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