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CDTI > SEC Filings for CDTI > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for CLEAN DIESEL TECHNOLOGIES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CLEAN DIESEL TECHNOLOGIES INC


10-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q should also be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. This discussion contains forward-looking statements, the accuracy of which involves risks and uncertainties, see "Cautionary Note Concerning Forward-Looking Statements" at the beginning of this Quarterly Report on Form 10-Q. Our 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 Part I - Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

All percentage amounts and ratios included in this Management's Discussion and Analysis of Financial Condition and Results of Operations were calculated using the underlying data in thousands.

Overview

We are a leading global manufacturer and distributor of heavy diesel and light duty vehicle emissions control systems and products to major automakers and retrofitters. Our emissions control systems and products are designed to deliver high value to our customers while benefiting the global environment through air quality improvement, sustainability and energy efficiency. Our business is driven by increasingly stringent global emission standards for internal combustion engines, which are major sources of a variety of harmful pollutants.

We organize our operations in two business divisions: the Heavy Duty Diesel Systems division and the Catalyst division.

Heavy Duty Diesel Systems: Through our Heavy Duty Diesel Systems division we design and manufacture verified exhaust emissions control solutions. Our Heavy Duty Diesel Systems division offers a full range of products for the verified retrofit and original equipment manufacturer, or OEM, markets through its distribution/dealer network and direct sales. Our products, such as Purifilter®, Purifier™, ARIS® and exhaust gas recirculation with selective catalytic reduction are used to reduce exhaust emissions created by on-road, off-road and stationary diesel and alternative fuel engines including propane and natural gas. Revenues from our Heavy Duty Diesel Systems division accounted for approximately 55% and 74% of the total consolidated revenues for the three months ended March 31, 2013 and 2012, respectively.

Catalyst: Through our Catalyst division, we produce catalyst formulations to reduce emissions from gasoline, diesel and natural gas combustion engines 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. Our technical and manufacturing competence in the light duty vehicle market is aimed at meeting auto makers' most stringent requirements, and we have supplied over ten million parts to light duty vehicle customers since 1996. Our Catalyst division also provides catalyst formulations for our Heavy Duty Diesel Systems division. Revenues from our Catalyst division accounted for approximately 45% and 26% of the total consolidated revenues for the three months ended March 31, 2013 and 2012, respectively.


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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 we base our estimates and judgments on our experience and on various other factors that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions.

We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, allowance for doubtful accounts, inventory valuation, product warranty reserves, accounting for income taxes, goodwill, impairment of long-lived assets other than goodwill and stock-based compensation have the greatest potential impact on our condensed consolidated financial statements. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our year ended December 31, 2012 for a more complete discussion of our critical accounting policies and estimates.

Recently Issued Accounting Guidance

In March 2013, the FASB issued ASU No. 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity," ("ASU 2013-05"). The objective of ASU 2013-05 is to resolve the diversity in practice regarding the release into net income of the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. ASU 2013-05 is effective for reporting periods beginning after December 15, 2013 and is not expected to have a material impact on our consolidated financial statements or financial statement disclosures.

For additional discussion regarding other recent accounting pronouncements, see Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Recent Developments

Joint Venture Agreement with Pirelli & C. Ambiente SpA

On February 19, 2013, we entered into a joint venture agreement (the "Joint Venture Agreement") with Pirelli & C. Ambiente SpA ("Pirelli") to form the joint venture entity, Eco Emission Enterprise Srl, under the laws of Italy (the "Joint Venture") through which we and Pirelli will jointly sell our emission control products in Europe and the Commonwealth of Independent States ("CIS") countries. The Joint Venture Agreement provides that we and Pirelli will each hold 50% of the total issued share capital of the Joint Venture. In conjunction with the formation and operation of the Joint Venture, in February 2013, we and Pirelli have each made an initial contribution of €50,000 (approximately $66,000) to the Joint Venture. In addition, in accordance with the Joint Venture Agreement, we and Pirelli each provided shareholder loans of €200,000 (approximately $261,000) in April 2013. Future contributions from us and Pirelli will be provided to the Joint Venture in the form of cash or shareholders loans, from time to time as necessary. The operations of the Joint Venture are expected to commence in the second quarter of 2013.

Amendment to 6% Shareholder Note Due 2013

On January 30, 2013, we and Kanis S.A. entered into an amendment to amend certain terms of our outstanding 6% note due 2013. As amended, the maturity date was changed from June 30, 2013 to June 30, 2015. In addition, the payment premium due under this note was changed from a range of $100,000 to $200,000, based proportionally on the number of days that the loan remains outstanding, to a fixed amount of $250,000, with $100,000 payable on June 30, 2013 and the remaining $150,000 payable at maturity on June 30, 2015. Finally, the interest rate was changed from 6% to 8% as of June 30, 2013. For more information relating to the terms of this note see "- Description of Indebtedness" below and Note 8 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.


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Letter Agreement related to 8% subordinated convertible note due 2016

On January 30, 2013, we and Kanis S.A. entered into a letter agreement regarding our outstanding 8% subordinated convertible note due 2016 whereby Kanis S.A. has agreed not to accelerate the maturity of these notes during the 2013 calendar year. For more information relating to the terms of our 8% subordinated convertible note due 2016, see "- Description of Indebtedness" below and Note 8 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Factors Affecting Future Results

Factors Affecting our Heavy Duty Diesel Systems Division

The nature of our business and, in particular, our Heavy Duty Diesel Systems division, is heavily influenced by government funding of emissions control projects and increased diesel emission control regulations and mandates. Compliance with these regulatory initiatives drives demand for our products and the timing of implementation of emission reduction projects.

Emission reduction programs are often one-off, or have staggered compliance dates, which mean they do not generally result in a regular source of recurring revenues for our company. For example, London, U.K. had mandated that certain heavy duty diesel vehicles entering the London Low Emissions Zone (or LEZ) were required to meet certain emission standards by January 2012. We believe that approximately 20,000 such vehicles were required to have a retrofit emission control device installed on the vehicle by year-end 2011. In December 2011, the regulator extended the deadline for compliance into the first quarter of 2012. We believe that the bulk of the vehicles were retrofitted in the fourth quarter of 2011, with sales of our products of approximately $6 million in the fourth quarter and $8 million in the full year 2011. However, due to the extension, we recorded additional sales of $4.3 million and $1.0 million in the first and second quarters of 2012, respectively. This program is now complete and as such, we do not expect system sales in London in 2013. In addition, the California Air Resources Board ("CARB") has mandated that all Class 7 and Class 8 heavy diesel trucks meet certain emission targets by 2016, with interim targets established for 2011, 2012 and 2013, such that 90% of current operating diesel trucks will be required to meet these targets by 2014. We estimate that this rule will require well over 100,000 heavy duty diesel trucks to be replaced or retrofitted. According to industry estimates, approximately 66,000 vehicles have elected or will elect to retrofit between 2011 and 2015. We believe that the rate of adoption of electing to retrofit by truck owners as well as the overall level of retrofit activity and our ability to gain sales are dependent upon several factors, including the level of enforcement of the mandate by CARB, the level of new truck acquisitions by truck owners and also our success in attaining the required verifications and approvals for products currently under review by CARB. In 2012, we experienced a slower than anticipated ramp up in adoption by truck owners, a delay in enforcement by CARB and a delay in verification for a product which was under review by CARB. This resulted in weaker than expected sales in 2012. CARB began to actively enforce the regulation in the latter part of 2012. In January 2013, we received the product verification from CARB. In addition, a key competitor exited the market. We continue to pursue this retrofit opportunity and expect sales in California in 2013 to be higher than in 2012. However, the rate of adoption, industry projections pertaining to the overall market opportunity remain uncertain and could result in fluctuations in revenue and working capital requirements from quarter-to-quarter next year.

Factors Affecting our Catalyst Division

Because the customers of our Catalyst division are primarily OEM auto makers, our 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 our products. Sales to our largest OEM auto customer were positively impacted during 2012 due to increased vehicle shipments, expansion of our catalysts onto new vehicle platforms, increased purchasing by the customer to build initial stock of parts for a new model and an increase in pass through sales of rare earth materials due to increased prices of these materials. In addition, our sales and gross margins are also impacted by the pass through sales of rare earth materials and the extent to which the price increases are shared with our customer. Through June 2012, the customer was reimbursing us for substantially the full amount actually spent by us on these materials. For the balance of the year, our customer reimbursed us partially, pending the agreement on a formula for this reimbursement which is based on formulae established by this customer with other vendors. A formula has been agreed to between our customer and us for all shipments going forward from January 1, 2013. Based on this agreed formula, reimbursement from our customer is expected to approach our costs as we deplete existing higher-priced inventory levels. The resolution of the rare earth reimbursement has enabled improved gross margins in this business in the first quarter of 2013 and we expect to see improved margins as 2013 progresses. However, this formula is based on published indices of rare earth prices and, as such,we could experience margin reductions if the formula does not accurately reflect our actual costs.


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Supply of Catalyst Division Products to Heavy Duty Diesel Systems Division

Our strategy is to progressively utilize the products of our Catalyst division in the products of our Heavy Duty Diesel Systems division. We anticipate that our intercompany sales of catalysts will increase compared to historical levels, as our planned new products are approved by the regulatory agencies and begin to generate sales. While this will not impact our reported sales, we believe that the manufacturing gross margin associated with these sales will improve our total gross margin.

Impact of the Pirelli Joint Venture

In February 2013, we announced the formation of a Joint Venture with Pirelli (See "-Recent Developments-Joint Venture Agreement with Pirelli & C. Ambiente SpA"above). The purpose of the Joint Venture is to market and sell products manufactured by both CDTi and Pirelli in Europe and the CIS countries. As such, both partners will sell products to the Joint Venture which will earn a commission to market and sell these products. All existing CDTi business in Sweden and the UK will be conducted through the joint venture. As a result, we will experience a decline in revenues and, hence, gross margins realized on our sales to the Joint Venture. Offsetting this decline in gross margins will be a reduction in infrastructure costs in Europe, as we will reduce sales, marketing and administrative activities in Europe as the majority of these activities will now be handled by the Joint Venture. We expect the price and margin impact to begin in the second quarter of 2013. Our infrastructure reduction is expected to be largely completed by the end of 2013. Lastly, it is the expectation of both partners that the Joint Venture will result in additional business for both companies' products over the next several years.

Results of Operations

Comparison of Three Months Ended March 31, 2013 to Three Months Ended March 31, 2012

Revenues

The table below and the tables in the discussion that follow are based upon the
way we analyze our business. See Note 14 to our condensed consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q for
additional information about our divisions.

                                            Three Months Ended March 31,
                                      % of                   % of
                           2013   Total Revenue   2012   Total Revenue  $ Change  % Change
                                               (Dollars in millions)
Heavy Duty Diesel Systems  $7.3           54.7%  $12.6           74.1%    $(5.3)   (42.2)%
Catalyst                    6.5           48.5%    6.1           35.9%       0.4      5.8%
Intercompany revenue       (0.5)         (3.2)%   (1.7)        (10.0%)       1.2   (74.6)%
      Total revenue       $13.3          100.0%  $17.0          100.0%    $(3.7)   (21.7)%

Total revenue for the three months ended March 31, 2013 decreased by $3.7 million, or 21.7%, to $13.3 million from $17.0 million for the three months ended March 31, 2012.

Revenues for our Heavy Duty Diesel Systems division for the three months ended March 31, 2013 decreased $5.3 million, or 42.2%, to $7.3 million from $12.6 million for the three months ended March 31, 2012. The decrease was due to decreased retrofit sales of $4.9 million and decreased non-retrofit sales of $0.4 million. Retrofit sales decreased $4.3 million in the London LEZ and decreased $0.6 million in North America. The decrease in North America consisted of an increase of $0.5 million in California sales under the California Truck and Bus Rule with decreases in the other 49 states. Non-retrofit sales decreased due to a decline in European mining of $0.5 million and a decrease in standard exhaust products of $0.6 million partially offset by $0.3 million in increased sales of fuel-borne catalysts in Europe, $0.3 million in sustainable system sales in North America and $0.1 million increase in licensing revenue.


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Revenues for our Catalyst division for the three months ended March 31, 2013 increased $0.4 million, or 5.8%, to $6.5 million from $6.1 million for the three months ended March 31, 2012. Excluding intercompany revenue, sales for this division increased 36.9% to $6.0 million for the three months ended March 31, 2013 as compared to $4.4 million for the three months ended March 31, 2012. The increase was due to a $1.2 million increase in sales to our Japanese OEM customer and an increase of $0.4 million in sales to other OEM customers.

We eliminate intercompany sales by the Catalyst division to our Heavy Duty Diesel Systems division in consolidation.

Cost of revenues

Cost of revenues decreased $2.8 million, or 21.9% to $10.2 million for the three months ended March 31, 2013, compared to $13.0 million for the three months ended March 31, 2012. The decrease in cost of revenues was primarily due to lower product sales volume. Additionally, we incurred $0.6 million in expense for the write-down of excess inventory during the three months ended March 31, 2012 primarily related to the London LEZ program, which was completed in 2012.

Gross profit

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

                                             Three Months Ended March 31,
                                       % of                    % of
                           2013     Revenue (1)    2012     Revenue (1)   $ Change   % Change
                                                 (Dollars in millions)
Heavy Duty Diesel Systems  $  1.8         25.2%    $  2.8         22.0%   $  (1.0)    (33.8)%
Catalyst                      1.2         19.2%       1.2         19.8%          -       2.7%
Intercompany eliminations     0.1             -         -             -        0.1         NM
     Total gross profit    $  3.1         23.4%    $  4.0         23.2%   $  (0.9)    (21.0)%

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

Gross profit for the three months ended March 31, 2013 decreased by $0.9 million, or 21.0%, to $3.1 million from $4.0 million for the three months ended March 31, 2012. Gross margin was 23.4% during the three months ended March 31, 2013 compared to 23.2% during the three months ended March 31, 2012.

The increase in gross margin for our Heavy Duty Diesel Systems division from 22.0% for the three months ended March 31, 2012 to 25.2% for the three months ended March 31, 2013 is a result of favorable product mix in 2013 and a $0.5 million reduction in the inventory obsolescence charges which were higher in the three months ended March 31, 2012 primarily due to the London LEZ program.

The decrease in gross margin for our Catalyst division from 19.8% for the three months ended March 31, 2012 to 19.2% for the three months ended March 31, 2013 is due to an unfavorable product mix with significantly lower intercompany diesel sales in the three months ended March 31, 2013 as compared to the comparable period in 2012.


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Operating expenses

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

                                         Three Months Ended March 31,
                                 % of                    % of
                                 Total                   Total
                     2013       Revenue      2012       Revenue     $ Change      % Change
                                            (Dollars in millions)
Selling, general
and administrative  $   3.8       28.9%     $   4.5       26.2%     $   (0.7)      (13.9)%
Research and
development             1.3        9.5%         1.9       11.3%         (0.6)      (33.9)%
Total operating
expenses            $   5.1       38.4%     $   6.4       37.5%     $   (1.3)      (19.7)%

For the three months ended March 31, 2013, operating expenses decreased by $1.3 million to $5.1 million from $6.4 million for the three months ended March 31, 2012.

Selling, general and administrative expenses

For the three months ended March 31, 2013, selling, general and administrative expenses decreased by $0.7 million, or 13.9%, to $3.8 million from $4.5 million for the three months ended March 31, 2012. This decrease is a result of cost savings due to headcount reductions made during 2012, a decrease in recruiting fees related to the hiring of two executives in the three months ended March 31, 2012, and to lower outside accounting and audit fees, travel expenses and public relations and marketing costs. Selling, general and administrative expenses as a percentage of revenues increased to 28.9% in the three months ended March 31, 2013 compared to 26.2% in the three months ended March 31, 2012.

Research and development expenses

Research and development expenses for the three months ended March 31, 2013 decreased by $0.6 million, or 33.9%, to $1.3 million from 1.9 million for the three months ended March 31, 2012. This decrease is a result of cost savings due to headcount reductions made in 2012 and a decrease in product verification testing and pre-production scale up activities in the three months ended March 31, 2013 as compared to the comparable period in 2012. As a percentage of revenues, research and development expenses were 9.5% in the three months ended March 31, 2013, compared to 11.3% in the three months ended March 31, 2012.

Other expense

The following table shows the components of other expense and other (expense) income as a percentage of revenues for the periods indicated.

                                                       Three Months Ended March 31,

                                                           % of                       % of
                                              2013     Total Revenue     2012     Total Revenue
                                                           (Dollars in millions)
Interest expense                              $(0.3)          (2.5)%     $(0.3)          (1.9)%
Loss on change in fair value of common
stock warrant liability                            -               -      (0.1)          (0.8)%
Foreign currency exchange (loss) gain            0.3            2.5%      (0.2)          (1.1)%
     Total other expense                     $    -               -      $(0.6)          (3.8)%


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We incurred interest expense of $0.3 million in each of the three months ended March 31, 2013 and 2012. The three months ended March 31, 2013 included a $0.3 million exchange gain related primarily to changes in value of the Canadian dollar in relation to the U.S. dollar as compared to a loss of $0.2 million in the three months ended March 31, 2012.

Net loss

For the foregoing reasons, we had a net loss of $2.1 million for the three months ended March 31, 2013 compared to a net loss of $2.8 million for the three months ended March 31, 2012. Excluding amounts related to discontinued operations, we had a net loss from continuing operations of $2.1 million for the three months ended March 31, 2013 compared to a net loss from continuing operations of $2.7 million for the three months ended March 31, 2012. We continue to have legal and other expenses as well as gains on litigation settlements related to the 2009 divestiture of the assets of Applied Utility Systems. We record these activities as discontinued operations. For additional information relating to Applied Utility Systems, see Note 15 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Liquidity and Capital Resources

Historically, the revenue that we have generated has not been sufficient to fund our operating requirements and debt servicing needs. Notably, we have suffered recurring losses since inception. As of March 31, 2013, we had an accumulated deficit of approximately $176.8 million compared to $174.6 million at December 31, 2012. We have also had negative cash flows from operations from inception through the quarter ended March 31, 2013. We had $4.6 million in cash at March 31, 2013 compared to $6.9 million in cash at December 31, 2012, and total current liabilities of $19.4 million at March 31, 2013 compared to $15.7 million at December 31, 2012. Our primary sources of liquidity in recent years have been asset sales, credit facilities and other borrowings and equity sales.

At March 31, 2013, $2.1 million of our cash was held by foreign subsidiaries in Canada, Sweden and the United Kingdom. We do not intend to repatriate any amount of this cash to the United States as it will be used to fund our subsidiaries' continued operations. If we decide to repatriate unremitted foreign earnings in the future, it could have negative tax implications.

We have a $7.5 million secured demand financing facility with FGI backed by our receivables and inventory that terminates on August 15, 2015 and may be extended at our option for additional one-year terms. However, FGI can cancel the facility at any time. For details regarding the FGI facility, see "-Description of Indebtedness" below and Note 8 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. At March 31, 2013, we had $5.1 million in borrowings outstanding with $2.4 million . . .

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