8-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 8-K

CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Date of Report (Date of earliest event reported): November 15, 2010

CLEAN DIESEL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

DELAWARE	001-33710	06-1393453
(State or other Jurisdiction of Incorporation)	(Commission File Number)	(IRS Employer Identification No.)

4567 TELEPHONE ROAD, SUITE 206 VENTURA, CALIFORNIA	93003
(Address of Principal Executive Offices)	(Zip Code)

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

(Former name or former address if changed since last report.)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 8.01 Other Events

On October 15, 2010, we completed the merger of our wholly-owned subsidiary, CDTI Merger Sub, Inc., with and into Catalytic Solutions, Inc., a California corporation (“CSI”), as contemplated by that certain Agreement and Plan of Merger dated May 13, 2010, as amended by letter agreements dated September 1, 2010 and September 14, 2010 (the “Merger Agreement”). We refer to this transaction as the “Merger.” The Merger was accounted for as a reverse acquisition and, as a result, our company’s (the legal acquirer) consolidated financial statements will, in substance, be those of CSI (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of our company being included effective from the date of the closing of the Merger.

Because the Merger was not completed until October 15, 2010, after the end of our most recent fiscal quarter on September 30, 2010, our quarterly report on Form 10-Q for the quarter ended September 30, 2010 reflects the unaudited consolidated financial statements (and discussion thereof in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) of our company, the legal acquirer, as of September 30, 2010 (i.e., prior to the closing of the Merger) on a stand-alone basis. In order to avoid a “gap” in financial reporting of information regarding CSI, the accounting acquirer, we are filing as Exhibits to this current report on Form 8-K CSI’s unaudited condensed consolidated financial statements as of and for the three and nine months ended September 30, 2010 and 2009 along with a Management’s Discussion and Analysis of Financial Condition and Results of Operations for such period.

We are also filing as an Exhibit to this current report on Form 8-K Unaudited Pro Forma Condensed Combined Financial Information including an unaudited pro forma condensed combined balance sheet as of September 30, 2010 and unaudited pro forma condensed combined statement of operations for the year ended December 31, 2009 and the nine months ended September 30, 2010. See Exhibits 99.1, 99.2 and 99.3 hereto.

Also on November 15, 2010, we issued a press release discussing our third quarter 2010 results. The press release is furnished as Exhibit 99.4 to this current report on Form 8-K.

Item 9.01 Financial Statements and Exhibits.

(d) Exhibits.

EXHIBIT INDEX

Exhibit
Number	Description of Exhibits
99.1	Management’s Discussion and Analysis of Catalytic Solutions Inc.’s Financial Condition and Results of Operations as at and for the period ended September 30, 2010.
99.2	Unaudited condensed consolidated financial statements of Catalytic Solutions, Inc. as of and for the three and nine months ended September 30, 2010 and 2009.
99.3	Unaudited Pro Forma Condensed Combined Financial Information including unaudited pro forma condensed combined balance sheet of the registrant as of September 30, 2010 and unaudited pro forma condensed combined statement of operations of the registrant for the year ended December 31, 2009 and the nine months ended September 30, 2010.
99.4	Press Release of the registrant dated November 15, 2010.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

CLEAN DIESEL TECHNOLOGIES, INC.

November 15, 2010

By: /s/ Charles F. Call                           
Name: Charles F. Call
Title: Chief Executive Officer

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EX-99.1

Exhibit 99.1

CSI MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of Catalytic Solutions, Inc.’s (“CSI”) financial condition and results of operations should be read in conjunction with CSI’s annual consolidated financial statements and related notes included in Clean Diesel Technologies, Inc.’s (“Clean Diesel”) Registration Statement on Form S-4/A filed with the Securities and Exchange Commission (“SEC”) on September 23, 2010 (the “Registration Statement”) and with CSI’s interim condensed consolidated financial statements and related notes appearing elsewhere in this current report on Form 8-K. This discussion contains forward-looking statements, the accuracy of which involves risks and uncertainties, see “Cautionary Statement Concerning Forward-Looking Statements” in the Registration Statement. CSI’s actual results could differ materially from those anticipated in these forward-looking statements for many reasons, as a result of many important factors, including those set forth in the section titled, “Risk Factors” in the Registration Statement.

Overview

CSI is a global manufacturer and distributor of emissions control systems and products, focused in the heavy duty diesel and light duty vehicle markets. CSI’s emissions control systems and products are designed to deliver high value to its customers while benefiting the global environment through air quality improvement, sustainability and energy efficiency.

Heavy Duty Diesel Systems Division: Through its Heavy Duty Diesel Systems division, CSI designs and manufactures verified exhaust emissions control solutions. CSI’s Heavy Duty Diesel Systems division offers a full range of products for the original equipment manufacturer, or OEM, occupational health driven and verified retrofit markets that reduce exhaust emissions created by on-road, off-road and stationary diesel and alternative fuel engines including propane and natural gas. Revenues from CSI’s Heavy Duty Diesel Systems division accounted for approximately 51% of its total consolidated revenues for the year ended December 31, 2009 and 63% of its total consolidated revenues for the nine months ended September 30, 2010.

Catalyst Division: Through its Catalyst division, CSI produces catalyst formulations for gasoline, diesel and natural gas induced emissions that are offered for multiple markets and a wide range of applications. A family of unique high-performance catalysts has been developed — with base-metals or low platinum group metal and zero-platinum group metal content — to provide increased catalytic function and value for technology-driven automotive industry customers. CSI’s technical and manufacturing competence in the light duty vehicle market is aimed at meeting auto makers’ most stringent requirements, and CSI has supplied over nine million parts to light duty vehicle customers since 1996. In addition to auto makers, CSI also provides catalyst formulations for its Heavy Duty Diesel Systems division. Revenues from CSI’s Catalyst division accounted for approximately 49% of its total consolidated revenues for the year ended December 31, 2009 and 37% of its total consolidated revenues for the nine months ended September 30, 2010.

Sources of Revenues and Expenses

Revenues

CSI generates revenues primarily from the sale of its emission control systems and products. CSI generally recognize revenues from the sale of its emission control systems and products upon shipment of these products to its customers. However, for certain customers, where risk of loss transfers at the destination (typically the customer’s warehouse), revenue is recognized when the products are delivered to the destination (which is generally within five days of the shipment).

Cost of revenues

CSI’s cost of revenues consists primarily of its direct costs for the manufacture of its emission control systems and products, including cost of raw materials, costs of leasing and operating manufacturing facilities and wages paid to personnel involved in production, manufacturing quality control, testing and supply chain management. In addition, cost of revenues include normal scrap and shrinkage associated with the manufacturing process and a expense from write down of obsolete and slow moving inventory. CSI includes the direct material costs and factory labor as well as factory overhead expense in the cost of revenue. Indirect factory expense includes the costs of freight (inbound and outbound for direct material and finished goods), purchasing and receiving, inspection, testing, warehousing, utilities and deprecation of facilities and equipment utilized in the production and distribution of products.

Sales and marketing expenses

CSI’s sales and marketing expenses consist primarily of compensation paid to sales and marketing personnel, and marketing expenses. Costs related to sales and marketing are expensed as they are incurred. These expenses include the salary and benefits for the sales and marketing staff as well as travel, samples provided at no-cost to customers and marketing materials.

Research and development expenses

CSI’s research and development expenses consist of costs associated with research related to new product development and product enhancement expenditures. Research and development costs also include costs associated with getting its heavy duty diesel systems verified and approved for sale by the United States Environmental Protection Agency (EPA), the California Air Resources Board (CARB) and other regulatory authorities. These expenses include the salary and benefits for the research and development staff as well as travel, research materials, testing and legal expense related to patenting intellectual property. Also included is any depreciation related to assets utilized in the development of new products.

General and administrative expenses

CSI’s general and administrative expenses consist primarily of compensation paid to administrative personnel, legal and professional fees, corporate expenses and regulatory, bad debt and other administrative expenses. These expenses include the salary and benefits for the administrative staff as well as travel, legal, accounting and tax consulting. Also included is any depreciation related to assets utilized in the general and administrative functions.

Recapitalization expenses

CSI’s recapitalization expense consists primarily of the expense for legal, accounting and other advisory professional services as a result of CSI’s efforts in 2009 and 2010 to explore strategic opportunities resulting in the Merger with Clean Diesel.

Total other income (expense)

CSI’s total other income (expense) primarily reflects interest expense and changes in the fair value of certain of its financial instrument liabilities related to the secured convertible notes, but also includes interest income as well as CSI’s share of income and losses from its Asian joint venture and income or losses from sale of fixed assets.

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Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures in the financial statements. Critical accounting policies are those accounting policies that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on financial condition or operating performance. While CSI bases its estimates and judgments on its experience and on various other factors that it believes to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. CSI believes the following critical accounting policies used in the preparation of its financial statements require significant judgments and estimates. For additional information relating to these and other accounting policies, see Note 2 to CSI’s Annual Consolidated Financial Statements appearing in the Registration Statement and Note 1 to CSI’s Interim Condensed Consolidated Financial Statements appearing elsewhere in this current report on Form 8-K.

Revenue Recognition

CSI generally recognizes revenue when products are shipped and the customer takes ownership and assumes risk of loss, collection of the related receivable is reasonably assured, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Where installation services, if provided, are essential to the functionality of the equipment, CSI defers the portion of revenue for the sale attributable to installation until it has completed the installation. When terms of sale include subjective customer acceptance criteria, CSI defers revenue until the acceptance criteria are met. Concurrent with the shipment of the product, CSI accrues estimated product return reserves and warranty expenses. Critical judgments include the determination of whether or not customer acceptance criteria are perfunctory or inconsequential. The determination of whether or not the customer acceptance terms are perfunctory or inconsequential impacts the amount and timing of the revenue that CSI recognizes. Critical judgments also include estimates of warranty reserves, which are established based on historical experience and knowledge of the product.

Allowance for Doubtful Accounts

The allowance for doubtful accounts involves estimates based on management’s judgment, review of individual receivables and analysis of historical bad debts. CSI monitors collections and payments from its customers and maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. CSI also assesses current economic trends that might impact the level of credit losses in the future. If the financial condition of CSI’s customers were to deteriorate, resulting in difficulties in their ability to make payments as they become due, additional allowances could be required, which would have a negative effect on CSI’s earnings and working capital.

Inventory Valuation

Inventory is stated at the lower of cost or market. Cost is determined on the first-in, first-out method. CSI writes down inventory for slow-moving and obsolete inventory based on assessments of future demands, market conditions and customers who are expected to reduce purchasing requirements as a result of experiencing financial difficulties. Such assessments require the exercise of significant judgment by management. If these factors were to become less favorable than those projected, additional inventory write-downs could be required, which would have a negative effect on CSI’s earnings and working capital.

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Accounting for Income Taxes

CSI’s income tax expense is dependent on the profitability of its various international subsidiaries including those in Canada and Sweden. These subsidiaries are subject to income taxation based on local tax laws in these countries. CSI’s United States operations have continually incurred losses since inception. CSI’s annual tax expense is based on its income, statutory tax rates and available tax planning opportunities in the various jurisdictions in which it operates. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining CSI’s tax expense and in evaluating its tax positions including evaluating uncertainties. CSI reviews its tax positions quarterly and adjusts the balances as new information becomes available. If these factors were to become less favorable than those projected, or if there are changes in the tax laws in the jurisdictions in which CSI operates, there could be an increase in tax expense and a resulting decrease in CSI’s earnings and working capital.

Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carry-forwards. CSI evaluates the recoverability of these future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income inherently rely on estimates. To provide insight, CSI uses its historical experience and its short and long-range business forecasts. CSI believes it is more likely than not that a portion of the deferred income tax assets may expire unused and have established a valuation allowance against them. Although realization is not assured for the remaining deferred income tax assets, primarily related to foreign tax jurisdictions, CSI believes it is more likely than not that the deferred tax assets will be fully recoverable within the applicable statutory expiration periods. However, deferred tax assets could be reduced in the near term if CSI’s estimates of taxable income in certain jurisdictions are significantly reduced or available tax planning strategies are no longer viable.

Business Combinations

Under the purchase method of accounting, CSI allocates the purchase price of acquired companies to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. CSI records the excess of purchase price over the aggregate fair values as goodwill. CSI engages third-party appraisal firms to assist it in determining the fair values of assets acquired and liabilities assumed. These valuations require CSI to make significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing purchased technology, customer lists and other identifiable intangible assets include future cash flows that CSI expects to generate from the acquired assets. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, CSI could experience impairment charges. In addition, CSI has estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If CSI’s estimates of the economic lives change, depreciation or amortization expenses could be accelerated or slowed.

Goodwill

CSI tests goodwill for impairment at the reporting unit level at least annually using a two-step process, and more frequently upon the occurrence of certain triggering events. Only CSI’s Heavy Duty Diesel Systems reporting unit has goodwill subject to impairment review, which totaled $4.2 million at December 31, 2009 and $4.3 million at September 30, 2010. Goodwill impairment testing requires CSI to estimate the fair value of its reporting unit. The estimate of fair value is based on internally developed assumptions approximating those that a market participant would use in valuing the reporting unit. CSI derived the estimated fair value of the Heavy Duty Diesel Systems reporting unit at December 31, 2009 primarily from a discounted cash flow model. Significant assumptions used in deriving the fair value of the reporting unit included: annual revenue growth over the next eight years ranging from 10.5% to 15.7%, long-term revenue growth of 3% and a discount rate of 25.3%. CSI deemed that estimating cash flows

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discretely for ten years was the most appropriate for its Heavy Duty Diesel Systems reporting unit, as this unit’s business growth is driven by changes in the regulation of diesel emissions. Regulations are planned to be increased in various countries over the next 10 years. These new emission regulations are a driver of business growth for the Heavy Duty Diesel Systems business. In order to take into account the business implications of such regulations, CSI estimated revenues and cash flows to meet the demands of this marketplace for a 10 year time period. The discount rate of 25.3% was developed based on a weighted cost of capital (WACC) analysis. Within the WACC analysis, the cost of equity assumption was developed using the Capital Asset Pricing Model (CAPM). The inputs in both the CAPM and the cost of debt assumption utilized in the WACC were developed for CSI’s Heavy Duty Diesel Systems reporting unit using data from comparable companies. While the revenue growth rates used are consistent with CSI’s historical growth patterns and consider future growth potential identified by management, there is no assurance such growth will be achieved. In addition, CSI considered the overall fair value of its reporting units as compared to the fair value of CSI. Because the estimated fair value of the reporting unit exceeded its carrying value by 6%, CSI determined that no goodwill impairment existed as of December 31, 2009; however, it is reasonably possible that future results may differ from the estimates made during 2009 and future impairment tests may result in a different conclusion for the goodwill of the Heavy Duty Diesel Systems reporting unit. In addition, the use of different estimates or assumptions by management could lead to different results. CSI’s estimate of fair value of the reporting unit is sensitive to certain factors, including but not limited to the following: movements in CSI’s share price, changes in discount rates and CSI’s cost of capital, growth of the reporting unit’s revenue, cost structure of the reporting unit, successful completion of research and development, capital expenditures, customer acceptance of new products, competition, general economic conditions and approval of the reporting unit’s product by regulatory agencies. CSI evaluated the reporting unit to assess if a triggering event occurred subsequent to December 31, 2009 through September 30, 2010 necessitating a detailed analysis (the first step in the two-step process) and concluded that no such triggering event had occurred in the HDD systems reporting unit.

Impairment of Long-Lived Assets Other Than Goodwill

CSI evaluates long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets. If an impairment does exist, CSI measures the impairment loss and records it based on discounted estimated future cash flows. In estimating future cash flows, CSI groups assets at the lowest level for which there are identifiable cash flows that are largely independent of cash flows from other asset groups. Considerable judgment is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. CSI’s most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows. These estimates and judgments are based upon, among other things, certain assumptions about expected future operating performance and growth rates and other factors actual results of which may vary significantly. In light of such analysis, in 2008, CSI recorded a $4.9 million impairment charge and CSI wrote down the assets of its Catalyst division to fair value. This analysis was triggered by a combination of the following factors: historic losses in the Catalyst division, the overall downturn in the automotive sector and the expectation of a slow recovery in the automotive sector. CSI utilized a discounted cash flow model to estimate the fair value of the long-lived assets. The following two scenarios were given equal weighting in determining the future cash flows for purposes of both the recoverability test and fair value: (a) the Catalyst division achieves revenue growth of (2)%-50% per year over the next 5 years and (b) the Catalyst division continues to experience cash flow losses and does not achieve profitability. The cash flows were discounted using a 1.6% risk free interest rate. This analysis indicated that the assets of the Catalyst division were impaired and, accordingly, CSI wrote down the assets by $4.9 million, from $5.8 million to $0.9 million, which represented their estimated fair value as of December 31, 2008. In 2009 and again through September 30, 2010, CSI considered whether any events or changes in circumstance indicated that the carrying amount of its Catalyst division’s long-lived assets, totaling $703,000, may not be recoverable. With the recent disruption of sales announced (further discussed in the “Results of Operations” section below), CSI conducted a recoverability test on the fixed assets of the Catalyst division as of June 30, 2010 and

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concluded that the expected undiscounted cash flows associated with the assets substantially exceed their carrying value. CSI’s analysis utilized two different scenarios over a five year period with a probability weighting. One scenario assumed no additional program wins while the other scenario was based on a set of assumed program wins, resulting of revenue growth ranging from zero to 35% over the next 5 years. Each scenario also included a terminal value based upon an estimated value of intellectual property that could be sold off. No events occurred during the quarter ended September 30, 2010 that significantly altered the assumptions made at June 30, 2010 and would necessitate further analysis. For the remaining long-lived assets of CSI, all of which are included in the Heavy Duty Diesel Systems reporting unit, CSI concluded the expected undiscounted cash flows associated with these assets substantially exceed their carrying value. In the event that actual results differ from CSI’s forecasts or the future outlook diminishes, the future cash flows and fair value of these assets could potentially decrease in the future, requiring further impairment charges. Although CSI believes the assumptions and estimates it has made in the past have been reasonable and appropriate, different assumptions and estimates could materially affect its reported financial results. To the extent additional events or changes in circumstances occur, CSI may conclude that a non-cash impairment charge against earnings is required, which could have an adverse effect on its financial condition and results of operations.

Fair Value of Embedded Financial Instruments

CSI’s secured convertible notes issued to investors (see “— Recent Developments — Capital Raise” below) in conjunction with the business combination with Clean Diesel contain two embedded financial instruments that require separate accounting at fair value: the premium redemption feature and the contingent equity forward. The estimate of fair value of such financial instruments involves unobservable inputs.

The premium redemption instrument represents the fair value of the additional penalty premium of two times (2x) the outstanding principal amount plus the default interest that is due if the secured convertible notes are in default. This instrument is considered a put option, as subsequent to August 2, 2010, the noteholders had the option of demanding payment or providing additional time extensions. The fair value of the premium redemption instrument was estimated by calculating the present value of $4.0 million plus accrued interest, based on an assumed payment date (eleven months after default date) using a high yield discount rate of 17%, multiplied by an estimated probability of its exercise. The fair value of this instrument at September 30, 2010 was $0.4 million. A ten percentage point change in CSI’s estimated probability of exercise would increase or decrease the fair value by approximately $362,000.

The contingent equity forward represents the additional $2.0 million that the investors committed to fund immediately prior to closing of the Merger. It is considered a commitment to purchase equity because the funding will only occur from the same events that will cause the secured convertible notes to automatically convert to equity. The fair value is estimated based on the intrinsic value of the forward discounted at a risk free rate multiplied by the estimated probability that the forward will fund. The fair value of this instrument at September 30, 2010 was $1.3 million. A ten percentage point change in CSI’s estimated probability of exercise would increase or decrease the fair value by approximately $140,000.

Stock-Based Compensation Expense

CSI accounts for share-based compensation using fair value recognition and record stock-based compensation as a charge to earnings net of the estimated impact of forfeited awards. As such, CSI recognizes stock-based compensation cost only for those stock-based awards that are estimated to ultimately vest over their requisite service period, based on the vesting provisions of the individual grants.

The process of estimating the fair value of stock-based compensation awards and recognizing stock-based compensation cost over their requisite service period involves significant assumptions and judgments. CSI estimates the fair value of stock option awards on the date of grant using a Monte Carlo univariate pricing model for awards with market conditions and the Black-Scholes option-valuation model for the remaining awards, which requires that CSI make certain assumptions regarding: (i) the expected volatility in the market price of its common stock; (ii) dividend yield; (iii) risk-free interest rates; and (iv) the period of time employees are expected to hold the award prior to exercise (referred to as the expected holding period). As a result, if CSI revises its assumptions and estimates, its stock-based compensation expense could change materially for future grants.

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Legal and Other Contingencies

CSI is subject to various claims and legal proceedings. Each reporting period CSI reviews the status of each significant legal dispute to which it is a party and assesses its potential financial exposure, if any. If the potential financial exposure from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, CSI records a liability and an expense for the estimated loss, or the low end of the range if no amount in a range of estimated losses is more likely than the others. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, CSI reassesses the potential liability related to its pending claims and litigation and revise its estimates accordingly. Such revisions in the estimates of the potential liabilities could have a material effect on its results of operations and financial position.

Recent Accounting Pronouncements

On July 1, 2009, the Financial Accounting Standards Board, or FASB, released the FASB Accounting Standards Codification™, sometimes referred to as the “Codification” or “ASC.” The Codification does not change how CSI accounts for its transactions or the nature of related disclosures made, and was made effective for periods ending on or after September 15, 2009. Accordingly, references in this current report on Form 8-K are updated to reflect the Codification Topics as applicable.

In October 2009, the FASB updated its guidance regarding accounting for multiple deliverable arrangements in order to require vendors to account for products and services (deliverables) separately rather than as a combined unit. These changes are effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010 and early adoption is permitted. CSI does not expect the adoption of this accounting update to have a significant impact on its financial statements.

In January 2010, the FASB issued guidance designed to improve disclosures about fair value measurements as well as disclosures related to significant transfers between each level and additional information about Level 3 activity. This guidance begins phasing in the first fiscal period after December 15, 2009, and CSI included such disclosures, as required, in its Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K.

For additional discussion regarding these, and other recent accounting pronouncements, see Note 2 to CSI’s Annual Consolidated Financial Statements included in the Registration Statement and Note 1 to CSI’s Interim Condensed Consolidated Financial Statements, appearing elsewhere in this current report on Form 8-K.

Recent Developments

Closing of Merger with Clean Diesel

On October 15, 2010, following receipt of necessary shareholder approvals at CSI’s special meeting of shareholders and Clean Diesel’s annual meeting of stockholders, each held on October 12, 2010, Clean Diesel’s wholly-owned subsidiary, CDTI Merger Sub, Inc., merged with and into CSI, with CSI as the surviving corporation, all as contemplated by the Agreement and Plan of Merger dated May 13, 2010, as amended, by and among Clean Diesel, CDTI Merger Sub, Inc. and CSI (the “Merger Agreement”). We refer to this transaction as the Merger. CSI is now a wholly-owned subsidiary of Clean Diesel. Immediately prior the Merger, the investors in CSI’s capital raise (described below) acquired the remaining $2.0 million principal amount of secured convertible notes, and all $4.0 million of the secured convertible notes converted into CSI’s Class B common stock, which was then exchanged for shares of Clean Diesel common stock at the effective time of the Merger as contemplated by the Merger Agreement. Immediately prior the Merger, CSI also issued additional shares of common stock (which was designated as Class A common stock) to its then non-employee Directors, which along with $100,000 in cash, as payment in full for accrued Directors fees for periods prior to January 1, 2010.

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The Merger was accounted for as a reverse acquisition and, as a result, Clean Diesel’s (the legal acquirer) consolidated financial statements will, in substance, be those of CSI (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of Clean Diesel being included effective from the date of the closing of the Merger. However, because the Merger was not completed until October 15, 2010, after the end of CSI’s most recent fiscal quarter on September 30, 2010, this Management’s Discussion and Analysis of Financial Condition and Results of Operations of CSI, the accounting acquirer and CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K reflect CSI as of September 30, 2010 and for the periods ending September 30, 2010 and September 30, 2009 (e.g., prior to the closing of the Merger).

Capital Raise

On June 2, 2010, CSI entered into agreements with a group of accredited investors providing for the sale of $4.0 million of secured convertible notes. Under the agreements, $2.0 million of the secured convertible notes were issued by CSI in four equal installments ($500,000 on each of June 2, 2010, June 8, 2010, June 28, 2010 and July 12, 2010), with the remaining $2.0 million to be issued after CSI’s shareholders approve the Merger and after other necessary approvals under CSI’s articles of incorporation, but prior to the effective time of the Merger. Under the terms of the agreements, it was a condition to the obligations of the investors with respect to the final $2.0 million tranche that all conditions precedent to the closing of the Merger be satisfied or waived (among other items). Additionally, because the necessary shareholder approvals were received at the special meeting of CSI’s shareholders held on October 12, 2010 to permit conversion thereof, the final $2.0 million tranche was issued on October 15, 2010 immediately prior to the Merger and the aggregate $4.0 million of secured convertible notes was converted into newly created “Class B” common stock immediately prior to the Merger such that at the effective time of the Merger, this group of accredited investors received approximately 66% of the shares of Clean Diesel common stock (but not warrants to purchase Clean Diesel common stock) issued to CSI’s stockholders in the Merger.

The initial $2.0 million of this capital raise provided CSI with financing for its immediate working capital needs and ensured the minimum cash position necessary such that CSI would meet the 60/40 target required by the Merger Agreement so that the Clean Diesel shares issued to CSI shareholders (including investors in the capital raise) in the Merger (taking into account shares issued to CSI’s financial advisor for its fees) would represent collectively 60% of the shares of Clean Diesel deemed to be outstanding after the Merger (without taking into account the warrants issued to CSI’s shareholders, the warrants issued to CSI’s financial advisor or the warrants issued to the investors in Clean Diesel’s Regulation S offering). The final $2.0 million tranche, funded immediately prior to the Merger provided CSI with the $3.0 million of cash necessary to meet the closing condition as well as working capital for the combined company. One of the members of CSI’s Board of Directors, Mr. Alexander (“Hap”) Ellis, III, is a partner of RockPort Capital Partners. RockPort Capital Partners subscribed for a portion of the secured convertible notes as part of the capital raise. For a description of the specific terms of the secured convertible notes, see “Description of Indebtedness — Secured Convertible Notes” below.

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Forbearance from Fifth Third Bank Extended to January 13, 2011

As of August 31, 2010, Fifth Third Bank, CSI’s secured lender, agreed to extend forbearance under the terms of CSI’s credit facility until October 15, 2010. Under the terms of the forbearance, CSI’s current credit limit was further reduced to Canadian $6.0 million from Canadian $7.0 million and the interest rate was further increased to U.S./Canadian Prime Rate plus 3.00%. A further extension until January 13, 2011 (90 days after the effective date of the Merger) was provided because the Merger was completed by October 15, 2010 and:

• as of October 15, 2010, the secured convertible notes issued by CSI in connection with the capital raise converted to common equity and the security granted to the secured convertible note holders was released;

• CSI and Clean Diesel collectively had $3.0 million of free cash on their balance sheet;

• CSI’s Engine Control Systems subsidiary had Canadian $2.0 million available under the existing loan agreement; and

• no default, forbearance default or event of default (as defined in the credit and forbearance agreements) was outstanding.

For more information relating to the credit facility, see “— Description of Indebtedness — Fifth Third Bank” below.

Asian Joint Venture — Reduction of Ownership Interest to 5%

In February 2008, CSI entered into an agreement with Tanaka Kikinzoku Kogyo Kabushiki Kaisha, or TKK, to form a new joint venture company, TC Catalyst Incorporated, or TCC, to manufacture and distribute catalysts in China, Japan, South Korea and other Asian countries. Under the terms of the agreement, CSI and TKK each originally owned 50% of TCC. TKK provided TCC with $1.0 million in equity and capital and $5.0 million in debt financing, while CSI provided $1.0 million of equity and licensed specific patents, and technology and intellectual property for use in the defined territories royalty-free to the venture. In exchange for the licensed technology, TCC issued CSI a promissory note for JPY 500 million (U.S. $4.7 million) that accrued interest at 2.8%, and was due in March 2018.

In December 2008, TKK and CSI agreed to modify the terms of the joint venture whereby CSI sold 40% of its ownership interest in TCC to TKK for $441,000, reducing its ownership share of TCC from 50% to 30%. In addition, CSI agreed to sell and transfer specific heavy duty diesel catalyst technology and intellectual property for use in the defined territories for $7.5 million to TKK and TKK agreed to provide that intellectual property to TCC on a royalty-free basis. CSI recognized $5.0 million as a gain in 2008 following completion of the sale with the balance of $2.5 million being recognized in 2009. The promissory note from TCC was reduced from JPY 500 million to JPY 250 million.

In December 2009, TKK and CSI further modified the terms of the joint venture agreement originally entered into in February 2008, whereby CSI sold 83% of its remaining ownership of TCC to TKK for $108,000 reducing its ownership share from 30% to 5%. CSI’s investment in TCC is accounted for using the equity method as CSI still has significant influence over TCC as a result of having a seat on TCC’s board. CSI agreed to sell and transfer specific three-way catalyst technology and intellectual property for use in the Asia-Pacific territories for $3.9 million to TKK, and TKK agreed to provide that intellectual property to TCC on a royalty-free basis. CSI recognized a gain of $3.9 million in January 2010. The promissory note with a remaining balance of JPY 250 million was retired. In 2010, pursuant with the terms of the joint venture agreement CSI has loaned TCC $0.4 million to fund operations. CSI has recognized this as an investment in the subsidiary, see Note 7 to the interim Condensed Consolidated Financial Statements.

Sale of Applied Utility Systems (Energy Systems Division)

In August 2006, CSI acquired the assets of Applied Utility Systems (Energy Systems division) a business engaged in the engineering and installation of emission control systems for natural gas fired boilers and process heaters in refineries and manufacturing plants. In October 2009, CSI sold the assets of this business to Johnson Matthey for $8.6 million of cash, as well as the right to receive up to $1.4 million additional consideration if a certain order was received and warranties are met. Because a certain order was not received, $0.5 million of the contingent consideration is no longer payable to CSI. The remaining $0.9 million of contingent consideration is payable to CSI through July 2013 if projected contract warranties are met. CSI used the proceeds from this sale to repay approximately $6.8 million in secured debt (see “— Liquidity and Capital Resources — Description of Indebtedness” below) and for general working capital. The operations and sale of Applied Utility Systems are reported as a discontinued operation in CSI’s financial statements for all periods represented.

9

Catalyst Division Restructuring

Beginning in 2008 and continuing through 2009, CSI initiated a series of restructuring activities as a result of a strategic review of its Catalyst division. These activities included reducing workforce by approximately 55% to eliminate excess capacity, consolidating certain functions to eliminate redundancies between engineering and manufacturing, focusing its marketing and product development strategies around heavy duty diesel catalysts and existing and selected new customers in the light duty vehicle market. The overall objectives of the restructuring activities were to lower costs and position the Catalyst division to break even at lower sales and to make this division profitable. To date, these efforts have helped enhance CSI’s ability to reduce operating losses, retain and expand existing relationships with existing customers and attract new business. The benefits of this cost reduction were realized partially in the year ended December 31, 2009 and the full effect of actions taken during 2009 is expected to be realized in the year ended December 31, 2010. CSI estimates that its efforts have reduced the cost structure of this division by approximately $12 million on an annualized basis. In connection with these efforts, CSI incurred $2.7 million of severance and recapitalization charges in the year ended December 31, 2009. These charges primarily included charges for severance payments for headcount reduction and fees for strategic advisors. In the year ended December 31, 2008, in concert with its strategic review, CSI assessed the carrying value of its fixed assets in the Catalyst division and recorded an impairment charge of $4.9 million.

A reconciliation of CSI’s accrued severance and related expenses are as follows:

Accrued severance at December 31, 2008	$	187,000
Accrued severance expense during 2009		1,429,000
Paid severance expense during 2009		(946,000	)
Accrued severance at December 31, 2009	$	670,000
Accrued severance expense during the nine months ended September 30, 2010		15,000
Paid severance expense during the nine months ended September 30, 2010		(322,000	)
Accrued severance at September 30, 2010	$	363,000

CSI may utilize similar measures in the future to realign its operations to further increase its operating efficiencies, which may materially affect its future operating results. CSI’s ability to implement corresponding significant reductions in costs of the combined company by making significant additional structural changes in the operations of the combined company in the future may be limited.

Factors Affecting Future Results

The recently completed Merger (described above under “Recent Developments—Closing of Merger with Clean Diesel”) will have an impact on CSI’s future results as CSI will consolidate Clean Diesel’s results operations for periods after the effective time of the Merger.

The nature of CSI’s business and, in particular, its Heavy Duty Diesel Systems division, are heavily influenced by government funding of emissions control projects and increased diesel emission control regulations, compliance with which drives demand for its products. Notably, the retrofit applications sold by the division are generally for funded one-off projects, and typical end-user customers include school districts, municipalities and other fleet operators. For example, due to the California state budget crisis in late 2008 and early 2009, a state-funded emissions control project that was anticipated to commence in the first half of 2009, did not receive funding and its commencement date, if ever, remains uncertain. As such, CSI’s Heavy Duty Diesel Systems division had lower revenues than anticipated in the first half of 2009 due to the lack of funding available to potential users of its products. However, following the passage of the American Recovery and Reinvestment Act of 2009 (commonly referred to as the Stimulus Bill), government spending (both federal and state) increased. As such, in the second half of 2009, additional government emissions control programs were funded, including a different California-state funded program, and consequently, CSI’s Heavy Duty Diesel Systems division revenues improved in the second half of 2009 due to the availability of government funding for users of its products. Future budget crises and changes in government funding levels will have a similar effect on the revenues of CSI’s Heavy Duty Diesel Systems division.

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Because the customers of CSI’s Catalyst division are auto makers, CSI’s business is also affected by macroeconomic factors that impact the automotive industry generally, which can result in increased or decreased purchases of vehicles, and consequently demand for CSI’s products. The global economic crisis in the latter half of 2008 that continued through 2009 had a negative effect on CSI’s customers in the automotive industry. As such demand for its products, which its auto maker customers incorporate into the vehicles they sell, decreased. In the future, if similar macroeconomic factors or other factors affect CSI’s customer base, its revenues will be similarly affected. In addition, two auto maker customers account for a significant portion of CSI’s Catalyst division revenues (see Note 2 to its Annual Consolidated Financial Statements appearing in the Registration Statement). In the second half of 2010, one of these auto makers accelerated manufacture of a vehicle that requires a catalyst product meeting a higher regulatory standard than the product currently supplied to such auto maker by CSI’s Catalyst division. Although CSI had already commenced the necessary testing and approval processes for its products under the higher regulatory standard, such processes are not yet complete. Accordingly, CSI now expects lower revenues in its Catalyst division for the last quarter of 2010 and early 2011 as compared to the nine months ended September 30, 2010 on an annualized basis as this auto maker winds down production of the vehicle that incorporates CSI’s verified product. Although CSI expects that sales of its Catalyst products to this auto maker will resume in the first half of 2011 once it has received the necessary regulatory approvals and customer qualifications, there is no guarantee that this will occur.

Results of Operations

Comparison of Three Months Ended September 30, 2010 to Three Months Ended September 30, 2009

Revenue

The table below and the tables in the discussion that follow are based upon the way CSI analyzes its business. See Note 12 to CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K for additional information about CSI’s division segments.

	Three Months Ended September 30
			% of Total						% of Total
	2010		Revenue			2009			Revenue			$ Change			% Change
	(Dollars in millions)
Heavy Duty Diesel Systems	$	6.9		63.3	%	$	5.9			44.0	%	$	1.0			16.9	%
Catalyst		4.0		36.7	%		7.7			57.5	%		(3.7	)		(48.1	)%
Intercompany revenue		—		—			(0.2	)		(1.5	)%		0.2			100.0	%
Total revenue	$	10.9				$	13.4					$	(2.5	)		(18.7	)%

Total revenue for the three months ended September 30, 2010 decreased by $2.5 million, or 18.7%, to $10.9 million from $13.4 million for the three months ended September 30, 2009.

Revenues for CSI’s Heavy Duty Diesel Systems division for the three months ended September 30, 2010 increased $1.0 million, or 16.9%, to $6.9 million from $5.9 million for the three months ended September 30, 2009. The increase was due largely to an expansion of CSI’s distributor channels in the United States as well as continued benefit from funding allocated to diesel emission control under the American Recovery and Reinvestment Act of 2009 (commonly referred to as the Stimulus Bill), which provided customers an incentive to acquire CSI’s emission control products. In addition, revenues for the three months ended September 30, 2009 were adversely impacted by the global economic slowdown and the California budget crisis, resulting in a favorable year-over-year comparison of three months ended September 30, 2010 compared to the same period in 2009.

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Revenues for CSI’s Catalyst division for the three months ended September 30, 2010 decreased $3.7 million, or 48.1%, to $4.0 million from $7.7 million for the three months ended September 30, 2009. Sales for this division decreased year over year as a result of an automaker accelerating the manufacture of a vehicle that requires a catalyst product meeting a higher regulatory standard than the product currently supplied to the automaker by CSI’s Catalyst division. CSI expects revenues in its Catalyst division for the fourth quarter of 2010 and the first quarter of 2011 to be similar to the third quarter of 2010 (see“—Factors Affecting Future Results” above).

Intercompany sales by the Catalyst division to its Heavy Duty Diesel Systems division are eliminated in consolidation.

Cost of revenues

Cost of revenues decreased by $1.7 million, or 16.8%, to $8.4 million for the three months ended September 30, 2010 compared to $10.1 million for the three months ended September 30, 2009. The primary reason for the decrease in costs was lower product sales volume in CSI’s Catalyst division, which was partially offset by the higher product sales volume in CSI’s Heavy Duty Diesel Systems division.

Gross profit

The following table shows CSI’s gross profit and gross margin (gross profit as a percentage of revenues) by division for the periods indicated.

	Three Months Ended September 30
			% of					% of
	2010		Revenue (1)			2009		Revenue (1)
	(Dollars in millions)
Heavy Duty Diesel Systems	$	2.0		29.0	%	$	1.9		32.2	%
Catalyst		0.5		12.5	%		1.4		18.2	%
Total gross profit	$	2.5		22.9	%	$	3.3		24.6	%

(1) Division calculation based on division revenue. Total based on total revenue.

Gross profit decreased by $0.8 million, or 24.2%, to $2.5 million for the three months ended September 30, 2010, from $3.3 million for the three months ended September 30, 2009. Gross margin decreased to 22.9% for the three months ended September 30, 2010 from 24.6% for the three months ended September 30, 2009. The decrease in gross profit was primarily due to product mix and decreased sales resulting in greater amortization of fixed manufacturing costs per sales dollar.

The reduction in gross margin for CSI’s Heavy Duty Diesel Systems division during the three months ended September 30, 2010 as compared to the same period in 2009 is a result of changes in product mix, reflecting a higher proportion of sales of a lower margin product, and higher proportion of sales through a distributor who has a preferred purchasing arrangement, where in exchange for higher volumes, the distributor receives a lower sales price, which results in lower profit to CSI.

The reduction in gross margin for CSI’s Catalyst Division during the three months ended September 30, 2010 as compared to the same period in 2009 is a result of lower factory production due to sales for this division decreased year over year as a result of an automaker accelerating the manufacture of a vehicle that requires a catalyst product meeting a higher regulatory standard than the product currently supplied to the automaker by CSI’s Catalyst division, resulting in greater amortization of the fixed manufacturing costs per sales dollar.

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Operating expenses

The following table shows CSI’s operating expenses and operating expenses as a percentage of revenues for the periods indicated.

	Three Months Ended September 30
			% of Total					% of Total
	2010		Revenue			2009		Revenue			$ Change			% Change
	(Dollars in millions)
Sales and marketing	$	0.8		7.2	%	$	1.0		7.6	%	$	(0.2	)		(22.0	)%
Research and development		1.1		9.7	%		2.1		15.9	%		(1.0	)		(50.3	)%
General and administrative		1.9		17.8	%		2.1		15.4	%		(0.2	)		(5.9	)%
Recapitalization expenses		0.8		7.1	%		0.3		2.2	%		0.5			155.5	%
Total operating expenses	$	4.6		41.8	%	$	5.5		41.1	%	$	(0.9	)		(17.3	)%

For the three months ended September 30, 2010, operating expenses decreased by $0.9 million, or 17.3%, to $4.6 million from $5.5 million for the three months ended September 30, 2009. The primary reason for the decrease in operating expenses was continued improvements in expense management as a result of the cost reduction efforts implemented as part of the Catalyst division restructuring, which were partially offset by increased recapitalization expenses resulting from expenses resulting from legal, accounting and regulatory costs as a result of the Merger with Clean Diesel.

Sales and marketing expenses

For the three months ended September 30, 2010, sales and marketing expenses decreased by $0.2 million, or 22.0%, to $0.8 million from $1.0 million for the three months ended September 30, 2009. The reduction is primarily due to the cost reduction efforts implemented in 2008 and 2009 as part of the Catalyst division restructuring. Sales and marketing expenses as a percentage of sales decreased to 7.2% in the three months ended September 30, 2010 compared to 7.6% in the three months ended September 30, 2009.

Research and development expenses

For the three months ended September 30, 2010, research and development expenses decreased by $1.0 million, or 50.3%, to $1.1 million from $2.1 million for the three months ended September 30, 2009. The decrease in research and development expenses was primarily attributable to the cost reduction efforts implemented in 2008 and 2009 as part of the Catalyst division restructuring. As a percentage of revenues, research and development expenses were 9.7% in the three months ended September 30, 2010, compared to 15.9% in the three months ended September 30, 2009.

General and administrative expenses

For the three months ended September 30, 2010, general and administrative expenses decreased $0.2 million or 5.9%, to $1.9 million from $2.1 million for the three months ended September 30, 2009. The decrease in general and administrative expenses was primarily attributable to the cost reduction efforts implemented in 2008 and 2009 as part of the Catalyst division restructuring. General and administrative expenses as a percentage of sales decreased to 17.8% in the three months ended September 30, 2010 as compared to 15.4% in the three months ended September 30, 2009.

Recapitalization expenses

For the three months ended September 30, 2010, recapitalization expenses increased $0.5 million, or 155.5%, to $0.8 million from $0.3 million for the three months ended September 30, 2009. In 2010, these expenses represent legal and professional fees paid that are directly related to the Merger, compared to professional fees paid to strategic financial advisors in connection with the recapitalization of CSI in 2009. Recapitalization expenses as a percentage of sales increased to 7.1% in the three months ended September 30, 2010 as compared to 2.2% in the three months ended September 30, 2009.

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Non-operating income (expense)

	Three Months Ended September 30
				% of Total						% of Total
	2010			Revenue			2009			Revenue
	(Dollars in millions)
Interest expense	$	(1.5	)		(13.8	)%	$	(0.6	)		(4.5	)%
Other expense, net		(0.6	)		(5.5	)%		(0.5	)		(3.7	)%
Total non-operating expense, net	$	(2.1	)		(19.3	)%	$	(1.1	)		(8.2	)%

Interest expense

For the three months ended September 30, 2010, CSI incurred interest expense of $1.5 million compared to $0.6 million in the three months ended September 30, 2009. This increase is due to $1.2 million of interest expense in the three months ended September 30, 2010 related to the June 2010 issuance of secured convertible notes. The interest expense is largely non-cash and related to the embedded financial instruments within the Notes. For additional information on the secured convertible notes, see “Recent Developments—Capital Raise” above and Note 3 to CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K. These notes were converted to equity immediately prior to the Merger and are no longer outstanding. This increase was partially off-set by a decrease in interest expense due to the reduction in outstanding indebtedness, excluding the secured convertible notes, from $12.4 million at September 30, 2009 to $5.6 million at September 30, 2010. Additionally, the three months ended September 30, 2009 included $0.2 million in acceleration of deferred financing expense due to the violation of covenants under CSI’s borrowing agreements with Fifth Third Bank and Cycad Group, LLC.

Other expense

For the three months ended September 30, 2010, other expense was $0.6 million compared to $0.5 million expense for the three months ended September 30, 2009, an increase of $0.1 million.

Income taxes

For the three months ended September 30, 2010, CSI had income tax benefits from continuing operations of $0.1 million compared to an income tax benefit of $0.2 million for the three months ended September 30, 2009. CSI has no significant tax expense in its U.S.-based operations. CSI’s Canadian and Swedish operations have an effective tax rate of 34%.

Net loss

For the foregoing reasons, CSI had a net loss of $3.3 million for the three months ended September 30, 2010 compared to a net loss of $3.1 million for the three months ended September 30, 2009. Excluding net income from discontinued operations, CSI had a net loss from continuing operations of $4.1 million for the three months ended September 30, 2010 compared to a net loss from continuing operations of $3.2 million for the three months ended September 30, 2009.

14

Comparison of Nine Months Ended September 30, 2010 to Nine Months Ended September 30, 2009

Revenue

The table below and the tables in the discussion that follows are based upon the way CSI analyzes its business. See Note 12 to CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K for additional information about CSI’s division segments.

	Nine Months Ended September 30
				% of Total						% of Total
	2010			Revenue			2009			Revenue			$ Change			% Change
	(Dollars in millions)
Heavy Duty Diesel Systems	$	22.7			62.5	%	$	14.7			45.2	%	$	8.0			54.4	%
Catalyst		13.9			38.3	%		18.1			55.7	%		(4.2	)		(23.2	)%
Intercompany revenue		(0.3	)		(0.8	)%		(0.3	)		(0.9	)%		—			—
Total revenue	$	36.3					$	32.5					$	3.8			11.7	%

Total revenue for the nine months ended September 30, 2010 increased by $3.8 million, or 11.7%, to $36.3 million from $32.5 million for the nine months ended September 30, 2009.

Revenues for CSI’s Heavy Duty Diesel Systems division for the nine months ended September 30, 2010 increased $8.0 million, or 54.4%, to $22.7 million from $14.7 million for the nine months ended September 30, 2009. The increase was due largely to an expansion of CSI’s distributor channels in the United States as well as continued benefit from funding allocated to diesel emission control under the American Recovery and Reinvestment Act of 2009 (commonly referred to as the Stimulus Bill), which provided customers an incentive to acquire CSI’s emission control products. In addition, revenues for the nine months ended September 30, 2009 were adversely impacted by the global economic slowdown and the California budget crisis, resulting in a favorable year-over-year comparison of the first nine months 2010 compared to the same period in 2009.

Revenues for CSI’s Catalyst division for the nine months ended September 30, 2010 decreased $4.2 million, or 23.2%, to $13.9 million from $18.1 million for the nine months ended September 30, 2009. Sales for this division decreased year over year as a result of an automaker accelerating the manufacture of a vehicle that requires a catalyst product meeting a higher regulatory standard than the product currently supplied to the automaker by CSI’s Catalyst division, and CSI expects revenues in its Catalyst division for the fourth quarter of 2010 and early 2011 to be similar to the third quarter of 2010 (see “Factors Affecting Future Results” above).

Intercompany sales by CSI’s Catalyst division to CSI’s Heavy Duty Diesel Systems division are eliminated in consolidation.

Cost of revenues

Cost of revenues increased by $1.3 million, or 5.1%, to $27.0 million for the nine months ended September 30, 2010 compared to $25.7 million for the nine months ended September 30, 2009. The primary reason for the increase in costs was higher product sales volume in CSI’s Heavy Duty Diesel Systems division, which was partially offset by lower product sales volume in CSI’s Catalyst division.

15

Gross profit

The following table shows CSI’s gross profit and gross margin (gross profit as a percentage of revenues) by division for the periods indicated.

	Nine Months Ended September 30
			% of					% of
	2010		Revenue (1)			2009		Revenue (1)
	(Dollars in millions)
Heavy Duty Diesel Systems	$	6.8		30.0	%	$	4.7		32.0	%
Catalyst		2.5		18.0	%		2.2		12.1	%
Total gross profit	$	9.3		25.6	%	$	6.9		21.0	%

(1) Division calculation based on division revenue. Total based on total revenue.

Gross profit increased by $2.4 million, or 34.8%, to $9.3 million for the nine months ended September 30, 2010, from $6.9 million for the nine months ended September 30, 2009. Gross margin increased to 25.6% for the nine months ended September 30, 2010 from 21.0% for the nine months ended September 30, 2009. The increase in gross profit was primarily due to both the increased sales of CSI’s Heavy Duty Diesel Systems division and reductions in manufacturing overhead costs as well as continued increases in efficiency in CSI’s Catalyst division following the restructuring efforts implemented in 2008 and 2009.

The reduction in gross margin for CSI’s Heavy Duty Diesel Systems division during the nine months ended September 30, 2010 as compared to the same period in 2009 is a result of changes in overall product mix, reflecting a higher proportion of sales of a lower margin product, and higher proportion of sales through a distributor that has a preferred purchasing arrangement, where in exchange for higher volumes the distributor pays a lower sales price, which results in lower profit to CSI. The margins will improve as the product sales mix shifts towards higher margin products, which is expected to occur in 2011.

The increase in the gross margin for CSI’s Catalyst division is a result of the restructuring actions taken with the Catalyst division. CSI expects continued benefit in the future from the restructuring, however expects to have downward pressure on margins until the restart of the production with the auto manufacturer once its product receives regulatory approval for the higher standard (see “Factors Affecting Future Results” above).

Operating expenses

The following table shows CSI’s operating expenses and operating expenses as a percentage of revenues for the periods indicated.

	Nine Months Ended September 30
				% of Total						% of Total
	2010			Revenue			2009			Revenue			$ Change			% Change
	(Dollars in millions)
Sales and marketing	$	2.3			6.3	%	$	3.1			9.5	%	$	(0.8	)		(25.8	)%
Research and development		3.2			8.8	%		5.9			18.2	%		(2.7	)		(45.8	)%
General and administrative		6.1			16.8	%		6.0			18.5	%		0.1			1.7	%
Recapitalization expenses		1.5			4.1	%		1.0			3.1	%		0.5			50.0	%
Gain on sale of intellectual Property		(3.9	)		(10.7	)%		(2.5	)		(7.7	)%		(1.4	)		56.0	%
Severance and other charges		—			—			0.2			0.6	%		(0.2	)		(100	)%
Total operating expenses	$	9.2			25.3	%	$	13.7			42.2	%	$	(4.5	)		(32.8	)%

16

For the nine months ended September 30, 2010, operating expenses decreased by $4.5 million, or 32.8%, to $9.2 million from $13.7 million for the nine months ended September 30, 2009. A significant reason for the decrease in operating expenses was the recognition of a $3.9 million gain in the nine months ended September 30, 2010 compared to a $2.5 million gain in the nine months ended September 30, 2009, which arose from the sale of specific three-way catalyst technology and intellectual property to TKK, CSI’s Asian joint venture partner (as described above under “Recent Developments—Asian Joint Venture — Reduction of Ownership Interest to 5%), and to a lesser extent, continued improvements in expense management as a result of the cost reduction efforts implemented as part of the Catalyst division restructuring.

Sales and marketing expenses

For the nine months ended September 30, 2010, sales and marketing expenses decreased by $0.8 million, or 25.8%, to $2.3 million from $3.1 million for the nine months ended September 30, 2009. The reduction is primarily due to the cost reduction efforts implemented in 2008 and 2009 as part of the Catalyst division restructuring. Sales and marketing expenses as a percentage of revenues decreased to 6.3% in the nine months ended September 30, 2010 compared to 9.5% in the nine months ended September 30, 2009.

Research and development expenses

For the nine months ended September 30, 2010, research and development expenses decreased by $2.7 million, or 45.8%, to $3.2 million from $5.9 million for the nine months ended September 30, 2009. The decrease in research and development expenses was primarily attributable to the cost reduction efforts implemented in 2008 and 2009 as part of the Catalyst division restructuring. As a percentage of revenues, research and development expenses were 8.8% in the nine months ended September 30, 2010, compared to 18.2% in the nine months ended September 30, 2009. CSI expects the research and development expense, as a percent of revenue, to continue to be similar to the nine months ending September 30, 2010.

General and administrative expenses

For the nine months ended September 30, 2010, general and administrative expenses increased $0.1 million, or 1.7%, to $6.1 million from $6.0 million for the nine months ended September 30, 2009. The increase was primarily due to increased legal and professional expenses, which were primarily due to legal and other professional fees incurred with respect to the forbearance arrangements of CSI’s outstanding debt. General and administrative expenses as a percentage of revenues decreased to 16.8% in the nine months ended September 30, 2010 as compared to 18.5% in the nine months ended September 30, 2009.

Recapitalization expenses

For the nine months ended September 30, 2010, recapitalization expenses increased $0.5 million, or 50%, to $1.5 million from $1.0 million for the nine months ended September 30, 2009. In the first nine months of 2010, these expenses represent legal and professional fees paid directly attributable to the Merger, compared to professional fees paid to strategic financial advisors in connection with efforts to recapitalize CSI in the same period in 2009. Recapitalization expenses as a percentage revenues increased to 4.1% in the nine months ended September 30, 2010 as compared to 3.1% in the nine months ended September 30, 2009.

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Non-operating income (expense)

	Nine Months Ended September 30
				% of Total						% of Total
	2010			Revenue			2009			Revenue
	(Dollars in millions)
Interest expense	$	(2.2	)		(6.1	)%	$	(2.1	)		(6.5	)%
Other expense, net		(0.7	)		(1.9	)%		(1.3	)		(4.0	)%
Total non-operating expense, net	$	(2.9	)		(8.0	)%	$	(3.4	)		(10.5	)%

Interest expense

For the nine months ended September 30, 2010, CSI incurred interest expense of $2.2 million compared to $2.1 million in the nine months ended September 30, 2009. The slight increase was due to $1.7 million of non-cash interest expense on the secured convertible notes issued in June 2010, which was offset by reductions in CSI’s other outstanding indebtedness, which decreased from $12.4 million at September 30, 2009 to $5.6 million at September 30, 2010. For more information on the secured convertible notes, see “Recent Developments—Capital Raise” above, “Description of Indebtedness—Secured Convertible Notes” below and Note 3 to CSI’s Interim Condensed Consolidated Financial Statements appearing elsewhere in this current report on Form 8-K. In addition, the nine months ended September 30, 2009 included $0.3 million in acceleration of deferred financing expense due to the violation of covenants under CSI’s borrowing agreements with Fifth Third Bank and Cycad Group, LLC.

Other expense

For the nine months ended September 30, 2010, other expense was $0.7 million compared to $1.3 million for the nine months ended September 30, 2009, a decrease of $0.6 million. The decrease was primarily a result of a reduction in CSI’s share of the net loss of its Asian joint venture (due to the decrease in its interest in such venture), which was $0.9 million in the nine months ended September 30, 2009 compared to a minimal loss for the same period in 2010, partially offset by expense of $0.2 million resulting from changes in the fair value of the derivative financial instruments issued in connection with the secured convertible notes issued in June 2010.

Income taxes

For the nine months ended September 30, 2010, CSI had income tax expense from continuing operations of $0.5 million compared to an income tax benefit of $0.1 million for the nine months ended September 30, 2009. The primary reason for the increase is the improved profitability of CSI’s Heavy Duty Diesel Systems division’s international operations. CSI has no significant tax expense in its U.S.-based operations. CSI’s Canadian and Swedish operations have an effective tax rate of 34%.

Net loss

For the foregoing reasons, CSI had a net loss of $2.7 million for the nine months ended September 30, 2010 compared to a net loss of $11.3 million for the nine months ended September 30, 2009. Excluding net income (loss) from discontinued operations, CSI had a net loss from continuing operations of $3.3 million for the nine months ended September 30, 2010 compared to a net loss from continuing operations of $10.2 million for the nine months ended September 30, 2009.

Liquidity and Capital Resources

The revenue that CSI generates is not sufficient to fund its operating requirements and debt servicing needs. Notably, CSI has suffered recurring losses and negative cash flows from operations since inception. CSI’s primary sources of liquidity in recent years have been asset sales and, to a limited extent, credit facilities and other borrowings. Such sources of liquidity, however, have not been sufficient to provide CSI with financing necessary to sufficiently capitalize its operations, and consequently, CSI’s working capital is severely limited.

18

As of September 30, 2010, CSI had an accumulated deficit of approximately $152.0 million and a working capital deficit of $6.2 million. As of December 31, 2009, CSI had an accumulated deficit of approximately $149.3 million and a working capital deficit of $4.4 million. CSI had $1.9 million in cash and cash equivalents at September 30, 2010 compared to $2.3 million in cash and cash equivalents at December 31, 2009 ($6.7 million at December 31, 2008), and total current liabilities of $20.0 million at September 30, 2010 compared to $22.9 million at December 31, 2009 ($35.9 million at December 31, 2008).

In light of CSI’s liquidity situation, in the first quarter of 2009, CSI retained Allen & Company LLC, a U.S.-based investment banking firm to act as a financial advisor to CSI in exploring alternatives to recapitalize CSI. Alternatives under consideration included the sale of CSI stock and/or a sale of CSI’s assets, continuing to negotiate with Fifth Third Bank and Cycad Group, LLC to modify loan terms in order to delay repayments while alternative capital is secured, and seeking out other alternatives, such as the proposed Merger.

During 2009, CSI took several actions to improve its liquidity. These actions included: (i) reduction in cash used in operations through cost reductions and improved working capital management, in particular as part of the restructuring of its Catalyst division (see “— Recent Developments — Catalyst Division Restructuring” above), but also due to implementing policies restricting travel, improving inventory management, and overall reductions in spending; (ii) improved operating efficiencies in light of installation of a new ERP system in 2008 (which lowered capital expenditures in 2009); (iii) capital expenditures have been reduced to necessary maintenance and targeted investments to improve processes or products; (iv) additional asset sales, including the sale of the assets of Applied Utility Systems and sale of intellectual property (see “Recent Developments” above); (v) repayment of debt, including pay off of Cycad Group, LLC (see Note 8 to CSI’s Annual Consolidated Financial Statements included in the Registration Statement), and (vi) entering into forbearance agreements with Fifth Third Bank to temporarily suspend its rights under CSI’s credit facility for a period of time (see “Description of Indebtedness — Fifth Third Bank” below). Notwithstanding the foregoing actions, CSI’s access to working capital continued to be limited and its debt service obligations and projected operating costs for 2010 exceeded its cash balance at December 31, 2009. As a result, CSI’s auditors’ report for fiscal year 2009 included an explanatory paragraph that expresses substantial doubt about CSI’s ability to continue as a “going concern.”

In the first half of 2010, CSI continued to work on its efforts to recapitalize its business and in May 2010, entered into the Merger Agreement and in June 2010 undertook the $4.0 million capital raise described above under “Recent Developments — Capital Raise,” continued to seek forbearance from its lender Fifth Third Bank as described above under “Recent Developments — Forebearance from Fifth Third Bank Extended to January 13, 2011,” and on October 15, 2010, completed the Merger with Clean Diesel. The completion of the Merger and the capital raise (see “Recent Developments—Closing of Merger with Clean Diesel” and “—Capital Raise” above) were important in addressing CSI’s ability to operate as a going concern. However, there is no certainty that existing cash will be sufficient to sustain operations of the combined company without additional financing and the replacement of CSI’s credit facility with Fifth Third Bank. At this time no assurances can be provided that CSI will be successful in these efforts.

The following table summarizes CSI’s cash flows for the nine months ended September 30, 2010 and 2009.

	September 30,
	2010			2009			$ Change			% Change
	(Dollars in millions)
Cash provided by (used in):
Operating activities	$	(0.5	)	$	(2.8	)	$	2.3			82.1	%
Investing activities	$	1.4		$	1.7		$	(0.3	)		(17.6	)%
Financing activities	$	(1.1	)	$	(2.5	)	$	1.4			56.0	%

19

Cash used in operating activities

CSI’s largest source of operating cash flows is cash collections from its customers following the sale of its products and services. CSI’s primary uses of cash for operating activities are for purchasing inventory in support of the products that it sells, personnel related expenditures, facilities costs and payments for general operating matters.

Cash used in operating activities in the nine months ended September 30, 2010 was $0.5 million, an increase of $2.3 million from nine months ended September 30, 2009, when CSI’s operating activities used $2.8 million of cash. This improvement was primarily due to higher gross profits and lower operating expenses in the nine months ended September 30, 2010 compared to the same period in 2009.

Cash provided by investing activities

Changes in CSI’s cash flows from investing activities primarily relate to asset sales and acquisitions, investment in its Asian joint venture as well as capital expenditures and other assets to support its growth plans.

Net cash generated by investing activities was $1.4 million in the nine months ended September 30, 2010; a decrease of $0.3 million as compared to the $1.7 million generated by investing activities in the nine months ended September 30, 2009. This decrease was primarily the result of $2.0 million received from CSI’s Asian joint venture partner, TKK, from the sale of intellectual property in the nine months ended September 30, 2010 compared to $2.5 million in the nine months ended September 30, 2009, as well as lower capital expenditures in the nine months ended September 30, 2010 of $0.2 million compared to $0.7 million in the same period of 2009. Offsetting this cash generated from investing activities was an additional investment of $0.4 million made in CSI’s Asian joint venture.

Cash used in financing activities

Since inception, CSI has financed its net operating cash usage through a combination of financing activities such as issuance of equity or debt and investing activities such as sale of intellectual property or other assets. Changes in CSI’s cash flows from financing activities primarily relate to borrowings and payments under debt obligations.

Net cash used in financing activities was $1.1 million in the nine months ended September 30, 2010; a $1.4 million decrease as compared to net cash used in financing activities of $2.5 million in the nine months ended September 30, 2009. The lower usage was primarily due to the receipt of $2.0 million of cash proceeds from the sale of secured convertible notes in June and July 2010, which was partially offset by a higher net pay-down of a line of credit for the nine months ended September 30, 2010 as compared to the same period in 2009.

Description of Indebtedness

CSI’s outstanding borrowing at September 30, 2010 and December 31, 2009 are summarized as follows:

	September 30,		December 31,
	2010		2009
	(Dollars in millions)
Line of credit	$	2.5	$	5.1
Consideration payable		3.0		3.0
Secured convertible notes, with a face value of $2.0 million		3.6		—
Capital lease obligations		0.1		0.1
Total borrowings	$	9.2	$	8.2

20

Fifth Third Bank

In December 2007, CSI and its subsidiaries, including Engine Control Systems, entered into borrowing agreements with Fifth Third Bank as part of the cash consideration paid for CSI’s December 2007 purchase of Engine Control Systems. The borrowing agreements initially provided for three facilities including a revolving line of credit and two term loans. The line of credit was a two-year revolving term operating loan up to a maximum principal amount of $8.2 million (Canadian $10 million), with availability based upon eligible accounts receivable and inventory. The other facilities included a five-year non-revolving term loan of up to $2.5 million, which was paid off during 2008, and a non-revolving term loan of $3.5 million which was paid off in October 2009.

At December 31, 2009, the line of credit consisted of a Canadian $8.5 million demand revolving credit line, subject to further reductions in the amount of availability during any forbearance period. Borrowings under this credit line bear interest at either (i) the U.S. Prime Rate plus 2.50% for borrowings in U.S. dollars; or (ii) the Canadian Prime Rate plus 2.50% for borrowings in Canadian dollars. As of January 31, 2010, the interest rates were increased as part of the forbearance agreement to U.S. Prime Rate plus 2.75% for U.S. dollar borrowings and to Canadian Prime Rate plus 2.75% for Canadian dollar borrowings. As of September 6, 2010, the interest rates were increased again as part of the forbearance agreement to U.S. Prime Rate plus 3.00% for U.S. dollar borrowings and to Canadian Prime Rate plus 3.00% for Canadian dollar borrowings. At September 30, 2010, the line of credit consisted of a Canadian $6.0 million demand revolving line of credit.

Under the terms of the Fifth Third Bank borrowing agreement, CSI’s Engine Control Systems subsidiary is restricted from making any distributions to CSI, the parent company, other than those for arms length transactions and management fees up to $250,000. The credit facility also requires that CSI maintain certain financial covenants and CSI has pledged as security for its obligations under the facility, its assets including share ownership and assets of principal subsidiaries. If CSI’s financial results do not reach the levels required by the covenants and CSI is unable to obtain a waiver, the credit facility would be in default and subject to acceleration. In addition to the foregoing, the credit facility also includes a material adverse change clause that is exercisable if, in the opinion of Fifth Third Bank, there is a material adverse change in the financial condition, ownership or operation of CSI or its principal subsidiary (Engine Control Systems). If Fifth Third Bank were to deem that such a material adverse change had occurred it may terminate CSI’s right to borrow under the facility and demand payment of all amounts outstanding.

On March 31, 2009, CSI failed to achieve two of the covenants under its Fifth Third Bank credit facility. These covenants related to the annualized EBITDA and the funded debt to EBITDA ratio for its Engine Control Systems subsidiary. Fifth Third Bank agreed to temporarily suspend its rights until July 1, 2009 subject to CSI, in Fifth Third Bank’s opinion, making reasonably satisfactory progress in its efforts to recapitalize its balance sheet and the provision of an audit report on the collateral pledged by CSI to Fifth Third Bank. In July 2009, the bank extended its forbearance until September 30, 2009, subject to similar terms. In October 2009, on the repayment of the term loan of $3.5 million, the bank verbally extended its forbearance until November 30, 2009. In December 2009, the bank extended its forbearance until January 31, 2010, converted the revolving line to a demand facility, reduced the credit limit to Canadian $8.5 million and raised the interest charged to Prime Rate plus 2.5%. This conversion to a demand facility effectively rendered the financial covenants under the original loan agreement meaningless. In January 2010, the bank further extended forbearance until April 30, 2010 and further reduced the credit limit to Canadian $7.5 million with a Canadian $100,000 reduction per month for the forbearance period. The interest rate was further increased to U.S./Canadian Prime Rate plus 2.75%. In June 2010, in connection with the capital raise (discussed above under “— Recent Developments — Capital Raise”), Fifth Third Bank agreed to further extend forbearance under the terms of its credit facility until August 31, 2010, and reduced the credit limit to Canadian $7.0 million, but made no further changes to the interest rate, which remained at U.S./Canadian Prime Rate plus 2.75%. A further extension until November 30, 2010 was to be granted if certain criteria were met. As of August 31, 2010, Fifth Third Bank agreed to further extend the forbearance until October 15, 2010 and, as the Merger was completed on such date, such forebearance was extended until January 13, 2011 (90 days after consummation of the Merger), but the credit limit was further reduced to $6.0 million, the interest rate was increased by 0.25% to U.S./Canadian Prime Rate plus 3.00%.

21

The current facility with Fifth Third is now effectively a demand facility, which means that Fifth Third may demand repayment of outstanding amounts at any time. Although CSI has no reason to believe that Fifth Third will not continue to extend credit to CSI on the terms set out in the forbearance agreement, or agree to modifications to the terms to extend the forbearance should the need arise, there is no guarantee that Fifth Third will do so. As such, if the forbearance agreement is not renewed by the time CSI is able to establish a new line of credit, CSI’s bank lender may move to exercise remedies that would materially adversely affect CSI and its business. These remedies would include setting off against the outstanding bank debt proceeds of its accounts receivable, the bank directing accounts receivable to be paid to it, the inability to make further borrowings under the credit agreement, and the seizure or sale of CSI’s equipment, inventory and general intangibles. These remedies would have a material adverse effect on CSI.

For further information regarding CSI’s credit agreement with Fifth Third Bank, see Note 8 to CSI’s Annual Consolidated Financial Statements appearing in the Registration Statement and Note 3 to CSI’s Interim Condensed Consolidated Financial Statements appearing elsewhere in this current report on Form 8-K.

Secured convertible notes

In June 2010, pursuant to the terms of its capital raise (discussed above under “Recent Developments — Capital Raise”), CSI agreed to issue up to $4 million of secured convertible notes, $2 million of which were issued as of September 30, 2010. The secured convertible notes, as amended, bore interest at a rate of 8% per annum, provided for a maturity date of August 2, 2010, and were secured by a subordinated lien on CSI’s assets, but were subordinated to Fifth Third Bank. Under the terms of the secured convertible notes, because the necessary shareholder approvals were received at the special meeting of CSI’s shareholders on October 12, 2010 to permit conversion thereof, CSI issued the remaining $2.0 million of secured convertible notes immediately prior to the Merger and all $4.0 million of secured convertible notes converted into newly created “Class B” common stock immediately prior to the Merger such that at the effective time of the Merger, this group of accredited investors received approximately 66% of the shares of common stock being issued by Clean Diesel to CSI shareholders in the Merger. This group of accredited investors did not receive any of the warrants issued by Clean Diesel to CSI shareholders in the Merger in exchange for their shares of “Class B” common stock. There are no longer any secured convertible notes issued and outstanding.

The secured convertible notes contained two embedded financial instruments that required separate accounting at September 30, 2010: the premium redemption feature (the penalty premium under default) and the contingent equity forward (the $2.0 million the noteholders committed to fund immediately prior to the Merger). The accounting for these and their impact on the book value of the convertible notes is discussed in Note 3 to CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K.

The secured convertible notes included a beneficial conversion feature totaling $0.7 million that was contingent on the approval by CSI’s shareholders of certain amendments to CSI’s Articles of Incorporation. As the related amendments were approved on October 12, 2010, the beneficial conversion feature will be recorded as additional non-cash interest expense in the three months ended December 31, 2010.

CSI recorded the initial value of the embedded financial instruments as a discount to the face value of the secured convertible notes and amortized it using the effective interest method through the original maturity date of the secured convertible notes, which was August 2, 2010. CSI then re-measured the embedded financial instruments at fair value at the end of the reporting period with recorded changes in fair value in other income (expense). At September 30, 2010 the fair value of the embedded financial instruments were $1.6 million.

22

Consideration payable

On October 20, 2010, CSI and the seller under the Applied Utility Systems Asset Purchase Agreement dated August 28, 2006 reached a settlement that ends all outstanding litigation and arbitration claims between such seller and CSI. On October 22, 2010, CSI made an initial payment to the seller of $1.5 million, pursuant to such settlement agreement. CSI is obligated to make eight subsequent payments of $250,000 each on December 31, April 30, July 31 and September 30, commencing December 31, 2010 and ending September 30, 2012, for an aggregate of $2.0 million. Under the settlement agreement, the seller may record a Uniform Commercial Code-1 (“UCC-1”) financing statement securing the subsequent payment obligations, which shall be subordinated to all existing liens against CSI’s assets and, subject to CSI not being in default with respect to the subsequent payment obligations, shall be subordinated to any new financing obtained by CSI or its affiliates. Details of the settlement, including the discount that CSI would receive for early prepayment, are included in a current report on Form 8-K filed by Clean Diesel with the Securities and Exchange Commission on October 21, 2010. For more information relating to this dispute, see Note 11 to CSI’s Interim Condensed Consolidated Financial Statements included elsewhere in this current report on Form 8-K.

Off-Balance Sheet Arrangements

As of September 30, 2010 and December 31, 2009, CSI had no off-balance sheet arrangements.

Commitments and Contingencies

As of September 30, 2010 and December 31, 2009, other than office leases and employment agreements with key executive officers, CSI had no material commitments other than the liabilities reflected in CSI’s Annual Consolidated Financial Statements and Interim Condensed Consolidated Financial Statements.

Related-Party Transactions

In June 2010, CSI agreed to issue up to $4 million of secured convertible notes to a group of accredited investors (see “Recent Developments—Capital Raise”). RockPort Capital Partners subscribed for a portion of the secured convertible notes as part of the capital raise. One of the members of CSI’s Board of Directors, Mr. Alexander (“Hap”) Ellis, III, is a partner of RockPort Capital Partners. At the effective time of the Merger, Mr. Ellis was appointed to the Board of Directors of Clean Diesel and resigned from the Board of CSI. Following the Merger, RockPort Capital Partners is a significant shareholder of Clean Diesel.

As part of the $4.0 million capital raise, CSI agreed to pay the accrued director fees as of December 31, 2009, which amounted to $0.4 million, in a combination of common stock and $0.1 million of cash. These fees were paid on October 15, 2010 immediately prior to the Merger.

23

EX-99.2

Exhibit 99.2

CATALYTIC SOLUTIONS, INC.
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share data)

	September 30,			December 31,
	2010			2009
Assets
Current assets:
Cash and cash equivalents	$	1,895		$	2,336
Trade accounts receivable, net		5,240			8,066
Inventories		4,707			6,184
Prepaid expenses and other current assets		1,944			2,010
Total current assets		13,786			18,596
Property and equipment, net		2,634			2,897
Intangible assets, net		4,118			4,445
Goodwill		4,339			4,223
Other assets		245			82
Total assets	$	25,122		$	30,243
Liabilities and stockholders’ equity
Current liabilities:
Line of credit	$	2,577		$	5,147
Current portion of long-term debt		3,000			3,000
Secured convertible notes		3,620			—
Accounts payable		4,811			4,967
Deferred revenue		—			195
Accrued salaries and benefits		1,606			1,294
Accrued expenses		3,807			5,365
Deferred gain on sale of intellectual property		—			1,900
Income taxes payable		624			1,081
Total current liabilities		20,045			22,949
Long-term debt, excluding current portion		53			75
Deferred tax liability		1,353			1,336
Total liabilities		21,451			24,360
Commitments and contingencies
Stockholders’ equity
Common stock, no par value. Authorized 148,500,000 shares; issued and outstanding 69,761,902 shares at September 30, 2010 and December 31, 2009		156,350			156,216
Treasury stock at cost (60,000 shares)		(100	)		(100	)
Accumulated other comprehensive loss		(543	)		(889	)
Accumulated deficit		(152,036	)		(149,344	)
Total stockholders’ equity		3,671			5,883
Total liabilities and stockholders’ equity	$	25,122		$	30,243

See accompanying notes to condensed consolidated financial statements.

1

CATALYTIC SOLUTIONS, INC.
Unaudited Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2010			2009			2010			2009
Revenues	$	10,939		$	13,401		$	36,310		$	32,545
Cost of revenues		8,416			10,115			27,012			25,697
Gross margin		2,523			3,286			9,298			6,848
Operating expenses:
Sales and marketing		789			1,012			2,350			3,124
Research and development		1,062			2,137			3,207			5,861
General and administrative		1,939			2,060			6,066			6,048
Recapitalization expense		769			301			1,496			956
Severance expense		—			11			15			249
Gain on sale of intellectual property		—			—			(3,900	)		(2,500	)
Total operating expenses		4,559			5,521			9,234			13,738
(Loss) income from operations		(2,036	)		(2,235	)		64			(6,890	)
Other income (expense):
Interest income		2			3			4			16
Interest expense		(1,487	)		(618	)		(2,165	)		(2,130	)
Other		(600	)		(532	)		(709	)		(1,307	)
Total other expense, net		(2,085	)		(1,147	)		(2,870	)		(3,421	)
Loss from continuing operations before income taxes		(4,121	)		(3,382	)		(2,806	)		(10,311	)
Income tax (benefit) expense from continuing operations		(52	)		(208	)		457			(141	)
Net loss from continuing operations		(4,069	)		(3,174	)		(3,263	)		(10,170	)
Discontinued operations:
Income (loss) from discontinued operations		1,097			36			936			(1,123	)
Income tax expense from discontinued operations		365			—			365			1
Net income (loss) from discontinued operations		732			36			571			(1,124	)
Net loss	$	(3,337	)	$	(3,138	)	$	(2,692	)	$	(11,294	)
Basic and diluted net loss per share:
Net loss from continuing operations	$	(0.06	)	$	(0.05	)	$	(0.05	)	$	(0.15	)
Net income (loss) from discontinued operations	$	0.01			—		$	0.01		$	(0.02	)
Basic and diluted net loss per share	$	(0.05	)	$	(0.04	)	$	(0.04	)	$	(0.16	)
Weighted average number of common shares outstanding (000s):
Basic and diluted		69,762			69,762			69,762			69,762

See accompanying notes to condensed consolidated financial statements.

2

CATALYTIC SOLUTIONS, INC.
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)

	Nine Months Ended
	September 30
	2010			2009
Cash flows from operating activities:
Net loss	$	(2,692	)	$	(11,294	)
Net (income) loss from discontinued operations		(571	)		1,124
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		925			963
Recovery of doubtful accounts, net		(24	)		—
Stock-based compensation		134			517
Change in fair value of financial instruments		261			(222	)
Amortization of debt discount on convertible notes		1,359			—
Loss on foreign currency transactions		438			513
Amortization of deferred financing costs		272			367
Loss on unconsolidated affiliate		31			916
Loss on sale of property and equipment		28			277
Gain on sale of intellectual property		(3,900	)		(2,500	)
Changes in operating assets and liabilities:
Trade accounts receivable		2,972			(1,643	)
Inventories		1,561			2,493
Prepaid expenses and other assets		854			2,500
Accounts payable		(209	)		2,973
Income taxes payable		(843	)		(362	)
Accrued expenses and other current liabilities		(532	)		(35	)
Cash provided by (used in) operating activities of continuing operations		64			(3,413	)
Cash (used in) provided by operating activities of discontinued operations		(564	)		657
Net cash used in operating activities		(500	)		(2,756	)
Cash flows from investing activities:
Purchases of property and equipment		(235	)		(728	)
Investment in unconsolidated affiliate		(413	)		—
Proceeds from sale of property and equipment		—			12
Proceeds from sale of intellectual property		2,000			2,500
Net cash provided by investing activities of continuing operations		1,352			1,784
Net cash used in investing activities of discontinued operations		—			(54	)
Net cash provided by investing activities		1,352			1,730
Cash flows from financing activities:
Borrowings under line of credit		835			—
Proceeds from issuance of debt		2,000			—
Repayments under line of credit		(3,659	)		(2,552	)
Proceeds from long-term debt		—			38
Repayment of long-term debt		(22	)		—
Payments for debt issuance costs		(272	)		(12	)
Net cash used in financing activities		(1,118	)		(2,526	)
Effect of exchange rates on cash		(175	)		(90	)
Net change in cash and cash equivalents		(441	)		(3,642	)
Cash and cash equivalents at beginning of period		2,336			6,726
Cash and cash equivalents at end of period	$	1,895		$	3,084
Supplemental disclosures of cash flow information:
Cash paid for interest	$	339		$	951
Cash paid for income taxes	$	1,171		$	141

See accompanying notes to condensed consolidated financial statements.

3

CATALYTIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Significant Accounting Policies:

a.	Description of Business
	Catalytic Solutions, Inc. (the “Company”, “CSI”) is a global manufacturer and distributor of emissions control systems and products, focused in the heavy duty diesel and light duty vehicle markets. The Company’s emissions control systems and products are designed to deliver high value to its customers while benefiting the global environment through air quality improvement, sustainability and energy efficiency.
	On October 15, 2010, Clean Diesel Technologies, Inc.’s (“Clean Diesel”, “CDTI”) wholly-owned subsidiary, CDTI Merger Sub, Inc., merged with and into CSI, with CSI continuing as the surviving corporation and as a wholly-owned subsidiary of Clean Diesel (the “Merger”). As further described in Note 13, the Company was considered the acquirer for accounting purposes and the surviving corporation in the merger. In addition, the shares of CSI common stock, which previously traded under the ticker symbols “CTS” and “CTSU” on the AIM market of the London Stock Exchange (the “AIM”), ceased trading on, and were delisted from, the AIM. These shares were converted into Clean Diesel common stock, ticker symbol “CDTID” on the NASDAQ Global Market. The ticker symbol reverted back to “CDTI” on November 15, 2010.
	CSI currently has operations in the USA, Canada, France, Japan and Sweden as well as an Asian joint venture.
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 its inception, resulting in an accumulated deficit of $152.0 million at September 30, 2010. The Company has funded its operations through equity sales, debt and bank borrowings. In addition, due to non-compliance with certain loan covenants (described below) and per the repayment obligations under the Company’s loan agreements, substantially all the debt of the Company has been classified as current at September 30, 2010. As a result of this classification, the Company has a working capital deficit of $6.2 million. The covenants are almost exclusively based on the performance of the Company’s Engine Control Systems subsidiary. As of March 31, 2009, the Company had failed to achieve two of the covenants under the bank loan agreement with Fifth Third Bank (see Note 3 for a discussion of the Fifth Third Bank loan agreement). The covenants that the Company failed to achieve are those related to the annualized earnings before interest, tax, depreciation and amortization (EBITDA) and the funded debt to EBITDA ratio for the Engine Control Systems subsidiary. The Bank agreed to temporarily suspend its rights with respect to the breach of these two covenants under a Forbearance Agreement that expires on January 15, 2011.
	At September 30, 2010 the Company had $1.9 million in cash. The Company’s access to working capital is limited and its debt service obligations and projected operating costs for 2010 exceed its cash balance at September 30, 2010. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

4

	In connection with the Merger, the Company issued $4.0 million of secured convertible notes (the “Notes”) to a group of qualified investors. $2.0 million of theses notes were issued in June and July 2010, with the remaining $2.0 million issued at the time of closing of the Merger. These agreements are discussed in greater detail in Note 3. However, there is no certainty that existing cash will be sufficient to sustain operations of the combined company without additional financing.
c.	Principles of Consolidation
	The consolidated financial statements include the financial statements of Catalytic Solutions, Inc. and its wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
d.	Concentration of Risk
	For the periods presented below, certain customers accounted for 10% or more of the Company’s revenues as follows:

	Three Months Ended September 30
Customer	2010			2009
A		29	%		33	%
B		13	%		8	%
C		12	%		37	%

	Nine Months Ended September 30
Customer	2010			2009
A		24	%		25	%
B		10	%		4	%
C		14	%		29	%

Customers A and C above are automotive original equipment manufacturers (OEMs) and relate to sales within the Catalyst segment. Customer B is a systems distributor within the HDD Systems segment.

Certain customers accounted for 10% or more of the Company’s accounts receivable balance as follows:

Customer	September 30, 2010			December 31, 2009
A		24	%		11	%
B		18	%		12	%

Customer A above is a HDD systems distributor and Customer B is an automotive OEM.

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

	Three Months Ended September 30
Vendor	2010			2009
A		20	%		14	%
B		14	%		15	%
C		12	%		22	%
D		8	%		16	%
E		4	%		10	%

5

	Nine Months Ended September 30
Vendor	2010			2009
A		21	%		10	%
B		11	%		13	%
C		8	%		16	%
D		13	%		18	%

	Vendor A above is a catalyst supplier, Vendors B, C and E are substrate suppliers, and Vendor D is a precious metals supplier.
e.	Use of Estimates
	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 and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Areas where significant judgments are made include but are not limited to the following: impairment of long-lived assets, stock-based compensation, the fair value of financial instruments, allowance for doubtful accounts, inventory valuation, taxes and contingent and accrued liabilities. Actual results could differ from those estimates. These estimates and assumptions are based on the Company’s best estimates and judgment. The Company evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which it believes to be reasonable under the circumstances. Estimates and assumptions are adjusted when facts and circumstances dictate. Illiquid credit markets, volatile equity markets, foreign currency fluctuations, and declines in customer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
f.	Accounting Changes
	On January 1, 2009, the Company adopted EITF 07-05, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock,” included in Accounting Standards Codification (ASC) topic 815. EITF 07-05 provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock. Upon adoption of the EITF, the Company reclassified certain of its warrants from equity to liabilities. See further discussion in Note 2.
	The Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157) included in ASC Topic 820, for all assets and liabilities effective January 1, 2008 except for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a non-recurring basis where the adoption was January 1, 2009. The adoption of this standard did not have a material effect on the Company’s consolidated financial statements. ASC 820 prioritizes the inputs used in measuring fair value into the following hierarchy:

• 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.

• 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.

6

	Goodwill impairment testing requires the Company to estimate the fair value of its reporting unit. The Company’s estimate of fair value of its reporting unit involves level 3 inputs. The estimated fair value of the HDD Systems reporting unit was derived primarily from a discounted cash flow model utilizing significant unobservable inputs including expected cash flows and discount rates. In addition, the Company considered the overall fair values of its reporting units as compared to the market capitalization of the Company. The Company determined that no goodwill impairment existed as of December 31, 2009. The Company evaluated the reporting unit to assess if a triggering event occurred subsequent to December 31, 2009 through September 30, 2010 necessitating a detailed analysis (the first step in the two-step process) and concluded that no such triggering event had occurred in the HDD Systems reporting unit. However, it is reasonably possible that future impairment tests may result in a different conclusion for the goodwill of the HDD Systems reporting unit. The estimate of fair value of the reporting units is sensitive to certain factors including but not limited to the following: movements in the Company’s share price, changes in discount rates and the Company’s cost of capital, growth of the reporting unit’s revenue, cost structure of the reporting unit, successful completion of research and development and customer acceptance of new products and approval of the reporting unit’s product by regulatory agencies.
	During 2009, the Company elected to change its accounting policy for legal costs incurred during the registration of patents to expense such costs as incurred. Previously, the Company capitalized such costs when they concluded such costs resulted in probable future benefits. Due to the administrative difficulties in documenting support for the future benefit of such costs as a result of uncertainty of ultimate patent approval, the Company concluded the new method of accounting was preferable.
	The adjustments to the Company’s balance sheet and statement of operations as of and for the nine months ended September 30, 2009 were not material and include: (i) reductions to intangible assets, total assets, and total stockholders’ equity and an increase to accumulated deficit of $0.6 million and (ii) increases to general and administrative expenses and net loss of $0.1 million. Loss per share and cash flows from operations are $0.01 greater and unchanged, respectively.
g.	Fair Value of Financial Instruments
	The fair values of the Company’s cash and cash equivalents, trade accounts receivable, prepaid expenses and other current assets, accounts payable, accrued salaries and benefits and accrued expenses approximate carrying values due to the short maturity of these instruments. The fair values of the Company’s debt and off-balance sheet commitments are less than their carrying values as a result of deteriorating credit quality of the Company and, therefore, it is expected that current market rates would be higher than those currently being experienced by the Company.
	It is not practical to estimate the fair value of these instruments as the Company’s debt is not publicly traded and the Company’s current financial position and the recent credit crisis experienced by financial institutions have caused current financing options to be limited.
h.	Recapitalization Expense
	The Company has been in the process of recapitalizing to improve its financial stability. The recapitalization has required the Company to hire a financial advisor, Allen & Company, as well as legal and accounting experts to evaluate its options and to guide it through the process of the Merger with CDTI. Such costs have been charged to expense as incurred.

7

Note 2. Warrants

The exercisable warrants and their associated exercise prices are shown below at September 30, 2010:

Warrants exercisable into common stock (issued in USD)		37,500
Exercise price	$	1.67
Warrants exercisable into common stock (issued in GBX)		4,367,115
Weighted average exercise price	$	1.02

The Company has outstanding warrants to purchase its common stock held by Cycad Group, LLC, Capital Works ECS Investors, LLC and SVB Financial Group, an affiliate of Silicon Valley Bank (“SVB”). The Company adopted EITF 07-05 on January 1, 2009. With the adoption of EITF 07-05, the warrants to Cycad Group, LLC and Capital Works ECS Investors, LLC were determined not to be solely linked to the stock price of the Company and therefore require classification as liabilities. As a result of the adoption on January 1, 2009, the Company recorded a cumulative effect of change in accounting principle of $2.3 million directly as a reduction of accumulated deficit representing the decline in fair value between the issuance and adoption date. For the nine months ended September 30, 2009, the application of EITF 07-05 resulted in an increase to other income of $0.2 million resulting from a decline in the fair value of the warrants during the period.

SVB Financial Group cancelled its 37,500 warrants on October 15, 2010, immediately prior to completion of the Merger. Warrants held by Cycad Group, LLC and Capital Works ECS Investors, LLC were converted to CDTI warrants upon completion of the Merger.

Note 3. Debt

The Company has a demand revolving credit line through Fifth Third Bank with a maximum principal amount of Canadian $6.0 million and availability based upon eligible accounts receivable and inventory. At September 30, 2010, the outstanding balance in U.S. dollars was $2.6 million with $2.8 million available for borrowings by Engine Control Systems in Canada. The loan is collateralized by the assets of the Company. The interest rate on the line of credit is variable based upon Canadian and U.S. Prime Rates. As of September 30, 2010, the weighted average borrowing rate on the line of credit was 6.17% compared to 4.48% as of December 31, 2009. The Company is also subject to covenants on minimum levels of tangible capital funds, fixed charge coverage, EBITDA, funded debt-to-earnings before income tax and depreciation and amortization. In the event of default, the bank may demand payment on all amounts outstanding immediately. The Company is also restricted from paying corporate distributions in excess of $250,000. The loan agreement also includes a material adverse change clause, exercisable if, in the opinion of the bank, there is a material adverse change in the financial condition, ownership or operation of Engine Control Systems or the Company. If the bank deems that a material adverse change has occurred, the bank may terminate the Company’s right to borrow under the agreement and demand payment of all amounts outstanding under the agreement. As of March 31, 2009, the Company had failed to achieve two of the covenants under the bank loan agreement with Fifth Third Bank. The covenants that the Company failed to achieve are those related to the annualized EBITDA and the funded debt to EBITDA ratio for the Engine Control Systems subsidiary. The bank agreed to temporarily suspend its rights with respect to the breach of these two covenants under a Forbearance Agreement that expired on August 31, 2010. A further extension until November 30, 2010 was to be granted if the proposed Merger with CDTI was completed by August 1, 2010, and as of August 31, 2010, the secured convertible notes issued by the Company in connection with the capital raise had been converted to common equity and the security granted to the convertible noteholders had been released; the Company had $3.0 million of free cash on its balance sheet; the Engine Control Systems subsidiary had Canadian $2.0 million available under the existing loan agreement; and no default, forbearance default or event of default (as defined in the credit and forbearance agreements) was outstanding.

8

Although the merger was not completed by August 1, 2010, or before the August 31, 2010, expiration date for the then current forbearance, Fifth Third Bank extended the forbearance until October 15, 2010, and, upon consummation of the Merger, for a further period of 90 days until January 15, 2011, but the credit limit has been reduced to $6.0 million, the interest rate has increased by 0.25% to U.S./Canadian Prime Rate plus 3.00%.

The Company has $3.0 million of consideration due to the seller as part of the Applied Utility Systems acquisition. The consideration was due August 28, 2009 and accrues interest at 5.36%. At September 30, 2010 the Company had accrued $0.7 million of unpaid interest. In addition, the Company may be obligated to pay in connection with its acquisition of the assets of Applied Utility Systems in 2006 an earn-out amount with respect to the period during which it operated the acquired business. The Company has reached an agreement with the seller on the payment terms and amounts due. See further discussion in Note 11.

On June 2, 2010, the Company entered into an agreement with a group of accredited investors providing for the sale of $4.0 million of secured convertible notes (“the Notes”). The Notes, as amended, bear interest at a rate of 8% per annum and were to mature on August 2, 2010. Under the agreements, $2.0 million of the Notes have been issued by the Company in four equal installments ($0.5 million each on June 2, June 8, June 28 and July 12, 2010) with the remaining $2.0 million to be issued after all conditions precedent to the closing of the merger with CDTI have been satisfied or waived (among other items). The final $2.0 million of Notes were issued on October 15, 2010. Under the terms of the Notes, the $4.0 million of Notes will be converted into newly created “Class B” common stock immediately prior to the merger with CDTI such that at the effective time of the Merger, this group of accredited investors will receive approximately 66.066% of the Company’s outstanding common stock on a fully diluted basis. A total of 75,217,000 Class B shares are issuable upon the conversion of the $2.0 million Notes issued through July 12, 2010 and an additional 75,217,000 Class B shares are issuable upon the funding and conversion of the final $2.0 million of Notes. The Company’s Class B common stock has rights identical to those of the Company’s existing Class A common stock other than its exchange rights into CDTI stock upon the Merger. Adjusted for CDTI’s one-for-six reverse stock split on October 15, 2010, each share of the Company’s Class B common stock will be exchanged for 0.010039 shares of CDTI common stock whereas each share of the Company’s Class A common stock will be exchanged for 0.007888 shares of CDTI common stock and warrants to purchase 0.006454 shares of CDTI common stock.

If the Merger was not completed by August 2, 2010, the Notes required repayment of principal including any interest and an additional payment premium of two times (2X) the outstanding principal amount. The Company did not repay the Notes or consummate the Merger prior to the August 2, 2010, maturity date or within the subsequent 10-day grace period. The noteholders agreed to forbear from exercising their rights or remedies with respect to the default under the terms of the Notes until October 15, 2010, per the Forbearance Letter Agreement, including any interest and additional payment premium of two times (2x) the outstanding principal amount and the interest rate increase from 8.0% to 15.0%, and to agree that the payment premium would be extinguished in the event that the Notes are converted and the Merger occurs prior to October 15, 2010.

The Notes contained two embedded financial instruments that required separate accounting at fair value. The instruments requiring separate accounting were the premium redemption feature related to the 2x premium and the contingent equity forward related to the future funding commitment. The estimate of fair value of such financial instruments involves unobservable inputs that are considered Level 3 inputs.

For the $2.0 million in Notes issued through September 30, 2010, the premium redemption instrument had an initial value upon issuance of $0.7 million and represents the fair value of the additional penalty premium of two times (2x) the outstanding principal amount plus the default interest that is due if the Notes are in default since the interest rate will increases from 8.0% to 15.0%. This instrument is considered a put option, as subsequent to August 2, 2010, the noteholders have the option of demanding payment or providing additional time extensions. The fair value of the premium redemption instrument is estimated by calculating the present value of $4.0 million plus accrued interest, based on an assumed payment date (eleven months after default date) using a high yield discount rate of 17%, multiplied by an estimated probability of its exercise.

9

The contingent equity forward had an initial value upon issuance of $0.7 million and represents the fair value of the additional $2.0 million that the investors have committed to fund immediately prior to the closing of the Merger with CDTI. It is considered a commitment to purchase equity since the funding would only occur from the same events that will cause the Notes to automatically convert to equity. The fair value is estimated based on the intrinsic value of the forward discounted at a risk free rate multiplied by the estimated probability that the forward will fund.

The initial value of the embedded financial instruments was recorded as a discount to the face value of the Notes and was amortized to interest expense using the effective interest method through the original maturity date of the Notes, which was August 2, 2010. The embedded financial instruments were re-measured at fair value at the end of the September 2010 reporting period with changes in fair value being recorded to other income (expense). While the financial instruments are bifurcated for measurement purposes, they are presented on a combined basis with the debt host contract.

The Notes included a beneficial conversion feature totaling $1.3 million that is contingent on the approval by the shareholders of certain amendments to the Company’s Articles of Incorporation. Once the related amendments are approved, the beneficial conversion feature will be recorded as additional non-cash interest expense. Such approvals were obtained on October 12, 2010.

A summary of the accounting at September 30, 2010 is presented in the table below.

	Convertible
	Notes (net of		Financial
(in thousands)	discount)		Instruments		Total
Assigned value on date of issuance	$	641	$	1,359	$	2,000
Amortization of discount on notes		1,359		—		1,359
Change in fair value of financial instruments		—		261		261
Balance at September 30, 2010	$	2,000	$	1,620	$	3,620

Long-term debt, long-term debt classified as current and financial instruments at fair value at September 30, 2010 and December 31, 2009 are summarized as follows:

(in thousands)	September 30, 2010			December 31, 2009
Line of credit	$	2,577		$	5,147
Consideration payable		3,000			3,000
Secured convertible notes payable with a face value of $2.0 million		3,620			—
Capital lease obligation		53			75
		9,250			8,222
Less current portion		(9,197	)		(8,147	)
	$	53		$	75

10

Note 4. Severance Charges

The Company has taken actions to reduce its cost base beginning in 2008 and continuing into the nine months ended September 30, 2010. As a result of these actions, the Company has accrued severance costs, which are included in accrued expenses on the accompanying consolidated balance sheets, as follows:

(in thousands)	September 30, 2010			September 30, 2009
Balance at beginning of period	$	670		$	187
Accrued severance expense		15			249
Paid severance expense		(322	)		(343	)
Balance at end of period	$	363		$	93

Note 5. Accrued Warranty

The Company accrues warranty upon shipment of its products. Accrued warranties are included in accrued expenses on the accompanying consolidated balance sheets. The accrued warranty is as follows:

(in thousands)	September 30, 2010			September 30, 2009
Balance at beginning of period	$	371		$	178
Accrued warranty expense		109			211
Warranty claims paid		(113	)		(126	)
Translation adjustment		8			21
Balance at end of period	$	375		$	284

Note 6. Net Income (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. Diluted net loss per share excludes certain dilutive potential common shares outstanding as their effect is anti-dilutive on loss from continuing operations. Dilutive potential common shares include employee stock options and other warrants that are convertible into the Company’s common stock. The Company had potential option and warrant dilutive securities totaling 8,524,000 and 9,358,000 for the three and nine months ended September 30, 2010 and 2009.

For the three and nine months ended September 30, 2010 and 2009 the effect of the option and warrant dilutive securities totaling 8,524,000 and 9,358,000 equivalent shares, respectively, have been excluded in the computation of net loss per share and net loss from continuing operations per share as their impact would be anti-dilutive.

In addition to the option and warrant dilutive securities, a total of 150,434,000 Class B shares are issuable upon the conversion of the convertible notes. These shares have been excluded from the computation of net loss per share and net loss from continuing operations per share as their impact would be anti-dilutive for the Notes issued through September 30, 2010 and the remainder was issuable upon contingencies that had not been resolved as of September 30, 2010.

Note 7. TCC Joint Venture

In February 2008, the Company entered into an agreement with Tanaka Kikinzoku Kogyo K.K. (TKK) to form a new joint venture company, TC Catalyst Incorporated (TCC), a Japanese corporation. The joint venture is part of the Catalyst division. The Company entered the joint venture in order to improve its presence in Japan and Asia and strengthen its business flow into the Asian market.

11

In December 2008, the Company agreed to sell and transfer specific heavy duty diesel catalyst technology and intellectual property to TKK for use in the defined territory for a total selling price of $7.5 million. TKK will provide that intellectual property to TCC on a royalty-free basis. The Company also sold shares in TCC to TKK reducing its ownership to 30%. $5.0 million of the sale was completed and recognized in 2008 with $2.5 million recognized in the three months ended March 31, 2009.

In December 2009, the Company agreed to sell and transfer specific three-way catalyst and zero PGM patents to TKK for use in specific geographic regions. The patents were sold for $3.9 million. TKK paid the Company $1.9 million in 2009 and $2.0 million in the first quarter of 2010. The Company recognized the gain on sale of the patents of $3.9 million in the three months ended March 31, 2010. As part of the transaction, the Company also sold shares in TCC, which reduced its ownership in the joint venture to 5%.

The Company’s investment in TCC is accounted for using the equity method as the Company still has significant influence over TCC as a result of having a seat on TCC’s board. In February 2010, the Company entered into an agreement to loan 37.5 million JPY (approximately $0.4 million) to TCC to fund continuing operations. The loan is funded in four monthly tranches starting in February 2010 and ending in May 2010. As of September 30, 2010, the Company had loaned TCC 37.5 million JPY. If the loan is not repaid by TCC, it will offset the Company’s obligation to fund its portion of TCC’s losses. Given TCC’s historical losses, the loan has been recorded as a reduction of such obligations. At September 30, 2010, the Company’s loan to TCC less its share of accumulated losses in the amount of $0.1 million is included in other current assets. TCC operates with a March 31 fiscal year-end. Financial information for TCC as of and for the nine months ended September 30, 2010 and 2009 is as follows:

(in thousands)	September 30, 2010			September 30, 2009
Assets	$	3,140		$	10,271
Liabilities		8,212			13,430
Deficit	$	(5,072	)	$	(3,159	)

	Nine Months Ended September 30,
	2010			2009
Net sales	$	1,797		$	640
Gross Margin	$	1,500		$	(169	)
Net loss	$	(569	)	$	(3,309	)

Note 8. Sale of Energy Systems Division

On October 1, 2009 the Company sold all significant assets of Applied Utility Systems, Inc., which comprised the Company’s Energy Systems division, for up to $10.0 million, including $8.6 million in cash and contingent consideration of $1.4 million. Of the contingent consideration, $0.5 million was contingent upon Applied Utility Systems being awarded certain projects and $0.9 million is retention against certain project and contract warranties and other obligations. The Company has not recognized any of the contingent consideration as of September 30, 2010 and will only do so if the contingencies are resolved favorably. The $0.5 million of contingent consideration that was contingent on the award of certain projects was not earned and will not be paid. The income (loss), net of tax of the Energy Systems division is presented as discontinued operations. There was no revenue included within discontinued operations for the nine month period ended September 30, 2010. Revenue included within discontinued operations was $14.1 million for the nine months ended September 30, 2009.

Note 9. Related-party Transactions

One of the Company’s Directors, Mr. Alexander (“Hap”) Ellis, III, is a partner of RockPort Capital Partners (“RockPort”), a shareholder in the Company which subscribed for $0.9 million of the Notes discussed in Note 3.

12

In October 2008, the Company’s Board of Directors unanimously adopted a resolution to waive the Non-Executive Directors’ right to receive, and the Company’s obligation to pay, any director fees with respect to participation in Board and Committee meetings and other matters with effect from July 1, 2008 and continuing thereafter until the Directors elect to adopt resolutions reinstating such fees. On May 1, 2009, the Directors adopted a resolution to reinstate the accrual of director fees effective January 1, 2009, with a payment schedule to be determined at a later date. As of September 30, 2010 an amount of $0.5 million was accrued for Directors fees and was due and payable to the Directors. As part of the $4.0 million issuance of Notes discussed in Note 3, the accrued director fees as of December 31, 2009, which amounted to $0.4 million, will be paid in a combination of common stock and cash, with the cash portion being $0.1 million. The 2010 director fees will be paid in cash.

Note 10. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended September 30, 2010 are as follows:

(in thousands)
Balance at December 31, 2009	$	4,223
Effect of translation adjustment		116
Balance at September 30, 2010	$	4,339

Intangible assets as of September 30, 2010 and December 31, 2009 are summarized as follows:

(in thousands)	Useful life	September 30, 2010			December 31, 2009
Trade name	15-20 years	$	753		$	738
Patents and know-how	5-10 years		3,862			3,792
Customer relationships	8 years		1,238			1,206
			5,853			5,736
Less accumulated amortization			(1,735	)		(1,291	)
		$	4,118		$	4,445

Aggregate amortization for amortizable intangible assets, using the straight-line amortization method for the nine months ended September 30, 2010 and 2009 was $0.4 million. Estimated amortization expense for existing intangible assets for the next five years is $0.5 million in each year.

Note 11. Legal Proceedings

In connection with the Company’s acquisition of the assets of Applied Utility Systems, Inc., Applied Utility Systems entered into a Consulting Agreement with M.N. Mansour, Inc. (“Mansour, Inc.”), pursuant to which Mansour, Inc. and Dr. M.N. Mansour (“Dr. Mansour”) agreed to perform consulting services for Applied Utility Systems. As further discussed in Note 8, the income (loss), net of tax of Applied Utility Systems is presented as discontinued operations. During February 2008, Applied Utility Systems terminated the Consulting Agreement for cause and alleged that Mansour, Inc. and Dr. Mansour had breached their obligations under the Consulting Agreement. The matter was submitted to binding arbitration in Los Angeles, California. On April 13, 2010, the Arbitrator rendered a Final Award (a) finding that the Consulting Agreement was properly terminated by the Company on February 27, 2008, (b) excusing the Company from any obligation to make any further payments under the Consulting Agreement, (c) obligating Mansour, Inc. to pay the Company an amount equal to 75% of all amounts paid to Mansour Inc. by the Company under the Consulting Agreement, and (d) awarding the Company attorney’s fees in the amount of $450,000, resulting in a total award of approximately $1.2 million. A hearing was held on August 2, 2010, during which the court confirmed the arbitrator’s award in its entirety. The Company reversed its accrued liability of $1.5 million and recorded an associated gain within discontinued operations during the quarter ending September 30, 2010, which represents the period in which the court confirmed the award and the Company was legally released from its liability. The Company has not recorded the $1.2 million gain associated with the monetary court award. The Company believes that this award is not collectible in light of other related court matters.

13

The Company has $3.0 million of consideration due to the seller under the Applied Utility Systems Asset Purchase Agreement dated August 28, 2006. The consideration was due August 28, 2009 and accrues interest at 5.36%. At September 30, 2010, the Company had accrued $0.7 million of unpaid interest in accrued liabilities in addition to the $3.0 million consideration due recorded as current portion of long-term debt. The Company has not paid the foregoing amounts. In addition, the Asset Purchase Agreement provides that the Company would pay the seller an earn-out amount based on the revenues and net profits from the conduct of the acquired business of Applied Utility Systems. The earn-out potentially was payable over a period of ten years beginning January 1, 2009. The Company has not paid any earn-out amount for the fiscal year ended December 31, 2009 or the nine months ended September 30, 2010. The assets of the business were sold on October 1, 2009. The seller commenced an action in California Superior Court to compel arbitration regarding the consideration which was due in August 2009. Such action was stayed by the court and the seller was directed to pursue any collection action through arbitration. The seller has commenced arbitration proceedings to collect the consideration which was due in August 2009 and any earn-out amounts payable under the Asset Purchase Agreement. The earn-out requested under the proceedings is $21.0 million, which is the maximum earnable over the ten-year period of the earn-out defined in the Asset Purchase Agreement. The Company has certain claims against the seller under the terms of the Asset Purchase Agreement. In connection with the arbitration proceedings, the seller sought a writ of attachment with respect to the foregoing amounts. On September 24, 2010, the arbitrator issued an interim award granting the seller a right to a writ in the amount of approximately $2.4 million (which amount was the net amount of the approximately $3.6 million that the seller claimed was payable by the Company during August 2009 and the amount of $1.2 million that the Company was awarded against the seller in a separate arbitration action by the Company relating to the seller’s breach of his Consulting Agreement with the Company). The seller has initiated action in the California Superior Court for Orange County, California, and was granted the writ of attachment.

On October 20, 2010, the Company and the seller reached a settlement, which ends all outstanding litigation and arbitration claims between the Seller and the Company. On October 22, 2010, the Company made an initial payment to the Seller of $1.5 million. The Company is obligated to make eight subsequent quarterly payments of $250,000, commencing December 31, 2010 and ending September 30, 2012, for an aggregate of up to $2.0 million. The Seller may record a Uniform Commercial Code-1 (“UCC-1”) financing statement securing the subsequent payment obligations of the Company under the settlement agreement, which shall be subordinated to all existing liens against the Company’s assets and, subject to the Company not being in default with respect to the subsequent payment obligations, shall be subordinated to any new financing obtained by the Company or its affiliates. A UCC-1 filing is a legal form that a creditor files to give notice that it has an interest in the personal property of the debtor. The Company will record a gain on this settlement of $340,000 as part of discontinued operations during the quarter ended December 31, 2010, which represents the period in which the settlement agreement was executed and the liability legally reduced. Details of the settlement, including the discount that the Company would receive for early prepayment, are included in a Form 8-K filed by CDTI with the Securities and Exchange Commission on October 21, 2010.

On September 30, 2008, Applied Utility Systems, Inc. (“AUS”), a former subsidiary of the Company, filed a complaint against Benz Air Engineering, Inc. (“Benz Air”). The complaint was amended on January 16, 2009, and asserts claims against Benz Air for breach of contract, common counts and slander. AUS seeks $0.2 million in damages, plus interest, costs and applicable penalties. In response to the complaint, Benz Air filed a cross-complaint on November 17, 2008, which named both AUS and the Company as defendants. The cross-complaint asserts claims against AUS and the Company for breach of oral contract, breach of express warranty, breach of implied warranty, negligent misrepresentation and intentional misrepresentation and seeks not less than $0.3 million in damages, plus interest, costs and punitive damages. The Company is unable to estimate any potential payment for punitive damages as they have not been quantified by Benz Air. The Company believes it is more likely than not to prevail in this matter. The trial began on September 14, 2010 and has been postponed to November 29, 2010.

14

Note 12. Segment Reporting

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

Heavy Duty Diesel (HDD) Systems division — The HDD Systems division includes retrofit of legacy diesel fleets with emissions control systems and the emerging opportunity for new engine emissions controls for on- and off-road vehicles. In 2007, the Company acquired Engine Control Systems (ECS), an Ontario, Canada-based company focused on a variety of heavy duty vehicle applications. This environmental business segment specializes in the design and manufacture of verified exhaust emissions control solutions. Globally, the HDD Systems division offers a range of products for the OEM, aftermarket and retrofit markets in order to reduce exhaust emissions created by on-road, off-road and stationary diesel, gasoline 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 HDD 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 is the original part of the Catalytic Solutions (CSI) business behind the Company’s proprietary Mixed Phase Catalyst (MPC^®) technology enabling the Company to produce catalyst formulations for gasoline, diesel and natural gas induced emissions that offer performance, proven durability and cost effectiveness for multiple markets and a wide range of applications. A family of unique catalysts has been developed — with base-metals or low platinum group metal (PGM) and zero PGM content — to provide increased catalytic function and value for technology-driven automotive industry customers.

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. During 2009, the Company changed its internal reporting to the Company’s chief operational decision makers to report corporate expenses separately from the Catalyst division. All data reported reflect this change.

Discontinued operations — In 2006, the Company purchased Applied Utility Systems, Inc., a provider of cost-effective, engineered solutions for the clean and efficient utilization of fossil fuels. Applied Utility Systems, referred to as the Company’s Energy Systems division, provided emissions control and energy systems solutions for industrial and utility boilers, process heaters, gas turbines and generation sets used largely by major utilities, industrial process plants, OEMs, refineries, food processors, product manufacturers and universities. The Energy Systems division delivered integrated systems built for customers’ specific combustion processes. As discussed in Note 8, this division was sold on October 1, 2009.

Summarized financial information for our reportable segments as of and for the nine months ended September 30, 2010 and 2009 are shown in the following table:

15

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2010			2009			2010			2009
Net sales
HDD Systems	$	6,956		$	5,904		$	22,732		$	14,700
Catalyst		3,983			7,698			13,919			18,155
Eliminations (1)		—			(201	)		(341	)		(310	)
Total	$	10,939		$	13,401		$	36,310		$	32,545
Income (loss) from operations
HDD Systems	$	454		$	554		$	2,367		$	493
Catalyst		(846	)		(2,040	)		2,257			(3,808	)
Corporate		(1,644	)		(749	)		(4,560	)		(3,575	)
Total	$	(2,036	)	$	(2,235	)	$	64		$	(6,890	)

(1) Elimination of Catalyst revenue related to sales to HDD Systems.

The nine months Catalyst division income from operations includes a $3.9 million gain on sale of intellectual property to TKK in 2010 and $2.5 million in 2009.

Net sales by geographic region based on location of sales organization for the nine months ended September 30, 2010 and 2009 are shown in the following table:

	Three Months Ended				Nine Months Ended
	September 30				September 30
(in thousands)	2010		2009		2010		2009
United States	$	4,990	$	8,257	$	16,336	$	20,137
Canada		4,582		4,193		15,759		9,491
Europe		1,367		951		4,215		2,917
Total	$	10,939	$	13,401	$	36,310	$	32,545

Note 13. Subsequent Events

The Company has evaluated subsequent events from the balance sheet date through November 15, 2010, the date at which the unaudited condensed consolidated financial statements were issued, and determined there are no other items to disclose.

On October 15, 2010, CDTI’s wholly-owned subsidiary, CDTI Merger Sub, Inc., merged with and into CSI, with CSI continuing as the surviving corporation and as a wholly-owned subsidiary of CDTI. CSI believes that the post merger company will be a better capitalized business with operations of the enlarged group having improved access to development capital. The Company also believes that the merged company will be better positioned to pursue and implement its business strategy with CSI providing manufacturing, regulatory expertise and North American distribution for CDTI products and technologies and CDTI providing a stronger distribution capability for CSI products in Europe and Asia.

Pursuant to the terms of the Merger Agreement, each outstanding share of (i) CSI Class A Common Stock was converted into and became exchangeable for 0.007888 fully paid and non-assessable shares of CDTI common stock on a post-split basis (0.04732553 on a pre-split basis) with any fractional shares to be paid in cash and warrants to acquire 0.006454 on a post-split basis of fully paid and non-assessable shares of CDTI common stock for $7.92 per share on a post-split basis (0.03872267 shares for $1.32 per share on a pre-split basis); and (ii) CSI Class B Common Stock was converted into and became exchangeable for 0.010039 fully paid and non-assessable shares of CDTI common stock on a post-split basis (0.06023308 on a pre-split basis) with any fractional shares to be paid in cash. In connection with the Merger and as contemplated by the Merger Agreement, CDTI also issued 166,666 shares of common stock on a post-split basis (1,000,000 shares on a pre-split basis) and warrants to purchase an additional 166,666 shares of common stock on a post-split basis (1,000,000 shares on a pre-split basis) to Allen & Company LLC, CSI’s financial advisor. The warrants issued in the Merger expire on the earlier of October 15, 2013 (the third anniversary of the effective time of the Merger) and the date that is 30 days after notice is given to the warrant holder that the market value of one share of CDTI’s common stock has exceeded 130% of the exercise price of the warrant for 10 consecutive days. As of November 9 2010, the market value of one share of CDTI’s common stock had exceeded 130% of the exercise price of the warrant for 10 consecutive days but such notice has not yet been given.

16

As provided in the Merger Agreement, CDTI is issuing (or reserving for issuance pursuant to “in-the-money” warrants) approximately 2,287,873 shares of CDTI common stock on a post-split basis (13,727,658 on a pre-split basis) and warrants to purchase an additional 666,583 shares of CDTI common stock (4,000,000 on a pre-split basis) in connection with the Merger. Based on the split adjusted closing price of $4.92 per share ($0.82 unadjusted for the split) of CDTI common stock on the NASDAQ Capital Market (“NASDAQ”) on October 15, 2010, the last trading day before the effectiveness of the reverse stock split and the closing of the Merger, the aggregate value of the CDTI common stock issued in connection with the Merger was approximately $11.3 million.

Following the consummation of the Merger, the holders of CSI securities (including the holders of the Notes) and CSI’s financial advisor collectively hold approximately 60% of CDTI’s outstanding common stock and CDTI stockholders (including investors in its Regulation S offering) hold the remaining 40% of CDTI’s outstanding common stock. Because CSI stockholders will own a majority of the voting stock of the combined company, CSI will assume key management positions and CSI will hold a majority of the board of directors’ seats upon closing of the Merger. CSI is deemed to be the acquiring company for accounting purposes and the transaction will be accounted for as a reverse acquisition in accordance with ASC Topic 805, Business Combinations. Accordingly, the assets and liabilities of CDTI will be recorded as of the Merger closing date at their estimated fair values.

The following table summarizes the estimated consideration paid for CDTI:

Fair Value of CDTI common stock at October 15, 2010	$	7,431,000
Estimated fair value of stock options and warrants at October 15, 2010		267,000
Total estimated purchase consideration	$	7,698,000

Estimated amounts of identifiable assets acquired and liabilities assumed as of acquisition date are as follows:

Current assets	$	5,858,000
Property plant and equipment		219,000
Intangible assets		3,750,000
Current liabilities		(2,028,000	)
Total identifiable assets assumed		7,799,000
Gain on acquisition		101,000
Total estimated purchase consideration	$	7,698,000

The gain on acquisition will be recognized in other income and resulted primarily from a decline in the fair value CDTI’s common stock after the merger ratio was agreed.

The fair value of the current assets acquired includes trade receivables with a fair value of $665,000. The purchase accounting is provisional pending certain items including: receipt of the valuation on intangible assets and purchase consideration and CDTI’s closing balance sheet. The acquired intangible assets, all of which will be amortized, have a weighted average useful life of approximately 9.6 years. The preliminary identification and estimated fair values of acquired intangible assets include customer relationships $180,000 (estimated 3-year useful life), trade name $948,000 (estimated 10-year useful life), patents $2,352,000 (estimated 10-year useful life), and in-process research and development $270,000 (estimated 10-year useful life).

17

Supplemental Pro Forma Clean Diesel Technologies, Inc. for Business Combination

The following pro forma combined financial information shows the Company’s revenue and earnings for the periods indicated as if the Merger had been completed on January 1^st of the relevant period:

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2010			2009			2010			2009
Revenues	$	11,280		$	13,654		$	37,707		$	33,519
Net Loss	$	(4,887	)	$	(5,138	)	$	(6,684	)	$	(17,096	)

The pro forma Combined Clean Diesel Technologies, Inc. net loss includes the elimination of historical CDTI depreciation and amortization and the addition of the amortization of the intangible assets acquired under the pro forma purchase accounting above. The pro forma net loss for the three and nine months ended September 30, 2010 includes $1.4 million and $2.8 million of merger related expense, respectively.

18

Following the completion of the merger, the Company will cancel its 1997 option plan and has requested all employees to consent to the cancellation of their options under the 2006 plan. All employees with options in the 2006 plan provided their consent to the Company. The cancellation of the options will result in acceleration of all remaining compensation expense yet to be earned on the cancelled options. The remaining compensation expense of $0.1 million will be recognized in the three months ending December 31, 2010.

19 EX-99.3 4 c08333exv99w3.htm EXHIBIT 99.3

Exhibit 99.3

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

On October 15, 2010, Clean Diesel Technologies, Inc. (“Clean Diesel”), CDTI Merger Sub, Inc., a California corporation and wholly-owned subsidiary of CDTI, and Catalytic Solutions, Inc., a California corporation (“CSI”), consummated a business combination pursuant to the terms of the Agreement and Plan of Merger dated May 13, 2010, as amended by letter agreements dated September 1, 2010 and September 14, 2010 (the “Merger Agreement”). Pursuant to the Merger Agreement, CDTI Merger Sub, Inc. merged with and into CSI, and CSI became our wholly-owned subsidiary. We refer to this business combination as the “Merger.” Immediately prior to the Merger, and as contemplated by the Merger Agreement, Clean Diesel effected a one-for-six reverse stock split of its common stock. Following the consummation of the Merger, the holders of CSI securities (including the holders of its secured convertible notes discussed herein) and CSI’s financial advisor collectively hold approximately 60% of our outstanding common stock and Clean Diesel stockholders (including investors in its Regulation S offering discussed herein) hold the remaining 40% of our outstanding common stock.

The following unaudited pro forma condensed combined financial statements were prepared in accordance with the regulations of the Securities and Exchange Commission, and give effect to the Merger including related capital raise transactions discussed herein that closed at or prior to the time of the Merger, as well as the one-for-six reverse stock split. All share and per share amounts herein reflect the impact of the reverse stock split unless otherwise noted. For accounting purposes, CSI is considered to be acquiring Clean Diesel. Accordingly, under the acquisition method of accounting in accordance with FASB Accounting Standards Codification (ASC) Topic 805, Business Combinations, CSI will record the purchase price based on the fair value of Clean Diesel’s outstanding equity at the acquisition date, with the deficit over the fair value of the acquired assets and liabilities being recorded as a transaction gain. The total estimated purchase price (consideration transferred) as described in Note 1 was measured on October 15, 2010, the acquisition date (which was the closing date of the Merger), using a closing price of $4.92 per share of Clean Diesel common on a post-split basis ($0.82 per share on a pre-split basis).

For purposes of this unaudited pro forma condensed combined financial data, Clean Diesel has made preliminary estimates of the purchase consideration and the values of the assets to be acquired and liabilities to be assumed based on preliminary estimates of their fair values. The purchase accounting is provisional pending certain items including: receipt of the valuation on intangible assets and purchase consideration and determination of Clean Diesel’s closing balance sheet.

The unaudited pro forma condensed combined financial data is based on the historical financial statements of Clean Diesel and CSI, adjusted to give effect to the acquisition of Clean Diesel by CSI for accounting purposes and the accounting impact of their respective capital raise transactions. The pro forma adjustments are described in the accompanying notes.

The unaudited pro forma condensed combined balance sheet as of September 30, 2010 gives effect to the proposed Merger and capital raise transactions as if they occurred on September 30, 2010, and combines the historical balance sheets of Clean Diesel and CSI as of September 30, 2010.

The unaudited pro forma condensed combined statement of operations for the nine months ended September 30, 2010 and the twelve months ended December 31, 2009 are presented as if the Merger and capital raise transactions were consummated on January 1, 2009, and combines the historical results of Clean Diesel and CSI for the nine months ended September 30, 2010, and the twelve months ended December 31, 2009, respectively. For purposes of the pro forma condensed statement of operations, the secured convertible notes are converted to equity at January 1, 2009; therefore, there are no resulting pro forma adjustments related to the secured convertible notes that impact the pro forma net income for the nine months ended September 30, 2010 or the twelve months ended December 31, 2009. Likewise, the Clean Diesel capital raise involved the issuance of equity and there are no resulting pro forma adjustments that impact the pro forma net income for the nine months ended September 30, 2010 or the twelve months ended December 31, 2009.

This unaudited pro forma condensed financial data has been prepared for illustrative purposes only and is not indicative of the consolidated financial position or results of operations in future periods or the results that actually would have been realized had Clean Diesel and CSI been a combined company during the periods presented or had Clean Diesel and CSI completed their capital raise transactions on the dates noted above. The pro forma adjustments are based on the preliminary information available at the time of the preparation of this current report on Form 8-K and are subject to change. This unaudited pro forma condensed financial data including the notes hereto should be read in conjunction with Clean Diesel’s historical consolidated financial statements and accompanying notes as of and for the nine month period ended September 30, 2010 included in its quarterly report on Form 10-Q, and as of and for the year ended December 31, 2009 included in its annual report on Form 10-K, as well as CSI’s historical consolidated financial statements and accompanying notes as of and for the nine month period ended September 30, 2010 included elsewhere in this current report on Form 8-K, and as of and for the year ended December 31, 2009, included in Clean Diesel’s registration statement on Form S-4/A filed with the Securities and Exchange Commission on September 23, 2010 (the “Registration Statement”).

As required, the unaudited pro forma condensed financial data includes adjustments that give effect to the events that are (i) directly attributable to the Merger; (ii) expected to have a continuing impact and (iii) factually supportable. The unaudited pro forma condensed combined statements of operations do not reflect any adjustments for non-recurring items or anticipated synergies resulting from the Merger. Merger expenses are expensed as incurred in accordance with applicable accounting rules regarding business combinations.

2

CLEAN DIESEL TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
SEPTEMBER 30, 2010

													Pro Forma
										Business			Clean Diesel
	Clean Diesel			Catalytic						Combination			Technologies, Inc.
	Technologies, Inc.			Solutions, Inc.						Pro Forma			For Business
(Amounts in thousands, except share data)	Historical			Historical			Subtotal			Adjustments			Combination
Assets
Current assets:
										$	1,000	(a)
Cash and cash equivalents	$	3,525		$	1,895		$	5,420			2,000	(b)	$	8,420
Trade accounts receivable, less allowance for doubtful accounts		198			5,240			5,438			—			5,438
Inventories		907			4,707			5,614			—			5,614
Prepaid expenses and other current assets		172			1,944			2,116			—			2,116
Total current assets		4,802			13,786			18,588			3,000			21,588
Property and equipment, net		219			2,634			2,853						2,853
Intangible assets, net		968			4,118			5,086			2,782	(d)		7,868
Goodwill		—			4,339			4,339			—			4,339
Other assets		56			245			301			—			301
Total assets	$	6,045		$	25,122		$	31,167		$	5,782		$	36,949
Liabilities and stockholders’ equity
Current liabilities:
Line of credit	$	—		$	2,577		$	2,577		$	—		$	2,577
Current portion of long-term debt		—			3,000			3,000			—			3,000
Secured convertible notes		—			3,620			3,620			(3,620	)(c)		—
Accounts payable		665			4,811			5,476			(599	)(e)		4,877
											230	(e)
											1,350	(f)
Accrued expenses		563			5,413			5,976			689	(i)		8,245
Income taxes payable		—			624			624			—			624
Total current liabilities		1,228			20,045			21,273			(1,950	)		19,323
Long-term debt		—			53			53			—			53
Deferred tax liability		—			1,353			1,353			—			1,353
Total liabilities		1,228			21,451			22,679			(1,950	)		20,729
Stockholders’ equity:
											(14	)(g)
											15	(h)
Clean Diesel common stock par value $0.01 per share		14			—			14			23	(j)		38
Historical authorized 2,000,000 shares; issued and outstanding 1,368,906 shares		—			—			—			—			—
Pro forma authorized 5,183,333 shares; issued and outstanding 3,788,354 shares		—			—			—			—			—
Catalytic Solutions Class A common stock no par value		—			—			—			—			—
Historical: Authorized 85,000,000 shares; issued 76,223,996 shares and outstanding 69,761,902 shares		—			—			—			—			—
Pro Forma: Authorized 85,000,000 shares; issued 76,223,996 shares and outstanding none		—			156,350			156,350			(156,350	)(j)		—
											2,000	(b)
											3,620	(c)
Catalytic Solutions Class B common stock no par value		—			—			—			(5,620	)(j)		—
Historical: Authorized 185,000,000 shares; issued and outstanding none		—			—			—			—			—
Pro Forma: Authorized 185,000,000 shares ; issued 150,443,943 shares and outstanding none		—			—			—			—			—
Catalytic Solutions treasury stock at cost Historical (60,000 shares)		—			(100	)		(100	)		100	(j)		—
											1,000	(a)
											820	(e)
											(75,846	)(g)
											7,683	(h)
											(689	)(i)
Additional paid in capital		74,846			—			74,846			161,847	(j)		169,661
Accumulated other comprehensive loss		(407	)		(543	)		(950	)		407	(g)		(543	)
											101	(d)
											(451	)(e)
											(550	)(f)
Accumulated deficit		(69,636	)		(152,036	)		(221,672	)		69,636	(g)		(152,936	)
Total stockholders’ equity		4,817			3,671			8,488			7,732			16,220
Total liabilities and stockholders’ equity	$	6,045		$	25,122		$	31,167		$	5,782		$	36,949
Book value per share	$	3.52		$	0.05								$	4.28
Equivalent book value per share													$	0.03

See accompanying notes to unaudited pro forma condensed combined balance sheet.

3

CLEAN DIESEL TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010

													Pro Forma
										Business			Clean Diesel
	Clean Diesel			Catalytic						Combination			Technologies, Inc.
	Technologies, Inc.			Solutions, Inc.						Pro Forma			For Business
(Amounts in thousands, except per share data)	Historical			Historical			Subtotal			Adjustments			Combination
Revenues	$	1,397		$	36,310		$	37,707		$	—		$	37,707
Cost of revenues		816			27,012			27,828			—			27,828
Gross margin		581			9,298			9,879			—			9,879
Operating expenses:
Sales and marketing		—			2,350			2,350			—			2,350
Research and development		244			3,207			3,451			—			3,451
											(140	)(k)
General and administrative		3,073			6,066			9,139			313	(l)		9,312
Severance expense		(163	)		15			(148	)		—			(148	)
Recapitalization expense		1,272			1,496			2,768			—			2,768
Gain on sale of intellectual property		—			(3,900	)		(3,900	)		—			(3,900	)
Total operating expenses		4,426			9,234			13,660			173			13,833
(Loss) income from operations		(3,845	)		64			(3,781	)		(173	)		(3,954	)
Other income (expense):
Interest income		93			4			97			—			97
Interest expense		—			(2,165	)		(2,165	)		—			(2,165	)
Other		(67	)		(709	)		(776	)		—			(776	)
Total other income (expense)		26			(2,870	)		(2,844	)		—			(2,844	)
Loss from continuing operations before income taxes		(3,819	)		(2,806	)		(6,625	)		(173	)		(6,798	)
Income tax expense from continuing operations		—			457			457			—			457
Net loss from continuing operations	$	(3,819	)	$	(3,263	)	$	(7,082	)	$	(173	)	$	(7,255	)
Basic and diluted loss per share:
Net loss from continuing operations	$	(2.80	)	$	(0.05	)							$	(1.92	)
Weighted average number of common shares outstanding:
Basic and diluted		1,365			69,762									3,788
Equivalent basic and diluted loss per share													$	(0.02	)
Cash dividends per share	$	—		$	—								$	—

See accompanying notes to unaudited pro forma condensed combined balance sheet.

4

CLEAN DIESEL TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2009

													Pro Forma
										Business			Clean Diesel
	Clean Diesel			Catalytic						Combination			Technologies, Inc.
	Technologies, Inc.			Solutions, Inc.						Pro Forma			For Business
(Amounts in thousands, except per share data)	Historical			Historical			Subtotal			Adjustments			Combination
Revenues	$	1,221		$	50,514		$	51,735		$	—		$	51,735
Cost of revenues		801			38,547			39,348			—			39,348
Gross margin		420			11,967			12,387			—			12,387
Operating expenses:
Sales and marketing		—			3,577			3,577			—			3,577
Research and development		386			7,257			7,643			—			7,643
											(184	)(k)
General and administrative		6,280			8,903			15,183			417	(l)		15,416
Severance expense		958			1,429			2,387						2,387
Recapitalization expense		—			1,258			1,258						1,258
Gain on sale of intellectual property		—			(2,500	)		(2,500	)					(2,500	)
Total operating expenses		7,624			19,924			27,548			233			27,781
(Loss) income from operations		(7,204	)		7,957			(15,161	)		(233	)		(15,394	)
Other income (expense):
Interest income		245			18			263			—			263
Interest expense		100			(2,304	)		(2,204	)		(1,342	)(n)		(3,546	)
Other		112			(291	)		(179	)		(118	)(m)		(297	)
Total other income (expense)		457			(2,577	)		(2,120	)		(1,460	)		(3,580	)
Loss from continuing operations before income taxes		(6,747	)		(10,534	)		(17,281	)		(1,693	)		(18,974	)
Income tax benefit from continuing operations		—			(1,036	)		(1,036	)		—			(1,036	)
Net loss from continuing operations	$	(6,747	)	$	(9,498	)	$	(16,245	)	$	(1,693	)	$	(17,938	)
Basic and diluted loss per share:
Net loss from continuing operations	$	(4.97	)	$	(0.14	)							$	(4.74	)
Weighted average number of common shares outstanding:
Basic and diluted		1,358			69,762									3,788
Equivalent basic and diluted loss per share													$	(0.04	)
Cash dividend per share	$	—		$	—								$	—

See accompanying notes to unaudited pro forma condensed combined balance sheet.

5

NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

1. The Merger, Capital Raise Transactions and Basis of Presentation

On October 15, 2010, Clean Diesel and CSI completed their Merger, under which a wholly-owned subsidiary of Clean Diesel merged with and into CSI, with CSI becoming a wholly-owned subsidiary of Clean Diesel. Pursuant to the Merger, Clean Diesel issued 2,278,014 shares of common stock of Clean Diesel on post split basis, par value $0.01 per share, in exchange for all outstanding shares of common stock of CSI.

Because CSI stockholders will own a majority of the voting stock of the combined company, CSI will assume key management positions and CSI will hold a majority of the board of directors seats upon closing of the Merger, CSI is deemed to be the acquiring company for accounting purposes and the transaction will be accounted for as a reverse acquisition in accordance with FASB Accounting Standards Codification (ASC) Topic 805, Business Combinations. Accordingly, the assets and liabilities of Clean Diesel will be recorded as of the Merger closing date at their estimated fair values.

On October 15, 2010, prior to the completion of the Merger, pursuant to binding commitment letters from investors in Clean Diesel’s Regulation S private placement described in the Registration Statement, Clean Diesel sold units consisting of 109,020 shares of common stock on a post-split basis and warrants to purchase 166,666 shares of common stock on a post-split basis for approximately $1,000,000 in cash before commissions and expenses. The warrants issued in Clean Diesel’s Regulation S private placement have an exercise price of $7.92 on a post-split basis and expire on the earlier of (i) October 15, 2013 (the third anniversary of the effective time of the Merger) and (ii) the date that is 30 days after Clean Diesel gives notice to the warrant holder that the market value of one share of the common stock has exceeded 130% of the exercise price of the warrant for 10 consecutive days.

On June 2, 2010, CSI entered into agreements with a group of accredited investors providing for the sale of $4,000,000 of secured convertible notes (the Notes). The Notes bore interest at a rate of 8% per annum and provided for a maturity date of August 2, 2010. Under the agreements, $2,000,000 of the Notes were issued by CSI in four equal installments ($500,000 on each of June 2, 2010, June 8, 2010, June 28, 2010 and July 12, 2010), with the remaining $2,000,000 issued on October 15, 2010 (after all conditions precedent to the closing of the Merger were satisfied or waived (among other items)). Under the terms of the Notes, the $4,000,000 was converted into 150,434,943 shares of newly created CSI “Class B” common stock immediately prior to the Merger. At the effective time of the Merger, this group of accredited investors received 150,434,943 shares of CSI’s Class B common stock, which was converted into approximately 66.0066% of the aggregate shares of Clean Diesel issued in the Merger. Each share of CSI Class B common stock was then exchanged for approximately 0.01004 shares of Clean Diesel common stock (whereas each share of CSI Class A common stock was exchanged for 0.007888 shares of Clean Diesel common stock and warrants to purchase 0.006454 shares of Clean Diesel common stock), which exchange ratio provided this group of accredited investors approximately 66.0066 of the aggregate shares of Clean Diesel issued in the merger. No fractional shares (or warrants to purchase fractional shares) were issued by Clean Diesel.

The unaudited pro forma condensed balance sheet as of September 30, 2010 includes pro forma adjustments to give effect to the accounting impact of the Merger and capital raise transactions described above as if they occurred on September 30, 2010.

The unaudited pro forma condensed statement of operations for the nine months ended September 30, 2010 and the twelve months ended December 31, 2009 include adjustments to give effect to the Merger and capital raise transactions as if such transactions occurred on January 1, 2009.

2. Estimate of Consideration Expected to Be Transferred

The acquisition method of accounting requires that the consideration transferred in a business combination be measured at fair value as of the closing date of the acquisition. The closing market price of Clean Diesel’s common stock as of the Merger date October 15, 2010 of $4.92 on a post-split basis was used. Clean Diesel believes this method provides the most reliable determination of fair value for the purposes of the unaudited pro forma condensed combined financial statements.

6

The following is a preliminary estimate of consideration expected to be transferred to effect the Merger:

Fair value of Clean Diesel outstanding common stock at October 15, 2010	$	6,735,000
Fair value of Clean Diesel shares issued to accredited investors		536,000
Fair value of Clean Diesel shares issued to Innovator Capital		159,000
Fair value of Clean Diesel stock options and warrants outstanding at October 15, 2010		17,000
Estimated fair value of Clean Diesel warrants issued to Innovator Capital and accredited investors		251,000
Total purchase consideration	$	7,698,000

On October 15, 2010, prior to the issuance of shares in the Merger and the issuance of shares in its Regulation S offering and to Innovator Capital, Clean Diesel had 1,368,906 shares of common stock outstanding on a post-split basis. The purchase consideration includes 109,020 shares issued immediately prior to closing to accredited investors and 32,414 shares issued to Innovator Capital, Clean Diesel’s financial advisor, as a transaction fee for their services in connection with the Merger. The fair value of Clean Diesel common stock used in determining the purchase price was $4.92 per share based on the $0.82 per share pre-split closing price on NASDAQ on October 15, 2010.

The estimated fair value of warrants to purchase a total of 181,529 shares of Clean Diesel common stock issued to Innovator Capital and accredited investors is $1.38 per warrant determined using the Black-Scholes Model. The warrants have a strike price of $7.92 per share on a post-split basis. The warrants also include a provision that they expire 30 days after a period where the Clean Diesel closing stock price exceeds 130% of the warrant exercise price for 10 consecutive days. As of November 9, 2010, the market value of one share of CDTI common stock has exceeded 130% of the exercise price of the warrant for 10 consecutive days but no such notice has been given. To value these warrants, the Black-Scholes Model was used with Clean Diesel’s stock price of $4.92 on October 15, 2010, a volatility of 59.9%, a risk free rate of 1.25% and a term of 3 years.

Clean Diesel estimated that professional fees and employee expenses related to the Merger were $4,179,000 with $1,350,000 to be incurred after the balance sheet date of September 30, 2010. These costs include fees for legal, accounting, and other direct costs necessary to complete the transaction. The estimated $1,350,000 of transaction costs remaining at September 30, 2010 consist of $800,000 of costs expected to be incurred by Clean Diesel and $550,000 of costs expected to be incurred by CSI. Clean Diesel’s $800,000 of professional and employee expenses are in addition to the shares and warrants to be issued to Innovator Capital, and these costs are included in liabilities to be assumed by CSI in the Merger. In addition, these costs include other direct costs of approximately $500,000 incurred related to employee retention and success bonuses as a result of successful completion of the transaction.

Transaction fees of CSI are expensed as incurred in accordance with applicable accounting rules regarding business combinations. In addition to the $550,000 of professional and employee expenses, CSI’s financial advisor, Allen & Company LLC, received 166,666 shares of Clean Diesel on a post-split basis and warrants to purchase an additional 166,666 shares of Clean Diesel on a post-split basis. The estimated fair value of such shares and warrants related to the closing of the Merger, which totaled $1,050,000, of which $599,000 has been accrued at September 30, 2010, related to the closing of the Merger will be expensed upon closing of the Merger in October 2010.

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3. Preliminary Allocation of Consideration Transferred to Net Assets Acquired

Under the acquisition method of accounting, the total purchase consideration is allocated to the acquired tangible and intangible assets and assumed liabilities of Clean Diesel based on their estimated fair values as of the Merger closing date. The excess of the purchase price over the fair value of assets acquired and liabilities assumed is recorded to goodwill, and any shortfall is recorded as a gain on transaction. The preliminary allocation of the purchase consideration, as shown above, to the acquired tangible and intangible assets and assumed liabilities of Clean Diesel based on the estimated fair values on October 15, 2010, is as follows:

Cash and cash equivalents (1)	$	4,525,000
Accounts receivable and other assets		426,000
Inventory (2)		907,000
Fixed assets		219,000
Intangible assets:
Customer relationships		180,000
Trade name		948,000
Patents		2,352,000
In-process research and development		270,000
Total assets acquired		9,827,000
Liabilities assumed		(1,228,000	)
Merger related liabilities		(800,000	)
Net assets acquired		7,799,000
Gain on transaction		(101,000	)
Total preliminary purchase price allocation	$	7,698,000

(1)	Includes $1,000,000 of cash received by Clean Diesel upon closing of sale of stock and warrants to accredited investors in its Regulation S offering described in note 4(a) below.
(2)	Assumed carrying value equals fair value.

A preliminary valuation of the intangible assets of Clean Diesel has been made. Each of the intangible assets and the methodology for the preliminary valuation is presented below.

Valuation of Customer Relationships

The ability to use Clean Diesel’s relationships with its clients provides the acquirer with a business advantage that is distinct and separable from the goodwill acquired. The presence of a loyal customer base provides management with the opportunity to sell additional products into the base, and further leverage cost efficiencies. Customer relationships are valued using the income approach excess earnings method, based on the operating profit of the expected revenue, less applicable capital charges for the use of assets. Key assumptions used in this valuation were a revenue growth rate of approximately 3% and an annual customer attrition of 50%.

Valuation of Trademarks and Tradenames

The fair value of the acquired trademarks or tradenames is the relief from the royalty method. Under this method, the subject trademark is valued by reference to the amount of royalty income it could generate if it were licensed, in an arm’s-length transaction, to a third party. Typically, a sample of a comparable arm’s-length royalty or license agreement is selected that reflects similar risk and return investment characteristics with the subject trademark or tradename. The royalty rate selected is then multiplied by the net revenue expected to be generated by the trademark or tradename over the course of the assumed life of the trademark or tradename. The product of the royalty rate times the revenue is an estimate of the royalty income that could be generated, hypothetically, by licensing the subject trademark or tradename. Therefore, in selecting a royalty rate for trademarks and tradenames, consideration was given to the products and Clean Diesel’s reputation in the marketplace, the historical and projected operating profitability of the business and relative importance of the name(s) compared to other factors driving profitability. It was determined that the primary driver of operating margins is resident in the products technological features and capabilities. Therefore, the value of the trademarks and tradenames would be relatively small in comparison to these factors. As such, a royalty rate of 1.5% was used.

Valuation of Patented Technology

To value the patent portfolio/patented technology assets, the income approach relief from royalty method was used, similar to that of the trademarks and tradenames. As noted earlier, market transactions involving licensing rates for similar technology as well as the profit split method were considered.

An examination of licensing royalty rates for similar technology was made using information provided by Royalty Source^® Intellectual Property Database, a third party reporting service. The search of their database resulted in 5 guideline license transactions for patents in similar technologies. The royalty rates paid ranged between 3.0% and 7.0%. The median transaction had a royalty rate of 4.0%, while the average transaction had a royalty rate of 4.5%. Based on this information, a royalty rate of 4.0% was used.

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Valuation of In-Process Technology

The fair value of in-process technology was calculated using the income approach multi-period excess earnings method, which is the same method used to value customer relationships. In addition, taken into account were the costs to complete of $250,000 for Clean Diesel’s IPR&D project expected to be launched by the end of 2010.

The final determination of the allocation of purchase consideration was based on the estimated fair values of the tangible and intangible assets acquired and liabilities assumed at the date of the closing of the Merger.

4. Pro Forma Adjustments

(a)	In May 2010, Clean Diesel received commitment letters from a group of accredited investors providing for the sale of units consisting of 109,020 shares of Clean Diesel’s common stock and warrants to purchase 166,666 shares of Clean Diesel’s common stock, each on a post-split basis, for a total purchase price of $1,000,000, which closed immediately prior to the closing of the Merger. This adjustment assumes the issuance of Clean Diesel units consisting of the stock and warrants and the receipt of $1,000,000 cash from the investors. This amount is reflected as part of the outstanding Clean Diesel equity in the calculation of the estimated purchase consideration described in note 2.
(b)	To reflect funding of the final $2,000,000 of secured convertible notes that were issued by CSI immediately prior to the Merger.
(c)	This adjustment reflects conversion of the Notes upon closing of the Merger. Refer to further discussion of the Notes in note 1.
(d)	To record the estimated fair value of the acquired intangible assets totaling $3,750,000 as more fully described in note 3. This adjustment also reverses the net book value of Clean Diesel’s pre-Merger intangible assets totaling $968,000, resulting in a net adjustment of $2,782,000. In addition, this adjustment records a gain on transaction as an adjustment to accumulated deficit of $101,000, calculated using the acquisition method of accounting more fully described in note 3. This gain has not been reflected on the pro forma condensed statement of operations as it is non-recurring in nature.
(e)	To record CSI’s Merger costs related to the issuance of shares and warrants to CSI’s financial advisor, Allen & Company LLC upon closing of the Merger as more fully described in note 2. These costs have not been reflected on the pro forma condensed statements of operations as they are non-recurring in nature. These shares, reflected as paid in capital, and warrants, reflected as accrued expense, have an estimated fair value of $820,000 and $230,000, respectively for a total of $1,050,000. Additionally, this adjustment reflects a reduction to accounts payable of $599,000 for such costs incurred and accrued prior to September 30, 2010 which results in a net reduction to accumulated deficit of $451,000. The warrants are classified as liabilities as their expected terms could compel cash settlement.
(f)	To record an increase to Merger-related liabilities for CSI’s and Clean Diesel’s estimated professional and employee related Merger costs totaling $1,350,000 not already incurred by CSI and Clean Diesel as of September 30, 2010. These costs, as more fully described in note 2, have not been reflected on the pro forma condensed statements of operations as they are non-recurring in nature. Merger related costs include fees payable to investment bankers, legal and accounting services, NASDAQ and other regulatory fees, printing, proxy solicitation and other costs, including an estimated $500,000 expected to be incurred related to employee retention and success bonuses as a result of successful completion of the transaction. Clean Diesel’s transaction costs of $800,000 will be incurred prior to the Merger and are reflected as an accrued expense in the allocation consideration transferred in note 3. CSI’s transaction costs of $550,000 are reflected as an increase to accumulated deficit as they will be an expense of the combined entity.
(g)	To eliminate the pro forma Clean Diesel equity account balances upon closing the Merger at September 30, 2010.
(h)	To reflect issuance of purchase consideration of $7,698,000 as more fully described in note 2 representing 1,510,340 shares on a post-split basis at par value of $0.01 or $15,000 with the remaining $7,683,000 reflected as additional paid-in capital.

9

(i)	To record an accrued liability for $689,000 representing the estimated fair value of the warrants to purchase 499,917 shares of Clean Diesel on a post-split basis issued (or reserved for issuance) to CSI equity holders upon closing of the Merger. This transaction has been reflected as a distribution to the shareholders of the accounting acquirer and, accordingly, a reduction of shareholders’ equity. The warrants are classified as liabilities as they are expected to have ongoing registration requirements, which could compel cash settlement.
(j)	To recast CSI’s historical Class A common stock and CSI’s Class B common stock capital accounts to reflect the appropriate post-Merger paid in capital of Clean Diesel.
	Summary of Pro Forma Adjustments to Additional Paid in Capital
	The Summary of pro forma adjustments to additional paid in capital reflect the impact of the business combination and associated transactions more fully described above:

Historical value of CSI’s outstanding shares including conversion of Notes	$	161,870
Fair value of shares held by Clean Diesel shareholders		7,698
Fair value of 166,666 shares issued to Allen & Company LLC as a Merger cost		820
Estimated fair value of 499,917 warrants issued (or reserved for issuance) to CSI equity holders recorded as a distribution		(689	)
Less: amount attributable to par value of shares		(38	)
	$	169,661

Statements of Operations Adjustments

(k) To eliminate historical Clean Diesel depreciation and amortization expense of $140,000 for the nine months ended September 30, 2010 and $184,000 for the twelve months ended December 31, 2009.

(l) To record amortization expense based on the preliminary estimated fair values of the underlying intangible assets to be acquired amortized over their estimated useful lives as follows:

				Amortization Expense
				Nine months		Twelve months
			Estimated	ended		ended
	Fair value		useful life	September 30, 2010		December 31, 2009
Customer relationships	$	180,000	3	$	45,000	$	60,000
Trade names		948,000	10		71,000		95,000
Patents		2,352,000	10		177,000		235,000
In process research and development		270,000	10		20,000		27,000
	$	3,750,000		$	313,000	$	417,000

(m)

To record the adjustment to of the carrying value of the financial instruments embedded in the convertible notes to their final intrinsic value.

(n)

This adjustment reflects additional non-cash interest expense of $1,342,000 for an embedded beneficial conversion feature included in the Notes. The beneficial conversion is calculated as the intrinsic value of the conversion feature at the loan commitment date, but is limited to the amount of proceeds allocated to the Notes of $1,342,000. The proceeds allocated to the Notes represent the $2,000,000 cash proceeds less the proceeds allocated to the contingent equity forward valued of $658,000. The beneficial conversion feature was contingent on CSI’s shareholders approval of amendments to the Articles of Incorporation and is recorded at the time of such approval. The necessary approvals were obtained October 12, 2010.

10

5. Pro Forma Loss Per Share

Historical weighted average shares outstanding for the nine months ended September 30, 2010 and the twelve months ended December 31, 2009 includes Clean Diesel’s and CSI’s historical weighted average shares outstanding of 1,364,228 and 69,761,902, respectively.

The pro forma Clean Diesel Technologies, Inc. weighted average shares outstanding for the nine months ended September 30, 2010, and the twelve months ended December 31, 2009, include the following:

	Post-Reverse
	Split
Clean Diesel shares outstanding		1,368,906
New shares issued in connection with the Merger to CSI shareholders and Allen & Company LLC		2,278,014
New shares issued to accredited investors		109,020
New shares issued to Innovator Capital		32,414
Total		3,788,354

Diluted weighted average shares outstanding at September 30, 2010 and December 31, 2010 exclude the anti-dilutive impact of approximately 1,081,558 and 1,103,290 warrants and options, each on a post-split basis, outstanding at the time of the closing of the Merger, respectively.

Equivalent Pro Forma Clean Diesel Technologies, Inc.

The equivalent pro forma loss per share amounts are calculated by multiplying the pro forma Clean Diesel Technologies, Inc. per share amounts by the CSI Class A common stock exchange ratio of 0.007888. For the nine months ended September 30, 2010 equivalent pro forma loss per share is ($0.02) calculated by multiplying the pro forma basic and diluted loss per share of ($1.92) by the Class A conversion ratio of 0.007888. For the twelve months ended December 31, 2009 equivalent pro forma loss per share is ($0.04) calculated by multiplying the pro forma basic and diluted loss per share of ($4.74) by the Class A conversion ratio of 0.007888.

6. Book Value per Share

Book value per share is calculated by dividing company shareholders’ equity by common shares outstanding at the end of the period. The equivalent pro forma book value per share is calculated by multiplying the pro forma Clean Diesel Technologies, Inc. per share amount by the CSI Class A common stock exchange ratio of 0.007888.

11

EX-99.3

Exhibit 99.3

EX-99.4

Exhibit 99.4

FOR IMMEDIATE RELEASE

Clean Diesel Technologies, Inc. Reports Third Quarter 2010 Results and
Third Quarter 2010 Results of Catalytic Solutions, Inc.

Ventura, CA — November 15, 2010 — Clean Diesel Technologies, Inc. (“Clean Diesel” or the “Company”) (NASDAQ:CDTI), a cleantech emissions reduction company, today announced its operating results and the operating results of its wholly-owned subsidiary, Catalytic Solutions, Inc. (“CSI”), for the third quarter ended September 30, 2010. These results represent the period prior to the recently completed merger and reflect each company on a standalone basis.

On October 15, 2010, Clean Diesel completed its business combination with CSI following which CSI became a wholly-owned subsidiary of Clean Diesel. Clean Diesel refers to this transaction as the “Merger.” The Merger was accounted for as a reverse acquisition and, as a result, Clean Diesel’s (the legal acquirer) consolidated financial statements will, in substance, be those of CSI (the accounting acquirer), with the assets and liabilities, and revenues and expenses, of the Company being included effective from the date of the closing of the Merger.

Because the Merger was not completed until after the quarter ended September 30, 2010, Clean Diesel is required to include in its quarterly report on Form 10-Q for the quarter ended September 30, 2010, the unaudited condensed consolidated financial statements of Clean Diesel, the legal acquirer, as of September 30, 2010 (i.e., prior to the closing of the Merger) and has filed such report today. In order to ensure that there is no gap in the public record of the financial information of Clean Diesel’s accounting acquirer, CSI, the Company has also filed today on Form 8-K, CSI’s unaudited condensed consolidated financial statements for its most recent fiscal quarter ended September 30, 2010, along with unaudited pro forma condensed combined financial statements of Clean Diesel as of September 30, 2010 and for the nine months ended September 30, 2010 and the year ended December 31, 2009, which give retroactive effect to the Merger.

Both filings may be found on Clean Diesel’s website at www.cdti.com or on the SEC’s website at www.sec.gov. The first company financials that include CSI and Clean Diesel on a consolidated basis will be for the period ending December 31, 2010 and will be included in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

Financial Highlights for the Quarter and the Nine Months Ended September 30, 2010

• Clean Diesel’s total revenue for the three months ended September 30, 2010 was $0.3 million, unchanged from the prior year period. Total revenue for the nine months ended September 30, 2010 was $1.4 million compared to $1.0 million for the prior year period, an increase of $0.4 million, or 40.0%, reflecting increased traction in Clean Diesel’s effort to establish itself in the retrofit space.

• CSI’s total revenue for the three months ended September 30, 2010 was $10.9 million, compared to $13.4 million, down $2.5 million, or 18.7%, from the prior year period. Total revenue for the nine months ended September 30, 2010 was $36.3 million compared to $32.5 million for the prior year period, an increase of $3.8 million, or 11.7%. Following are the revenues for such three and nine month periods broken down for CSI’s two principal divisions, the Heavy Duty Diesel Systems and Catalyst:

Clean Diesel Technologies, Inc. * 4567 Telephone Road, Suite 206 * Ventura CA 93003 * 805-639-9458
www.cdti.com

• CSI’s Heavy Duty Diesel Systems division’s revenue for the three months ended September 30, 2010 increased $1.0 million, or 16.9%, to $6.9 million from $5.9 million for the prior year period. Revenue for the nine months ended September 30, 2010 increased $8.0 million, or 54.4%, to $22.7 million from $14.7 million for the prior year period. The increase was due largely to an expansion of CSI’s distributor channels in the United States as well as continued benefit from funding allocated to diesel emission control under the American Recovery and Reinvestment Act of 2009 (commonly referred to as the Stimulus Bill), which provided customers an incentive to acquire emission control products including CSI’s. In addition, revenues for the three months ended September 30, 2009 were adversely impacted by the global economic slowdown and the California budget crisis, resulting in a favorable year-over-year comparison of three months ended September 30, 2010 compared to the same period in 2009.

• CSI’s Catalyst division’s revenue for the three months ended September 30, 2010 decreased $3.7 million, or 48.1%, to $4.0 million from $7.7 million for the prior year period. Revenue for the nine months ended September 30, 2010 decreased $4.2 million, or 23.2%, to $13.9 million from $18.1 million for the prior year period. Sales for this division decreased year over year as a result of an automaker accelerating the manufacture of a vehicle that requires a catalyst product meeting a higher regulatory standard than the product currently supplied to the automaker by CSI’s Catalyst division.

• Clean Diesel’s gross profit as a percentage of revenue was 41.6% and 31.4% for the nine month periods ended September 30, 2010 and 2009, respectively.

• CSI’s gross profit as a percentage of revenue was 25.6% and 21.0% for the nine month periods ended September 30, 2010 and 2009, respectively.

• Clean Diesel’s net loss was $3.8 million for the nine months ended September 30, 2010 compared to $5.6 million for the nine months ended September 30, 2009.

• CSI’s net loss including discontinued operations was $2.7 million for the nine months ended September 30, 2010 compared to $11.3 million for the nine months ended September 30, 2009; net loss from continuing operations was $3.3 million for the nine months ended September 30, 2010 compared to $10.2 million for the nine months ended September 30, 2009.

• Cash and cash equivalents of the combined companies was $5.4 million as of September 30, 2010.

Clean Diesel’s Chief Executive Officer, Charles Call stated, “We now end the last calendar quarter in which the Company and CSI conducted their businesses separately, with stand alone financial reporting for each. We now combine to build upon our strengths and move to capture the potential that led to this Merger, although we understand that some bumps likely lie ahead. While we expect a strong fourth quarter in our diesel systems retrofit business, year-over-year comparisons will be dampened due to an exceptionally strong fourth quarter in 2009 when we benefited from significant sales driven by funding made available by the State of California subsequent to the resolution of the 2009 budget crisis. As stated in CSI’s half year results, there is a slow down in our Catalyst business due to a production change at one of our key customers. We expect that our catalyst products will continue to demonstrate cost and technological superiority and those sales will start improving sometime in the first half of 2011 once regulatory approval is received. On a pro-forma basis, despite the significant reduction in the Catalyst business, the combined companies had revenues of $37.7 million for the nine months ended September 30, 2010, up 12.5% compared to the same period in 2009.”

Clean Diesel Technologies, Inc. * 4567 Telephone Road, Suite 206 * Ventura CA 93003 * 805-639-9458
www.cdti.com

2

Selected Unaudited Pro Forma Clean Diesel Technologies, Inc.

On October 15, 2010, immediately prior to the Merger, a one-for-six reverse stock split of the Company’s common stock took effect. The following pro forma combined financial information shows the Company’s revenue and earnings for the periods indicated as if the Merger had been completed and the reverse stock split had been effective on January 1^st of the relevant period prepared in accordance with Financial Accounting Standards Board Accounting Standards Codification Section 805:

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2010			2009			2010			2009
Revenue	$	11,280		$	13,654		$	37,707		$	33,519
Net Loss	$	(4,887	)	$	(5,138	)	$	(6,684	)	$	(17,096	)
Net Loss Per Share	$	(1.29	)	$	(1.36	)	$	(1.76	)	$	(4.51	)
Weighted Average Shares Outstanding		3,788			3,788			3,788			3,788

The pro forma combined Clean Diesel Technologies, Inc. net loss includes the elimination of historical Clean Diesel depreciation and amortization and the addition of the amortization of the intangible assets acquired based on our preliminary purchase accounting. The pro forma net loss for the three and nine months ended September 30, 2010 includes $1.4 million and $2.8 million of Merger-related expense, respectively. Weighted average shares outstanding represent the issued and outstanding shares upon completion of the Merger.

Unaudited pro forma condensed combined financial statements as of September 30, 2010 and for the nine months ended September 30, 2010 and the year ended December 31, 2009 prepared in accordance with the regulations of the Securities and Exchange Commission reflecting the Merger and the capital raise transactions are included in the Company’s current report on Form 8-K filed today with the SEC and available on the Company’s website at www.cdti.com and on the SEC’s website at www.sec.gov.

Our Capitalization

Immediately prior to the Merger, after giving effect to the reverse stock split, the Company had 1,368,906 shares outstanding, as well as options, warrants and restricted stock with respect to an aggregate of 195,585 shares. In connection with the Merger, the Company issued an aggregate of 2,111,348 shares of its common stock and warrants to acquire 491,850 shares of its common stock to the former shareholders of CSI; 166,666 shares of its common stock and warrants to acquire an aggregate of 166,666 shares of its common stock to CSI’s financial advisor Allen & Company; 109,020 shares of its common stock and warrants to acquire an aggregate of 166,666 shares of its common stock in the Company’s Reg S offering; and 32,414 shares of its common stock and warrants to acquire an aggregate of 14,863 shares of its common stock to the Company’s financial advisor Innovator Capital.

Accordingly, as of Friday, November 12, 2010, the Company had outstanding approximately 3,788,354 shares of its common stock and no shares of its preferred stock. The Company also reserved for issuance 9,859 shares of common stock and warrants to acquire 8,067 shares of common stock, with such shares and warrants being issuable upon exercise of a preexisting CSI warrant to Cycad Group LLC. In addition, as of such date, the Company had outstanding options, warrants and restricted stock with respect to an aggregate of 1,060,216 shares of its common stock.

Clean Diesel Technologies, Inc. * 4567 Telephone Road, Suite 206 * Ventura CA 93003 * 805-639-9458
www.cdti.com

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About the Company

Clean Diesel Technologies, Inc. (NASDAQ:CDTI), “Clean Diesel,” “CDT” or the “Company” is, with the recent business combination with Catalytic Solutions, Inc. (“CSI”), a vertically integrated global manufacturer and distributor of emissions control systems and products, focused in the heavy duty diesel (HDD) and light duty vehicle (LDV) markets. As a cleantech company, CDT utilizes its proprietary patented Mixed Phase Catalyst (MPC^®) technology, as well as its ARIS^® selective catalytic reduction; Platinum Plus^® Fuel-Borne Catalyst (FBC), and other technologies to provide high-value sustainable solutions to reduce emissions, increase energy efficiency and lower the carbon intensity of on- and off-road engine applications. CDT is headquartered in Ventura, California, along with its wholly-owned subsidiary, CSI, and currently has operations in the U.S., Canada, U.K., France, Japan and Sweden as well as an Asian joint venture. For more information, please visit www.cdti.com and www.catsolns.com.

Forward-Looking Statements Safe Harbor

Certain statements in this news release such as statements about a strong fourth quarter in our diesel systems retrofit business, cost and technological superiority and improved sales beginning in 2011 constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (including, without limitation, information regarding the Company’s opportunity for combined revenue synergies and cost reductions). Such forward-looking statements involve known or unknown risks, including those detailed in the Company’s filings with the U.S. Securities and Exchange Commission, uncertainties and other factors that may cause the actual results, performance or achievements of the Company following the business combination with CSI to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company assumes no obligation to update the forward-looking information contained in this release.

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Contact Information:

Kristi Cushing, Investor Relations Manager

Tel: +1 (805) 639-9458

Clean Diesel Technologies, Inc. * 4567 Telephone Road, Suite 206 * Ventura CA 93003 * 805-639-9458
www.cdti.com

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