Clean Diesel Technologies, Inc (CDTI) - Description of business

GENERAL

Clean Diesel Technologies, Inc., a Delaware corporation with a principal place of business at 300 Atlantic Street, Stamford, CT 06901, was formed in 1994 as a wholly owned subsidiary of Fuel-Tech N.V., incorporated under the laws of the Netherlands Antilles (Fuel Tech), to develop technologies that reduce harmful emissions from diesel engines while reducing fuel consumption and improving fuel economy. CDT was spun-off by Fuel Tech in a rights offering in December 1995. Over the past ten years, CDT has developed its technologies in the areas of platinum fuel catalysts (PFCs) for emissions control and fuel economy improvement in diesel engines, and nitrogen oxide (NOx) reduction systems for control of NOx emissions from diesel engines.

CDT is now commercializing the Platinum Plus(R) fuel-borne catalyst (FBC), a diesel fuel PFC additive, the ARIS(R) NOx reduction system, an advanced reagent injection system used in catalytic NOx reduction systems , and Clean Diesel's diesel particulate filter technology based on catalyzed wire mesh filter elements. CDT has 26 U.S. patents issued and 17 U.S. patent applications pending, as well as 106 foreign patents issued and 65 foreign patent applications pending. Increasingly, combustion engine development is influenced by concern over global warming caused by carbon dioxide (CO2) emissions from fossil fuels and toxic exhaust emissions. Because carbon dioxide results from the combustion of fossil fuels, reducing fuel consumption is often cited as the primary way to reduce carbon dioxide emissions. Diesel engines are as much as 40% more fuel-efficient than gasoline engines. Thus, increased use of diesel engines relative to gasoline engines is one way to reduce overall fuel consumption and thereby significantly reduce carbon dioxide emissions. Diesel engines, however, emit higher levels of two toxic pollutants than gasoline engines fitted with catalytic converters, specifically, particulate matter (PM) and nitrogen oxides. Both of these pollutants affect human health and also damage the environment.

TECHNOLOGIES AND PRODUCTS

CDT has succeeded in developing technologies and products that, when combined with other after-treatment devices, can reduce particulate emissions and nitrogen oxides from diesel engines to or below the emission levels of natural gas engines, while also reducing fuel consumption. This results in a reduction in fuel costs and greenhouse gas emissions, primarily carbon dioxide, as well as a reduction in emissions of particulates, nitrogen oxides, carbon monoxide and un-burnt hydrocarbons.

PLATINUM PLUS FBC

CDT has successfully developed and patented the Platinum Plus additive as a diesel fuel soluble, fuel-borne catalyst, which contains minute amounts of platinum and cerium catalysts and is used to improve combustion, reduce emissions and improve the performance and reliability of emission control equipment. Platinum Plus FBC takes the catalytic action into engine cylinders where it improves combustion thereby reducing particulates, un-burnt hydrocarbons and carbon monoxide emissions and improves fuel economy. Fleet tests using Platinum Plus FBC have shown improvements in fuel economy of between 3% and 12%. Platinum Plus FBC can be used alone or with either regular or ultra low-sulfur diesel fuel to reduce particulate emissions by 10% to 25% within the engine while also improving the performance of diesel oxidation catalysts and particulate filters (which trap up to 95% of particulates but in doing so become clogged with soot) by burning off the soot particles at lower temperatures and further reducing toxic emissions of carbon monoxide and un-burnt hydrocarbons.

From 1996 to 1999, CDT defined and managed several research and development programs on platinum fuel catalysts which were conducted by Delft Technical University (Netherlands), Ricardo Consulting Engineers (U.K.), Cummins Engine Company (USA) and Southwest Research Institute (USA). Through a strategy of using independent test houses, CDT's small technical team has been able to run several programs on a cost effective basis while bringing in a wide range of expertise. Most importantly, the results have been independently derived.

CDT completed the first stage of development of the Platinum Plus FBC in 1999. In December of that year, CDT received EPA registration for the Platinum Plus FBC for use in bulk fuel by refiners, distributors and truck fleets. In 2000, CDT completed the certification protocol for particulate filters and additives for use with particulate filters with VERT, the main recognized authority in Europe that tests and verifies diesel particulate filters for emissions and health effects. In 2001, the Swiss Authority BUWAL approved the Platinum Plus fuel-borne catalyst for use with particulate filters. In 2002, the U.S. Mining, Safety and Health Administration (MSHA) accepted the Platinum Plus fuel-borne catalyst for use in mines, with or without diesel particulate filter after-treatment.

In 2003, CDT received EPA verification for the Platinum Plus FBC and a diesel-oxidation catalyst (the Purifier System). In June 2004, CDT received EPA verification for the Catalyzed Wire Mesh Filter System, which combines the Platinum Plus fuel borne catalysts with a catalyzed wire mesh filter (CWMF). CDT has also applied to the California Air Resources Board (CARB) for verification of these combination systems. In 2005, CDT applied for CARB verification of Platinum Plus FBC in combination with high efficiency diesel particulate filter. Verification is given for specific engine groups, and the initial verification and applications are for older engines (pre-1994 manufactured), which are higher emitters of particulates and nitrogen oxides than newer engines. CDT also received verification extension for fuel-borne catalysts and diesel-oxidizing catalysts to cover engines manufactured between 1994 and 2003. Verification is needed for the end user of the Platinum Plus FBC to get emissions reduction credit from the EPA's voluntary retrofit program or CARB's mandatory retrofit program. In the U.S., truck fleets, municipalities and off-road equipment operators are generally moving toward using only verified technologies when installing retrofit emissions reduction systems.

Over the past several years, CDT has carried out 11 large fleet fuel economy demonstration trials in the U.S. in a range of industries, including the waste hauling, beverage, grocery and fuel delivery industries. The improvements in fuel economy from using Platinum Plus FBC in these demonstrations ranged from 3% to 12%, with an average 8% improvement. The best results were generally attributable to short-haul "stop-and-go" driving, as is generally the pattern for local delivery vehicles, buses and garbage trucks. Lab engine test beds run at both Cummins Engine Company and the Southwest Research Institute showed a 2% to 8% improvement in fuel economy, respectively, which have been confirmed by field testing programs. Platinum Plus FBC is effective with normal sulfur diesel, ultra low sulfur diesel, arctic diesel (kerosene) and biodiesel. When used with biodiesel and kerosene, Platinum Plus FBC prevents the normal increase in nitrogen oxides associated with biodiesel.

ARIS SCR

The ARIS (Advanced Reagent Injection System) is the patented injection system for the reduction of nitrogen oxide emissions from diesel engines. The system comprises of a single fluid computer-controlled injector that provides precise injection of nontoxic urea-based reagents into the exhaust of a stationary or mobile engine, where the system then converts nitrogen oxides across a catalyst to nitrogen and water vapor. The system has shown reduction of nitrogen oxides of up to 90% and, on occasion, higher percentages on a steady state operation and of up to 85% in transient operations. This process, known as selective catalytic reduction (SCR), has been in use for many years in power stations, and it is well proven in mobile and stationary applications. The ARIS system is a compact version of the selective catalytic reduction injection system. The principal advantage of the patented ARIS system is that compressed air is not required to operate the system and that a single fluid is used for both NOx reduction and injector cooling. The system is designed for high-volume production and is very compact, with very few components, making it inherently cheaper to manufacture, install and operate than the compressed air systems, which were first developed for heavy-duty vehicles. The ARIS system may be used in both stationary diesel engines for power generation and mobile diesel engines used in trucks, buses, trains and boats.

CATALYZED WIRE MESH DIESEL PARTICULATE FILTER

Clean Diesel had partnered with Mitsui and PUREarth in the development and testing of catalyzed wire mesh filter (CWMF) technology. The CWMF technology was initially developed by Mitsui/PUREarth for use in conjunction with CDT's FBC as a lower cost and reliable alternative to the traditional heavily catalyzed filter systems. The system has been verified by CDT under the EPA's Environmental Technology Verification protocol as reducing toxic particulates by up to 75 percent, carbon monoxide by 60 percent, hydrocarbons by 80 percent, and NOx by 9 percent. It also provides lower NO2 emissions levels relative to traditional, heavily catalyzed filter systems. In 2005 the CWMF technology was transferred to CDT under a technology transfer agreement with Mitsui and PUREarth. Under the agreement CDT acquired the worldwide title to the patents and other intellectual properties, excluding Japan. The CWMF technology is designed for use in a wide range of diesel engine particulate emission control applications.

The CWMF technology is a durable, low-cost filter design to bridge the gap between low efficiency diesel-oxidation catalysts and expensive, heavily catalyzed particulate filters. The wire-mesh filter system is designed to work synergistically with a FBC for reliable performance. This combined FBC/CWMF technology is especially suited to solving the challenging

problem of delivering a reliable pollution control solution which can be easily retrofitted for the older, higher-emission diesel engines expected to be in service for years to come.

In addition to reducing the cost to achieve these emissions improvements, the patented combination with a FBC permits the CWMF to operate effectively at the lower exhaust temperatures found in stop-and-go service applications. The FBC reduces the engine-out emissions and allows soot captured in the CWMF to be reliably combusted at lower exhaust temperatures. Commercial systems of Platinum Plus FBC with this durable CWMF have demonstrated performance in beverage delivery vehicles, refuse trucks and buses.

THE MARKET AND THE REGULATORY ENVIRONMENT

CDT estimates that worldwide annual consumption of diesel fuel amounts to approximately 200 billion USG, including approximately 50 billion in the United States, 60 billion in Europe and 50 billion in Asia.

NEW DIESEL ENGINES

While engine manufacturers have, to date, generally met emissions regulations by engine design changes (which tend to increase fuel consumption), CDT believes that further reduction in emissions can be achieved best by using combinations of cleaner-burning fuels and after-treatment systems such as diesel-particulate filters and catalytic systems for reducing nitrogen oxides.

In the last several years, emissions regulations for new mobile diesel engines in the major markets of North America, Asia and Europe have continued to tighten and are now 40% to 90% lower than the mid-1980s regulations. Regulations proposed through 2010 in the U.S., Europe and Asia are expected to reduce the emissions level for new mobile diesel engines to 85 to 99% of the levels mandated in the mid-1980s. The market for mobile NOx reduction systems is expected by management to develop between 2006 and 2010. European engine manufacturers have decided to use urea SCR in 2006, at least on heavy duty vehicles and very likely on medium and light trucks in later years. There is a clear preference to use a single fluid system for the medium and light trucks which have no compressed air system. It also seems probable that European manufacturers will adopt particulate filters to meet 2010 regulations which are being formulated.

In May 2004 the U.S. Environmental Protection Agency (EPA) announced proposals to regulate 'nonroad' engines. The regulations are planned to be phased in from 2008 to 2014. Proposals include a wide range of construction equipment, agricultural equipment, as well as railroad and marine applications.

CDT believes the U.S. market for diesel engines is poised for significant growth because of the favorable fuel economy performance of diesel engines coupled with the increased ability to control effectively, particulate and emissions of nitrogen oxides from such engines. Europe and Asia already use significantly more mobile diesel engines, particularly for passenger and light-duty vehicles. Most U.S. engine manufacturers have indicated that they intend to use particulate filters, to meet new diesel vehicle regulations in the 2007 to 2010 time period. European engine manufacturers have committed to adopt urea-selective catalytic reduction by the 2007 to 2010 period. CDT believes it is probable that both particulate filters and some emissions of nitrogen oxides control technology will be required in Europe and the U.S. by the 2010 to 2015 period.

EXISTING DIESEL ENGINES AND THE RETROFIT MARKET

While much of the regulatory pressure and the response from engine manufacturers has focused on reducing emissions from new engines, there is increasing concern over pollution from existing diesel engines that have 20- to 30-year life cycles. CDT believes this trend underlies the growing interest in the potential market that may exist for retrofitting diesel engines with emissions reduction systems. Stationary diesel engines, construction equipment and public transportation vehicles such as buses and commercial and municipal truck fleets will all be included in such a retrofit diesel engine market.

In 1998, the California Air Resources Board (CARB) declared diesel particulates to be toxic and in 2000 it proposed reductions in particulate emissions from over one million existing engines in California as well as more stringent controls for new engines. The EPA stated its objective for retrofitting vehicles with particulate controls and developed the Clean School Bus U.S.A program to reduce emissions on school buses and the Smartway Transport Program to reduce both diesel emissions and fuel consumption on over-the-road trucks.

COMPETITION

There is significant competition among companies that provide solutions for pollutant emissions from diesel engines. Several companies market products that compete directly with CDT's products and other companies offer products that potential customers may consider to be acceptable alternatives. In addition, newly developed products could be more effective and cost-efficient than CDT's current products or those developed in the future.

CDT faces direct competition from companies with far greater financial, technological, manufacturing and personnel resources, including Engelhard, Donaldson, Fleetguard, Octel, Rhodia and Johnson Matthey. Moreover, many of the current and potential future competitors have substantially more engineering, sales and marketing capabilities and broader product lines than CDT does. CDT also faces indirect competition in the form of alternative fuel consumption vehicles such as those using methanol, hydrogen, ethanol and electricity.

CDT believes that its technologies and products occupy a strong competitive position relative to others in the diesel emissions reduction technology market. Competition in verified particulate reduction systems for retrofit is from catalyst systems suppliers like Johnson Matthey and Engelhard. These companies employ systems that rely on much greater quantities of platinum and that have the undesirable effect of increasing emissions of NO2, a component of NOx. Competition in the diesel fuel additive market is from additive suppliers such as Associated Octel, who markets an iron product and Rhodia and Oxonica , who market cerium products. The Platinum Plus FBC competes on performance in regenerating filters and lower metal usage which results in less ash buildup on filters. Platinum Plus FBC also offers better performance in terms of carbon monoxide reduction and hydrocarbon reduction. In addition, Platinum Plus FBC is the only fuel additive to provide fuel economy improvement. Finally, in the NOx control market, competition is from other suppliers of reagent-based post-combustion NOx control systems such as KleenAir Systems for retrofit and Robert Bosch for OEMs. Bosch has stated that it will offer a single fluid system after 2007. CDT, however, already has proprietary technology for a single fluid system, which requires no compressed air and involves fewer components.

MARKET OPPORTUNITY

The two principal market drivers for CDT's products are emission reduction and fuel economy improvement. Platinum Plus FBC is an "enabling technology" that enables emission reductions from the engine itself and enhances performance of the exhaust treatment system while improving fuel economy. The continued tightening of clean air standards, emissions control regulations, pressure for fuel efficiency and growing international awareness of the greenhouse effect should provide CDT with substantial opportunities in local markets throughout North America, Asia and Europe.

Without compromising the fuel economy benefits of diesel, a significant reduction of particulate and NOx emissions can only be achieved by using combinations of improved engine design, cleaner burning fuels and after-treatment systems such as diesel particulate filters and catalytic systems. The Platinum Plus FBC (which improves combustion catalytically and enables higher performance of exhaust treatment devices) and the ARIS 2000 technology can form key components of both of these after-treatment systems.

The convergence of requirements for emissions compliance and the high cost of fuel make the use of the products economical. With diesel fuel selling at approximately $2.50 per USG, or more, in the United States as of December 2005, a fuel savings of at least 2% corresponds to $0.05 per USG and effectively pays the cost of dosing with Platinum Plus FBC by truck fleet operators. Platinum Plus FBC in controlled fleet tests showed an average of 7% fuel economy improvement. In Europe, where diesel fuel retails in some countries for as much as $7.50 per USG because of the high tax on fuels, potential fuel economy benefits are even more pronounced.

MARKETING STRATEGY AND COMMERCIALIZATION

The market for after-treatment systems for emissions control from diesel engines is currently moving from the demonstration and development phase to a commercialization phase. The only exception to this general trend is in the market for passenger cars in France, where PSA Peugeot has taken the lead and has already begun offering particulate filter systems with fuel-borne catalysts on several of its models. EPA and CARB programs are only now beginning to result in the creation of active markets for diesel emissions reduction technologies and products. Thus, the market for diesel emissions reduction technologies and products is relatively new. CDT expects opportunities and demand for verified diesel emissions reduction technologies and products from both larger companies with established distribution channels to the diesel engine market and owners of existing public and private fleets of diesel-powered vehicles. At the same time, engine manufacturers are looking to subsystem suppliers to provide complete exhaust subsystems including particulate filters and/or NOx abatement systems and eventually both.

It is an essential requirement of the U.S. retrofit market that emissions control products and systems are verified under the EPA or CARB protocols to qualify for credits within the EPA and CARB programs. Funding for these emissions control products and systems is mostly limited to those products and technologies that have already been verified. CDT has received verification from the US EPA for two systems based upon the use of the Platinum Plus FBC. The Platinum Plus Purifier System uses the FBC and a DOC for up to a 50% particulate reduction. A second system is verified for up to 75% reduction and uses a CWMF and the Platinum Plus FBC. CDT may seek to verify its Platinum Plus FBC in combination with additional emissions control devices manufactured by other vendors. CDT may receive royalties from sales of such devices in the event sales of such devices include the Platinum Plus FBC product as part of the devices' verification.

CDT currently manufactures and ships the Platinum Plus FBC product from a toll blender in Pittsburg, Pennsylvania and from a small warehouse in Milford, Connecticut. However, as demand for the product increases, CDT intends to expand the manufacturing and shipping points by supplying platinum concentrate to large chemical and additive manufacturing companies. These companies will then blend and market the finished Platinum Plus FBC products to fuel suppliers and end users.

CDT has licensed the ARIS 2000 NOx reduction technology in both the U.S. and Japan. CDT plans to widen distribution to Europe and Asia by selling key components with the technology licenses. CDT believes this strategy of licensing the products and technologies represents the most efficient way to gain widespread distribution quickly and to exploit demand for the technologies in North America, Asia and Europe.

In 2005 CDT acquired the rights to several worldwide patents from the Mitsui Company of Japan relating to catalized wire mesh filter technology. CDT is in the process of commercializing the technology in combination with its Platinum Plus FBC.

HEALTH EFFECTS AND REGISTRATION OF ADDITIVES

Metallic additives have come under scrutiny for their possible effects on health. CDT registered its platinum additive in 1997 in both the U.S. and the U.K. The platinum-cerium bimetallic additive required further registration in the U.S. and that process involved a 1,000-hour engine test and extensive emission measurements and analysis. The registration was completed in 1999 and issued in December 1999.

Germany, Austria and Switzerland have set up a protocol (VERT) for approving diesel particulate filters and additive systems used with them. CDT completed the required tests under the VERT protocol in 2000 and in January 2001, the Swiss authority BUWAL approved the Platinum Plus FBC fuel additive for use with a filter.

Engine tests in the U.S. and Switzerland show that 95% to 99% of the catalyst metal introduced to the fuel by the FBC is retained within the engine and exhaust after a filter and that the amount of platinum emitted from the use of Platinum Plus FBC is roughly equivalent to platinum attrition from automotive catalytic converters.

In December 1996, the United Kingdom Ministry of Health's Committee on Toxicity reviewed the product and all the data submitted by CDT and stated "The Committee is satisfied that the platinum emission from vehicles would not be in an allergenic form and that the concentrations are well below those known to cause human toxicity." In 1997, Radian Associates, an independent research consulting firm, reviewed our data and the literature on platinum health effects and concluded, "the use of Clean Diesel Technologies' Platinum containing diesel fuel additive is not expected to have an adverse health effect on the population under the condition reviewed." Radian also concluded that emissions of platinum from the additive had a margin of safety ranging from 2,000 to 2,000,000 times below workplace standards.

In 2002, the U.S. Mining Safety and Health Administration (MSHA) accepted the use of Platinum Plus FBC with particulate filters and also allowed its use in all fuel used in underground mining, even without filters.

In October 2003, the EPA verified the Platinum Plus FBC Purifier System, which is the first time the EPA has verified a metal catalyst additive-based system.

In January 2005 CDT announced it had initiated independent tests to address recent questions from the EPA on the use of its fuel borne catalyst as a result of growing commercial interest in its diesel emission control products. The results from testing of the Platinum Plus FBC over eight months at EPA approved laboratories confirmed that any potentially allergenic platinum emissions from the use of the Platinum Plus FBC were hundreds to thousands of times below the lowest published safe level and were consistent with reported platinum emissions from catalyzed control devices.

SOURCES OF SUPPLY

Platinum and cerium are the principal raw materials used in the production of the Platinum Plus fuel borne catalyst. These metals are generally available from multiple sources in the market place. CDT does not anticipate a shortage in the supply of the raw materials used in the production of the FBC in the foreseeable future. While CDT has outsourcing arrangements with two companies in the precious metal refining industry to procure this precious metal, there are no fixed commitments with these parties to provide supplies and CDT may make procurement arrangements with others to fulfill the raw materials requirements. In the past, CDT manufactured the product internally but now considers outsourcing of the manufacturing process to a precious metal refinery to be more cost effective.

RESEARCH AND DEVELOPMENT

During 2005, CDT employed several individuals in engineering and product development. During the years ended December 31, 2005, 2004, and 2003, the research and development expenses, exclusive of patent costs, totaled approximately $439,000, $506,000, $855,000 respectively. The 2005 decrease resulted from lower personnel allocation and consultant use, partially offset by higher EPA testing expense. In addition, 2004 expense was lower as a result of the completion of verification testing expense in 2003. CDT expenses all research and development costs as incurred.

PROTECTION OF PROPRIETARY INFORMATION

CDT holds the rights to a number of patents and patent applications pending. There can be no assurance that pending patent applications will be approved or that the issued patents or pending applications will not be challenged or circumvented by competitors. Certain critical technology incorporated in the products is protected by trademark and trade secret laws and confidentiality and licensing agreements. There can be no assurance that such protection will prove adequate or that CDT will have adequate remedies for disclosure of the trade secrets or violations of the intellectual property rights.

INSURANCE

CDT maintains coverage for the customary risks inherent in its operations. Although CDT believes the insurance policies to be adequate in the amount and coverage for the current operations, no assurance can be given that this coverage will, in fact, be or continue to be available in adequate amounts, or at a reasonable cost or that such insurance will be adequate to cover any future claims.

EMPLOYEES

CDT has 13 full-time employees. In addition, one executive officer of Fuel Tech provides management and legal services to CDT on an "as needed" basis pursuant to a Management and Services Agreement with Fuel Tech Inc. CDT also retains several outside technical consultants and marketing agents for specific projects related to platinum, engines and NOx reduction and fuel additive selling.

CDT enjoys good relations with its employees and is not a party to any labor management agreements.

RISK FACTORS OF THE BUSINESS

Investors in Clean Diesel Technologies should be mindful of the following risk factors relative to Clean Diesel Technologies' business:

CDT HAS INCURRED LOSSES IN THE PAST AND EXPECTS TO INCUR LOSSES IN THE FUTURE.

Prior to 2000, Clean Diesel Technologies was a development stage business and has incurred losses since inception totaling $34,841,000 (excluding the effect of non-cash preferred stock dividends). At the date of this report, Clean Diesel Technologies has cash resources estimated to be sufficient for its needs into the first quarter of 2007.

CDT has had minimal revenues through December 31, 2005 and expects to continue to incur operating losses at least through 2006. There can be no assurance that CDT will achieve or sustain significant revenues or profitability in the future. See the text below under the captions "Liquidity and Sources of Capital" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," elsewhere herein.

CDT FACES CONSTANT CHANGES IN GOVERNMENTAL STANDARDS BY WHICH ITS PRODUCTS ARE EVALUATED.

CDT believes that, due to the constant focus on the environment and clean air standards throughout the world, a requirement in the future to adhere to new and more stringent regulations both domestically and abroad is possible as governmental agencies seek to improve standards required for certification of products intended to promote clean air. In the event CDT's products fail to meet these ever-changing standards, some or all of the products may become obsolete.

FUTURE GROWTH OF CDT'S BUSINESS DEPENDS IN PART ON ENFORCEMENT OF EXISTING EMISSIONS-RELATED ENVIRONMENTAL REGULATIONS AND FURTHER TIGHTENING OF EMISSION STANDARDS WORLDWIDE.

CDT expects that the future business growth will be driven, in part, by the enforcement of existing emissions-related environmental regulations and tightening of emissions standards worldwide. If such standards do not continue to become stricter or are loosened or are not enforced by governmental authorities, it could have a material adverse effect on business, operating results, financial condition and long-term prospects.

THE POSSIBILITY OF NEW METAL STANDARDS, ,LOWER ENVIRONMENTAL LIMITS OR STRICTER REGULATION FOR HEALTH REASONS OF PLATINUM OR CERIUM EXISTS.

New standards or environmental limits on the use of platinum and / or cerium metal by a governmental agency could adversely affect the ability of CDT to use its Platinum Plus FBC in some applications. In addition CARB will require "multimedia" analysis of the FBC. The EPA could require a "Tier III" test of the Platinum Plus FBC at any time to determine additional health effects of platinum or cerium which tests would likely involve costs beyond the current resources of Clean Diesel.

CDT FACES COMPETITION AND TECHNOLOGICAL ADVANCES BY COMPETITORS.

There is significant competition among companies that provide solutions for pollutant emissions from diesel engines. Several companies market products that compete directly with CDT's products. Other companies offer products that potential customers may consider to be acceptable alternatives to CDT's products and services. CDT faces direct competition from companies with far greater financial, technological, manufacturing and personnel resources, including Engelhard, Donaldson, Fleetguard, Octel, Rhodia, Bosch and Johnson Matthey. Newly developed products could be more effective and cost efficient than CDT's current or future products. Many of the current and potential future competitors have substantially more engineering, sales and marketing capabilities and broader product lines than CDT does. CDT also faces indirect competition in the form of alternative fuel consumption vehicles such as those using methanol, hydrogen, ethanol and electricity.

CDT DEPENDS ON INTELLECTUAL PROPERTY AND THE FAILURE TO PROTECT THE INTELLECTUAL PROPERTY COULD ADVERSELY AFFECT FUTURE GROWTH AND SUCCESS.

CDT relies on patent, trademark and copyright law, trade secret protection, and confidentiality and other agreements with employees, customers, partners and others to protect its intellectual property. However, some of the intellectual property is not covered by any patent or patent application, and, despite precautions, it may be possible for third parties to obtain and use the intellectual property without authorization.

CDT does not know whether any patents will be issued from the pending or future patent applications or whether the scope of the issued patents is sufficiently broad to protect the technologies or processes. Moreover, patent applications and issued patents may be challenged or invalidated. CDT could incur substantial costs in prosecuting or defending patent infringement suits. Furthermore, the laws of some foreign countries may not protect intellectual property rights to the same extent as do the laws of the United States.

Some of the key patents, including the fundamental platinum additive patent, will expire during the period 2006-2008. However, CDT believes that other longer lived patents, including those for platinum additives in combination with after-treatment devices, will provide adequate protection of the proprietary technology, but there can be no assurances CDT will be successful in protecting the proprietary technology.

As part of the confidentiality procedures, CDT generally has entered into nondisclosure agreements with employees, consultants and corporate partners and has attempted to control access to and distribution of the technologies, documentation and other proprietary information. CDT plans to continue these procedures. Despite these procedures, third parties could copy or otherwise obtain and make unauthorized use of the technologies or independently develop similar technologies. The steps that have been taken and that may occur in the future might not prevent misappropriation of the solutions or technologies, particularly in foreign countries where laws or law enforcement practices may not protect the proprietary rights as fully as in the United States.

There can be no assurance that CDT will be successful in protecting its proprietary rights. Any infringement on any of the intellectual rights could have an adverse effect on the ability to develop and sell successfully commercially competitive systems and components.

IF THIRD PARTIES CLAIM THAT THE PRODUCTS INFRINGE UPON THEIR INTELLECTUAL PROPERTY RIGHTS, CDT MAY BE FORCED TO EXPEND SIGNIFICANT FINANCIAL RESOURCES AND MANAGEMENT TIME LITIGATING SUCH CLAIMS AND THE OPERATING RESULTS COULD SUFFER.

Third parties may claim that the products and systems infringe upon third-party patents and other intellectual property rights. Identifying third-party patent rights can be particularly difficult, especially since patent applications are not published until up to 18 months after their filing dates. In the event a competitor were to challenge the patents, or assert that the products or processes infringe its patent or other intellectual property rights, CDT could incur substantial litigation costs, be forced to make expensive product modifications, pay substantial damages, or even be forced to cease some operations. Third-party infringement claims, regardless of their outcome, would not only drain financial resources but also divert the time and effort of management and could result in customers or potential customers deferring or limiting their purchase or use of the affected products or services until resolution of the litigation.

AN EXTENDED INTERRUPTION OF THE SUPPLY OR A SUBSTANTIAL INCREASE IN THE PRICE OF PLATINUM COULD HAVE AN ADVERSE EFFECT ON BUSINESS.

The cost of platinum or the processing cost associated with converting the metal may have a direct impact on the future pricing and profitability of the Platinum Plus FBC. Although in the future, CDT intends to minimize this risk through various purchasing and hedging strategies, there can be no assurance that this will be successful. A shortage in the supply of platinum or a significant prolonged increase in the price of platinum, in each case, could have a material adverse effect on the business, operating results and financial condition.

FAILURE TO ATTRACT AND RETAIN KEY PERSONNEL COULD HAVE A MATERIAL ADVERSE EFFECT ON FUTURE SUCCESS.

CDT's success will depend, in large part, on the ability to retain current key personnel, attract and retain additional qualified management, scientific, and manufacturing personnel, and develop and maintain relationships with research institutions and other outside consultants. The loss of key personnel or the inability to hire or retain qualified personnel, or the failure to assimilate effectively such personnel could have a material adverse effect on the business, operating results and financial condition.

CDT'S RESULTS MAY FLUCTUATE DUE TO CERTAIN REGULATORY, MARKETING AND COMPETITIVE FACTORS FROM WHICH CDT HAS LITTLE OR NO CONTROL OVER.

The factors listed below, some of which CDT cannot control, may cause the revenues and results of operations to fluctuate significantly: - Actions taken by regulatory bodies relating to the verification or registration of the products.

- The extent to which the Platinum Plus FBC and ARIS 2000 NOx reduction products obtain market acceptance.

- The timing and size of customer purchases.

- Customer concerns about the stability of the business which could cause them to seek alternatives to CDT's product.

CDT IS CURRENTLY DEPENDENT ON A FEW MAJOR CUSTOMERS FOR A SIGNIFICANT PORTION OF REVENUES AND THE REVENUES COULD DECLINE IF CDT IS UNABLE TO MAINTAIN OR DEVELOP RELATIONSHIPS WITH CURRENT OR POTENTIAL CUSTOMERS.

A few customers currently account for a significant portion of revenues. For the three-year period ended December 31, 2005, three customers accounted for approximately 43% of revenues. The majority of the revenues received from these three customers consisted of license fees and ARIS hardware purchases. CDT intends to establish long-term relationships with existing customers and continue to expand its customer base. While CDT diligently seeks to become less dependent on any single customer, it is likely that certain contractual relationships may result in one or more customers contributing to a significant portion of the revenue in any given year for the foreseeable future. The loss of one or more of these significant customers may result in a material adverse effect on revenues, the ability to become profitable or the ability to continue the business operations.

CDT DEPENDS ON THE MARKETABILITY OF THREE PRIMARY PRODUCTS - PLATINUM PLUS FBC, ARIS SYSTEMS AND CATALYZED WIRE MESH FILTERS.

The Platinum Plus fuel borne catalyst, ARIS advanced reagent injection system for selective catalytic reduction and the catalyzed wire mesh filter are the three primary products of Clean Diesel. Failure of any of the products to achieve market acceptance may limit the company's growth potential. Clean Diesel may have to cease operations if all of the primary products fail to achieve market acceptance and/or fail to generate significant revenues. Additionally, the marketability of the products is dependent upon obtaining verifications from agencies such as the EPA, CARB, or similar European agencies as well as the effectiveness of the products in relation to various environmental regulations in the many jurisdictions in which Clean Diesel markets and sells its products.

CDT MAY NOT BE ABLE TO SUCCESSFULLY MARKET NEW PRODUCTS THAT ARE DEVELOPED AND OR OBTAIN DIRECT OR INDIRECT VERIFICATION OR APPROVALS OF THE NEW PRODUCTS.

CDT plans to market other emissions reduction devices used in combination with the Platinum Plus fuel borne catalyst and ARIS injector. There are numerous development and verification issues that may preclude the introduction of these products into commercial sale. If CDT is unable to demonstrate the feasibility of these products or obtain verification or approval for the products from agencies such as the EPA, CARB or similar European agencies, CDT may have to abandon the products or alter the business plan. Such modifications to the business plan will likely delay achievement of milestones related to revenue increases and achievement of profitability.

NO ASSURANCES OF ADDITIONAL FUNDING

Clean Diesel Technologies may seek additional funding in the form of a private or public offering of additional shares of equity securities. Any such funding will depend on prior stockholder approval of an amendment to the Clean Diesel certificate of incorporation authorizing additional equity. Any offering of such securities would result in dilution to the stockholders of Clean Diesel Technologies. The ability of CDT to consummate financing will depend on the status of CDT's marketing programs and commercialization progress, as well as conditions then prevailing in the relevant capital markets. There can be no assurance that such funding will be available if needed, or on acceptable terms. In the event that CDT needs additional funds and is unable to raise such funds, CDT may be required to delay, scale back, or severely curtail its operations or otherwise impede its ongoing commercialization, which could have a material adverse effect on the business, operating results, financial condition and long-term prospects. See the text below under the captions "Liquidity and Sources of Capital" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," elsewhere herein.

CURRENCY FLUCTUATIONS COULD IMPACT FINANCIAL PERFORMANCE.

The majority of recent activities have been in the U.S. However, CDT has increased its activities in Europe and Asia, and thus potential for currency exposure exists. CDT intends to manage the risk to such exposure, if any, by entering into foreign currency futures and options contracts. There can be no assurance that currency fluctuation will not have a significant effect on the operations in the future.

CDT HAS NOT AND DOES NOT INTEND TO PAY DIVIDENDS ON THE COMMON STOCK SHARES.

CDT has not paid dividends on its common stock since inception, and does not intend to pay any dividends to the holders of common stock in the foreseeable future. CDT intends to reinvest earnings, if any, in the development and expansion of the business.

THE PRICE OF THE COMMON STOCK SHARES MAY BE ADVERSELY AFFECTED BY THE SALE OF A SIGNIFICANT NUMBER OF NEW SHARES.

The sale, or availability for sale, of substantial amounts of common stock, including shares issued upon exercise of outstanding options and warrants, or in the event that CDT elects to sell shares of common stock in the future to fund continuing operations, in the public market or a private placement, or the perception by the market that these sales could occur, could adversely affect the market price of the common stock and could impair the ability to raise additional capital through the sale of equity securities or debt financing. The perceived risk of dilution may cause the existing stockholders and other holders to sell their shares of stock, which would contribute to a decrease in the stock price. In that regard, significant downward pressure on the trading price of CDT's common stock may also cause investors to engage in short sales, which would further contribute to significant downward pressure on the trading price of the stock.

CDT'S COMMON STOCK IS CURRENTLY TRADED ON THE OVER-THE COUNTER MARKET, THE ALTERNATIVE INVESTMENT MARKET OF THE LONDON EXCHANGE AND THE FRANKFURT STOCK EXCHANGE AND AN INVESTOR'S ABILITY TO TRADE THE STOCK MAY BE LIMITED BY TRADING VOLUME AND PRICE VOLATILITY.

The trading volume in CDT's common stock has been relatively limited. A consistently active trading market for its common stock may not continue on the OTC market or on the Alternative Investment Market of the London Stock Exchange. The average daily trading volume in the common stock on the OTC market for the month ended January, 2006 was approximately 4,140 shares. The average daily trading volume in the common stock on Alternative Investment Market of the London Stock Exchange for the month ended January, 2006 was approximately 494 shares. In February 2006, clean Diesel began trading on the Frankfurt stock exchange in Germany.

There has been significant volatility in the market prices of publicly traded shares of emerging growth technology companies, including CDT. Factors such as announcements of technical developments, verifications, establishment of distribution agreements, significant sales orders, changes in governmental regulation and developments in patent or proprietary rights may have a significant effect on the market price of CDT's common stock. In addition, there has been a low average daily trading volume of the common stock. To the extent this trading pattern continues, the price of the common stock may fluctuate significantly as a result of relatively minor changes in demand for such shares and sales of stock by holders.