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Warrants

12 Months Ended

Dec. 31, 2012

11. Warrants

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

Warrant activity is summarized as follows:

	Shares	Weighted Average Exercise Price	Range of Exercise Prices
Outstanding at December 31, 2010	942,870	$16.36	$2.80 - $169.47
Warrants issued	61,076	$4.50	$4.50
Warrants exercised	(49,779)	$7.92	$7.92
Warrants expired / forfeited	(24,253)	$50.95	$50.63 - $60.00
Outstanding at December 31, 2011	929,914	$15.13	$2.80 - $169.47
Warrants issued	50,000	$2.26	$2.09 - $3.80
Warrants expired / forfeited	(56,824)	$123.37	$75.00– $169.47
Outstanding at December 31, 2012	923,090	$7.77	$2.09 – $48.90
Warrants exercisable at December 31, 2012	863,090	$7.92	$2.09 – $48.90

The Company determines the grant-date fair value of warrants using the Black-Scholes option-pricing model unless the awards are subject to market conditions, in which case it uses a Monte Carlo simulation model, which utilizes multiple input variables to estimate the probability that market conditions will be achieved. Due to the significant change in the Company following the Merger, CDTi’s pre-Merger historical price volatility was not considered representative of expected volatility going forward. Therefore, the Company has utilized an estimate based upon a weighted average of implied and historical volatility of a portfolio of peer companies and CDTi’s post-Merger historical volatility for valuation of its warrants. The expected life is equal to the contractual life of the warrants.

Warrants issued in 2012 were issued in connection with the Company’s issuance or modification of debt. See Note 9. Warrants issued in 2011 were issued to underwriters in connection with the public offering of the Company’s common stock. See note 10.

The weighted-average assumptions and grant date fair value, determined using the Black-Scholes option-pricing model, for warrants issued in 2012 was as follows:

	2012
Expected volatility	91.6%
Risk-free interest rate	0.9%
Dividend yield	─
Expected life in years	6.0
Weighted average grant date fair value	$1.57

In 2011, the Company issued an aggregate 49,779 shares of common stock related to the exercise of warrants. The Company received cash proceeds of $0.4 million related to these exercises.

The following table summarizes information on warrants outstanding on December 31, 2012:

Number Outstanding	Exercise Price	Issuance Date	Expiration Date
7,577	$48.90	9/26/03	9/25/2013
9,859	$2.80	6/25/2008	10/1/2014
616,245	$7.92	10/15/2010	10/15/2013
25,000	$7.92	12/21/2010	12/21/2013
128,333	$7.92	12/22/2010	12/22/2013
25,000	$10.40	12/30/2010	6/30/2016
61,076	$4.50	7/5/2011	6/28/2016
5,000	$3.80	2/16/2012	8/16/2017
45,000	$2.09	7/27/2012	7/27/2018

Warrant Classification

The Company evaluates warrants on issuance and at each reporting date to determine proper classification as equity or as a liability. The Company has 379,678 outstanding warrants issued to former CSI Class A shareholders in connection with the Merger that it is required to physically settle by delivering registered shares. In addition, while the relevant warrant agreement does not require cash settlement if the Company fails to maintain registration of the warrant shares, it does not specifically preclude cash settlement. Accordingly, the Company’s agreement to deliver registered shares without express terms for settlement in the absence of continuous effective registration is presumed to create a liability to settle these warrants in cash, requiring liability classification. The contracts for the remaining warrants allow for settlement in unregistered shares and do not contain any other characteristics that would result in liability classification. Accordingly, these instruments have been classified in stockholders’ equity in the accompanying consolidated balance sheets and are only valued on the issuance date and not subsequently revalued. The Company evaluated the balance sheet classification of all warrants at December 31, 2012 and noted no changes.

The liability-classified warrants are considered Level 3 in the fair value hierarchy because they are valued based on unobservable inputs. The Company determined the fair value of its liability-classified warrants using a Monte Carlo simulation model, which utilizes multiple input variables to estimate the probability that market conditions will be achieved. As noted above, the Company has utilized an estimate based upon a weighted average of implied and historical volatility of a portfolio of peer companies and CDTi’s post-Merger historical volatility for valuation of its warrants. At December 31, 2012, the Company utilized an estimate based upon a weighted average of implied volatility of peer companies and CDTi’s post-Merger historical volatility, with an increase in weighting toward CDTi’s post-Merger historical volatility.

The assumptions used in the Monte Carlo simulation model were as follows:

	December 31,
	2012	2011
Expected volatility	71.3%	58.8%
Risk-free interest rate	0.3%	0.7%
Closing price of Clean Diesel Technologies, Inc. common stock	$2.17	$2.80

The liability, which is included in accrued liabilities in the accompanying consolidated balance sheets, is remeasured at the end of each reporting period with changes in fair value recognized in other income (expense) in the consolidated statements of operations and comprehensive loss.

The following is a reconciliation of the warrant liability measured at fair value using Level 3 inputs (in thousands):

	Years Ended December 31,
	2012	2011
Balance at beginning of year	$ 100	$ 1,238
Exercise of common stock warrants	─	(39)
Remeasurement of common stock warrants	(90)	(1,099)
Balance at end of year	$ 10	$ 100