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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ                                     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

or

o                                     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 001-33710

CLEAN DIESEL TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

1621 Fiske Place

Oxnard, CA  93033

(Address of principal executive offices) (Zip Code)

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

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  þ  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  þ  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):

(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).          Yes  o  No  þ

As of November 5, 2015, the outstanding number of shares of the registrant’s common stock, par value $0.01 per share, was 16,828,806.

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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 refer to the discussion under the caption “Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission (the “SEC”) on March 18, 2015 and important factors discussed in this report and our other filings with the SEC, including without limitation the following:

·                  We have incurred losses and 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 reports on our financial statements for the years ended December 31, 2014 and 2013. Our ability to achieve profitability and positive cash flows from operations, or finance negative cash flows 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;

·                  Future growth of our business depends, in part, on the general availability of funding for emissions control programs, enforcement of existing emissions-related environmental regulations, further tightening of emission standards worldwide, market acceptance of our catalyst products, and successful product verifications;

·                  We recently announced the hiring of a new Chief Executive Officer, and our Executive Team, with input from our Board of Directors, is in the process of accelerating the execution of our business strategy. However, we cannot assure you that we will successfully complete our transformation from serving as a manufacturer of emissions solutions to a developer and supplier of proprietary powders used by other catalyst manufacturers for supply to the global automotive industry or that those efforts will have the intended effect of increasing profitability;

·                  Currently, we derive the majority of our revenue from our catalyst coating business with Honda. We anticipate that our supply of coated catalysts to Honda will begin to significantly decline in the second half of 2017, as certain current vehicle models are phased out. Accordingly, it will be critical that our powder-to-coat business strategy produces revenues with new customers, which may include Honda directly or indirectly, to replace those from our current core catalyst business. 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 the ability to license certain technology;

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

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

·                  We are subject to restrictions and must pay a royalty on certain sales of our products and technology in specified countries in Asia;

·                  If we are unable to attract and retain qualified personnel, it will harm the ability of our business to grow;

·                  We have entered into contractual agreements in connection with past sales of certain of our assets, which may expose us to liability for claims for indemnification under such agreements;

·                  Our results may fluctuate due to certain regulatory, marketing and competitive factors over which we have little or no control; and

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·                  We face constant changes in governmental standards by which our products are evaluated as well as competition and technological advances by competitors.

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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PART I—FINANCIAL INFORMATION

Item 1.  Financial Statements

CLEAN DIESEL TECHNOLOGIES, INC.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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CLEAN DIESEL TECHNOLOGIES, INC.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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CLEAN DIESEL TECHNOLOGIES, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.              Description of Business

Clean Diesel Technologies, Inc. (“CDTi” or the “Company”) currently commercializes its material technology by manufacturing and distributing light duty vehicle catalysts and heavy duty diesel emissions control systems and products to major automakers, distributors, integrators and retrofitters.

The Company is transitioning its business from being a niche manufacturer of emissions control solutions for the automotive and heavy duty diesel markets to becoming an advanced materials technology provider for these markets. The Company has a proven ability to develop proprietary materials incorporating various base metals that replace costly platinum group metals (“PGMs”) in coatings on vehicle catalytic converters. Recently, the Company has expanded its materials platform to include new synergized-PGM diesel oxidation catalysts (SPGMTM DOC), Base-Metal Activated Rhodium Support (BMARSTM), and Spinel™ technologies, and it is in the process of introducing these new catalyst technologies to OEMs and other vehicle catalyst manufacturers in a proprietary powder form. The Company believes that this powder-to-coat business model will allow it to achieve greater scale and higher return on its technology investment than in the past.

The Company’s business is driven by increasingly stringent global emission standards for internal combustion engines, which are major sources of a variety of harmful pollutants. It has operations in the United States (“U.S.”), Canada, the United Kingdom, France, Japan and Sweden as well as an Asian investment.

2.              Liquidity and Going Concern

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 $198.7 million at September 30, 2015. The Company has funded its operations through asset sales, credit facilities and other borrowings and equity sales.

At September 30, 2015, the Company had $3.0 million in cash, and based upon the Company’s current and anticipated usage of cash resources, the Company expects to require additional financing in the form of funding from outside sources during the next three to six months. The Company will evaluate the amount of cash needed, and the manner in which such cash will be raised, on an ongoing basis. The Company’s continuation as a going concern is dependent upon its ability to obtain adequate additional financing, which the Company has successfully secured since inception, including financing from equity sales and asset divestitures. However, there is no assurance that the Company will be able to achieve projected levels of revenue and maintain access to sufficient working capital, and accordingly, there is substantial doubt as to whether the Company’s existing cash resources and working capital are sufficient to enable it to continue its operations for the next twelve months.

The Company has a $7.5 million secured demand financing facility backed by its receivables and inventory with Faunus Group International, Inc. (“FGI”) that terminates on August 15, 2016 and may be extended at the Company’s option for additional one-year terms. However, FGI can cancel the facility at any time. At September 30, 2015, the Company had $3.6 million in borrowings outstanding under this facility with $3.9 million available, subject to the availability of eligible accounts receivable and inventory balances for collateral. 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.

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 May 19, 2015 and November 10, 2015, the Company filed shelf registration statements on Form S-3 and Form S-3/A, respectively, with the SEC to replace the existing Shelf Registration (collectively, the “Replacement Shelf”), which the Company anticipates will be declared effective later this year. Once declared effective, the Replacement Shelf will permit 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 Replacement Shelf 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 April 4, 2014, the Company sold 2,030,000 units pursuant to the Shelf Registration for $3.40 per unit, with

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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.

On October 20, 2014, the Company completed the sale of its Reno, Nevada-based custom fabricated exhaust parts and accessories business (the “Reno Business”) for $1.3 million in cash.

On November 4, 2014, the Company entered into subscription agreements to sell 1,385,000 shares of common stock and 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 received net proceeds of $3.8 million after deducting placement agent fees and other offering expenses.

On November 11, 2014, the Company and Kanis S.A. (“Kanis”) entered into a letter agreement whereby Kanis agreed to amend the terms of the outstanding loans, in the aggregate principal amount of $7.5 million, made to the Company, such that (i) the maturity dates of all outstanding loans were extended to October 1, 2016; and (ii) the early redemption feature applicable to one of the outstanding loans was removed.

On June 2, 2015, the Company entered into an underwriting agreement to sell 2,500,000 units pursuant to the Shelf Registration for $2.05 per unit, with each unit consisting of one share of common stock and 0.2 of one warrant to purchase one share of common stock with an exercise price of $2.65 per share. The Company received net proceeds of $4.5 million after deducting the underwriting discounts and other offering expenses. For additional information, refer to Note 10, “Stockholders’ Equity”.

On October 7, 2015, the Company and Kanis entered into a letter agreement whereby Kanis agreed to amend the terms of the outstanding loans, in the aggregate principal amount of $7.5 million, made to the Company, such that the maturity dates of all outstanding loans were extended to October 1, 2018. For additional information, refer to Note 15, “Subsequent Events”.

3.              Summary of Significant Accounting Policies

a.              Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC for interim financial reporting. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been reflected. Intercompany transactions and balances have been eliminated in consolidation. The results reported in these unaudited condensed consolidated financial statements should not necessarily be taken as indicative of results that may be expected for the entire year. Certain financial information that is normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), but is not required for interim reporting purposes, has been condensed or omitted. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

The preparation of financial statements in conformity with U.S. GAAP requires management of the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ materially from those estimates.

Discontinued Operations

In October 2014, the Company completed the sale of substantially all of the assets of its Reno Business, and the operations of this business were classified as discontinued operations for all periods presented in this report. Discontinued operations also includes costs for the Company’s liability to settle its indemnification matters with Johnson Matthey (“JM”) associated with the sale of Applied Utility Systems, Inc. (“AUS”), a former subsidiary of the Company, in 2009. All liabilities for the indemnification matters were settled and paid. In the statements of cash flows, the cash flows of discontinued operations are separately classified and aggregated.

For additional information, refer to Note 14, “Discontinued Operations”.

All discussions and amounts in the consolidated financial statements and related notes for all periods presented relate to continuing operations only, unless otherwise noted.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

b.              Concentration of Risk

For the three months ended September 30, 2015 and 2014, one automotive OEM customer within the Catalyst segment accounted for 61% and 60%, respectively, of the Company’s revenues. For the nine months ended September 30, 2015 and 2014, one automotive OEM customer within the Catalyst segment accounted for 60% and 50%, respectively, of the Company’s revenues. This customer accounted for 44% and 50% of the Company’s accounts receivable at September 30, 2015 and December 31, 2014, respectively. No other customers accounted for 10% or more of the Company’s revenues or accounts receivable for these periods.

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

c.               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 and warrants and debt that are convertible into the Company’s common stock. Because the Company incurred net losses in the three and nine months ended September 30, 2015 and 2014, 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 3.4 million and 2.4 million shares during the three months ended September 30, 2015 and 2014, respectively. Potentially dilutive common stock equivalents excluded were 3.0 million and 2.2 million shares during the nine months ended September 30, 2015 and 2014, respectively.

d.              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. For additional information, refer to Note 11, “Warrants”. The valuation inputs hierarchy classification for the warrant liability measured at fair value on a recurring basis is summarized as follows (in thousands):

The following is a reconciliation of the warrant liability, included in accrued expenses and other current liabilities in the accompanying unaudited condensed consolidated balance sheets, measured at fair value using Level

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

3 inputs (in thousands):

e.               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 the line of credit approximates its 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 $7.7 million at September 30, 2015 and December 31, 2014.

f.                 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. The Company reclassified $0.7 million from prepaid expenses and other current assets to income taxes payable on the condensed consolidated balance sheet at December 31, 2014 to net certain income taxes receivable and payable, per jurisdiction, and conform to the current period presentation.

g.              Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. ASU No. 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”. ASU No. 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. In July 2015, the FASB finalized the delay of the effective date by one year, making the new standard effective for interim periods and annual periods beginning after December 15, 2017. Early adoption is permitted, but it is not permitted earlier than the original effective date. ASU No. 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. The Company is currently in the process of evaluating the impact of the adoption of ASU No. 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 No. 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 has not elected to early adopt, and it is currently in the process of evaluating the impact of the adoption of ASU No. 2014-15 on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”. ASU No. 2015-03 requires that debt issuance costs related to a recognized debt liability be reported on the consolidated statements of financial condition as a direct deduction from the carrying amount of that debt liability. It is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period with early application permitted for financial statements that have not been previously issued. The Company has not elected to early adopt, and it does not expect the impact of the adoption of ASU No. 2015-03 to be material to its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement”. ASU No. 2015-05 provides clarification on whether a cloud computing arrangement includes a software license. If a software license is included, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a software license is not included, the arrangement should be accounted for as a service contract. It is effective for reporting periods beginning after December 15, 2015, with early adoption permitted. Entities can elect to adopt the standard update prospectively or retrospectively to arrangements entered into, or materially modified, after the effective date. The Company does not expect to early adopt ASU 2015-05, and it is currently in the process of evaluating the impact of the adoption of ASU No. 2015-05 on its consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”. ASU No. 2015-11 changes the measurement principle for inventory from the “lower of cost or market” to “lower of cost and net realizable value.” Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.”  ASU 2015-11 eliminates the guidance that entities consider replacement cost or net realizable value less an approximately normal profit margin in the subsequent measurement of inventory when cost is determined on a first-in, first-out or average cost basis. It is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Company has not yet determined whether it will elect to early adopt ASU 2015-11, and it is currently in the process of evaluating the impact of the adoption of ASU No. 2015-11 on its consolidated financial statements.

4.              Inventories

Inventories consist of the following (in thousands):

5.              Goodwill and Intangible Assets

Goodwill

The change in the carrying amount of goodwill during the nine months ended September 30, 2015 was due to the effect of foreign currency translation.

Intangible Assets

Intangible assets consist of the following (in thousands):

The Company recorded amortization expense related to amortizable intangible assets of $0.1 million and $0.2 million during the three months ended September 30, 2015 and 2014, respectively. The Company recorded amortization expense related to amortizable intangible assets of $0.4 million and $0.5 million during the nine months ended September 30, 2015 and 2014, respectively.

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

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

6.              Accrued Expenses and Other Current Liabilities

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

(1) For additional information, refer to Note 7, “Severance and Other Charges”.

(2) For additional information, refer to Note 8, “Accrued Warranty”.

(3) For additional information, refer to Note 11, “Warrants”.

(4) For additional information, refer to Note 14, “Discontinued Operations”.

7.              Severance and Other Charges

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

The following summarizes the activity in the Company’s accrual for severance and other charges (in thousands):

8.              Accrued Warranty

The following summarizes the activity in the Company’s accrual for product warranty (in thousands):

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9.              Debt

Debt consists of the following (in thousands):

(1)    The aggregate amount of unamortized debt discount was $0.1 million and $0.2 million at September 30, 2015 and December 31, 2014, respectively. Refer to Note 15, “Subsequent Events”, regarding recent amendments to the shareholder notes.

Line of Credit with FGI

At September 30, 2015, the Company had $3.2 million of gross accounts receivable pledged to FGI as collateral for short-term debt in the amount of $2.2 million. At September 30, 2015, 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, 2015. 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.

10.       Stockholders’ Equity

June 2015 Offering

On June 2, 2015, the Company entered into an underwriting agreement with Cowen and Company, LLC, as the representative of the several underwriters identified therein, pursuant to which the Company agreed to offer and sell up to 2,500,000 units at a price to the public of $2.05 per unit (the “Offering”). Each unit consisted of one share of common stock and 0.2 of a warrant (the “Offering Warrants”) to purchase one share of common stock. The Offering Warrants have an exercise price of $2.65 per share and can be exercised during the period commencing after six months and ending five and a half years from the date of issuance.

The Company received gross proceeds of $5.1 million and net proceeds of $4.5 million after deducting the underwriting discounts and other offering expenses. The Offering Warrants are within the scope of ASC 815-40 and are required to be recorded as liabilities. For additional information, refer to Note 11, “Warrants”. Accordingly, of the $4.5 million in net proceeds, $3.7 million was allocated to the common stock and included in additional paid-in capital and $0.8 million was allocated to the warrant liability based on the fair value of the warrants on the issuance date. Additionally, $0.1 million of the underwriter discounts 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 was included in other expense, net in the accompanying statements of comprehensive loss for the three and nine months ended September 30, 2015. 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.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

11.       Warrants

Warrants outstanding and exercisable are summarized as follows:

(1) Includes 170,676 equity-classified warrants.

Warrant Classification

The Company evaluates warrants on issuance and at each reporting date to determine proper classification as equity or as a liability. The Offering Warrants require physical settlement by delivering registered shares, and the provisions of the warrant agreement include potential cash payments for failure to timely deliver shares and fractional share settlement. Accordingly, the Offering Warrants require liability classification.

Warrant 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 warrants 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 warrant’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.

Due to the significant change in the Company following its business combination with Catalytic Solutions, Inc. (the “Merger”), CDTi’s pre-Merger historical price volatility was not considered representative of expected volatility going forward. Therefore, for warrants with an expected term that required a volatility look-back that pre-dated the Merger, the Company used an estimate based upon a weighted average of implied and historical volatility of a portfolio of peer companies and CDTi’s post-Merger historical volatility for the valuation of these warrants prior to 2015. For warrants with an expected term that did not require a volatility look-back that pre-dated the Merger, CDTi’s post-Merger historical price volatility was considered representative of expected volatility, and accordingly, only CDTi’s historical volatility was used for the valuation of these warrants prior to 2015. During 2015, the Company determined that its post-Merger historical volatility was considered representative of expected volatility for the valuation of its warrants. The expected life is equal to the remaining contractual life of the warrants.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the warrant liability for these warrants outstanding are as follows:

(1)    During 2015, the Company’s post-Merger historical volatility began to be considered representive of expected volatility for these warrants.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

(1)    During 2015, the Company’s post-Merger historical volatility began to be considered representive of expected volatility for these warrants.

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 expense, net in the accompanying 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. For additional information regarding the fair value of the warrant liability, amounts recognized in other income (expense) and amounts reclassified to additional paid-in capital upon exercise, refer to the warrant liability reconciliation in Note 3(d), “Summary of Significant Accounting Policies—Fair Value Measurements”.

12.       Commitments and Contingencies

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 is 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 consolidated financial statements as of September 30, 2015, nor is it possible to estimate what litigation-related costs will be in the future.

By email dated June 26, 2015, the California Air Resources Board (“CARB”) asserted the Company had deficiencies in compliance with the Verification Procedure, Aftermarket Parts Regulations and the Vehicle Code. The penalty calculated by CARB for these alleged violations was $1.8 million, with the largest component relating to the use of empty center bodies to allow trucks to be placed back in service while warranty claims are being evaluated. This process is now explicitly permitted by regulation, but was not permitted at the time of the alleged violation. Although the Company disagreed, and continues to disagree, with CARB’s findings, the Company has cooperated with CARB’s investigation and is discussing with CARB whether and to what extent the payment of monetary penalties would be appropriate. After review and evaluation of CARB’s findings and publicly available CARB settlements for similar matters, the Company has accrued an expense of less than $0.1 million as of September 30, 2015 to resolve this matter. In the event that a mutually satisfactory agreement cannot be reached, the Company plans to defend any formal action taken by CARB.

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

For information related to commitments and contingencies related to AUS, a former subsidiary of the Company that was sold in 2009, refer to Note 14, “Discontinued Operations”.

13.       Segment Reporting and Geographic Information

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

Catalyst division — The Catalyst division develops and 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 to provide increased catalytic function and value for technology-driven automotive industry customers. The Catalyst division has supplied over twelve 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.

Heavy Duty Diesel Systems division — The Heavy Duty Diesel Systems division designs and manufactures exhaust emissions control solutions. This division offers a full range of DuraFit™ OEM replacement diesel particulate filters and products for the verified retrofit and non-retrofit OEM 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.

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.

Summarized financial information for the Company’s reportable segments is as follows (in thousands):

(1)    Elimination of Catalyst revenue and profit in ending inventory related to sales to Heavy Duty Diesel Systems.

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

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

14.       Discontinued Operations

The Reno Business

On October 20, 2014, the Company completed the sale of its Reno Business for $1.3 million in cash. The net assets held for sale of the Reno Business were eliminated from the Company’s balance sheet as of the sale date, and the Company recognized a gain of $0.2 million. Historically, the Reno Business was a component of the Company’s Heavy Duty Diesel Systems division.

Applied Utility Systems, Inc.

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 $0.9 million, inclusive of interest. The Company continues to not agree with these findings based on the aforementioned reasons. However, in October 2015, the Company offered to settle this case for $0.1 million, which is based on the expected cost of continuing to contest this audit. Accordingly, an accrual was charged to discontinued operations for the three and nine months ended September 30, 2015 for the recent offer to settle this case. Should the Company not prevail with the recent offer to settle this case, it plans to continue with the appeals process. Further, should the Company not prevail in this case, it will pursue reimbursement from the customer for all assessments from the State.

On November 15, 2013, BP Products North America (“BP”) instituted claims against Johnson Matthey (“JM”) as the parent company of and purchaser of Applied Utility Systems, Inc. (“AUS”), a former subsidiary of the Company. On May 12, 2010, JM tendered to the Company a claim for indemnification under the Asset Purchase Agreement dated October 1, 2009 (the “Asset Purchase Agreement”) among JM, the Company and AUS. On June 11, 2013, BP, JM and the Company entered into a settlement agreement and mutual release pursuant to which they settled all claims. This settlement agreement had no material impact on the Company. Under the indemnification clauses of the Asset Purchase Agreement, the Company may be liable for legal expenses incurred by JM. These legal costs may be offset against funds withheld by JM from the acquisition of AUS.

In connection with the Asset Purchase Agreement, on October 1, 2009, JM presented the Company with an indemnification claim seeking recovery of the net amount of $0.9 million after offsetting the funds withheld by JM from the acquisition of AUS. These claims were for matters relating to various customer contracts that JM purchased, including the BP contract discussed above. The Company and JM entered into discussions relating to the application of offsets and the validity of the claims presented. On June 3, 2015, JM and the Company entered into a settlement and release agreement pursuant to which they settled all claims for $0.7 million. This settlement was paid

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CLEAN DIESEL TECHNOLOGIES, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

with an initial $0.1 million installment upon execution of the settlement and release agreement, and the remaining balance was paid in July 2015.

In presenting discontinued operations, general corporate overhead expenses that have been historically allocated to the Reno Business for segment presentation purposes are not included in discontinued operations. The following table presents revenue and expense information for discontinued operations (in thousands):