a minimum
recognition threshold, for a tax position taken or expected to be taken in
a tax
return, that is required to be met before being recognized in the financial
statements. Under FIN 48, the Company must recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position are measured based on the largest benefit that
has a greater than 50% likelihood of being realized upon ultimate
resolution.
The
Company is subject to the provisions of FIN 48 as of January 1, 2007, and has
analyzed filing positions in all of the U.S. federal and state jurisdictions
where it is required to file income tax returns, its federal and state tax
returns in Ireland, Spain and Brazil and all open tax years in these
jurisdictions. The Company has identified its U.S. federal tax return and its
state tax returns in Delaware and California as “major” tax jurisdictions as
defined. Based on the Company's evaluation, we have concluded that there are
no
significant uncertain tax positions requiring recognition in our financial
statements. Our evaluation was performed for the tax years which remain subject
to examination by the major U.S. tax jurisdictions (tax years ended December
31,
2003 to December 31, 2006) and for the tax years which remain open for
examination in Ireland (December 31, 2006), Spain (December 31, 2006) and Brazil
(December 31, 2006). Based on this evaluation, no reserves for uncertain income
tax positions have been recorded pursuant to FIN 48 during the period ended
September 30, 2007 and the Company does not anticipate that it is reasonably
possible that any material increase or decrease in its unrecognized tax benefits
will occur within twelve months. In addition, the Company did not record a
cumulative effect adjustment related to the adoption of FIN 48.
Upon
adoption on January 1, 2007 and as of September 30, 2007, the Company had no
unrecognized tax benefits or accruals for the potential payment of interest
and
penalties. The Company's policy for recording interest and penalties associated
with tax audits is to record such items as a component of income or loss before
provision (benefit) for income taxes. Penalties are recorded in other expenses,
and interest paid or received is recorded in interest expense or interest
income, related to the settlement of tax audits for certain prior periods.
For
the period ended September 30, 2007, there were no penalties or interest
recorded relating to the settlement of tax audits.
Federal
tax rules under Section 382 of the Code impose limitations on the use of
net operating losses following certain changes in ownership. If such a change
occurs, the limitation would reduce the amount of the benefits that would be
available to offset future taxable income each year, starting with the year
of
ownership change. In general, an ownership change, as defined by Section 382,
results from transactions increasing the ownership of certain shareholders
or
public groups in the stock of a corporation by more than 50 percentage points
over a there-year period. Since the Company's formation, the Company has raised
capital through the issuance of capital stock on several occasions which,
combined with the purchasing shareholders' subsequent disposition of those
shares, may have resulted in a change of control, as defined by Section 382,
or
could result in a change of control in the future upon subsequent disposition.
The Company has not currently completed a study to assess whether a change
of
control has occurred or whether there have been multiple changes of control
since the Company's formation due to the significant complexity and cost
associated with such study and that there could be additional changes in control
in the future. If we have experienced a change of control at any time since
the
Company's formation, utilization of our NOL carryforwards would be subject
to an
annual limitation under Section 382. Any limitation may result in the expiration
of a portion of the NOL carryforwards before utilization. Further, until a
study
is completed and any limitation is known, no amounts are being presented as
an
uncertain tax position under FIN 48.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
10.
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 affected 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
was carried forward after the transaction; and the loss per share for all
periods prior to the transaction was restated to reflect the number of
equivalent common shares received by AAE in the transaction.
Common
Stock and Warrant Activity
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 additional paid-in capital.
Subsequent
to its first private placement in 2003, the Company undertook to raise an
additional $3.5 million through a follow-on private placement of our common
stock (the “Follow-On Private Placement”). In the Follow-On Private Placement,
we raised $1,535,570, before expenses, and issued 1,025,784 shares of our common
stock at a price of $1.50 per share. The Follow-On Private Placement was closed
on March 31, 2004. There was no underwriter involved in the Follow-On Private
Placement. Sales of common stock under the Follow-On Private Placement that
were
completed in non-U.S. transactions were exempt from registration pursuant to
Regulation S promulgated under the Securities Act. The sales of common stock
under the Follow-On Private Placement to accredited U.S. investors were exempt
pursuant to Regulation D promulgated under the Securities Act.
On
July
17, 2007, the Company repurchased 100,000 shares of its common stock for
treasury for an aggregate purchase price of $40,100. The purchase price was
$0.401 per share, which was the daily volume weighted average for the five
trading days prior to the day the Company’s board of directors approved the
repurchase.
$2.0
and $3.0 Million Private Placements
In
a
series of two private placements of the Company’s common stock in 2005, the
Company raised $4,833,192 after payment of an 8% commission and other expenses,
and issued 7,535,981 shares of common stock at a price of $0.70 per share.
Subscribers to these private placements received for each two shares of common
stock purchased one warrant to purchase one additional share of common stock.
The warrant expires twenty-four months following the closing of the private
placement. Each warrant is exercisable at a price of $0.70 per share during
the
first twelve months following the close of the private placement, or at an
exercise price of $1.05 per share in the second twelve months following the
close of the private placement. The total number of warrants issued was
3,757,990. The common stock and the warrants were issued to the accredited
investors in a transaction that will be exempt from registration pursuant to
Section 4(2) of the Securities Act, and/or Regulation D promulgated under the
Securities Act.
$2.3
Million Private Placement
On
October 24, 2005, the Company issued 3,228,070 shares of common stock at a
purchase price of $0.7125 per share in a private placement for total proceeds
of
$2,300,000.
As
part
of this sale, the Company also issued warrants to purchase 1,614,035 shares
of
common stock at an exercise price of $1.425 per share during the period of
six
months to forty-two months subsequent to issuance or at a cashless exercise
if a
registration statement is not effective within one year of issuance. The
warrants expire forty-two months after the date of issuance.
As
part
of the transaction, the Company agreed to sell up to an additional $700,000
of
its common stock to the Purchaser at a purchase price of $0.7125 per share
for
982,456 shares. The Company also issued warrants to purchase 491,228 shares
of
common stock at an exercise price of $1.425 per share during the period of
six
months to forty-two months subsequent to issuance or at a cashless exercise
if a
registration statement is not effective within one year of issuance. The
warrants expire forty-two months after the date of issuance. The purchaser
had
180 days following the date of the Purchase Agreement to acquire additional
shares. This offer expired unexercised on March 20, 2006.
The
Company agreed to issue warrants to purchase 1,614,035 shares of common stock
at
an exercise price of $0.7125 per share to its advisor in connection with this
transaction. The warrants expire forty-two months after the date of issuance.
The common stock and the warrants were issued to the accredited investor in
a
transaction that will be exempt from registration pursuant to Section 4(2)
of
the Securities Act, and/or Regulation D promulgated under the Securities
Act.
$3.6
Million Private Placement
On
December 16, 2005, the Company issued 6,419,840 shares of the Company's common
stock in a private placement, for total proceeds of 3,000,000€, or approximately
$3.6 million at the then current exchange rates.
As
part
of the transaction, the Company issued warrants to purchase 2,853,262 shares
of
common stock at an exercise price of $0.85 per share during the period six
to
forty-two months subsequent to the date of issuance or at an exercise price
of
$1.13 per share during the period forty-three to sixty-six months after the
date
of issuance. The warrants expire sixty-six months after the date of
issuance.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
$4.0
and $2.5 Million Private Placements
On
April
6, 2006, the Company entered into a Common Stock and Warrant Purchase Agreement
(“$4.0 million Purchase Agreement”) with a UK investor (the “Investor”) for
5,333,333 shares of common stock at a purchase price of $0.75 per share in
a
private placement for total proceeds of $4,000,000 (the “$4.0 million Private
Placement”). As part of this sale, the Company also issued warrants to purchase
2,666,667 shares of common stock at an exercise price of $0.825 per share during
the period of six months to forty-two months subsequent to issuance. The
warrants expire forty-two months after the date of issuance.
Also
on
April 6, 2006, the Company entered into a Common Stock and Warrant Purchase
Agreement (“$2.5 million Purchase Agreement”) with a different European
investor (the “2
nd
Investor”) for 3,333,333 shares of common stock at a purchase price of $0.75 per
share in a private placement for total proceeds of $2,500,000 (the “$2.5 million
Private Placement”) before payment of a 9% commission and other expenses.
As part of this sale, the Company also issued warrants to purchase 1,666,667
shares of common stock at an exercise price of $0.825 per share during the
period of six months to forty-two months subsequent to issuance. The warrants
expire forty-two months after the date of issuance.
Subsequent
to entering into these agreements, the Company entered into an identical
amendment to each agreement which (i) modified the amount of liquidated damages
to a maximum of 8% of the purchase price and (ii) added that shareholder
approval will be obtained prior to the Company issuing the shares of common
stock issuable upon exercise of the warrants. There were no other changes to
either agreement. Both transactions closed and the warrants were issued on
April
27, 2006.
AMEX
requires that shareholder approval be obtained by the Company for the sale
of
common stock in a transaction if the price of the shares to be sold is less
than
the greater of book or market value, and the number of shares is equal
twenty-percent (20%) or more of the presently outstanding common stock. In
order
to comply with this requirement, the Company was required to obtain shareholder
approval for the $4.0 and the $2.5 million Private Placements. Shareholder
approval was obtained at the Company's annual shareholder meeting on July 6,
2006.
$1.0
Million Private Placement
On
November 9, 2006, the Company issued 1,371,742 shares of the Company's common
stock at a purchase price of $0.729 per share in a private placement for total
proceeds of $1,000,000.
As
part
of the sale, the Company issued warrants to purchase 685,871 shares of common
stock at an exercise price of $0.972 per share during the period of six months
to sixty-six months subsequent to issuance. The warrants expire
sixty-six months after the date of issuance.
The
common stock and the warrants were issued to the accredited investor in a
transaction that is exempt from registration pursuant to Section 4(2) of
the Securities Act, and/or Regulation D promulgated under the Securities
Act.
The
transaction closed and the funds were received on November 22,
2006.
$10.0
Million Private Placement
On
February 16, 2007, the Company entered into a common stock purchase agreement
(the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
Company's discretion, the Company may sell up to $10.0 million of the Company's
common stock to Fusion Capital from time to time over a twenty-five month
period. The Company has reserved for issuance up to 12,000,000 shares of the
Company's common stock for sale to Fusion Capital under this agreement. The
Company has issued to Fusion Capital 805,987 shares of the Company's common
stock as a commitment fee for entering into the Purchase Agreement.
Concurrent
with entering into the Purchase Agreement, the Company entered into a
registration rights agreement with Fusion Capital (the “Registration Rights
Agreement”). Under the Registration Rights Agreement, the Company filed a
registration statement with the SEC covering the shares that have been issued
or
may be issued to Fusion Capital under the Purchase Agreement. Subject to earlier
termination at the Company's discretion, Fusion Capital's purchases commenced
after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
effective the registration statement related to the transaction. Generally,
the Company has the right but not the obligation from time to time to sell
an
aggregate of up to 12 million shares of the Company's common stock to Fusion
Capital in amounts between $100,000 and $1 million depending on certain
conditions. The Company has the right to control the timing and amount of any
sales of the Company's shares to Fusion Capital. The purchase price of the
shares will be determined based upon the market price of the shares of common
stock without any fixed discount. Fusion Capital shall not have the right or
the
obligation to purchase any shares of the Company's common stock on any business
day that the price of the Company's common stock is below either $0.50 or $0.60,
depending on the transaction size of the purchase. The agreement may be
terminated by the Company at any time at its discretion without any cost to
the
Company.
During
the quarter ended September 30, 2007, the Company did not execute any
transactions under this agreement. During the nine months ended September 30,
2007, the Company executed five separate transactions under this agreement,
selling a total of 970,994 shares of common stock at an average price of $0.515
per share for total proceeds of $500,000.
$2.52
Million Private Placement
Between
June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
European institutional and private investors for the sale of 6,123,346 shares
of
the Company’s common stock at a purchase price of approximately $0.41 per share
in a private placement, for total proceeds of $2,517,710 before commissions.
As
a condition to the enforceability of these agreements against the Company,
the
investors were required to fund the purchase price in an escrow account, which
funds were received between June 19, 2007 and July 31, 2007.
As
part
of the sale, the Company will issue warrants to purchase 1,530,827 shares of
common stock at an exercise price of $0.62 per share during the period of six
months to sixty-six months subsequent to issuance. The warrants expire sixty-six
months after the date of issuance.
The
Company was obligated to file a registration statement with the SEC including
the common stock and the shares issuable upon exercise of the warrants within
90
days of the closing date. A Form S-3 registration statement, including these
shares and shares issuable upon exercise of the warrants, was filed by the
Company on October 18, 2007 and declared effective by the SEC on October 31,
2007. All the costs and expenses incurred in connection with the registration
of
the common stock and warrants are paid by the Company. The Company closed this
transaction on July 20, 2007 and August 20, 2007.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
Issuances
of Preferred Stock
Series A
0% Convertible Preferred Stock Private Placement
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 0% Convertible Preferred Stock, par value $.0001
(“Series A Preferred Stock”). The offering resulted in gross proceeds of
approximately $3,200,000 to the Company, prior to the deduction of fees and
commissions. The sale of the Series A Preferred Stock was exempt
from registration pursuant to Regulation S promulgated under the
Securities Act.
The
Series A Preferred Stock was initially convertible into the Company's
common stock at a variable conversion ratio which was 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 50% of the Series A
Fixed Conversion Price. In September 2004, we renegotiated the conversion
formula with the holder of these shares. Thus, the minimum price at which the
shares may be converted is equal to twenty-five percent (25.0%) of the Fixed
Conversion Price, or $1.00 per share. Pursuant to the amended agreement, the
Series A Purchaser may not convert Series A Preferred Stock into our
common stock for a period of two (2) years following the closing date of
this transaction. Under the revised agreement, in no event will the
Series A Purchaser receive more than 8,000,000 or less than 2,000,000
shares of the Company's common stock upon conversion of the Series A
Preferred Stock.
The
Series A Purchaser was granted an option to purchase additional shares of
the Company's common stock equal to the difference between the number of shares
of common stock actually received upon conversion and the number of shares
that
would have been received at a conversion price of $1.82. The exercise price
shall be the Series A Fixed Conversion Price.
Series B
0% Convertible Preferred Stock Private Placement
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, 750,000
shares of Series B 0% Convertible Preferred Stock, par value $.0001
(“Series B Preferred Stock”). The offering resulted in gross proceeds
of approximately $3,000,000 to the Company, prior to the deduction 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.
The
Series B Preferred Stock was initially convertible into the Company's
common stock at a variable conversion ratio which was 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 September 2004, we renegotiated the conversion
formula with the holder of these shares. Now the minimum price at which the
shares may be converted is equal to twenty-seven and four tenths per cent
(27.4%) of the Series B Fixed Conversion Price, or $1.00 per share.
Pursuant to the amended agreement, the Series B Purchaser may not convert
Series B Preferred Stock into our common stock for a period of two
(2) years following the closing date of this transaction. Under the revised
agreement, in no event will the Series B Purchaser receive more than
7,500,000 or less than 2,054,795 shares of the Company's common stock upon
conversion of the Series B Preferred Stock.
The
Series B Purchaser was granted an option to purchase additional shares of
the Company's common stock equal to the difference between the number of shares
of common stock actually received upon conversion and the number of shares
that
would have been received at a conversion price of $1.82. The exercise price
shall be the Series B Fixed Conversion Price.
In
April
2006, the holders of both the Series A and Series B Convertible Preferred Stock
exercised all of their conversion rights and converted 1,550,000 shares of
Convertible Preferred Stock into 15,500,000 shares of common stock.
Warrants
A
wholly-owned subsidiary of the Company entered into a supply and distribution
agreement (the “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 Company for $1.00 per share should certain
sales
targets be achieved. The warrant was to expire on July 10, 2006. None of
the sales targets have been achieved under the Distribution Agreement and as
of
December 10, 2004 this Distribution Agreement was terminated and replaced
by a new supply and distribution agreement (the “New Agreement”). Under this New
Agreement, the distributor received a warrant to purchase 600,000 shares of
O2Diesel's common stock at a price of $2.00 per share, which expired on
May 5, 2007.
On
February 3, 2006, the Company offered existing warrant holders from the
$2.0 million and $3.0 million Private Placements and the $2.3 million
Private Placement an opportunity to exercise their warrants at the reduced
price
of $0.35 per share. On February 27, 2006, the Warrant Offering expired and
the Company received proceeds of $592,692 (after expenses) for the exercise
of
warrants to purchase 1,864,035 shares of common stock. Between May 31 and June
12, 2006, several other existing warrant holders elected to exercise their
warrants at the contract price identified in their warrant documentation.
Proceeds for these exercises were $865,452 (after expenses) for the purchase
of
1,287,857 shares of common stock.
On
April
27, 2007, the Company offered existing warrant holders an opportunity to
exercise their warrants at the reduced price of $0.50 per share. If all eligible
warrant holders were to exercise their warrants at the reduced price, the
Company would receive proceeds of approximately $4.3 million. The warrant offer
was originally set to expire on May 25, 2007, however on May 9, 2007, the
Company extended this reduced price offer until June 8, 2007. As of May 15,
2007, the Company amended the offer to grant the warrant holders, who tender
their warrants, additional shares of Common Stock if the Company enters
into any agreement for the sale of shares of Common Stock at less than $0.50
per
share prior to June 8, 2008. The offer expired on June 8, 2007, without any
of the warrant holders exercising at the reduced price.
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
Options
The
Company implemented a Stock Incentive Plan (the “Incentive Plan”) in 2004 for
which the Board of Directors has authorized 9,750,000 shares of common stock
to
be reserved for future issuance under the Incentive Plan.
The
following table shows the outstanding options granted under the 2004 Stock
Incentive Plan:
|
|
|
|
|
|
Weighted
Ave
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
Shares
|
|
Weighted
Ave
Exercise
Price
|
|
Contractual
Term
|
|
Outstanding
at January 1, 2004
|
|
|
500,000
|
|
$
|
1.50
|
|
|
-
|
|
Granted
in 2005
|
|
|
5,450,000
|
|
$
|
1.50
|
|
|
7.9
|
|
Exercised
in 2005
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
Forfeited
or Expired
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
Outstanding
at December 31, 2005
|
|
|
5,950,000
|
|
$
|
1.50
|
|
|
7.9
|
|
Granted
During the Year Ended December 31, 2006
|
|
|
1,350,000
|
|
$
|
1.28
|
|
|
8.8
|
|
|
|
|
200,000
|
|
$
|
1.50
|
|
|
8.8
|
|
|
|
|
100,000
|
|
$
|
0.71
|
|
|
9.2
|
|
Exercised
During the Year Ended December 31, 2006
|
|
|
-
|
|
$
|
-
|
|
|
-
|
|
Forfeited
or Expired
|
|
|
(100,000
|
)
|
$
|
1.28
|
|
|
-
|
|
Outstanding
at December 31, 2006
|
|
|
7,500,000
|
|
$
|
1.45
|
|
|
8.2
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
During the Nine Months Ended September 30, 2007
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Exercised
During the Nine Months Ended September 30, 2007
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Forfeited
or Expired
|
|
|
(1,475,000
|
)
|
$
|
1.50
|
|
|
-
|
|
Outstanding
at September 30, 2007
|
|
|
6,025,000
|
|
$
|
1.44
|
|
|
8.1
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2007
|
|
|
5,265,000
|
|
|
1.46
|
|
|
8.1
|
|
Restricted
Stock Awards
On
November 16, 2006, the Board of Directors approved the grant of 500,000 shares
of restricted stock to Mr. Roger, pursuant to the terms of the Company's 2004
Stock Incentive Plan and Mr. Roger's employment agreement. The terms of the
award were that the shares were to be issued on January 1, 2007 with 166,667
shares to vest on January 1, 2007, 166,667 shares to vest on January 1, 2008
and
166,666 shares to vest on January 1, 2009. The receipt of shares is contingent
on Mr. Roger remaining employed by the Company on the date of vesting. In 2006,
there was no FAS 123(R) expense for the grant of restricted stock.
On
August
1, 2007, the Company entered into a Separation Agreement with Mr. Roger. Mr.
Roger will receive severance payments and health benefits from the Company
in
accordance with his Employment Agreement. Mr. Roger's Separation Agreement
includes continuing obligations relating to confidentiality, non-competition
and
non-solicitation. The Separation Agreement also provides for a release by Mr.
Roger of any and all claims he may have against the Company. In addition, all
of
Mr. Roger's options vested as of the date of the Separation Agreement and in
accordance with the Incentive Plan, Mr. Roger had thirty days to exercise these
options, which expired unexercised. Finally, 166,667 of the remaining shares
of
Mr. Roger's restricted stock vested on the date of the Separation Agreement
and
166,666 of the remaining shares will vest on July 31, 2008. Mr. Roger agreed
not
to sell or transfer these shares until after that date.
On
May
14, 2007, the Company entered into an investor relations consulting agreement
for a term of two months. In exchange for services, the Company paid
the consultant a fee of $10,000. In addition, the Company awarded the
consultant 50,000 shares of restricted stock. In connection with the stock
award, the Company recognized $0 and $27,000 of consulting expense during
the three and nine months ended September 30, 2007,
respectively.
On
May
16, 2007, the Company entered into a second investor relations consulting
agreement for a term of six months. In exchange for services, the Company
awarded the consultant 440,000 shares of restricted stock. In connection with
the stock award, the Company recognized $96,400 and $213,000 of the
consulting expense during the three and nine months ended September
30, 2007, respectively. Pursuant to the terms of the consulting agreement,
220,000 shares, 120,000 shares and 100,000 shares of the restricted stock were
earned by the consultant on May 16, 2007, July 16, 2007 and September 17, 2007,
respectively. As of September 30, 2007, the restrictions on 440,000 shares
issued under this contract have lapsed and such shares were
earned.
On
November 4, 2004, the Company entered into a separate investor relations
consulting agreement for a term of four years. In exchange for services,
the
Company awarded the consultant 50,000 shares of restricted stock as settlement
of this agreement, effective November 9, 2007. In connection with this stock
award, the Company has recognized $23,500 of consulting expense in the third
quarter of 2007 and recorded this as an accrued expense.
The
following schedule presents shares of common stock issued and outstanding and
reserved for future issuance as of
September
30,
2007:
Common
Shares Outstanding
|
|
|
|
|
|
83,186,786
|
|
Reserved
For Future Issuance
|
|
|
|
|
|
|
|
Options
Granted to officers and directors
|
|
|
6,025,000
|
|
|
|
|
Unearned
common stock issued for compensation
|
|
|
166,666
|
|
|
|
|
Unearned
common stock issues for commitment shares
|
|
|
561,888
|
|
|
|
|
Treasury
shares
|
|
|
100,000
|
|
|
|
|
Warrants
|
|
|
9,486,502
|
|
|
16,340,056
|
|
|
|
|
|
|
|
|
|
Total
shares issued and outstanding and reserved for future
issuance
|
|
|
|
|
|
99,526,842
|
|
O2Diesel
Corporation
(A
Development Stage Company)
Notes
to Financial Statements
(Unaudited)
11. Related
Party Transactions
A
company
controlled by the former Chairman of the Board provides office space, accounting
and other services to the Company at a cost of approximately $2,500 per month.
The Company paid $5,221 and $15,505 for the three and nine months ended
September
30,
2006, respectively, and paid $2,873, $27,744 (of which approximately $16,700
relates to the first nine months of 2007) and $207,594 for the three and nine
months ended September 30, 2007 and for the period October 14, 2000
(inception) through
September
30,
2007, respectively, to the company controlled by the former Chairman.
Included
in Other Receivables at
September
30, 2007
is $24,923 which is related to travel advances made to employees. Included
in
Accounts Payable at
September
30, 2007
is $139,839 which represents travel expenses reimbursable to employees and
directors.
The
Company has entered into two separate consulting contracts with two shareholders
of its Brazilian subsidiary for the purpose of providing office rent and
administrative services and in lieu of employment contracts with these two
individuals. These two contracts provide support significant to the operation
of
the Brazilian subsidiary. The company incurred expenses of $37,352 and $137,060
for the three and nine months ended
September
30,
2006, respectively, and $37,059, $107,735 and $581,119 for the three and nine
months ended
September
30, 2007
and for the period October 14, 2000 (inception) through
September
30,
2007, respectively.
12.
Commitments
Operating
leases
The
Company leases office space and certain office equipment under agreements that
are accounted for as operating leases. As of September 30, 2007, future minimum
lease payments under non-cancelable operating leases were as
follows:
Operating
Leases
2007
|
|
$
|
25,506
|
|
2008
|
|
|
89,779
|
|
Thereafter
|
|
|
-
|
|
Total
|
|
$
|
115,285
|
|
Rent
expense under the leases with unrelated parties was $26,798 and $79,896 for
the
three and nine months ended
September
30, 2006
and was $54,291, $140,361 and $436,836 for the three and nine months ended
September
30, 2007
and for the period October 14, 2000 (inception) through
September
30,
2007, respectively.
13.
Subsequent Events
On
October 17, 2007, the Company entered into a private financing agreement and
a
joint venture transaction with Energenics Holdings Pte Ltd (“Energenics
Holdings”) to provide funding and commercial support to develop the Asian market
for O2Diesel™, the Company's ethanol diesel fuel blend.
The
parties entered into a Common Stock and Warrant Purchase Agreement (the
“Energenics Agreement”) pursuant to which Energenics Holdings agreed to purchase
2,551,020 shares of the Company's common stock in a private placement, for
total
proceeds of approximately $1.25 million. As part of the transaction, the Company
agreed to issue a warrant to purchase 1,275,510 shares of common stock at an
exercise price of $0.50 per share, which warrant will be issued upon the closing
of the transactions contemplated by the Energenics Agreement and shall be
exercisable from the date that is six months following the date of issuance
until October 17, 2012 (“Investment Warrant”).
The
parties also entered into a Shareholders Agreement, in which Energenics Holdings
and the Company will jointly develop the market for O2Diesel™ in Asia through
O2Diesel Asia Limited (“O2Diesel Asia”). Energenics agreed to pay the Company
$750,000 for a fifty percent (50%) equity interest in O2Diesel Asia. The balance
of the interest in O2Diesel Asia will be held by O2Diesel Europe Limited, a
wholly-owned subsidiary of the Company. For the past year, pursuant to the
Supply and Distribution Agreement, dated September 15, 2006, O2Diesel has
supplied its additive to Energenics for the manufacture and distribution of
O2Diesel™ in the Asian Pacific and South Asia.
The
parties also will enter into a License agreement whereby O2Diesel Europe Limited
(formerly AAE Technologies International Plc) will license to O2Diesel Asia
certain patents and know-how that are required to make and sell O2Diesel™ in the
territory in exchange for certain payments pursuant to the Shareholders
Agreement. In addition, the Company will enter into a similar License agreement
with O2Diesel Asia, pursuant to which the Company will pay to O2Diesel Asia
a royalty based on sales of the Company's product in the Territory.
As
part
of the transaction, upon the purchase of a certain quantity of O2D05 or the
equivalent, the Company will also issue a warrant to purchase 1,500,000 shares
of common stock at an exercise price of $0.50 per share, which warrant shall
be
exercisable during the period from the date of issuance until October 17,
2012 (“JV Warrant”).
Also,
as
part of the transaction, upon the achievement by Energenics Holdings of certain
levels of additional purchases of O2D05 or the equivalent, the Company will
issue additional warrants to purchase up to an aggregate of 6,500,000 shares
of
common stock at a price per share equal to the lesser of $0.50 or 106% of the
closing price per share (rounded to the nearest cent) of the Company's common
stock on the American Stock Exchange on the date such warrants are earned
(“Market Development Warrants,” and, collectively with the Investment Warrant
and the JV Warrant, the “Warrants”). The Market Development Warrants are
exercisable from the date of issuance to October 17, 2012.
The
parties expect to close the transaction in the fourth quarter
of 2007.
The
common stock and the Warrants will be issued to the accredited investor in
a
transaction that will be exempt from registration pursuant to Section 4(2)
of
the Securities Act and/or Regulation D promulgated under the Securities
Act.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
OVERVIEW
Business
Plan
Overview
The
Company is classified as a development stage company as shown on its unaudited
consolidated financial statements for the period from inception
(October 14, 2000) through September 30, 2007.
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 (the “Offer”). 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.
Subsequent
to the Offer and during 2003, the Company undertook an effort to raise an
additional $3.5 million through a follow-on private placement. Pursuant to
the follow-on financing, the Company issued 1,025,784 shares of its common
stock
at $1.50 per share for total proceeds of $1,535,877. The follow-on placement
was
closed as of March 31, 2004.
On
December 29, 2004, the Company consummated a merger (the “Reincorporation
Merger”) with and into its wholly owned subsidiary, O2Diesel Delaware
Corporation, a Delaware corporation (“O2Diesel Delaware”), in order to
reincorporate in the State of Delaware (the “Reincorporation”). The
Reincorporation Merger was affected pursuant to an Agreement and Plan of Merger
entered into between the Company and O2Diesel Delaware on December 29,
2004. The Reincorporation was submitted to a vote of, and approved by, the
Company's shareholders at its annual meeting held on August 16, 2004. As a
result of the Reincorporation, the legal domicile of the Company is now
Delaware. The merger became effective on December 31, 2004.
Since
July 2003, the Company has raised approximately $36 million for its operations.
Transactions
During the First Nine Months of 2007
ProEco
Transaction
On
January 12, 2007, the Company entered into a share exchange agreement (“Share
Exchange Agreement”) with ProEco and its shareholders (“ProEco Shareholders”) to
acquire shares equal to 80% of the outstanding capital stock of ProEco in
exchange for approximately 9.2 million shares of the Company's common stock
(the
“Transaction Shares”) valued at $0.872 per share for a total purchase price of
$8.0 million.
ProEco,
which has had limited operations to date, has been developing a new
fuel-grade ethanol plant (the “Ethanol Plant”) with planned capacity of 100
million gallons per year to be built in two 50 million gallon trains (each
a
“Train”). Under the terms of the Shareholder Exchange Agreement, ProEco
Shareholders would receive 60% of the Transaction Shares at the time of the
closing and would receive the remaining 40% of the Transaction Shares in two
equal installments upon the completion of construction of the first Train (20%)
and the commencement of construction of the final Train (20%). The remaining
40%
of the Transaction Shares would be held in escrow until the conditions for
their
release have been met. The parties intend the transaction to qualify as a
tax-free reorganization under Section 368(a) of the Code.
The
Share
Exchange Agreement requires ProEco to complete a number of steps toward
completion of the Ethanol Plant project in order for the closing of the share
exchange to occur. At the time of the closing, ProEco must have entered into
a
definitive engineering, procurement and construction (“EPC”) contract with a
reputable firm with extensive experience in implementing and completing projects
similar to the Ethanol Plant project and executed marketing agreements for
the
sale of the production of the Ethanol Plant. Under the terms of the Share
Exchange Agreement, ProEco is responsible for having the Ethanol Plant
designated as a facility nameplated, or certified, as producing ethanol at
a
level of at least 100 million gallons of production a year.
As
a
condition to the closing of the ProEco share exchange, the Company would
be
obligated to secure the financing necessary to complete the construction
costs
to build the Ethanol Plant. Accordingly, the Company would be required to
raise
$60 to $70 million in debt and between $30 and $40 million in equity in the
first quarter of 2008 for each train.
Prior
to
closing, the Company and the ProEco Shareholders will enter into a stockholder
agreement that will, among other things, impose restrictions on the transfer
of
the Transaction Shares.
The
Common Stock will be issued to the ProEco Shareholders in a transaction that
will be exempt from the registration requirement pursuant to Section 4(2)
of the
Securities Act and under Regulation D promulgated under the Securities
Act.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
Under
the
terms of the letter of intent for the Share Exchange Agreement, the Company
agreed to enter into a secured loan agreement with ProEco for the purposes
of
financing the purchase options for the land to be used for the Ethanol Plant
and
certain engineering and permitting work required for the closing of the ProEco
share exchange. The annual interest rate on the loan is 7% and the maturity
date
of the loan is December 15, 2007.
Current
trends in the ethanol industry have seen increases in the price of corn and
other feedstocks as well as a decline in the average selling price of ethanol.
For a number of new plant construction projects, the lack of EPC contractor
availability has resulted in increased costs and delays in completion dates.
We
are continuing our review of both the timing and scope of this project in light
of the present industry environment. Our estimated timetable to obtain the
financing and start construction has now shifted to the first half of
2008.
Based
on
FIN
46R,
the Company is the holder of the majority of the risks and rewards relating
to
ProEco. As such, the Company is considered to be the “primary beneficiary” of
ProEco, and ProEco is deemed to be a VIE. Accordingly, the
Company has included ProEco’s assets, liabilities and operating results in
its consolidated financial statements.
In
general, a VIE is a corporation, partnership, limited-liability corporation,
trust or any other legal structure used to conduct activities or hold assets
that either (i) has an insufficient amount of equity to carry out its principal
activities without additional subordinated financial support; (ii) has a group
of equity owners that are unable to make significant decisions about its
activities; or (iii) has a group of equity owners that do not have the
obligation to absorb losses or the right to receive returns generated by its
operations. Based on these guidelines, the Company has determined that ProEco
is
a VIE beginning with the third quarter of 2007. Prior to that period,
activity with ProEco was not material.
The
following table summarizes the significant assets and liabilities of ProEco
as
of September 30, 2007:
Cash
|
|
$
|
35,554
|
|
Construction
in progress
|
|
|
994,008
|
|
Accounts
payable
|
|
|
341,904
|
|
Accrued
expenses
|
|
|
74,978
|
|
ProEco
operating expenses of $327,216, after the elimination of inter-company
transactions, are also reflected in the Company’s consolidated statements of
operations.
$10.0
Million Private Placement
On
February 16, 2007, the Company entered into a common stock purchase agreement
(the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
Company's discretion, the Company may sell up to $10.0 million of the Company's
common stock to Fusion Capital from time to time over a twenty-five month
period. The Company has reserved for issuance up to 12,000,000 shares of the
Company's common stock for sale to Fusion Capital under this agreement. The
Company has issued to Fusion Capital 805,987 shares of the Company's common
stock as a commitment fee for entering into the Purchase Agreement.
Concurrent
with entering into the Purchase Agreement, the Company entered into a
registration rights agreement with Fusion Capital (the “Registration Rights
Agreement”). Under the Registration Rights Agreement, the Company filed a
registration statement with the SEC covering the shares that have been issued
or
may be issued to Fusion Capital under the Purchase Agreement. Subject to earlier
termination at the Company's discretion, Fusion Capital's purchases commenced
after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
effective the registration statement related to the transaction. Generally,
the
Company has the right but not the obligation from time to time to sell shares
of
the Company's common stock to Fusion Capital in amounts between $100,000 and
$1
million depending on certain conditions. The Company has the right to control
the timing and amount of any sales of the Company's shares to Fusion Capital.
The purchase price of the shares will be determined based upon the market price
of the shares of common stock without any fixed discount. Fusion Capital does
not have the right or the obligation to purchase any shares of the Company's
common stock on any business day that the price of the Company's common stock
is
below either $0.50 or $0.60, depending on the transaction size of the purchase.
The agreement may be terminated by the Company at any time at its discretion
without any cost to the Company.
During
the quarter ended September 30, 2007, the Company did not execute any
transactions under this agreement. During the nine months ended September 30,
2007, the Company executed five separate transactions under this agreement
selling a total of 970,994 shares of common stock at an average price of $0.515
per share for total proceeds of $500,000.
Warrants
On
April
27, 2007, the Company offered existing warrant holders an opportunity to
exercise their warrants at the reduced price of $0.50 per share. If all eligible
warrant holders were to exercise their warrants at the reduced price, the
Company would receive proceeds of approximately $4.3 million. The warrant offer
was originally set to expire on May 25, 2007, however on May 9, 2007, the
Company extended this reduced price offer until June 8, 2007. As of May 15,
2007, the Company amended the offer to grant the warrant holders, who tender
their warrants, additional shares of Common Stock if the Company enters
into any agreement for the sale of shares of Common Stock at less than $0.50
per
share prior to June 8, 2008. The offer expired on June 8, 2007, without any
of the warrant holders exercising at the reduced price.
$2.52
Million Private Placement
Between
June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
European institutional and private investors for the sale of 6,123,346 shares
of
the Company’s common stock at a purchase price of approximately $0.41 per share
in a private placement, for total proceeds of $2,517,710 before commissions.
As
a condition to the enforceability of these agreements against the Company,
the
investors were required to fund the purchase price in an escrow account, which
funds were received between June 19, 2007 and July 31, 2007.
As
part
of the sale, the Company issued warrants to purchase 1,530,827 shares of common
stock at an exercise price of $0.62 per share during the period of six months
to
sixty-six months subsequent to issuance. The warrants expire sixty-six months
after the date of issuance.
The
Company was obligated to file a registration statement with the SEC including
the common stock and the shares issuable upon exercise of the warrants within
90
days of the closing date. A Form S-3 registration statement, including these
shares and shares issuable upon exercise of the warrants, was filed by the
Company on October 18, 2007 and declared effective by the SEC on October 31,
2007. All the costs and expenses incurred in connection with the registration
of
the common stock and warrants are paid by the Company. The Company closed this
transaction on July 20, 2007 and August 20, 2007.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
Listing
of Common Stock on AMEX
On
June 15, 2004, the AMEX approved an application to list 46,518,898 shares
of our common stock under the symbol OTD. Subsequent to this date, the Exchange
has approved additional applications to list 72,830,013 more shares of our
common stock so that the total number of shares approved for listing is
119,348,911. Our shares began to trade on the Exchange on July 1,
2004.
The
Company's audited consolidated financial statements for the year ended
December 31, 2006, were prepared on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities and
commitments in the normal course of business. Our independent registered public
accounting firm included an explanatory paragraph in their report on the
December 31, 2006 audited consolidated financial statements to highlight
that the Company's accumulated losses and lack of available working capital
raised substantial doubt about the Company's ability to continue as a going
concern.
The
Company's unaudited consolidated financial statements for the three and nine
months ended September 30, 2007, have been prepared on a going concern basis,
which also contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. At September
30,
2007, the Company had working capital of $1,959,349, including $2,898,550 of
restricted cash, and had accumulated losses of $40,500,079.
The
Company was notified by the AMEX in December 2004 that it was not in
compliance with AMEX Company Guide Section 1003(a)(iii) which requires listed
companies to have at least $6.0 million of stockholders' equity when it has
sustained
losses from continuing operations and/or net losses in its five most recent
fiscal years
.
AMEX
indicated that, in order to return to full compliance, O2Diesel needed to
have
stockholders' equity of $6.0 million by June 2006 and to maintain this
level going forward.
In
accordance with the procedures of the Exchange, we filed a plan with it to
demonstrate the steps we would take to return to full compliance. On
February 15, 2005, the AMEX notified us that it had accepted our plan, and
that we would be given until June 2006 in which to regain compliance with
the Exchange's listing rules. To achieve that level of stockholders' equity,
we
anticipated having to raise a total of approximately $10.0 million in new
equity during 2005. In December 2005, the Company determined that it could
not meet certain conditions of the plan and met with representatives of the
AMEX
to discuss the need to develop an amended plan to demonstrate how the Company
would be in compliance by June 2006. During 2006, as part of its efforts to
meet these requirements, the Company closed an offer to existing warrant holders
to exercise their warrants at a reduced price for proceeds of approximately
$1.5
million (after expenses) and three private placements totaling
$7.5 million.
On
July
17, 2006, the Company received a letter from the AMEX indicating that the
Company had regained compliance with AMEX listing requirements. At December
31,
2006, the Company was in compliance with AMEX listing requirements, but for
the period ended March 31, 2007, the Company was not able to meet the
listing requirements. On June 29, 2007, the Company was notified by AMEX that
it
was not in compliance with the listing standards of the Exchange because it
lacked the requisite amount of stockholders' equity. The Company was asked
to
submit a plan by July 27, 2007 advising AMEX of actions the Company would be
taking to bring it into compliance with the continued listing standards by
December 29, 2008.
On
July
27, 2007, the Company filed a plan with the Exchange describing the steps it
plans to take to return to full compliance. The Company has entered into a
common stock purchase agreement with Fusion Capital
Fund
II,
LLC
to raise
up to $10 million in new equity over a twenty-five month period starting on
February 16, 2007. Also, the Company announced a private placement in which
we
raised an additional $2.52 million in July and August 2007. As noted below,
the
Company intends to raise additional new equity in conjunction with the
acquisition of the ProEco Energy Company. We believe these actions will enable
us to meet or exceed the equity requirements of the Exchange.
On
September 13, 2007, the Company received a written notice from the AMEX
indicating that AMEX had reviewed and accepted the Company’s plan to regain
listing qualifications compliance. With the acceptance of the plan, the Company
will be able to continue its listing during the plan period pursuant to an
extension granted until December 29, 2008. The AMEX notice also advised the
Company that, in addition to the previously disclosed deficiency with respect
to
Section 1003(a)(iii) of the AMEX Company Guide, it had triggered an additional
deficiency with respect to Section 1003(a)(ii) of the AMEX Company Guide
which
requires listed companies to have at least $4.0 million of stockholders' equity
when it has
sustained
losses from continuing operations and/or net losses in its four most recent
fiscal years
.
During
the interim period until December 29, 2008, the Company must continue to provide
AMEX staff with updates regarding initiatives set forth in its plan of
compliance. The Company will be subject to periodic review by AMEX staff during
the interim period. If the Company is not in compliance with the continued
listing standards on December 29, 2008, or the Company does not make progress
consistent with the plan during the interim period,
the
AMEX
would likely initiate procedures to de-list the Company's common stock. If
the
Company's common stock were to be de-listed by the AMEX, its shares would
continue to be traded as a bulletin board stock.
The
consolidated financial statements in this report do not include any adjustments
to reflect other anticipated private placements or the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result should management be unsuccessful
in obtaining financing on terms acceptable to the Company.
Operations
During
the third quarter of 2007, we continued our efforts to generate sales to our
targeted fleet customers in North America and Brazil, as well as our efforts
to
develop targeted demonstrations in Europe. At the same time, the Company
continued its relationship with its Asian partner, Energenics Pte Ltd
(“Energenics”) and expanded its sales in India.
In
Canada, we intend to focus our efforts on the country’s large population centers
in the Eastern and Western provinces, but until we have commercialized our
technology in the U.S., no significant resources will be devoted to
Canada.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
United
States:
Our
focus
for the U.S. has been 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
|
|
Municipal
transit and school bus fleets with an emphasis on public policy and
a
positive environmental image;
|
|
|
|
|
|
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;
and
|
|
|
|
Ø
|
|
Military
installations in non-combat
vehicles.
|
In
the
U.S., O2Diesel's third quarter sales and marketing efforts for fleet sales
were
focused in the state of California and in the Midwest. The Company maintained
commercial activities at the Port of Long Beach and continued to pursue
additional opportunities in this market segment. These efforts resulted in
the
addition of a third fleet operator at the Port. This customer is one of the
largest at the Port and its fuel requirements are expected to double the sales
of O2Diesel™ at the Port. The Company had previously received a letter from the
Port recommending the use of O2Diesel™ in any of the existing centrally fueled
fleets throughout the Port as part of its Green Port Policy and its Clean Air
Action Plan. The Company also continued with the expansion of its successful
test demonstration at a U.S. Air Force base in Nevada, both in the number of
vehicles to be used and the length of time the demonstration will now be
run.
The
Company previously concluded a successful test demonstration in Clark County,
Nevada which was devoted to documenting the reduced emission benefits of
O2Diesel™ over a range of temperatures and engine types as well as
demonstrations at a large coal mining operation in Wyoming and a municipal
waste
fleet in California.
We
also
continued to devote resources to our CityHome™ marketing program as a means of
documenting operating performance data. CityHome™ is a marketing and sales
initiative directed at municipal transit agencies in the United States as an
opportunity to improve air quality in urban locations. This program stresses
the
environmental benefits of our fuel and is designed to allow municipal transit
authorities to convert their fleets to O2Diesel™ without having to pay the
higher costs of our fuel.
Through
an innovative cost sharing concept with companies that wish to be good corporate
citizens (sponsors), we have designed a program which permits the municipalities
to purchase our fuel at costs which are the same as what they pay for regular
diesel fuel. Corporate sponsors, generally with a national or international
presence, will pay sponsorship fees to O2Diesel to take part in a clean air
program for one or more of the communities participating in a CityHome™ program.
In return for sponsorship payments, each sponsor will be given access to
currently unused advertising space on buses and other advertising assets owned
by the municipality. Sponsorship fees will become additional revenue for us
and
will be recognized as such when the related advertising is displayed and all
other criteria for revenue recognition have been met. Costs that are intended
to
be supported by the sponsorship fees are recorded separately in the related
expense line in our statement of operations. With regard to the advertising
space, since we have been unable to assess the fair market value of the
advertising space received, we assign no value to the space at the time of
the
receipt. We are recognizing the value associated with the advertising space
when
we enter into a contractual arrangement with a third party. The Company will
consider assigning a fair value to the advertising space received at the time
of
the initial sale when such fair value is more readily determinable, based upon
a
history of cash transactions.
In
the
third quarter of 2007, we had a CityHome™ installation with one municipal bus
fleet as well as several small school bus fleets in Chicago and South Dakota.
To
date, we have used this initiative as an important component of our
test/demonstration strategy and have been successful in attracting fuel
distributors to work with us in getting this initiative started. However, while
we have received sponsorship funding for several CityHome™ programs, the fleet
demonstrations executed under this program have required significant financial
support from the Company. As a result, we have limited new CityHome™ programs to
instances where we are assured of a level of sponsorship funding needed to
cover
all expenses of the demonstration. The Company’s future involvement with the
CityHome™ program has thus been reduced only to programs that can be consider to
be cost neutral. During the third quarter of 2007, we concluded our
demonstrations in Johnson County, Kansas and continued to run one CityHome™
fleet in Lincoln, Nebraska.
We
have
also expanded our efforts to establish and improve the logistics network
required for the delivery of O2Diesel™ to fleet and CityHome™ customers in the
third quarter of 2007. These efforts have centered on developing strategic
relationships with ethanol producers and distributors in order to improve both
quality consistency and price stability. As of September 30, 2007, the Company
had supply agreements in place with two ethanol industry groups to obtain a
supply of limited amounts of ethanol at preferential pricing for our Midwestern
customers.
In
addition, the Company continued to support its efforts to acquire an 80%
ownership share in ProEco, which has been planning to build a 100 million gallon
ethanol plant in South Dakota. Once this acquisition has closed and the plant
is
operational, it is expected that this facility will provide a reliable source
of
high quality, competitively priced ethanol for the Company to use in developing
the U.S. market. During the third quarter of 2007, the Company expanded its
support of ProEco to obtain options for land purchases, the submission of
permits for construction, the negotiation of an EPC contract, the negotiation
of
supply and transportation agreements and the development of marketing agreements
for sale of the ethanol to be produced at this facility.
During
the third quarter, the U.S. ethanol industry experienced several economic and
logistical challenges to the general expansion of production capacity. The
prices of various ethanol feedstocks, most notably corn, have increased while,
at the same time, ethanol prices have seen a general decline as new production
capacity comes on line. In addition, the demands on experienced EPC contractors
have increased, particularly with the need for qualified skilled labor to build
new plants. As a consequence, many new projects have experienced increased
construction costs and project delays at a time when the profitability of the
industry is being tested.
We
are
continuing our review of both the timing and scope of this project in light
of
the present industry environment. Our estimated timetable to obtain the
financing and start construction has now shifted to the first half of
2008.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
We
are
continuing a series of product tests and demonstrations that relate directly
to
obtaining regulatory approval forO2Diesel™ and which are designed to meet the
needs of our targeted customers. During the quarter ended September 30, 2007,
the Company continued its efforts to register O2Diesel™ fuel and fuel blends
with the EPA and has decided to alter its regulatory approval strategy in
California. The Company is now developing a revised series of tests to qualify
O2Diesel™ as a California Diesel Emissions Control Strategy only in conjunction
with various exhaust after treatment devices, such as Diesel Oxidation Catalysts
(DOC's) and Diesel Particulate Filters(DPF's), rather than as a standalone
fuel.
In
addition, we continued to develop a revised ballot for incorporation of
ethanol-diesel fuel as an American Society for Testing and Materials (ASTM)
specification. This revision is based on the results of the initial voting
on
the original ballot submitted in December 2006. A member of the Company serves
as the chairman of the subcommittee tasked with revising this ballot and it
is
expected to be resubmitted during the second half of 2007 so that it can be
discussed and voted on during the December 2007ASTM international
meeting.
Finally,
during the third quarter of 2007 we continued to develop contract proposals
for
submission to the DOE and the DoD to utilize the $2.0 million of available
appropriations approved in prior years. These appropriations were awarded for
the purpose of continued testing and verification of O2Diesel™, including the
requirements of both DECS and the U.S.
military.
In
September 2007, the Company announced that the Senate subcommittee had approved
additional DoD funding to continue demonstration tests of O2Diesel’s O28 fuel
blend at Nellis Air Force Base. The appropriations bill covering this funding
has now been sent on to be reconciled with the House Defense Appropriations
bill.
Brazil:
In
Brazil, O2Diesel is targeting customers on a very focused basis. In general,
these will be miller fleets (sugar and ethanol producers), municipal bus and
other fleets, and to a lesser extent centrally fueled truck fleets. The roll
out
of our product has been much slower than planned. Obtaining government approvals
and gaining market awareness has taken longer than we anticipated. In response
to these matters, we have made a decision to reduce our overhead and our
marketing plans until we have a solid base of customers in Brazil. During the
third quarter of 2007, we continued our support of one test fleet and continued
negotiations with a municipal bus fleet in Curitiba.
In
April,
2007, we announced the appointment of Fair Energy, S.A. as our distributor
for
several new markets in Central and South America. Demonstration programs in
Columbia, Paraguay and Bolivia are targeted by the Company over the next several
quarters. The first of these demonstrations will be initiated in the fourth
quarter of 2007 in Asunción, Paraguay’s capital.
Europe:
During
the third quarter of 2007, we pursued discussions and initiatives in Europe
to
test our fuel and to determine the market size and regulatory hurdles to be
overcome to gain wider acceptance of our fuel in Europe. As of September 30,
2007, the Company had identified two municipal transit fleets, a waste fleet
and
a port facility that were interested in evaluating O2Diesel™ fuel. The Company
recently announced that it had received regulatory approval in France to begin
testing O2Diesel™ in a large transit system in Angouleme in the Bordeaux region
of France. This demonstration has now started and we expect these activities
to
develop into additional demonstration programs over the next several
months.
In
addition, the Company announced that it will commence its first demonstration
in
Spain with Tussam (Transportes Urbanos De Sevilla Sociedad Anonima Municipal),
who operates the collective urban transport system in Seville.
Asia:
In
Asia,
the company that serves as our exclusive distribution agent announced that
it
had concluded a successful trial demonstration of the fuel and we commenced
supplying the first 2,500 buses of a large municipal fleet in Karnataka, India.
Expanded fueling of this fleet continued during the third quarter of 2007 and
it
is anticipated that all 17,000 buses in this fleet will be running on our fuel
by the end of the second quarter of 2008. In addition, the Company recently
announced that O2Diesel and Energenics have formed a joint venture to secure
Energenics’ rights to our fuel technology in the Asian region and to expand the
development of this market.
Technical
and Logistical Issues
Significant
technical and logistical issues continued to affect our ability to generate
sales in the third quarter of 2007. While we have made substantial progress
in
addressing these challenges over the course of the year, they have continued
to
impede our efforts to commercialize O2Diesel™ fuel. In general, these challenges
fall into the following categories: (1) logistics of delivering and dispensing
O2Diesel™, (2) obtaining consistent high quality fuel grade ethanol at
competitive prices and (3) acquiring regulatory approval and an industry
accepted specification for our “e-diesel” (ethanol-diesel) fuel. O2Diesel has
devised several strategies to meet these challenges and has undertaken a variety
of activities to overcome them and to position O2Diesel™ as a premium
clean-burning fuel.
Logistics
Under
the
first element of our strategy, we have signed distribution agreements with
fourteen jobbers, who in turn have centrally fueled fleets as their customers.
We sell additive to these jobbers and assist them in purchasing ethanol by
either locating ethanol suppliers or purchasing and reselling ethanol to them.
However, we will only purchase ethanol as an accommodation to a jobber, because
we do not wish to tie-up our limited working capital to finance the purchases
of
ethanol. The jobbers blend our additive and ethanol with diesel fuel and then
sell O2Diesel™ to their customers. O2Diesel's sales force and technical staff
work jointly with each jobber and the jobber's customers to assist in the
transition from the use of regular diesel fuel toO2Diesel™. A key part of
working with each jobber and its customers is to provide safety and training
materials covering the use of the fuel. In addition, O2Diesel's technical staff
works closely with each customer in the process of purchasing and installing
flame arrestors and other devices for customer vehicles and storage facilities.
In some cases, we are responsible for sourcing and installing these devices
while, in other cases, our technical staff will only have an oversight role.
Finally, our technical staff will work with the customer to insure that its
storage facilities are clean and are compatible for storing and dispensing
O2Diesel™.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
Our
sales
strategy is to market and sell O2Diesel™ directly to companies, governmental
port facilities and others that operate large centrally fueled fleets. These
customers may include large truck and bus fleets, construction municipalities,
and mining companies as well as port cargo handling facilities and agricultural
users. To date, these customers have only included centrally fueled truck fleets
and cargo handling facilities at a major port. In these transactions, the
Company will maintain a similar working relationship with the customer's
blending facilities and staff as it does with third party jobbers.
Secondly,
as part of the process by which O2Diesel™ was approved for sale in California,
the California Air Resources Board set a number of conditions that we must
adhere 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 case a spark or other type of ignition might
inadvertently enter the fill inlet of a fuel tank. Imposing this requirement
proved to be a serious issue prior to 2006, and was a serious challenge to
our
ability to effectively commercialize our technology in the U.S. Even though
flame arrestor technology has been used for many years in other applications,
flame arrestors in the required sizes and designs were not yet available as
an
“off the shelf item” for use with O2Diesel™ during this time. At the beginning
of 2007, the flame arrestor challenge had been largely resolved for the vehicles
within O2Diesel's target markets.
A
third
concern we have relates to the logistics and storage of O2Diesel™ for fleets and
other diesel equipment that may use the fuel. In particular, it is very
important that storage tanks be cleaned prior to the introduction of O2Diesel™
into the customer's refueling station. We have made important strides in working
with customers to insure that their storage facilities are compatible with
O2Diesel™ and have now included this step as a critical component of our
implementation planning process.
The
Company has taken several steps prior to 2007 to overcome these problems and
to
support the introduction of O2Diesel™ fuel to new customer opportunities. First,
we assembled our knowledge and documentation regarding the design requirements
of flame arrestors in the market areas we served and developed a catalogue
of
flame arrestors and parts that can be used for a wide variety of engine/vehicle
types and customer applications. Second, we developed a checklist of procedures
to be used by our technicians (in conjunction with our customer) that enabled
our technicians to prepare a comprehensive fleet profile of hardware
requirements, tank cleaning procedures and the time required to perform the
work
necessary to bring a fleet on-line. Third, we have identified several equipment
vendors who we plan to work with so that needed equipment can be delivered
to
customer locations quickly and at competitive prices. Fourth, we have developed
a training program that will enable our
technicians
to teach our customers' fleet maintenance staff about handling and storing
O2Diesel™ fuel, fleet modification and maintenance issues that can be expected.
Finally, we have developed a modest parts inventory at our laboratory facility
so that in the event of an emergency, required parts can be supplied to our
customers.
Our
present planning methodology is based on a mutually agreed upon implementation
time frame that requires the project to be a joint effort utilizing
the
customer's
employees and identifies the timing and costs that the customer can expect.
During 2005 and 2006, we continued the research and development efforts begun
in
2004 to design and to identify flame arrestors, adaptors and other equipment
for
vehicles that use O2Diesel™. Where required, these devices have undergone and
passed tests to insure that they are capable of complying with all required
specifications. In addition, we have learned that certain engines require the
fitting of a primer pump to insure that the vehicle starts and 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 has, in
some cases, increased our costs as well as the time required to transition
a
fleet from using regular diesel fuel to the use of O2Diesel™.Lastly, in some
buses, we have had to install safety fueling devices in the fuel inlet that
serve the function of flame arrestors, but are generally more expensive. These
particular devices are readily available in the market. To support our
implementation efforts, we commissioned a third party engineering consulting
firm to review our written safety training procedures as well as to conduct
on-site reviews of four of our customer locations in order to evaluate the
adequacy of the training and the quality of safety procedure implementation.
The
ensuing report from the consultant indicated that our safety program
requirements were well conceived and were being followed quite closely at all
locations. Additional safety procedures to enhance this program are currently
being evaluated.
In
the
past, these issues have led to greater lead times than expected to convert
fleets from using regular diesel to O2Diesel™. In fact, we have seen that the
time it takes to do the conversion work can be the most important factor in
bringing on more customers to use our fuel. As a means of mitigating the time
required for converting a fleet, we have sought to have our customers complete
much of this work under our direction. However, this policy is dependent upon
obtaining an agreement from the customer to do the work. The actual time
required to convert a fleet to use O2Diesel™ may be further limited by the
availability of the customers' vehicles to be in one place long enough to effect
the required changes. In some cases for safety, insurance or union reasons,
customers will require that they complete all of the work necessary for their
vehicles and diesel powered equipment to use O2Diesel™, as well as arranging to
insure that their storage and dispensing facilities are compatible with the
use
of the fuel.
The
Company has made significant progress in addressing these key logistical issues
over the past several years and we now feel that we can provide the necessary
support to our customers both before and during implementation of our fuel
in
their fleets. The Company anticipates that the work achieved prior to 2007
with
all of these implementation factors will allow us to avoid the costs and delays
we experienced in the past.
Ethanol
Supply
Our
experience has demonstrated that it is important to carefully select ethanol
suppliers because there is a wide range of fuel grade ethanol in the
marketplace. It is critical that the ethanol component of O2Diesel™ be of a
consistently high quality and that it meet certain other specifications.
Selection of ethanol suppliers and creating a relationship with those that
can
provide the quality of product we require is a significant need, and is a task
that we will devote more time to during the remainder of 2007. We are currently
working closely with the industry to identify ethanol suppliers who meet
our criteria. As of September 30, 2007, we had continued to maintain contracts
with two ethanol industry groups to provide a supply of limited amounts of
ethanol at preferential pricing for our Midwestern customers.
In
order
to insure fuel quality, we have developed a quality control function that
constantly tests the ethanol used by all customers. In addition, we have learned
that it is necessary to test the quality of diesel blended with our additive
and
ethanol. Establishing our own laboratory facility has been a significant help
to
us in developing quality control standards, and for carrying out the tests
that
are necessary in preparing a fleet for conversion to use O2Diesel™.
Additionally, the Company has installed several testing devices in the field
so
that samples can be evaluated more efficiently than with a centralized
laboratory alone. None of these tests are time consuming or technically
difficult, but they are critical to ensuring that our product functions as
intended. As we gain more experience, it may not be necessary to conduct the
level and frequency of tests that we expect to do over this coming
year.
The
Company has seen that even with a reliable supplier, the price of ethanol can
be
volatile as a result of a number of factors, such as the overall supply and
demand, the level of government support, and the availability and price of
competing products. For example, many petroleum refiners have recently replaced
methyl tertiary butyl ether (MBTE) in gasoline with ethanol during the second
quarter of 2006. The replacement of this ingredient in gasoline has caused
the
demand for ethanol to increase dramatically, with a corresponding increase
in
its price. A benefit of this phenomenon has been to increase the availability
of
ethanol at petroleum terminals when compared to the recent past. However, the
rise in the cost of ethanol has made the price of O2Diesel™ fuel increase in
relation to conventional diesel fuel during the first half of 2007. In the
short
term, it is the Company's strategy to contract with third parties to help
control the costs of ethanol and reduce short-term exposure to price
fluctuations by continuing our contracts with the ethanol industry groups for
limited amounts of ethanol at preferred prices.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
In
the
longer term, the Company has seen the clear advantage represented by
partnerships with distributors who have access to high quality, price
competitive ethanol in the local market. In this regard, our partnership with
Energenics in Asia, Abengoa in Europe and Fair Energy in South America have
provided significant support to our efforts to blend O2Diesel™ fuel at prices
that are competitive with conventional diesel fuel in the markets we are
entering. For this same reason, we have decided to acquire ProEco Energy so
that
we can have a similar quality and price advantage with our ethanol supply in
the
United States.
As
a
result of these efforts, the Company believes it has both an interim and
long-term strategic opportunity to achieve a supply of high quality, price
competitive ethanol among its key markets,
Regulatory
Approval
As
outlined in “Research and Development”, the Company must obtain regulatory
approvals at a number of levels in order to be able to sell commercial
quantities of O2Diesel™ in the United States. These approvals involve the
Environmental Protection Agency (EPA) at the federal level, the California
Air
Resources Board (CARB) at the state level and the American Society for Testing
Materials (ASTM) at both a military and industry level. The process of acquiring
these approvals requires significant testing for emissions, impact to the
environment, safety, performance and engine warranty considerations among a
broad range of engine types and ages. In some cases, existing regulations or
the
interpretation of the requirements to meet these regulations can change over
the
testing periods, either because of new legislation, additional technical data
in
the industry or the agencies' understanding of the technology they are
evaluating. Such changes can add significant time to completing the required
testing, either through changes in protocols or additional tests to be
performed. While the Company has achieved important verification of its
technology among these various agencies, the time and expense required to obtain
final approval remains quite lengthy. Our experience in Europe has been similar,
indicating that final regulatory approval here will also take additional time.
In Asia and South America, similar approvals need to be obtained, but we are
able to rely on our strategic partners in these areas to assist us in obtaining
the appropriate regulatory permission to sell our fuel.
The
technical challenges in the past year have presented significant hurdles to
commercializing our technology. In most cases, we have overcome these obstacles
by the application of technical resources, payments to support our customers
and
a high level of customer service. All of this has been time-consuming and has
slowed our ability to bring our product to market. But it has also created
a
base of knowledge which is helpful as we continue our efforts to commercialize
our technology. We have been encouraged by the fact that among our customers,
we
have a municipal bus fleet and a port facility that have been successfully
utilizing the fuel for more than one year. Even though we have gained a
significant amount of technical knowledge, we will continue to refine our
efforts in this area in order to improve our ability to bring on greater numbers
of customers and to better predict the cost and timing of the work required
to
have fleets conform to the requirements of using our product.
Third
Quarter Summary
Operating
results
for the
nine month period ended September 30, 2007 showed mixed results compared to
those during the nine month period ended September 30, 2006.
Sales
in the
first nine months of 2007 more than doubled to $304,126, from $141,201 in the
comparable 2006 period, primarily due to several major shipments of additive
to
our Asian distributor.
Cost
of goods sold
increased by $132,342 reflecting a combination of the increased sales activity
and higher raw material costs causing the gross margin percentage to be
approximately 7.4% lower compared to the nine months ended September 30, 2006.
ProEco
operating expenses
increased by $327,216 as, pursuant to the requirements of FIN 46R discussed
previously, ProEco was consolidated with O2Diesel beginning in the third quarter
of 2007.
Selling
and marketing
expenses
for the nine months ended September 30, 2007 were $239,488 higher than the
comparable 2006 period, primarily reflecting higher sales and marketing costs
at
the Spanish subsidiary which was in start-up mode in the latter half of last
year.
Product
testing and government grant expenses (net)
in the
nine months ended September 30, 2007 were $646,148 higher than in the period
ended September 30, 2006 due to the combination of a $209,113 increase in
research and development costs associated with the Spanish subsidiary offset
by
the $437,035 decrease in net government contract billing activity.
General
and administrative
expenses
for the nine months ended September 30, 2007 were $307,758 lower than for the
comparable 2006 period primarily due to a $1.4 million decrease in FAS 123(R)
stock compensation expense attributable to a cumulative adjustment of $1.6
million in 2006. These savings were largely offset by higher 2007 expenses
related to share issuance costs for investor relations firms ($391,603),
severance pay ($282,604), an officer’s restricted stock award ($273,299) and the
use of additional accounting consultants related to the ProEco transaction
($267,901).
Cash
Requirements, Liquidity and Risk Factors
Based
on
our projected level of expenses and the cash on hand as shown on our
consolidated balance sheet at September 30, 2007, we will need to raise
additional funds in 2007. Even with the capital raised in 2006 and 2007, we
believe it will be necessary to raise additional funds in 2007 to allow us
to
execute our business plan and to be in compliance with the AMEX's listing
standards.
To
date,
we have not had any bank trade facilities, except an overdraft line in the
U.K.
used to meet operating needs and a small vehicle loan. This overdraft facility
was repaid and canceled during 2003 and the vehicle loan was paid off in
November 2005. 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. In the third quarter of 2007, the Company
continued to have favorable trade terms with its supplier, Cognis Deutschland
GmbH (“Cognis”) for the supply of additive.
AMEX
requires that minimum levels of stockholders' equity be maintained. In December,
2004, the Company was notified that it was not in compliance because its
stockholders’ equity had dropped below the required minimums, and it had
experienced continuing losses for the past four years. In order to return to
full compliance, O2Diesel needed to have stockholders' equity of
$6.0 million by June 2006 and maintain this level going forward. In
accordance with the procedures of the AMEX, we filed a plan (“Plan”) with it to
demonstrate the steps we will take to return to full compliance. On
February 15, 2005, the AMEX notified us that it had accepted our Plan, and
that we would be given until June 2006 in which to regain compliance with the
AMEX's listing rules. To achieve that level of stockholders' equity, we
anticipated having to raise a total of approximately $10.0 million in new
equity during 2005. In December 2005, the Company determined that it could
not
meet certain conditions of the plan and met with representatives of the AMEX
to
discuss the need to develop an amended plan to demonstrate how the Company
would
be in compliance by June 2006. During 2006, as part of its efforts to meet
these requirements, the Company closed an offer to existing warrant holders
to
exercise their warrants at a reduced price for proceeds of approximately $1.5
million (after expenses) and three private placements totaling $7.5
million.
On
July
17, 2006, the Company received a letter from the AMEX indicating that the
Company had regained compliance with AMEX listing requirements. At December
31,
2006, the Company was in compliance with AMEX listing requirements, but as
of
March 31, 2007, the Company was not able to meet the listing requirements.
On
June 29, 2007, the Company was notified by AMEX that it was not in compliance
with the listing standards of the Exchange because it lacked the requisite
amount of stockholders' equity. The Company was asked to submit a plan by July
27, 2007 advising AMEX of actions the Company would be taking to bring it into
compliance with the continued listing standards by December 29,
2008.
On
July
27, 2007, the Company filed a plan with the Exchange to describe the steps
to be
taken to return to full compliance. The Company has entered into a common stock
purchase agreement to raise up to $10.0 million in new equity over a
twenty-five month period starting on February 16, 2007. Also, the Company
announced a private placement in which we raised an additional $2.52 million.
The Company intends to raise additional new equity in conjunction with the
acquisition of ProEco. We believe these actions will enable us to meet or exceed
the equity requirements of the Exchange.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007
As
a
result of the lack of a sales history for our products, we do not have
sufficient historical financial data for any periods on which to accurately
forecast future revenues or operating expenses in connection with achieving
such
revenues. As such, we are not able to project with certainty the additional
funds that may need to be raised. In 2005, we raised new equity of approximately
$11.1 million, before payment of expenses. As stated previously, even with
the fund raising completed in 2005, and the $8.7 million raised during 2006
and
the $2.8 million raised in the first nine months of the current year, we will
need to raise additional equity in 2007. We continue to hold discussions with
a
number of potential investors and work with a professional investor relations
service company to assist with these efforts. In connection with our efforts
to
attract new investment, there can be no assurance that we will be successful
in
doing so. Nor can there be any assurance that the Company will generate sales
and sponsorship fees followed by the collection of cash to offset our operating
expenses.
As
shown
in the consolidated statements of operations contained in this report, we have
generated only $123,128 and $304,126 in sales and had sponsorship income of
$1,875 and $21,375 associated with the CityHome™ programs for the three and nine
months ended September 30, 2007, respectively. As of the date of this report,
excluding orders from Energenics, we have only minimal orders on hand for either
O2D05 or O2Diesel™. Lastly, there can be no assurance that actual events will
not differ from those anticipated, or that general economic conditions may
not
vary significantly in ways that could negatively impact our operations and
cash
position.
Research
& Development
The
Company has 81 patents granted or applications pending for nine different
proprietary fuel and additive product inventions registered with the
international WIPO (PCT) Registration System. Six inventions currently have
38
patents granted, and 22 applications pending, in 22 different countries in
Europe, North America, South America and Asia. An additional three other
inventions have 21 patent applications pending which are undergoing examination
at the national level in 16 different countries. If patent applications for
these latter three inventions are granted, we expect to immediately file related
patent applications in several European, South American and Asian countries.
During this period, O2Diesel's intellectual property rights over its additive
products are protected through its registration with the WIPO (PCT) Registration
System and its pending national patent applications.
As
part
of our cooperation agreement with Cognis, we, along with Cognis, are the joint
owners of all patents covering both the use and composition of O2D05. All legal
costs associated with preparing, filing and administering the jointly owned
patents are shared equally by the Company and Cognis. We also have a number
of
patents that have been issued that relate to the predecessor technology of
O2D05. As a strategic measure, we continue to fund all costs necessary to
maintain some of these patents. O2Diesel is the sole owner of these latter
patents, which in general cover the use and composition of its prior generation
technology.
We
have
registered a trademark in the U.S. and the European Union for a mark which
includes the words and numbers O2Diesel™ as well as a figurative logo of the
words. We also registered trademarks for “CityHome” (and design) in eight
classes of goods and services, “TODAY'S CLEAN AIR SOLUTION TOMORROW'S BRIGHTER
FUTURE” and “CITYHO2ME”, each covering one class of goods and
services.
The
Company has incurred substantial costs in carrying out tests to demonstrate
that
the use of our product will enable customers to comply with environmental laws
and regulations. As of September 30, 2007, we incurred external expenses of
$650,202 during 2007 in the U.S. in connection with governmental sponsored
projects and tests. Most of the costs incurred in these government test
programs will be reimbursed by appropriations from the U.S.
Departments of Energy and Defense.
At
the
end of the third quarter of 2007, we had government test programs in progress
with total remaining costs to complete of approximately $1.3 million. Under
these programs, a wide array of engine tests and product demonstrations are
to
be conducted to further prove the emissions benefits of O2Diesel™ and to show
that the fuel performs well in specific applications.
Included
in the foregoing programs are a number of emissions validation and verification
projects as well as fleet demonstrations. All of the verification and validation
programs are complicated and may take considerable time to complete. Finishing
the protocols to allow O2Diesel™ to be classified as a Diesel Emission Control
Strategy fuel by the California Air Resources Board and registering the fuel
with the EPA so that the emissions benefits can be quantified in their testing
protocols are critical to our success. At this point, we are at an early stage
so that it is not possible to predict when this work will be completed or if
we
will obtain the desired results once it is completed. We are also working with
the military on a procurement specification for O2Diesel™ alone or in
combination with up to 20% biodiesel which should be completed this year. Based
on the government funding in place, we believe that approximately 80% of the
costs to conduct these tests and field demonstrations may be funded by
appropriations from the U.S. Departments of Energy and Defense.
We
have
generated several successes in our fleet demonstration projects. These fleets
are key to developing the no harm field experience necessary to demonstrate
the
commercial value of the fuel. Based upon its positive experience at Nellis
Air
Force base, the U.S. Air Force has expanded product demonstrations in Nevada
to
test O2Diesel™ with 20% biodiesel in twice the number of non-tactical military
vehicles that were used in the original test fleet. O2Diesel™ is also conducting
demonstrations with a number of school bus and transit agencies. In order to
demonstrate the fuel’s capability in a broad array of conditions, O2Diesel™ and
O2Diesel™ blended with up to 20% biodiesel are in fleets containing assorted
engine types and uses and facing various weather conditions. We are continuing
to refine our additive formulations in order to reduce their costs and increase
their performance. In this regard, we have registered a second additive package
with the Environmental Protection Agency that accomplishes both goals.
Additionally we have formulated and field tested cold weather and detergent
containing fuel formulations which are working as intended. We expect this
work
to continue in 2007 and 2008.
Employees
As
of
September 30, 2007, O2Diesel had fifteen full-time employees of which fourteen
are in the U.S. and one is in Europe. We had one part-time employee. Currently,
we rely on consultants to assist in commercializing our technology and to help
us in key technical areas. At present, we employ seven consultants in the U.S.:
three in marketing and business development; one laboratory technician, one
chemist and two in regulatory affairs. The Company has entered into separate
consulting contracts with two shareholders of its Brazilian subsidiary for
the
purpose of providing office rent and administrative services and in lieu of
employment contracts with these two individuals. In Europe, we employ two
consultants, one for general management and business development and one for
regulatory affairs.
We
will
add new personnel in 2007 based on the pace of our commercialization. Under
our
business plan, we do not see the need to add employees in the U.S. or Brazil,
but we do plan to add technical positions for our European market testing and
development in 2007. We anticipate continuing to employ a total of eleven
consultants serving in most of the same capacities in 2007.
O2Diesel
Corporation
(A
Development Stage Company)
September
30, 2007