Form 10-Q CLEAN DIESEL TECHNOLOGIE For: Sep 30

UNITED STATES

�SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

For the quarterly period ended September 30, 2014

or

For the transition period from ��������������������� to��������������������

Commission File Number: 001-33710

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CLEAN DIESEL TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

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1621 Fiske Place

Oxnard, CA� 93033

(Address of principal executive offices) (Zip Code)

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Registrant�s telephone number, including area code:� (805) 639-9458

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������� Indicate by check mark whether the registrant (1)�has filed all reports required to be filed by Section�13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12�months (or for such shorter period that the registrant was required to file such reports), and (2)�has been subject to such filing requirements for the past 90�days. �������������������� ����������������������������������������������� Yes� � No� o

������� Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule�405 of Regulation�S-T (232.405 of this chapter) during the preceding 12�months (or for such shorter period that the registrant was required to submit and post such files). ������������ Yes� � No� o

������� Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of �large accelerated filer,� �accelerated filer� and �smaller reporting company� in Rule�12b-2 of the Exchange Act. (Check one):

Large Accelerated filer ��o����������Accelerated filer����o�����������Non-accelerated filer���o����������Smaller reporting company �

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule�12b-2 of the Exchange Act). �� �Yeso No�� ��

As of October 31, 2014, the outstanding number of shares of the registrant�s common stock, par value $0.01 per share, was 12,536,071.�

CLEAN DIESEL TECHNOLOGIES, INC.

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

������� As used in this Quarterly Report on Form 10-Q, the terms �CDTi� or the �Company� or �we,� �our� and �us� refer to Clean Diesel Technologies, Inc. and its consolidated subsidiaries.

������� This Quarterly Report on Form�10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, adopted pursuant to the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties, as well as assumptions, which could cause our results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements generally are identified by the words �may,� �will,� �project,� �might,� �expects,� �anticipates,� �believes,� �intends,� �estimates,� �should,� �could,� �would,� �strategy,� �plan,� �continue,� �pursue,� or the negative of these words or other words or expressions of similar meaning. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements. These forward-looking statements are based on information available to us, are current only as of the date on which the statements are made, and are subject to numerous risks and uncertainties that could cause our actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, the forward-looking statements. For examples of such risks and uncertainties, please see the discussion under the caption �Risk Factors� contained in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the �SEC�) on March 31, 2014 and important factors discussed in this report and our other filings with the SEC, including without limitation the following:

���������� We have incurred losses, have not experienced positive cash flows from operations in the past and our independent registered public accounting firm expressed substantial doubt about our ability to continue as a going concern in their report on our financial statements for the period ended December 31, 2013. Our ability to achieve profitability and positive cash flows from operations, or finance negative cash flow from operations, could depend on reductions in our operating costs, which may not be achievable, or from increased sales, which may not occur;

���������� We could require additional working capital to maintain our operations in the form of funding from outside sources which may be limited, difficult to obtain, or unavailable on acceptable terms or not available at all, or in the case of an offering of common stock or securities convertible into or exercisable�for�common stock, may result in dilution to our existing stockholders;

���������� The pursuit of opportunities relating to special government mandated retrofit programs requires cash investment in operating expenses and working capital such as inventory and receivables prior to the realization of profits and cash from sales and, if we are not successful in accessing cash resources to make these investments, we may miss out on these opportunities; further, if we are not successful in generating sufficient sales from these opportunities, we will not realize the benefits of the investments in inventory, which could have an adverse effect on our business, financial condition and results of operations;

���������� We cannot assure you that we will be successful in realigning our strategic path to pursue aggressive development of our unique materials science platform or that those efforts will have the intended effect of increasing profitability;

���������� Historically, we have been dependent on a few major customers, particularly Honda, for a significant portion of our revenue and our revenue would decline if we are unable to maintain those relationships, if customers reduce their orders for our products, or if we are unable to secure new customers. In addition, we have an expired agreement with Honda that may limit our rights to commercialize certain technology within the scope of that agreement and adversely affect our technology licensing strategy;

���������� We may not be able to successfully market new products that are developed or obtain verification or approval of our new products;

���������� We have entered into contractual agreements in connection with the sale of certain of our assets, which may expose us to liability for claims for indemnification under such agreements; and

���������� We depend on intellectual property and the failure to protect our intellectual property could adversely affect our future growth and success.

������� You should not place undue reliance on any forward-looking statements. Except as otherwise required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to other forward-looking statements.

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CLEAN DIESEL TECHNOLOGIES, INC.

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(In thousands, except share and per share amounts)

(Unaudited)

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See accompanying notes to condensed consolidated financial statements.

(In thousands, except per share amounts)

(Unaudited)

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See accompanying notes to the condensed consolidated financial statements.

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(In thousands)

(Unaudited)

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See accompanying notes to the condensed consolidated financial statements.

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1.������ Organization�

a.������ Description of Business

������� Clean Diesel Technologies, Inc. (�CDTi� or the �Company�) is a global manufacturer and distributor of heavy duty diesel and light duty vehicle emissions control systems and products to major automakers and retrofitters. CDTi�s business is driven by increasingly stringent global emission standards for internal combustion engines, which are major sources of a variety of harmful pollutants. The Company has operations in the United States, Canada, the United Kingdom, France, Japan and Sweden as well as an Asian investment.

b.������ Liquidity�

������� The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. Therefore, the consolidated financial statements contemplate the realization of assets and liquidation of liabilities in the ordinary course of business. The Company has suffered recurring losses and negative cash flows from operations since inception, resulting in an accumulated deficit of $188.3�million at September�30, 2014. The Company has funded its operations through equity sales, debt and bank borrowings.

������� The Company has a $7.5 million secured demand facility backed by its receivables and inventory with Faunus Group International, Inc. (�FGI�). At September 30, 2014, the Company had $2.9 million in borrowings outstanding under this facility with $4.6 million available, subject to the availability of eligible accounts receivable and inventory balances for collateral. There is no guarantee that the Company will be able to borrow to the full limit of $7.5 million if FGI chooses not to finance a portion of its receivables or inventory. Additionally, FGI can cancel the facility at any time.

������� On May 15, 2012, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (�SEC�) (the �Shelf Registration�), which was declared effective by the SEC on May 21, 2012. The Shelf Registration permits the Company to sell, from time to time, up to an aggregate of $50.0 million of various securities, provided that the Company may not sell its securities in a primary offering pursuant to the Shelf Registration or any other registration statement on Form S-3 with a value exceeding one-third of its public float in any 12-month period (unless the Company�s public float rises to $75.0 million or more).

������� On July 3, 2013, the Company sold 1,730,000 units pursuant to the Shelf Registration for $1.25 per unit, with each unit consisting of one share of common stock and one half of a warrant to purchase one share of common stock with an exercise price of $1.25 per share. The Company received net proceeds of $1.7 million after deducting discounts and commissions to the underwriter and offering expenses. In the first quarter of 2014, warrant holders exercised an aggregate of 800,000 of the warrants issued in the offering at an exercise price of $1.25 per share for proceeds of $1.0 million.

������� On March 21, 2014, the Company and Kanis S.A. entered into a letter agreement whereby Kanis S.A. agreed not to accelerate the maturity of the Company�s 8% subordinated convertible notes (the �Convertible Notes�) due 2016 prior to July 1, 2015. See Note 8 for additional information on the Convertible Notes.

������� On April�4, 2014, the Company sold 2,030,000 units pursuant to the Shelf Registration for $3.40 per unit, with each unit consisting of one share of common stock and 0.4 of one warrant to purchase one share of common stock with an exercise price of $4.20 per share. The Company received net proceeds of $6.1 million after deducting placement agent fees and other offering expenses. See Note 9 for additional information.

������� On October 20, 2014, the Company completed the sale of its Reno Business for approximately $1.3 million in cash, subject to certain working capital adjustments to be reviewed during the 60 day period following the sale date. See Notes 2, 15 and 16 for additional information.

������� On November�4, 2014, the Company entered into subscription agreements to sell 1,385,000 shares of common stock, warrants to purchase up to an aggregate of 388,393 shares of common stock with an exercise price of $3.25 per share (the �Series A Warrants�), for a combined purchase price of $2.80 per share and 0.28 of one Series A Warrant and other warrants to purchase up to an aggregate of 168,571 shares of common stock with an exercise price of $0.01 per share (the �Series B Warrants�) for a purchase price of $2.79 per Series B Warrant, pursuant to the Shelf Registration. The Company expects to receive net proceeds of approximately $3.8 million after deducting placement agent fees and other estimated offering expenses. See Note 16 for additional information.

������� At September 30, 2014, the Company had $4.9 million in cash. Based on the Company�s current cash levels, the net�proceeds from its recent offerings and expected cash flows from operations, management believes that the Company will have access to sufficient working capital to fund operations through the end of this year and into next year. However, there can be no assurances that the Company will be able to achieve projected levels of revenue and maintain access to sufficient working capital. If cash from operations is not sufficient for the working capital needs of the Company, the Company may be forced to seek additional financing in the form of funding from outside sources. However, there is no assurance that the Company will be able to raise additional funds or reduce its discretionary spending to a level sufficient for its working capital needs.

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d.������ Concentration of Risk

������� For the periods presented below, certain vendors accounted for 10% or more of the Company�s raw material purchases as follows:

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e.������� Net Loss per Share

������� Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of common shares and dilutive potential common shares. Dilutive potential common shares include employee stock options and restricted share units (�RSUs�) and warrants and debt that are convertible into the Company�s common stock.

������� Diluted net loss per share excludes certain dilutive potential common shares outstanding as their effect is anti-dilutive. Because the Company incurred net losses in the three and nine months ended September 30, 2014 and 2013, the effect of potentially dilutive securities has been excluded in the computation of net loss per share as their impact would be anti-dilutive. Potentially dilutive common stock equivalents excluded were 2.4 million and 3.2 million shares during the three months ended September 30, 2014 and 2013, respectively. Potentially dilutive common stock equivalents excluded were 2.2 million and 2.6 million shares during the nine months ended September 30, 2014 and 2013, respectively.��

f.�������� Fair Value Measurements

������� The Company measures certain financial assets and liabilities at fair value in accordance with a hierarchy which requires an entity to maximize the use of observable inputs which reflect market data obtained from independent sources and minimize the use of unobservable inputs. There are three levels of inputs that may be used to measure fair value:

��������� Level 1: Quoted prices (unadjusted)�in active markets for identical assets or liabilities;

��������� Level 2: Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable including quoted prices for similar instruments in active markets and quoted prices for identical or similar instruments in markets that are not active; and

��������� Level 3: Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.

The Company records its liability-classified warrants at fair value in accordance with the fair value measurement framework. See Note 10 for further information on these liability-classified warrants. The valuation inputs hierarchy classification for the warrant liability measured at fair value on a recurring basis is summarized as follows (in thousands):��

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g.������ Fair Value of Financial Instruments

������� Accounting Standards Codification (�ASC�) Topic 825, �Financial Instruments,� requires disclosure of the fair value of financial instruments for which the determination of fair value is practicable.�The fair values of the Company�s cash, trade accounts receivable, prepaid expenses and other current assets, accounts payable and accrued expenses and other current liabilities approximate carrying values due to the short maturity of these instruments. The fair value of borrowings under the line of credit approximates their carrying value due to the variable interest rates. The fair value of shareholder notes payable calculated using level 3 inputs, using a Black-Scholes option-pricing model to value the debt�s conversion factor and a net present value model was $7.6 million and�$7.5 million�at September 30, 2014 and December 31, 2013, respectively.

h.������ Reclassifications�

������� Certain prior-period amounts have been reclassified to conform to the current period presentation. These changes had no impact on the previously reported consolidated results of operations or stockholders' equity.

i.�������� Recent Accounting Pronouncements�

������� In April 2014, the Financial Accounting Standards Board (�FASB�) issued Accounting Standards Update (�ASU�) No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity". ASU 2014-08 raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. It is effective for annual reporting periods beginning on or after December 15, 2014. Early adoption is permitted but only for disposals that have not been reported in financial statements previously issued. The Company has not elected to early adopt, and it�does not expect the impact of the adoption of ASU 2014-08 to be material to its consolidated financial statements.

������� In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers". ASU 2014-09 supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)". ASU 2014-09 requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. It is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. ASU 2014-09 provides for either full retrospective adoption or a modified retrospective adoption by which it is applied only to the most current period presented. Early adoption is not permitted. The Company is currently in the process of evaluating the impact of the adoption of ASU 2014-09 on its consolidated financial statements.

������� In August 2014, the FASB issued ASU No. 2014-15, �Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity�s Ability to Continue as a Going Concern�. ASU 2014-15 defines management's responsibility to assess an entity's ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. It is effective for annual reporting periods ending after December 15, 2016, and for annual and interim reporting periods thereafter. Early adoption is permitted. The Company is currently in the process of evaluating the impact of the adoption of ASU 2014-15 on its consolidated financial statements.

3.������ Inventories�

Inventories consist of the following (in thousands):

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4.������ Goodwill and Intangible Assets

������� Goodwill�

������� The Company�s Engine Control Systems reporting unit, which is within its Heavy Duty Diesel Systems reporting segment, contains all of the Company�s allocated goodwill. The change in the carrying amount of goodwill is as follows (in thousands):�

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������� Intangible Assets

������� Intangible assets consist of the following (in thousands):

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������� The Company recorded amortization expense related to amortizable intangible assets of $0.2 million during each of the three months ended September 30, 2014 and 2013. The Company recorded amortization expense related to amortizable intangible assets of $0.5 million during each of the nine months ended September 30, 2014 and 2013.

������� Estimated amortization expense for each of the next five years is as follows (in thousands):

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5.������ Accrued Expenses and Other Current Liabilities

������� Accrued expenses and other current liabilities consist of the following (in thousands):

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6.������ Severance and Other Charges

������� Severance and other charges consist of the following (in thousands):

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Severance and Other Exit Costs�������������� �

������� The Company incurred severance costs in 2014 related to its North American and United Kingdom locations, including severance benefits covering a one year period for its former chief financial officer, pursuant to a separation and release agreement, dated July 31, 2014. The Company incurred additional lease exit costs related to the exit of leases in North America. ��������

������� The following summarizes the activity in the Company�s accrual for severance and other exit costs (in thousands):

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The Company expects to pay substantially all of the accrued amounts by the third quarter of 2015.

Legal Settlements

On March 13, 2014, the Company reached a settlement with a past chief financial officer pursuant to an administrative complaint that was filed in 2010 which provides for a one-time lump sum amount of $0.4 million and the issuance of 75,000 shares of Company common stock. The Company�accrued a liability of�$0.6 million at December 31, 2013, which included the lump sum amount, the market value of the common stock on December 31, 2013 and $0.1 million in legal expenses incurred as of December 31, 2013, which is included in accrued expenses and other current liabilities in the accompanying balance sheet. The settlement was paid and stock issued in April 2014, and the Company recorded an additional loss of �$0.1 million related to the increase in the fair value of its common stock at the time of issuance. See Note 13 for further discussion.

During the nine months ended September 30, 2014, the Company also incurred $0.1 million related to the settlement of a customer dispute.

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8.������ Debt�

������� Debt consists of the following (in thousands):

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������� Line of Credit with FGI

������� The Company has a $7.5 million secured demand facility with FGI backed by its receivables and inventory (as amended, the �FGI Facility�). The FGI Facility expires on August 15, 2015 and may be extended at the Company�s option for additional one-year terms.�However, FGI can cancel the facility at any time.

������� Under the FGI Facility, FGI can elect to purchase eligible accounts receivables from the Company and certain of its subsidiaries at up to 80% of the value of such receivables (retaining a 20% reserve). Purchased receivables are subject to full recourse to the Company in the event of nonpayment by the customer. FGI becomes responsible for the servicing and administration of the accounts receivable purchased. The Company is not obligated to offer accounts in any month and FGI has the right to decline to purchase any accounts. At FGI�s election, FGI may advance the Company up to 80% of the value of any purchased accounts receivable, subject to the $7.5�million limit. Reserves retained by FGI on any purchased receivable are expected to be refunded to the Company net of interest and fees on advances once the receivables are collected from customers. The Company may also borrow against eligible inventory up to the inventory sublimit, as determined by FGI, subject to the aggregate $7.5�million limit under the FGI Facility and certain other conditions. At September 30, 2014, the inventory sublimit amount was the lesser of $1.5 million or 50% of the aggregate purchase price paid for accounts receivable purchased under the FGI facility. While the overall credit limit and the inventory sublimit were not changed, in the third quarter of 2014, borrowing against the Company�s significant OEM customer�s inventory has been limited to $0.2 million by FGI due to their concerns about customer concentration.

������� The interest rate on advances or borrowings under the FGI Facility is the greater of (i) 6.50% per annum and (ii) 2.50% per annum above the prime rate, as defined in the FGI Facility and was 6.50% at September 30, 2014 and December 31, 2013. Any advances or borrowings under the FGI Facility are due on demand. The Company also agreed to pay FGI collateral management fees of 0.30% per month on the face amount of eligible receivables as to which advances have been made and 0.38% per month on borrowings against inventory, if any. At any time outstanding advances or borrowings under the FGI Facility are less than $2.4�million, the Company agreed to pay FGI standby fees of (i)�the interest rate on the difference between $2.4 million and the average outstanding amounts and (ii)�0.44% per month on 80% of the amount by which advances or borrowings are less than the agreed $2.4�million minimum.���

������� At September 30, 2014, the Company had $3.2 million of gross accounts receivable pledged to FGI as collateral for short-term debt in the amount of $1.5 million. At September 30, 2014, the Company also had $1.4 million in borrowings outstanding against eligible inventory. The Company was in compliance with the terms of the FGI Facility at September 30, 2014. However, there is no guarantee that the Company will be able to borrow to the full limit of $7.5 million if FGI chooses not to finance a portion of its receivables or inventory.

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$1.5 Million, 8% Shareholder Note Due 2015

������� On December�30, 2010, the Company executed a Loan Commitment Letter with Kanis S.A., a shareholder of the Company, pursuant to which Kanis S.A. loaned the Company $1.5 million. The unsecured loan, as amended, bears interest on the unpaid principal at a rate of 8%, with interest only payable quarterly in arrears. In addition to principal and accrued interest, the Company is obligated to pay Kanis S.A. �Payment Premium� of $250,000 with $100,000 paid on June 30, 2013 and the remaining amount payable on the June 30, 2015 maturity date. There is no prepayment penalty.

������� $3.0 Million, 8% Subordinated Convertible Shareholder Notes Due 2016

������� On April�11, 2011, the Company entered into a Subordinated Convertible Notes Commitment Letter with Kanis S.A. that provides for the sale and issuance by the Company of 8% subordinated convertible notes. As provided in the Commitment Letter, on May�6, 2011 Kanis S.A. purchased from the Company at par $3.0 million aggregate principal amount of the Convertible Notes, which bear interest at a rate of 8%�per annum, payable quarterly in arrears.

������� The Convertible Notes have a stated maturity of five years from the date of issuance. The agreement, as amended, allows for the acceleration of the maturity of the Convertible Notes if: (i) the Company was in breach of the Convertible Notes or other agreements with Kanis S.A., or (ii) Kanis S.A. provided written notice, not less than 30 days prior to such date, that it elected to accelerate the maturity to a date not earlier than May 12, 2013. On March 21, 2014, the Company and Kanis S.A. entered into a letter agreement whereby Kanis S.A. agreed not to accelerate the maturity of these Convertible Notes prior to July 1, 2015. The Convertible Notes have been classified as noncurrent in the unaudited condensed consolidated balance sheets at September 30, 2014 and December 31, 2013.

������� The Convertible Notes also provide that the Company has the option to redeem the Convertible Notes at any time at a price equal to 100% of the face amount plus accrued and unpaid interest through the date of redemption. There is no prepayment penalty. The Convertible Notes are unsecured obligations of the Company and subordinated to existing and future secured indebtedness of the Company.������������

�������� As amended, the outstanding principal balance of the Convertible Notes, and accrued and unpaid interest are convertible, at the option of Kanis S.A., at any time upon written notice given not less than 75 calendar days prior to the date of conversion, into no more than 250,000 shares of the Company�s common stock at a conversion price of $4.00 per share.

$3.0 Million, 8% Shareholder Note Due 2015

����� On July 27, 2012, the Company executed a Loan Commitment Letter with Kanis S.A., pursuant to which the Company issued an unsecured promissory note in the principal amount of $3.0 million, which bears interest at 8% per annum, payable quarterly in arrears. The promissory note matures on July 27, 2015. There is no prepayment penalty or premium.

9.������ Stockholders� Equity

������� Significant Changes in Stockholders� Equity �

������� During the nine months ended September 30, 2014, additional paid-in capital increased by $9.2 million. $8.2 million of this increase is attributable to (i) $4.6 million in proceeds, net of costs, from a recent registered offering, (ii) $1.0 million in proceeds received from the exercise of warrants to purchase a total of 800,000 shares of the Company�s common stock and (iii) $2.5 million being the fair value of these warrants reclassified from liabilities. See the April 2014 Offering discussion below and Note 10 for additional information.����������� �

������� Shelf Registration

������� On May 15, 2012, the Company filed a Shelf Registration which was declared effective by the SEC on May 21, 2012. The Shelf Registration permits the Company to sell, from time to time, up to an aggregate of $50.0 million of various securities, including common stock, preferred stock, warrants to purchase common stock or preferred stock and units consisting of one or more shares of common stock, shares of preferred stock, warrants, or any combination of such securities. However, the Company may not sell its securities in a primary offering pursuant to the Shelf Registration or any other registration statement on Form S-3 with a value exceeding one-third of its public float in any 12-month period (unless the Company�s public float rises to $75.0 million or more). The Shelf Registration is intended to provide the Company with additional flexibility to access capital markets for general corporate purposes, subject to market conditions and the Company's capital needs.

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������� On April 1, 2014, the Company entered into a placement agent agreement with Roth Capital Partners, LLC and Craig-Hallum Capital Group LLC related to the registered direct offering (the �Offering�) of an aggregate of 2,030,000 shares of the Company�s common stock together with warrants to purchase up to 812,000 shares of common stock. The Offering was made pursuant to the Company�s Shelf Registration discussed above. On April�4, 2014, the Company closed the Offering in which it sold 2,030,000 shares of common stock and warrants to purchase 812,000 shares of common stock. The shares of common stock and warrants were sold in units at $3.40 per unit, with each unit consisting of one share of common stock and 0.4 of one warrant to purchase one share of common stock at an exercise price of $4.20 per share. ��

������� The Company received gross proceeds of $6.9 million and net proceeds of $6.1 million after deducting placement agent fees and other offering expenses. The Offering warrants are within the scope of ASC 815-40 and are required to be recorded as liabilities (see Note 10). Accordingly, of the $6.1 million in net proceeds, $4.6 million was allocated to the common stock and included in additional paid-in capital and $1.5 million was allocated to the warrant liability based on the fair value of the warrants on the issuance date. Additionally, $0.2 million of the placement agent fees and other offering costs were allocated to the Offering warrants, based on the relative fair value of the Offering warrants and the common stock on the issuance date, and is included in other expense, net in the accompanying statement of�comprehensive loss�for the three and nine months ended September 30, 2014. The Company intends to use the net proceeds for general corporate purposes, which may include working capital, general and administrative expenses, capital expenditures and implementation of its strategic priorities. The Company may also use a portion of the net proceeds to acquire or invest in businesses, products and technologies that are complementary to its current business, although there are no present commitments or agreements for any such transactions.

������� November 2014 Offering

������� On November�4, 2014, the Company entered into subscription agreements to sell 1,385,000 shares of common stock, Series A Warrants to purchase up to an aggregate of 388,393 shares of common stock with an exercise price of $3.25 per share, for a combined purchase price of $2.80 per share and 0.28 of one Series A Warrant, and Series B Warrants to purchase up to an aggregate of 168,571 shares of common stock with an exercise price of $0.01 per share for a purchase price of $2.79 per Series B Warrant, pursuant to the Shelf Registration. The Company expects to receive net proceeds of approximately $3.8 million after deducting placement agent fees and other estimated offering expenses. See Note 16 for additional information.

������� Common Stock Purchase Agreement with Lincoln Park Capital (�LPC�)

������� On October�7, 2011, the Company signed a Purchase Agreement with LPC, together with a Registration Rights Agreement, whereby LPC agreed to purchase up to $10.0�million of the Company�s common stock over a 30-month period ending April 24, 2014. This expired unused in April 2014.

10.��� Warrants�

������� From time to time, the Company issues warrants to purchase its common stock. These warrants have been issued for consulting services, in connection with the Company�s issuance of debt and sales of its common stock.

������� Warrant activity is summarized as follows:���

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������� Warrant Liability

������� The Company evaluates warrants on issuance and at each reporting date to determine proper classification as equity or as a liability. The Company�s warrant liability is carried at fair value and is classified as Level 3 in the fair value hierarchy because the warrants are valued based on unobservable inputs.

������� The Company determines the fair value of its warrant liability using the Black-Scholes option-pricing model unless the awards are subject to market conditions, in which case it uses a Monte Carlo simulation model, which utilizes multiple input variables to estimate the probability that market conditions will be achieved. These models are dependent on several variables such as the instrument�s expected term, expected strike price, expected risk-free interest rate over the expected term of the instrument, expected dividend yield rate over the expected term and the expected volatility. The expected strike price for warrants with full-ratchet down-round price protection is based on a weighted average probability analysis of the strike price changes expected during the term as a result of the full-ratchet down-round price protection.

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������� The Offering warrants require physical settlement by delivering registered shares. In addition, while the relevant warrant agreement does not require cash settlement if the Company fails to maintain registration of the warrant shares, it does not specifically preclude cash settlement. Accordingly, the Company�s agreement to deliver registered shares without express terms for settlement in the absence of continuous effective registration is presumed to create a liability to settle these warrants in cash, requiring liability classification. The assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the warrant liability for these warrants are as follows:

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������� The assumptions used in the Monte Carlo simulation model to estimate the fair value of the warrant liability for warrants with full-ratchet down-round protection are as follows:

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������� The warrant liability, included in accrued expenses and other current liabilities in the accompanying unaudited condensed consolidated balance sheets, is re-measured at the end of each reporting period with changes in fair value recognized in other income (expense) in the unaudited condensed consolidated statements of comprehensive loss. Upon the exercise of a warrant that is classified as a liability, the fair value of the warrant exercised is re-measured on the exercise date and reclassified from warrant liability to additional paid-in capital. The Company recorded other income of $0.7 million for the three months ended September 30, 2014 as a result of the change in fair value of the warrant liability, which was primarily due to a decrease in the Company�s stock price during this period. The Company recorded other expense of $0.9 million for the nine months ended September 30, 2014 as a result of the change in fair value of the warrant liability which was primarily due to an increase in the Company�s stock price during the reporting period. During the nine months ended September 30, 2014, as a result of the exercise of warrants to purchase 800,000 shares of the Company�s common stock, the warrant liability decreased $2.5 million, excluding the effects of re-measurement, with an offsetting increase to additional paid-in capital.

11.��� Stock-Based Compensation

������� The Clean Diesel Technologies, Inc. Stock Incentive Plan, as amended (the �Plan�), provides for the awarding of incentive stock options, non-qualified stock options, stock appreciation rights, restricted shares, performance awards, bonuses or other forms of share-based awards, or combinations of these to the Company�s directors, officers, employees, consultants and advisors (except consultants or advisors in capital-raising transactions) as determined by the Board of Directors. As of September 30, 2014, there were 152,211 shares available for future grants under the Plan.

������� Total stock-based compensation expense for the three months ended September 30, 2014 and 2013 was $0.2 million. Total stock-based compensation expense for the nine months ended September 30, 2014 and 2013 was $0.5 million. Compensation expense is recognized on a straight-line basis over the requisite service period for all stock-based awards made to employees and directors in the unaudited condensed consolidated statements of comprehensive loss.

������� Stock Options��������������

������� Stock option activity is summarized as follows:�

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������� The aggregate intrinsic value represents the difference between the exercise price and the Company�s closing stock price on the last trading day of the quarter. As of September 30, 2014, the Company had $0.1 million of unrecognized compensation cost related to stock option grants which will be recognized over a weighted average estimated period of 0.4 years.

������� Restricted Stock Units (�RSUs�)

������� RSU activity is as follows:�

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������ As of September 30, 2014, the Company had $1.0 million of unrecognized compensation cost related to RSUs, which will be recognized over a weighted average estimated period of 2.0 years. The RSUs vested and unissued noted in the table above represent awards granted to employees who are subject to the terms of the Company�s black out policy from time to time due to their knowledge of non-public information and who were unable to sell shares on the open market to cover their tax obligations for their vested RSUs by the dates noted above. �

������� Modification

������ On July 31, 2014, the Compensation Committee approved the modification of the Company�s former chief financial officer�s unvested equity awards to accelerate the vesting upon his termination, effective August 30, 2014, and extend the expiration of his stock options from 90 days to 180 days following the date of his termination. This was considered a Type III modification in accordance with the authoritative guidance for share-based compensation, and, as a result, the Company reversed all expense previously recorded for his unvested awards and recorded the�fair value of the modified awards. The total compensation expense resulting from this modification was not significant.

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������� In addition to the foregoing, the Company is involved in legal proceedings from time to time in the ordinary course of its business. Management does not believe that any of these claims and proceedings against it are likely to have, individually or in the aggregate, a material adverse effect on the Company�s consolidated financial condition, results of operations or cash flows.�Accordingly, the Company cannot determine the final amount, if any, of its liability beyond the amount accrued in the unaudited condensed consolidated financial statements as of September 30, 2014, nor is it possible to estimate what litigation-related costs will be in the future.

Sales and Use Tax Audit

������� The Company is undergoing a sales and use tax audit by the State of California (the �State�) on AUS for the period of 2007 through 2009. The audit has identified a project performed by the Company during that time period for which sales tax was not collected and remitted and for which the State asserts that proper documentation of resale may not have been obtained and that the Company owes sales tax of $1.5 million, inclusive of interest. The Company contends and believes that it received sufficient and proper documentation from its customer to support not collecting and remitting sales tax from that customer and is actively disputing the audit report with the State. On August 12, 2013, the Company appeared at an appeals conference with the State Board of Equalization (�BOE�). On July 21, 2014, the Company received a Decision and Recommendation (�D&R�) from the BOE. The D&R�s conclusion was that the basis for the calculation of the aforementioned $1.5 million tax due should be reduced from $12.2 million to $9.0 million with a commensurate reduction in the tax owed to the State. Regardless of this finding, the Company continues to believe that it will prevail in this matter, as it believes that the State did not adequately address the legal arguments related to the Company�s acceptance of the valid resale certificate from its customer. The Company has not agreed to these findings, and therefore, it will be appealing at a higher level at the BOE. Based on a re-audit, the BOE lowered the tax due to $0.8 million, inclusive of interest. However, the Company continues to not agree to these findings based on the aforementioned reasons, and it will continue with the appeals process. Accordingly, no accrual has been recorded for this matter as the Company does not assess a loss as being probable. Should the Company not prevail in this matter, it will pursue reimbursement from the customer for all assessments from the State.����

14.��� Segment Reporting and Geographic Information

������� The Company has two business division segments based on the products it delivers:

������� Heavy Duty Diesel�Systems division � The Heavy Duty Diesel Systems division designs and manufactures verified exhaust emissions control solutions.�This division offers a full range of products for the verified retrofit and non-retrofit OEM and replacement markets through its distributor/dealer network and direct sales. These products are used to reduce exhaust emissions created by on-road, off-road and stationary diesel and alternative fuel engines including propane and natural gas. The retrofit market in the U.S. is driven in particular by state and municipal environmental regulations and incentive funding for voluntary early compliance. The Heavy Duty Diesel Systems division derives significant revenues from retrofit with a portfolio of solutions verified by the California Air Resources Board and the United States Environmental Protection Agency.

������� Catalyst division � The Catalyst division produces catalysts to reduce emissions from gasoline, diesel and natural gas combustion engines that are offered for multiple markets and a wide range of applications. The Catalyst Division developed a family of unique high-performance catalysts, featuring inexpensive base-metals with low or even no platinum group metals, or PGMs, to provide increased catalytic function and value for technology-driven automotive industry customers. The Catalyst division�s technical and manufacturing competence in the light duty vehicle market is aimed at meeting auto makers� most stringent requirements, and it has supplied over eleven million parts to light duty vehicle customers since 2001. The Catalyst division also provides catalyst formulations for the Company�s Heavy Duty Diesel Systems division. Intersegment revenues are based on market prices.

������� Corporate� � Corporate includes cost for personnel, insurance and public company expenses such as legal, audit and taxes that are not allocated down to the operating divisions.

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������� Net sales by geographic region based on the location of sales organization is as follows (in thousands):�

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15.��� Discontinued Operations

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The Reno Business that the Company committed to sell in July 2014 is presented below as discontinued operations. Historically, the Reno Business was a component of the Company�s Heavy Duty Diesel Systems division. The expense information for discontinued operations also includes an additional $0.3 million�accrual recorded during the three and nine months ended September 30, 2014, to increase the Company�s�estimated liability to settle�its ongoing indemnification matters with JM associated with the sale of AUS in 2009. See Note 13 for additional information.

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The following table presents the major classes of the assets and liabilities of discontinued operations held for sale in the consolidated balance sheets as of September�30, 2014 and December 31, 2013.

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