CLEAN DIESEL TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

4567 Telephone Road, Suite 100

                      Ventura, CA  93003                       

(Address of principal executive offices) (Zip Code)

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

Securities registered pursuant to Section 12(b):

Securities registered pursuant to Section 12(g): None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in rule 405 of the Securities Act. Yes        No  X   

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes        No  X   

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  X   No  __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  X     No  __

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated filer ___            Accelerated filer ___               Non-accelerated filer ___               Smaller reporting company  X   

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes        No  X    

The aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the closing price as of the last business day of the registrant’s most recently completed second fiscal quarter, June 30, 2013, was $8,285,600. This calculation does not reflect a determination that persons are affiliates for any other purposes. The registrant does not have non-voting common stock outstanding.

As of March 25, 2014, the outstanding number of shares of the registrant’s common stock, par value $0.01 per share, was 10,150,575.

Documents incorporated by reference:

The registrant has incorporated by reference in Part III of this report on Form 10-K portions of its definitive Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (“SEC”)  within 120 days after the end of the registrant’s fiscal year.

Table of Contents   

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS  

        This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, adopted pursuant to the Private Securities Litigation Reform Act of 1995.  Forward-looking statements involve risks and uncertainties, as well as assumptions that could cause our results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements generally are identified by the words “may,” “will,” “project,” “might,” “expects,” “anticipates,” “believes,” “intends,” “estimates,” “should,” “could,” “would,” “strategy,” “plan,” “continue,” “pursue,” or the negative of these words or other words or expressions of similar meaning. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements. These forward-looking statements are based on information available to us, are current only as of the date on which the statements are made, and are subject to numerous risks and uncertainties that could cause our actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, the forward-looking statements. For a discussion of such risks and uncertainties, please see the discussion under the caption “Risk Factors” contained in this Annual Report on Form 10-K and in other information contained in this annual report and our publicly available filings with the SEC. You should not place undue reliance on any forward-looking statements. Except as otherwise required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or any other reason.

EXPLANATORY NOTE

        The terms “CDTi” or the “Company” or “we,” “our” and “us” means Clean Diesel Technologies, Inc. and its consolidated subsidiaries as of the date of this Annual Report on Form 10-K.   

TRADEMARKS

        The Clean Diesel Technologies name with logo, CDT logo, CDTi name with logo, CSI ^® , CATALYTIC SOLUTIONS ^® , CSI logo, ARIS ^® , BARETRAP ^® , CATTRAP ^® , COMBICLEAN ^® , COMBIFILTER ^® , MPC ^® , PATFLUID ^® , PLATINUM PLUS ^® , PURIFIER and design, PURIFILTER ^® , PURIMUFFLER ^® , TERMINOX ^® and UNIKAT ^® , among others, are registered or unregistered trademarks of Clean Diesel (including its subsidiaries).

Market Overview

        Regulatory standards have been adopted worldwide to control the exhaust emissions from on- and off-road engines. These emissions typically include nitrogen oxides, hydrocarbons, particulate matter, carbon monoxide and more recently greenhouse gases such as carbon dioxide. Emission regulations for mobile sources have tightened and expanded over the years due to an increased understanding of the impacts of these emissions on human health and the environment. Because standards put in place by the EPA, CARB, the European Union and other international regulators continue to become more restrictive, we view the markets for our products as continually expanding. Although control measures have reduced pollutant emissions per vehicle over the past 40 years, the number of cars and trucks on the road and the miles they are driven have increased significantly in the United States. According to the EPA, the total vehicle miles people travel in the United States increased 178% between 1970 and 2005 and continues to increase. In the United States, there are more than 210 million cars and light duty trucks on the road. According to a March 2014 EPA report, over 149 million Americans today still experience unhealthy levels of air pollution which are linked to adverse health impacts such as hospital admissions, emergency room visits and premature mortality. Motor vehicles remain a particularly important source of air pollution, especially in urban areas.   

Our light duty vehicle catalyst products and heavy duty diesel emission control systems are designed specifically to deal with emissions from gasoline, diesel and a variety of alternative fuel powered engines.

Light duty vehicle regulations.   In 1970, the United States Congress passed the Clean Air Act, which required a 90% reduction in emissions from new automobiles by 1975, and resulted in the introduction of the first generation two-way catalytic converter to remove carbon monoxide and hydrocarbon emissions. In 1977, Congress amended the Clean Air Act in order to further reduce the limits for nitrogen oxide emissions which resulted in the introduction of the three-way catalytic converter in 1981. These early emissions standards for automobiles yielded the first improvement in air quality in over 100 years.

In 1990, amendments were made to the Clean Air Act to further reduce nitrogen oxide emission limits by another 40% beginning in 1994. These “Tier 1” standards also resulted in standards for certain trucks. In 1998, the Clinton Administration, auto industry and Northeast States came to a voluntary agreement to implement the National Low Emissions Vehicles, or NLEV, which was fully implemented across the United States by 2001. This program set the stage for formal “Tier 2” standards to be set in 1999, which took effect in 2004.

CARB has typically enacted even more stringent emission standards than the EPA to address its significant air quality challenges. In late 1998, to address light duty vehicle emissions, CARB adopted the Low Emission Vehicle II, or LEV II, program which was a predecessor to the EPA’s NLEV and Tier 2 program. Europe implemented similar regulations under Euro III (effective 2000), Euro IV (effective 2005), and Euro V (effective 2009).

In response to a 2010 Presidential memorandum, the EPA announced in March 2014 their finalized “Tier 3” light duty vehicle emission standards which are to be phased in between 2017 and 2025. The Tier 3 emission standards further reduce emissions from light duty vehicles by approximately 70% to 80% and some heavy duty vehicles by approximately 60%. The EPA Tier 3 standards are closely coordinated with the CARB LEV III standards as well as with the EPA and CARB programs for reducing greenhouse gas emissions from light duty vehicles. The EPA and CARB are setting these new standards to further address air quality and public health issues that exist currently and are projected to continue in the future. Of particular note, they further tighten particulate matter standards to ensure that new advanced combustion strategies such as gasoline direct injection and diesel fueled vehicles do not pose additional new sources of particulate matter.

We currently supply our catalyst products featuring our proprietary MPC ^® technology to OEMs such as Honda, whose 2014 Plug-in Hybrid Accord was approved by CARB as the first gasoline-powered car to meet what is known as the SULEV20 standard, the most stringent standard in the nation.

Diesel engine regulations. In 1985, the EPA mandated stringent emission standards for diesel-fueled trucks and busses. In 1991, 1994, 1998, and 2004, emissions standards were largely met with advanced engine technologies. In approximately 375 engine certifications between 1994 and 2006, diesel oxidation catalysts were also used to help engines comply with particulate matter standards.

In 2007, EPA and CARB standards further reduced particulate matter emissions limits for heavy duty engines by an additional 90% which led to the introduction of catalyzed diesel particulate filters. In 2010, nitrogen oxide emissions were reduced by an additional 83% which led to the introduction of selective catalytic reduction catalysts.

Off-road compression ignition emissions standards (non-road Tier 1) were first set in 1996 and consistently phased in and further tightened by off-road Tier 2 and Tier 3 emissions limits. Tier IV emissions limits which have been phased in between 2011 and 2014 saw the first introduction of various exhaust emissions controls including diesel oxidation catalysts, diesel particulate filters and selective catalytic reduction catalysts. Given the global nature of the off-road diesel powered equipment market, common EPA and European Union standards have typically been enacted at comparable times.

Health impact/cost backdrop - According to a 2011 report prepared by the American Lung Association in California, over 90% of California residents live in areas with serious air quality problems, largely caused by the transportation sector. That analysis showed that vehicles not meeting current tailpipe standards would cause $14.5 billion in public health and societal costs annually. In Europe, according to their website, the World Health Organization estimated that particulate matter claims an average of 8.6 months from the life of each person and that €58-161 billion could be saved if deaths from particulate matter pollution were reduced, noting that diesel combustion contributes 1/3 of total emissions of particulate matter less than 2.5 micrometers in diameter (PM _2.5 ).

Regulatory response and drivers - Governments continue to issue increasingly stringent diesel emission control regulations and mandates. Funding mechanisms are evolving which involve government and private sector funding of emission control projects. Increased compliance with these regulatory initiatives drives demand for our products and the timing of implementation for emission reduction projects.

In the United States, the EPA has established the National Clean Diesel Campaign in order to promote diesel emission reduction strategies and oversee regulatory programs that address new diesel engines as well as other innovative programs to address the millions of diesel engines already in use.  Retrofitting of this fleet was estimated by the EPA to cost approximately $7 billion, according to a 2005 National Clean Diesel Campaign fact sheet.  In the United States, heavy duty diesel retrofits have been driven primarily by subsidy programs supported under the Diesel Emissions Reduction Act, or DERA, the American Recovery and Reconstruction Act, or ARRA, Proposition 1B in California, the U.S. Department of Transportation’s Congestion Mitigation and Air Quality Improvement program, or CMAQ, as well as various other state and local programs. 

The CMAQ program provides a flexible funding source to State and local governments for transportation projects and programs to help meet the requirements of the Clean Air Act. Over $2.2 billion in funding was authorized  for 2013 and 2014 to reduce congestion and improve air quality for areas that do not meet the National Ambient Air Quality Standards (NAAQS) for ozone, carbon monoxide or particulate matter (nonattainment areas) and for former nonattainment areas that are now in compliance (maintenance areas). According to a 2012 EPA study, approximately 142 million people live in counties that do not meet the EPA’s NAAQS standards and thus are exposed to substantial penalties for non-compliance (fines/loss of federal highway funds). As a result, states have major incentive to focus on emission reduction, specifically with heavy duty diesel engines as they are the largest contributor of toxic emissions. CMAQ in MAP-21 calls for a State with PM _2.5 nonattainment or maintenance areas to give priority to using funds for projects proven to reduce emissions in such areas—eligible projects to mitigate PM _2.5 include diesel retrofits. It also establishes a set-aside specifically to support this priority. More than $325 million was set-aside in 2013 for PM _2.5 reduction projects.

Several U.S. state, county and city governments have ongoing retrofit programs for on- and off-road diesel engines. California has been a leader in driving increasingly tough emissions standards for heavy duty diesel vehicles. Implementation continues surrounding the 2010 California Truck and Bus Regulation, which mandates that all 1996 through 2006 diesel trucks in Class 7 (gross vehicle weight of 26,001-33,000 pounds) and Class 8 (gross vehicle weight greater than 33,000 pounds) be retrofitted with diesel particulate filters.  Based on figures available from CARB and the Manufacturers of Emission Controls Associations, or MECA, we estimate that during 2014 to 2016, potentially 28,000 heavy duty diesel trucks have yet to be replaced or retrofitted .  Beyond California, we see increased funding and continued retrofit potential in other states including New Jersey, New York, Massachusetts, Illinois and Texas. 

Meanwhile, we believe that major South American countries and municipal areas will likely follow Europe and the United States in passing more stringent regulations, funding retrofit programs, and establishing low emission zones, or LEZs.  Stricter London LEZ regulations, which went into effect in early 2012, resulted in the successful retrofit of an estimated 17,000 heavy duty diesel vehicles during 2011 and early 2012. We believe our emission reduction systems were used to retrofit approximately 20% of those vehicles.  Now, cities such as Santiago de Chile and Bogota are leading the way with urban bus retrofit programs. We estimate over 50,000 urban buses could be retrofitted by 2016 in major metropolitan areas in Chile, Colombia and Brazil with the potential for major follow-on LEZ programs and on-road mandates. 

Global PGM Supply and Demand. Expensive PGM metals, which include palladium, platinum and rhodium, are used in the manufacture of emission control catalysts, with palladium being the primary component used in catalysts serving the global light duty vehicle market. According to Johnson Matthey PLC’s “Platinum 2013 Interim Review,” in 2013, over 70% of all primary platinum produced originated in Southern Africa and 80% of all primary rhodium. Russia and Southern Africa combined supplied over 75% of palladium. We believe that the continued growth of these metals from the mines in Southern Africa and Russia will be critical in order to meet the increasingly stringent global emission control standards. According to the same report, an estimated $7 billion is spent annually by OEMs on PGM purchases for catalysts. The global auto industry is expected to produce 85 million vehicles in 2014 and over 100 million by 2018, according to IHS Automotive. These production levels are expected to result in a continued increase in PGM demand for the foreseeable future. In addition, continued tightening of emission standards by regulators globally will require increased loading of PGM in emission catalysts. For example, the landmark Tier 3 emission standards recently announced by the EPA are expected to increase per-vehicle PGM requirements and volumes, which will contribute to higher demand for North America. The United States EPA expects the new standards will increase PGM loadings by 50% for palladium and 20% for rhodium. The need to reduce the dependence of the use of PGMs in vehicle emission control systems is one of our primary drivers for developing catalysts that use much less or zero PGM to achieve air quality standards

Strategy

Our strategy is to pursue aggressive development of our unique materials science platform, which we view as the most likely path to enhance growth and improve shareholder value over the long-term. This strategy is intended to build on recent initiatives and announcements, including an increased focus on developing and patenting our proprietary advanced low- and zero-PGM, or ZPGM, catalysts. We believe our disruptive technology provides a solution to OEMs that contrasts current solutions; one that reduces the dependence upon increasingly costly and scarce PGMs to meet stringent emission standards, such as Tier 3. Our strategy includes combining our manufacturing expertise with advanced low-PGM and ZPGM materials to develop advanced catalysts in powder form to allow for potentially broader distribution and delivery options resulting in new commercial opportunities. We intend to pursue licensing and partnership arrangements to accelerate the commercialization of our patented and proprietary materials technology. Our strategic priorities include:

·         Explore strategic options to maximize the value of our manufacturing assets and business;

·         Focus our research and development efforts on new technology development, patent protection and commercialization of new advanced low-PGM and ZPGM materials and robust manufacturing process technology;

·         Aggressively build our patent portfolio to maintain and protect our technology leadership position;

·         Develop and qualify emission catalysts for a variety of applications in multiple segments of the emissions control market;

·         Seek customers or partners for core emission control technologies via development partnerships, licensing, joint venture or manufacturing agreements and pursue short-term catalyst sales opportunities;  and

·         Pursue new end markets, including fuel cells, petro-chemicals and thermo-electrics.

Since 2013, we have filed 40 patents pertaining to our unique ZPGM catalyst technology and 6 patents pertaining to our advanced low-PGM catalyst technology. While we have not developed any licensing arrangements or new OEM customers, the development of our advanced low-PGM and ZPGM technology and its commercialization is a strategic priority and will require investment in research, development, marketing and sales.

Our strategy also includes a continued focus on growth opportunities in certain segments of the heavy duty diesel systems market that will benefit most from our catalyst technology and strengths in that space. We expect to continue to leverage our vertical integration and capitalize on the growing market for heavy duty diesel systems, including near-term retrofit opportunities in North America, particularly in California, and anticipated opportunities in South America as well as in the emerging aftermarket for emission control systems. Our Heavy Duty Diesel Systems division affords us opportunities to field test and commercialize new proprietary catalyst technologies. We continue to seek opportunities to grow our OEM customer base and expand our presence in the heavy duty diesel markets. We continue to evaluate and refine our strategic plan.

Table of Contents

Competitive Advantages

Through persistent technology development, we maintain a broad portfolio of emission control products ranging from catalysts to complete retrofit or OEM systems. We believe that our technologies and products represent a fundamentally different solution, and the following competitive strengths position us as a leading global provider of emission control products and systems.

Superior Catalyst Performance. Our proprietary MPC ^® technology enables us to produce catalytic coatings capable of significantly better catalytic performance than previously available. We have achieved this demonstrated performance advantage by creating a catalyst using unique nanostructures with superior stability under prolonged exposure to high temperatures. This nanostructure technology enables the oxide catalysts in its compounds to resist sintering, or fusing, thereby maintaining a high catalytic surface area. As a result, in heavy duty diesel and automotive applications, our catalyst formulations are able to maintain high levels of performance over time using substantially lower – or zero –PGMs than products previously available. With new developments underway, we are making significant progress towards new ZPGM oxide materials to enable PGM-free three-way catalysts and diesel oxidation catalysts as well as low-PGM products with performance synergies.

Catalyst Cost Advantage.   Globally, the emission control catalyst market is estimated to reach $7.7 billion by 2017 from approximately $6 billion today, according to a report issued by Global Industry Analysts, Inc. in 2012. According to Johnson Matthey PLC’s “Platinum 2013 Interim Review,” it is estimated that an additional $7 billion will be spent annually by OEMs on PGM purchases for catalysts. In the automotive market in particular, where PGM costs represent a large portion of manufacturers’ costs, a significant benefit of our catalyst technology is that it offers performance equal to or exceeding that of other catalyst technologies with up to a 50% reduction in PGM loadings — platinum, palladium and rhodium. The cost of PGMs has trended up over the past 15 years due to growing demand and limited supply. In 2013, the average troy ounce costs of PGMs were $725 for palladium, $1,487 for platinum and $1,075 for rhodium compared to the base metals used in certain of our catalysts that cost less than $1 per troy ounce.  

Highly Customizable Catalyst Formulations. Our proprietary MPC ^® technology is a design approach, as opposed to a single chemical formulation. We have developed this technology since inception as a platform that can be tailored for a range of different industrial catalyst applications. Specifically, our formulations can be tailored in two distinct ways. First, the oxide compounds used in our formulations can be adapted for specific applications by adding to them, or doping them with, a wide range of chemical elements, a process known as tuning. This technical approach is accelerating with major new resource investments to establish a new family of ZPGM oxide compounds. By contrast, the catalyst offerings of our competitors can be tuned only by adjusting the PGM content. Second, we are able to vary the mixtures of our compounds to create customized solutions for specific applications. In the emissions control market, these two independent design mechanisms allow for customization and optimization for different vehicle platforms within the auto industry, complex heavy duty diesel equipment for OEMs, aftermarket and retrofit markets, and for different applications in the energy sector, such as selective catalytic reduction nitrogen oxide control for industrial and utility boilers, process heaters, gas turbines and generator sets. In addition, the material science underlying our MPC ^® technology could have applications where reduction in PGMs would provide cost advantages. These could include applications in the fuel cell, petrochemical and refinery, and thermoelectric industries.

Proven Durability.  Our products and systems have undergone substantial laboratory and field testing by our existing and prospective customers and have demonstrated their durability and reliability in a wide range of applications in actual use for many years. In addition, our products and systems have achieved numerous certifications and meet or exceed industry standards. Of particular note, our Catalyst division has supplied  over eleven  million catalyst parts to light duty vehicle customers since 2001.

Broad Portfolio of Verified Heavy Duty Diesel Systems.   We believe we offer one of the industry’s most comprehensive portfolios of system products that have been evaluated and verified (approved) by the EPA and CARB, as well as regulators in several European countries, for use in engine retrofit programs. Additionally, we have a thorough understanding of the verification process and the demonstrated ability to obtain broad verifications of products for use in the retrofit market.

Compatibility with Existing Manufacturing Infrastructure and Operating Specifications. Catalytic converters using our catalyst products are compatible with existing automotive manufacturing processes as well as specific vehicle operating specifications. There is no need for our customers to change their manufacturing operations, processes, or how their products operate in order to utilize our proprietary technology. Our heavy duty diesel emission control products and solutions are engineered to each customer’s specific application and designed to deliver custom and industry-leading solutions that meet or exceed environmental mandates.

         Technology 

        We have succeeded in developing a world-class technology portfolio to meet and exceed regulatory emission standards around the globe. In particular, our MPC ^® and Platinum Plus ^® fuel-borne catalyst technologies, as well as our diesel particulate filter and selective catalytic reduction system design and packaging know-how, ar e at the core of our business.

        ZPGM materials. Our new technology pathway now gathering momentum is based on two major themes. One is the discovery and development of a powder process route to making new nano-scale powder materials that can be readily coated and formed into catalyst products. These materials synthesized by scalable, industry standard processes are driving new levels of performance in ZPGM and low-PGM diesel oxidation catalysts and three-way catalysts, both of which are currently the main users of PGM worldwide. The second and related theme is the specific discoveries in the structure and composition of new families of base-metal oxide materials, or ZPGM materials that can be synthesized as powders. The parallel discovery of advanced ZPGM compositions and low-cost and efficient powder synthesis techniques opens the path for a new generation of products and new business models for stronger commercialization.

        Our current Catalyst technologies include:

        MPC ^® .   We have developed and patented intellectual property rights to a novel technology for creating and manufacturing catalysts known as mi xed phase catalyst (MPC ^® ). This technolo gy involves the self-assembly of a ceramic oxide matrix with catalytic metals precisely positioned within three-dimensional structures. The MPC ^® design gives our catalyst products two critical attributes that differentiate them from competing offerings: superior stability that allows heat, resistance and high performance with very low levels of precious metals; and base metal activation that allows base metals to be used instead of costly PGMs without compromising catalytic performance. The stability platform will continue to be important in the context of the new ZPGM materials. The design methodology of sintering resistance will continue to be a key focus as we integrate the new materials with full catalyst design strategies.

        Platinum Plus ^® .  We have developed and patented our Platinum Plus ^® fuel-borne catalyst as a diesel fuel soluble additive, which contains minute amounts of organo-metallic platinum and cerium catalysts. Platinum Plus ^® enables rapid conversion of particulate matter from diesel engines when coupled with a diesel particulate filter. It also improves combustion, which acts to reduce engine-out emissions. Platinum Plus ^® fuel-borne catalyst lends itself to a wide range of enabling solutions including diesel particulate filtration, low emission biodiesel, carbon reduction and exhaust emission reduction. Environmentally conscious corporations and fleets can utilize this solution to voluntarily reduce emissions.

        Our selective catalytic reduction systems design and packaging know-how includes:

        ARIS ^® . We have developed technology for selective catalytic reduction using urea, which is a highly effective method of reducing oxides of nitrogen. ARIS ^® technology forms a key part of the selective catalytic reduction system and is an advanced, computer-controlled, reagent injection system. Our ARIS ^® technology applies to single-fluid systems, methods of control and the combination of selective catalytic reduction with exhaust gas recirculation technology. It covers a concept for injecting urea into the engine exhaust where it reacts across a catalyst to reduce oxides of nitrogen and water vapor. ARIS ^® technology also provides reliable hydrocarbon (HC) injection into the exhaust stream for applications including lean NOx traps, reformer systems and diesel particulate filter active regeneration. Effective heat removal and reliable, trouble-free fuel injection for durable exhaust emissions systems performance is a paramount consideration for designing OEM and retrofit solutions. Our patented ARIS ^® for selective catalytic reduction reduces nitrogen oxide by up to 90%. We have numerous U.S. and corresponding international patents on the use of ARIS ^® technology.

        Exhaust Gas Recirculation and Selective Catalytic Reduction. Exhaust Gas Recirculation, or EGR, and Selective Catalytic Reduction, or SCR, are technologies developed in the global transportation industry by manufacturers of diesel  powered equipment. In order to meet the standards of oxides of nitrogen emissions defined by the EPA and other global environmental regulation agencies. In 1997, we developed and patented the concept of combined use of EGR and SCR to minimize emissions and take advantage of the benefits each can bring in terms of oxides of nitrogen reduction. As legislation tightens across the globe, we believe EGR in combination with SCR is a key solution to meet strict oxides of nitrogen solutions. Previously seen as competing approaches, combined EGR/SCR allows users to meet strict oxides of nitrogen levels outlined by the U.S. 2010 and Euro 6/VI emission standards. The EGR system can be activated to reduce oxides of nitrogen when starting a cold engine. The SCR operates at a higher temperature when the catalyst is fully active and at low EGR rates. With both EGR and SCR in place, engines can be fine-tuned to optimize fuel efficiency and deliver greater emissions reduction. We have intellectual property holdings for the design and implementation of these combination systems and have licensed these patents to several industry providers.

        We protect our proprietary technologies, along with our other intellectual property, through the use of patents, trade secrets and registered and common law trademarks. See “— Intellectual Property” below.

Products

        Catalyst Division

        Our Catalyst division currently produces catalyst formulations for gasoline, diesel and natural gas induced emissions that offer superior performance, proven durability and cost effectiveness for multiple markets and a wide range of applications. The Catalyst division products include catalysts for gasoline (light duty vehicle) engines, diesel engines and for energy applications.

        Catalysts for Gasoline Engines.  Three-way catalytic converters have been the primary emission control technology on light-duty gasoline vehicles since the early 1980’s. Our technology for light duty vehicles significantly improves catalytic performance, is highly durable and cost-effective. We have developed unique nanostructures that are extremely thermally stable and resistant to sintering. Catalytic converters using our technology have superior catalytic performance, can cost substantially less as a result of significantly reduced PGM or zero-PGM loadings, have comparable or better durability and are physically and operationally compatible with all existing manufacturing processes and operating requirements. Our solution is based on industry-leading, patent-protected technology and a scalable manufacturing business model.

        Catalysts for Diesel Engines.   Diesel engines are more durable and are more fuel efficient than gasoline engines, but can pollute significantly more. Current techniques for diesel engines to meet emissions standards require the use of several methods, including diesel oxidation catalysts, catalyzed diesel particulate filters and selective catalytic reduction systems. We have been producing diesel oxidation catalysts since 2000. We offer a full range of catalyst products for the control of carbon monoxide, hydrocarbons, particulate matter and nitrogen oxide in light and heavy duty applications.

        Catalysts for Energy Applications. We have developed and can manufacture catalysts for use in selective catalytic reduction and carbon monoxide reduction systems, which are used to reduce nitrogen oxide and carbon monoxide emissions from natural gas and petroleum gas burning utility plants, industrial process plants, OEMs, refineries, food processors, product manufacturers and universities. Our customized catalysts provide design flexibility and our proprietary MPC ^® coating technology allows for optimal temperature operation of the plant and an overall superior system design when compared to existing technologies. We have achieved this demonstrated performance advantage by creating a catalyst using unique nanostructures with superior stability under prolonged exposure to high temperatures.

        In addition to the portfolio of products already developed from our proprietary MPC ^® technology platform, we have a pipeline of new products under development. We are working on the next generation of our current product offerings and in growing the portfolio of ZPGM products and verified technologies.      

        Other potential applications.   Our disruptive and unique materials science technology provides a number of potential vertical market opportunities for us that we are focused on pursuing. These opportunities arise from our ability to reduce the use of PGMs and even eliminate the PGM content. Other than the emission reduction market, we believe that the fuel cells market, petrochemicals catalyst market and the thermoelectric market may provide us the opportunity to use our materials science technology to develop and sell or license products.

Heavy Duty Diesel Systems Division

        Our Heavy Duty Diesel Systems division offers a full range of products globally for OEM and verified retrofit markets for the reduction of exhaust emissions of on-road, off-road and stationary diesel and alternative fuel engines including propane and natural gas. These division products include:

        Diesel Oxidation Catalysts .  A diesel oxidation catalyst is a device that utilizes a chemical process in order to break down pollutants from diesel engines in the exhaust stream, turning them into less harmful components. When combined with our closed crankcase ventilation system, our AZ Purifier™ and AZ Purimuffler ^® DOCs can reduce particulate matter by up to 40%. Our line of DOC products also includes DZ and EZ Purifier™.

Table of Contents

        Diesel Particulate Filters.   A diesel particulate filter is a device designed to remove diesel particulate matter, or soot, from the exhaust of diesel engines. Diesel particulate filters typically remove more than 85% to 90% of the soot found in diesel emissions.  Diesel particulate filter systems utilize two methodologies to regenerate the filter: (1) passive filter regeneration, which uses heat generated by the exhaust to oxidize soot; or (2) active filter regeneration, where external energy sources are employed to initiate filter regeneration. Our systems can reduce particulate matter by up to 90% or more. We market both passively and actively regenerating diesel particulate filters under the Purifilter ^® , Combifilter ^® , Purifier ^™ , Actifilter™  and Cattrap ^®    brand names.

         Closed Crankcase Ventilation Systems.  Closed crankcase ventilation systems assist in elevating the level of exhaust emission reduction by eliminating crankcase emissions. Our closed crankcase ventilation system is a truly closed crankcase ventilation system that effectively eliminates 100% of crankcase emissions at all times. Our line of closed crankcase ventilation systems are EPA verified in connection with our AZ Purifier ^™ and AZ Purimuffler ^® diesel oxidation catalyst products, helping customers not only lower emissions, but lower operating costs as well.

        Alternative Fuel Products.   We design and supply verified products to address the emissions issues of liquefied petroleum gas and compressed natural gas fueled engines used in industrial applications such as forklifts, aerial platforms, etc. We have been providing three-way catalyst technology in both integrated muffler form and catalytic converter style to OEMs and manufacturers of record since the inception of the Large Spark Ignited Regulation by the EPA and CARB. We also offer a two-Way Purimuffler ^® product for liquefied petroleum gas, and gasoline industrial engines.

        Exhaust Accessories and Specialty Parts.   We manufacture a wide array of exhaust accessories including connectors, elbows, mounting brackets, clamps, exhaust stacks and guards, and intake air components. These exhaust accessories are used as aftermarket replacement components or in the installation of OEM and verified retrofit products. Our CombiClean ^® systems utilize economical, safe and environmentally friendly technology developed to clean diesel filters, whether it is a passive filter, or active, cordierite or silicon carbide filter. Our Back Pressure Monitor and Logger provides onboard monitoring of retrofitted emissions control systems, providing the operator notification of required maintenance.

        We also manufacture and distribute large diesel and natural gas exhaust and intake parts as well as fenders, catalytic converter components, numerous brackets, guards and clamps for mounting and sealing components. We also produce exhaust and intake components for racing enthusiasts and manufacture intake and exhaust components for off-road and mining equipment as well as diesel and natural gas generators. We have the ability to react quickly to requests for quotes and the manufacture of specialty items. We manufacture components in carbon, aluminized and stainless steel.

Sales and Marketing

        The catalyst industry is mainly comprised of a few suppliers serving large, sophisticated customers such as automobile manufacturers. Purchase cycles for catalysts tend to be long, resulting in generally predictable and stable revenue streams. Catalysts are technology intensive products that have a profound effect on the performance of the large, expensive systems in which they are embedded. Extensive interaction is required between catalyst manufacturers and their customers in the course of developing an effective, reliable catalyst for a particular application. For this reason it would appear that even the largest customers prefer to work with only two or three preferred catalyst suppliers on a specific application. The collaboration required for catalyst development and the technical hurdles involved in making effective and reliable catalysts create barriers to entry and provide an opportunity for catalyst manufacturers to earn attractive margins. We are an approved supplier of catalysts for major automotive manufacturers, such as Honda. In addition, the Catalyst division targets large heavy duty diesel engine manufacturers as potential buyers of our catalyst products and explores potential vertical markets for utilization of our technologies. Our Heavy Duty Diesel Systems division is also a customer of our catalyst products.

        A significant portion of Catalyst division sales to external customers in 2013 and 2012 were made to Honda. Sales to Honda represented 83% and 75% of Catalyst division revenues and 39% and 30% of consolidated revenues for the years ended December 31, 2013 and 2012, respectively. A significant loss in sales to Honda could have a material adverse effect on our business.

Competition

        Our company operates in two market segments, with two different competitive landscapes.       

        Heavy Duty Diesel Systems . Our Heavy Duty Diesel Systems division competes directly against other companies that market verified products. In North America, our key competitors with verified products include: Donaldson Company, Inc., ESW, Inc., Hug Filtersystems and Johnson Matthey plc. In Europe, we compete with a number of companies, including Dinex Exhausts Ltd, Eminox Ltd, Huss Group and HJS Emission Technology. Key competitive factors are:

Manufacturing Operations

        Our Catalyst division developed an innovative and sophisticated manufacturing process for coating substrates using our MPC ^® catalytic coatings. The manufacturing process consists of mixing specially formulated catalytic coatings, applying the coatings to ceramic substrates, then firing the coated substrates in a furnace. The process of mixing and applying the various types of coatings onto high cell density substrates is complex and requires sophisticated manufacturing technology. We have been manufacturing automotive catalysts since 1999. Our manufacturing lines are designed to provide a high level of quality control at every step of the unique manufacturing process. We manufacture our proprietary catalyst products in our manufacturing facility in Oxnard, California.

        Our Heavy Duty Diesel Systems division engineers our emissions control products to customer-specific applications. We believe that this approach reduces installation or assembly time and optimizes operating uptime. Our Heavy Duty Diesel Systems division works as the customer’s partner to deliver custom, industry-leading solutions that address each customer’s particular environmental mandates. Our heavy duty diesel systems are designed and manufactured in facilities located in Reno, Nevada; Thornhill, Ontario; and Malmö, Sweden.

        We maintain ISO 9001:2008, ISO/TS 16949:2009 and ISO 14001:2004 certifications.

        Our raw material requirements vary by division. Our Catalyst division purchases ceramic substrates that we coat with specialty formulated catalysts comprised of PGMs and various chemicals. PGMs are either provided on a consignment basis by the customers of the division or are purchased by us on behalf of the customer. Our Heavy Duty Diesel Systems division purchases filters, filters coated with catalysts and other materials to manufacture our emission systems, which are purchased from third party suppliers as well as internally from our Catalyst division. For the Catalyst division, the availability of our raw materials is generally dictated by global market supply of key materials. Key materials such as rare earth metals and platinum group metals have at times had supply constricted due to global supply constraints. The ceramic substrates that we buy are generally sourced by our automotive OEM customers and adequate supply is generally available. The filters for our Heavy Duty Diesel division can generally be purchased from more than one source, limiting our risk of supply, and coated filters, can be sourced from either our Catalyst division or outside suppliers, though changing suppliers for some catalysts may require regulatory approval. For further discussion of risk of supply, see “Risk Factors— Failure of one or more key suppliers to timely deliver could prevent, delay or limit us from supplying products. Delays in delivery times for platinum group metal purchases could also result in losses due to fluctuations in prices. Delays in the delivery times and cost impact of the world-wide shortage of rare earth metals could delay us from supplying products and could result in lower profits” in Item IA.

Intellectual Property

        Our intellectual property includes patent rights, trade secrets and registered and common law trademarks. Historically, we have primarily protected our intellectual property, particularly in the area of three-way catalysts (and particularly in the automotive area) by maintaining our innovative technology as trade secrets. We believe that the protection provided by trade secrets for our intellectual property was the most suitable protection available for the automotive industry where our business initially started and in which we currently sell our commercial products. Our automotive competitors largely rely on trade secret protection for their innovative technology.

Table of Contents

Table of Contents

If the revenues from our growth opportunities and operations are below expectations or delayed, we could require additional working capital in order to maintain our operations.

We have historically relied on outside sources of funding in the form of debt or equity. Although we have a demand credit facility backed by our receivables and inventory, there is no guarantee that we will be able to borrow to the full limit of $7.5 million if the lender chooses not to finance a portion of our receivables or inventory. Additionally, the lender may terminate the facility at any time. We were successful in raising $1.7 million through a public offering of shares in July 2013 but there is no guarantee that should the need arise, we will be able to do so again.                

Any required additional funding may be in the form of debt financing or a private or public offering of equity securities. We believe that debt financing would be difficult to obtain because of our limited assets and cash flows as well as current general economic conditions. Any additional offering of shares of our common stock or of securities convertible into shares of our common stock may result in further dilution to our existing stockholders. Our ability to consummate a financing will depend not only on our ability to achieve positive operating results, but also on 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 we are unable to raise such funds, we may be required to delay, reduce or severely curtail our operations or the implementation of our business strategies or otherwise impede our on-going business efforts, which could have a material adverse effect on our business, operating results, financial condition and long-term prospects.

Future growth of our business depends, in part, on the general availability of funding for emissions control programs, as well as enforcement of existing emissions-related environmental regulations and further tightening of emission standards worldwide.

Future growth of our business depends in part on the general availability of funding for emissions control programs, which can be affected for economic as well as political reasons. For example, in light of the recent budget crisis in California, funding was not available for a state-funded emissions control project for off-road diesel equipment and its start date was pushed back. Additionally, funding for the EPA’s Diesel Emissions Reductions Act, or DERA, for 2014 has been substantially reduced from historic levels and beyond remains uncertain as budget discussions continue to be debated in the U.S. Congress. Funding under the U.S. Congestion Mitigation and Air Quality program or CMAQ can be used by states for a variety of emission reduction programs including purchase of new vehicles, building high occupancy travel lanes (car-pool lanes) and retrofit programs. To the extent that these funds are not used for retrofit programs, it limits our sales opportunities. Funding for these types of emissions control projects drives demand for our products. If such funding is not available, it can negatively affect our future growth prospects. In addition to funding, we also expect that our 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 due to commercial and business pressure or otherwise, it could have a material adverse effect on our business, operating results, financial condition and long-term prospects.

Foreign currency fluctuations could impact financial performance.

Because of our activities in the U.K., Europe, Canada and Asia, we are exposed to fluctuations in foreign currency rates. We may manage the risk to such exposure by entering into foreign currency futures and option contracts of which there were none in 2013 or 2012. Foreign currency fluctuations may have a significant effect on our operations in the future.

The Merger adversely affects our ability to take advantage of the significant U.S. federal tax loss carryforwards and tax credits accumulated.

In connection with the Merger, we performed a study to evaluate the status of net operating loss carryforwards as a result of the Merger. Because the Merger caused an “ownership change” (as defined for U.S. federal income tax purposes) as of the date of the Merger, our ability to use our net operating losses and credits in future tax years has been significantly limited. In addition, due to the “ownership change,” our federal research and development credits have also been limited and, consequently, we do not anticipate being able to use any of these credits that existed as of the date of the Merger in future tax years. Our limited ability to use these net operating losses and tax credits as a result of the Merger could have an adverse effect on our results of operations.

Table of Contents

Risks Related to Our Business

We cannot assure you that we will be successful in realigning our strategic path.

Our board of directors and management team conducted a strategic review of our business and determined to pursue aggressive development of our unique materials science platform. The new strategy contemplated an increased focus on patenting our proprietary advanced low-PGM and zero-PGM, or ZPGM, catalysts. We determined to pursue licensing and partnership arrangements to accelerate the commercialization of our patented and proprietary materials technology and reduce our need for additional, significant capital expenditures to expand our manufacturing platform. 

Based on our strategic review, we defined our near-term priorities as follows:

·         Explore strategic options to maximize the value of our existing manufacturing assets and business;       

·         Aggressively build our patent portfolio to maintain and protect our technology leadership position;

·         Pursue new end markets, including fuel cells, petro-chemicals and thermo-electrics.

We cannot assure you that these efforts will be successful and, if they are, that they will have the intended effect of increasing profitability. 

We may not be able to implement these strategies for a number of reasons, including, but not limited to:

·         Unforeseen costs and delays;

·         Unexpected legal, regulatory, or administrative hurdles;

·        Unfamiliarity with these initiatives;

·         Restrictions on our technology; and

·         The inability to:

§   Obtain additional capital to pursue such strategies on favorable terms or at all;

§   Protect our intellectual property;

§   Secure viable alternatives to maximize the value of our manufacturing assets and business;

§   Develop products that meet or exceed the qualification standards of OEMs and partners;

§   Find suitable third parties with whom to enter into licensing or partnering arrangements or invest in our business;

§   Create innovative products and technologies that provide value to our customers; and

§   Compete successfully or enter new markets.

In this regard, we have not developed any licensing arrangements or new OEM customers to date, and have terminated our joint venture with Pirelli.  We have also not made any final decisions regarding our manufacturing operations.  Moreover, we believe some of these initiatives to be relatively uncommon in our industry, and, as a result, are unfamiliar to us.  The success of our business assumes we will be able to execute these strategies and increase our profitability as a result.  This assumption is unproven, and, if incorrect, we may be unable to generate sufficient revenues to sustain our business, implement or business strategies, or to obtain profitability.

      Historically, we have derived a significant portion of our revenue from a limited number of customers. For the years ended December 31, 2013 and 2012, sales to Honda, our largest customer, accounted for approximately 39% and 30%, respectively, of our revenue. While we continually seek to broaden our customer base, it is likely that for the foreseeable future we will remain dependent on Honda to supply a substantial portion of our revenue. Manufacturers typically seek to have two or more sources of critical components; however, there can be no assurance that manufacturers for which we are a shared supplier will not sole source the products we supply. Once our product is designed into a vehicle model, we generally supply our component for the life of that model. There can be no assurance, however, that our customers will retain us for a full model term. In this regard, relationships with our customers are based on purchase orders rather than long-term formal supply agreements and customers can discontinue or materially reduce orders without warning or penalty. In addition, while new models tend to remain relatively stable for a few years, there can be no assurance that manufacturers will not change models more rapidly, or change the performance requirements of components used in those models, and use other suppliers for these new or revised models. Demand for our products is tied directly to demand for vehicles. Accordingly, factors that affect the truck and automobile markets have a direct effect on our business, including factors outside of our control, such as vehicle sales slowdowns due to economic concerns, or as a result of natural disasters, including earthquakes and/or tsunamis. The loss of one or more of our significant customers, or reduced demand from one or more of our significant customers, particularly Honda, would result in an adverse effect on our revenue, and could affect our ability to become profitable or continue our business operations.

In conjunction with our longstanding relationship with Honda, we entered into a joint research agreement with the motorcycle division of Honda regarding the development of ZPGM catalysts for motorcycles. The agreement was signed in 2010, extended in 2012 and expires on March 31, 2014, although confidentiality provisions survive thereafter. The agreement provides that technology within the scope of the agreement developed solely by one party is owned by that party, and that technology within the scope of the agreement that is jointly developed by both parties is jointly owned. Beginning in April, the parties plan to assess what technology, if any, developed during the term of the agreement is jointly owned. To the extent that Honda is a joint owner of critical technology developed under the agreement, Honda (including its automotive division) might not be required to pay us a license or royalty fee for use of the jointly owned technology; Honda may be able to manufacture its own catalysts based on the jointly owned technology; and Honda may be able to license the jointly owned technology to others without our consent. In addition, under the terms of the agreement, we may not be able to license jointly owned technology to others without Honda’s consent. Our inability to license jointly owned technology to others could adversely affect our technology licensing strategy. Further, as noted above, we do not have long-term supply agreements with Honda and accordingly Honda could terminate its relationship with us at any time for any reason.

We have entered into contractual agreements in connection with the sale of certain of our assets, which may expose us to liability for claims for indemnification under such agreements.

In the ordinary course of our business, we have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of the contract terms. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement.

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

Table of Contents

We rely on patent, trademark and copyright law, trade secret protection, and confidentiality and other agreements with employees, customers, partners and others to protect our intellectual property. In addition, some of our intellectual property is not protected by any patent or patent application. The lack of patent and trademark protection may be intentional as we may lack sufficient resources to protect our intellectual property in every applicable jurisdiction. As a result, it may be possible for third parties to obtain and use our intellectual property without the need to obtain our authorization.

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

The patents protecting our proprietary technologies expire after a period of time. Currently, our patents have expiration dates ranging from 2014 through 2030. Although we have attempted to incorporate technology from our core patents into specific patented product applications, product designs and packaging, there can be no assurance that this building block approach will be successful in protecting our proprietary technology and products . If we are not successful in protecting our proprietary technology, it could have a material adverse effect on our business, financial condition and results of operations. In recent periods, questions have arisen regarding our exclusive ownership and control of  certain technologies, including by our principal customer, Honda, and a former employee, who claims ownership in a patent relating to ZPGM. In addition, we have sold  technology for exclusive use in Asia to another party.   See "—Historically, we have been dependent on a few major customers, particularly Honda…" and "—We may not be able to sell our current products in certain countries in Asia since such products are based on technology which we sold to a third party" above. Past or future weaknesses in control of our intellectual property could render unachievable our current strategies, require that we change our strategies which could prove unsuccessful, result in litigation over ownership issues including the costs thereof and potential adverse findings, require that we pay to license back technology that we developed or co-developed, or otherwise material adversely affect us, our business and our financial performance.

As part of our confidentiality procedures, we generally have entered into nondisclosure agreements with employees, consultants and corporate partners. We also have attempted to control access to and distribution of our technologies, documentation and other proprietary information. We plan to continue these procedures. Despite these procedures, third parties could copy or otherwise obtain and make unauthorized use of our technologies or independently develop similar technologies. The steps that we have taken and that may occur in the future might not prevent misappropriation of our 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 we will be successful in enforcing our proprietary rights. For example, from time to time we have become aware of competing technologies employed by third parties who might be covered by one or more of our patents. In such situations, we may seek to grant licenses to such third parties or seek to stop the infringement, including through the threat of legal action. There is no assurance that we would be successful in negotiating a license agreement on favorable terms, if at all, or able to stop the infringement. Any infringement upon our intellectual property rights could have an adverse effect on our ability to develop and sell commercially competitive systems and components.

Table of Contents

We may not be able to successfully market new products that are developed or obtain direct or indirect verification or approval of our new products.

Some of our catalyst products and heavy duty diesel systems are still in the development or testing stage with targeted customers. We are developing technologies in these areas that are intended to have a commercial application, however, there is no guarantee that such technologies will actually result in any commercial applications. In addition, we plan to market other emissions reduction devices used in combination with our current products. There are numerous development and verification issues that may preclude the introduction of these products for commercial sale. These proposed operations are subject to all of the risks inherent in a developing business enterprise, including the likelihood of continued operating losses. If we are unable to demonstrate the feasibility of these proposed commercial applications and products or obtain verification or approval for the products from regulatory agencies, we may have to abandon the products or alter our business plan. Such modifications to our business plan will likely delay achievement of revenue milestones and profitability.

Any liability for environmental harm or damages resulting from technical faults or failures of our products could be substantial and could materially adversely affect our business and results of operations.

Customers rely upon our products to meet emissions control standards imposed upon them by government. Failure of our products to meet such standards could expose us to claims from customers. Our products are also integrated into goods used by consumers and therefore a malfunction or the inadequate design of our products could result in product liability claims. Any liability for environmental harm or damages resulting from technical faults or failures could be substantial and could materially adversely affect our business and results of operations. In addition, a well-publicized actual or perceived problem could adversely affect the market’s perception of our products, which would materially impact our financial condition and operating results.

Risks Related to Our Industry

We face constant changes in governmental standards by which our products are evaluated.

We believe 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 our products fail to meet these ever-changing standards, some or all of our products may become obsolete.

We face 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 our products. Other companies offer products that potential customers may consider to be acceptable alternatives to our products and services, including products that are verified by the EPA, the CARB or other environmental authorities. We face direct competition from companies with greater financial, technological, manufacturing and personnel resources. Newly developed products could be more effective and cost-efficient than our current or future products. We also face indirect competition from vehicles using alternative fuels, such as methanol, hydrogen, ethanol and electricity.

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

The factors listed below, some of which we cannot control, may cause our revenue and results of operations to fluctuate significantly:

·              Actions taken by regulatory bodies relating to the verification, registration or health effects of our products;

·              The extent to which our products obtain market acceptance;

·              The timing and size of customer purchases;

·               Customer concerns about the stability of our business, which could cause them to seek alternatives to our solutions and products; and

·               Increases in raw material costs, particularly platinum group metals and rare earth metals.

Table of Contents

Future growth of our business depends, in part, on market acceptance of our catalyst products, successful verification of our products and retention of our verifications.

While we believe that there exists a viable market for our developing catalyst products, there can be no assurance that such technology will succeed as an alternative to competitors’ existing and new products. The development of a market for the products is affected by many factors, some of which are beyond our control. The adoption cycles of our key customers are lengthy and require extensive interaction with the customer to develop an effective and reliable catalyst for a particular application. While we continue to develop and test products with key customers, there can be no guarantee that all such products will be accepted and commercialized. Our relationships with our customers are based on purchase orders rather than long-term formal supply agreements. Generally, once a catalyst has successfully completed the testing and certification stage for a particular application, it is generally the only catalyst used on that application and therefore unlikely that, unless there are any defects, the customer will try to replace that catalyst with a competing product. However, our customers usually have alternate suppliers for their products and there is no assurance that we will continue to win the business. Also, although we work with our customers to obtain product verifications in accordance with their projected production requirements, there is no guarantee that we will be able to receive all necessary approvals for our catalysts by the time a customer needs such products, or that a customer will not accelerate its requirements. If we are not successful in having verified catalyst products to meet customer requirements, it will have a negative effect on our revenues, which could have a material adverse effect on our results of operations.

If a market fails to develop or develops more slowly than anticipated, we may be unable to recover the costs we will have incurred in the development of our products and may never achieve profitability. In addition, we cannot guarantee that we will continue to develop, manufacture or market our products or components if market conditions do not support the continuation of the product or component.

We believe that it is an essential requirement of the U.S. retrofit market that emissions control products and systems are verified under the EPA and/or CARB protocols to qualify for funding from the EPA and/or CARB programs. Funding for these emissions control products and systems is generally limited to those products and technologies that have already been verified. Verification is also useful for commercial acceptability. Notably, EPA verifications were withdrawn on two of our products in January 2009 because available test results were not accepted by the EPA as meeting new emissions testing requirements for nitrogen dioxide (NO2) measurement. As a general matter, we have no assurance that our products will be verified by the CARB or that such a verification will be acceptable to the EPA. If we are not able to obtain or maintain necessary product verifications, it will limit our ability to commercialize such products, which could have a negative effect on our revenues and on our results of operations.

New metal standards, lower environmental limits or stricter regulation for health reasons of platinum or cerium could be adopted and affect use of our products.

New standards or environmental limits on the use of platinum or cerium metal by a governmental agency could adversely affect our ability to use our Platinum Plus ^® fuel-borne catalyst in some applications. In addition, the CARB requires “multimedia” assessment (air, water, soil) of the fuel-borne catalyst. The EPA could require a “Tier III” test of the Platinum Plus ^® fuel-borne catalyst at any time to determine additional health effects of platinum or cerium, which tests may involve additional costs beyond our current resources. Government or regulatory bodies in other countries where we sell our Platinum Plus ^® fuel-borne catalyst could adopt similar limits or regulations.

Risks Related to Our Common Stock

The price of our common stock may be adversely affected by the sale by us or our shareholders of a significant number of new common shares.

The sale, or availability for sale, of substantial amounts of our common stock could adversely affect the market price of our common stock and could impair our ability to raise additional working capital through the sale of equity securities. On July 3, 2013, we issued 1,730,000 shares of our common stock and warrants to purchase 865,000 shares of our common stock in an underwritten public offering under our shelf registration statement as described below. Concurrent with this public offering, we paid $235,000 of principal and interest due June 30, 2013, pursuant to loans made to us by Kanis S.A., with 188,000 shares of our common stock and warrants to purchase 94,000 shares of our common stock. Also, on July 3, 2013, we issued 54,347 shares of our common stock in a private placement. On July 5, 2011, we issued 3,053,750 shares of our common stock in an underwritten public offering. On October 15, 2010, we issued (or reserved for issuance) an aggregate 2,287,872 shares of our common stock and warrants to purchase an additional 666,583 shares of our common stock, each on a post-split basis after eliminating fractional shares, in connection with the Merger. We also issued 109,020 shares and warrants to purchase an additional 166,666 shares of our common stock, each on a post-split basis after eliminating fractional shares, in a Regulation S offering, as well as 32,414 shares and warrants to purchase an additional 14,863 shares, each on a post-split basis after eliminating fractional shares, as compensation for services rendered in connection with the Merger and our Regulation S offering. Resale of these shares by the holders thereof (some of whom received registered shares and some of whom have registration rights) or resale of the shares received upon exercise of the warrants could contribute to downward pressure on the trading price of our stock.

Table of Contents

In addition, to provide us with additional flexibility to access capital markets for general corporate purposes, we filed a shelf registration statement which was declared effective by the SEC on May 21, 2012. The shelf registration statement permits us to sell, from time to time, up to an aggregate $50.0 million of various securities, including common stock, preferred stock warrants to purchase common stock or preferred stock and units consisting of one or more shares of common stock, shares of preferred stock, warrants or any combination of such securities. To the extent that we raise additional capital by issuing equity securities under our shelf registration statement, our stockholders may experience dilution. Any dilution or potential dilution may cause our stockholders to sell their shares, which would contribute to a downward movement in the trading price of our stock.

The sale of our common stock to LPC may cause dilution and the sale of the shares of common stock acquired by LPC could cause the price of our common stock to decline.

In connection with entering into the Purchase Agreement with LPC in October 2011, we authorized the issuance to LPC of up to $10,000,000 worth of shares of our common stock, plus 120,741 shares of common stock as commitment shares. As of the date of this Annual Report on Form 10-K, we have not sold any shares to LPC under the Purchase Agreement. The number of shares ultimately offered for sale by LPC is dependent upon the number of shares purchased by LPC under the Purchase Agreement. The purchase price for the common stock to be sold to LPC pursuant to the Purchase Agreement will fluctuate based on the price of our common stock. If we do sell shares to LPC, LPC may offer and sell 1,823,577 shares over a period of up to 30 months from December 2011 pursuant to an effective registration statement. Depending upon market liquidity at the time, a sale of the 1,823,577 registered shares, or additional shares we register or which LPC sells other than by means of a registration statement, at any given time could cause the trading price of our common stock to decline. We can elect to direct purchases in our sole discretion. After LPC has acquired such shares, it may sell all, some or none of such shares. Therefore, sales to LPC by us under the Purchase Agreement may result in substantial dilution to the interests of other holders of our common stock. The sale of a substantial number of shares of our common stock by LPC, or anticipation of such sales, could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

The risk of dilution, perceived or actual, may contribute to downward pressure on the trading price of our stock.

We have outstanding warrants and stock options to purchase shares of our common stock, and it is contemplated that additional shares or options to acquire shares of our common stock will be issued. The exercise of these securities will result in the issuance of additional shares of our common stock. We may also issue additional shares of our common stock or securities exercisable for or convertible into shares of our common stock, whether in the public market or in a private placement to fund our operations, or as compensation. These issuances, particularly where the exercise price or purchase price is less than the current trading price for our common stock, could be viewed as dilutive to the holders of our common stock. The risk of dilution, perceived or actual, may cause existing stockholders to sell their shares of stock, which would contribute to a decrease in the price of shares of our common stock. In that regard, downward pressure on the trading price of our common stock may also cause investors to engage in short sales, which would further contribute to downward pressure on the trading price of our stock.

There has been and may continue to be significant volatility in the volume and price of our common stock on the NASDAQ Capital Market and an investment in our stock could suffer a decline in value.

CDTI’s common stock began trading on the NASDAQ Capital Market effective October 3, 2007. In the period immediately following the Merger and the reverse stock split, we experienced significantly higher trading volume than typical for our Company. Unusual trading volume in our shares has continued to occur from time to time. For example, the trading volume in our common stock exceeded nineteen million shares on March 11, 2014, whereas the average trading volume for the three weeks prior to that date was 569,161 shares per day. The market price of our common stock also has been and may continue to be highly volatile. During the last two weeks of October 2010 following the Merger and the reverse stock split, the price for a share of our common stock ranged from as low as $1.50 per share to as high as $44.38 per share. On March 18, 2014, the closing price for a share of our common stock was $6.33 per share. Factors, including announcements of technological innovations by us or other companies, regulatory matters, new or existing products or procedures, concerns about our financial position, operations results, litigation, government regulation, developments or disputes relating to agreements, patents or proprietary rights, may have a significant impact on the market volume and price of our stock.

As a publicly traded company, CDTi is assessed periodically by securities analysts. Changes in assessments by such analysts may increase the volatility or our stock price and may result in a decline in value if the assessments are negative.

Table of Contents

We have not paid and do not intend to pay dividends on shares of our common stock.

We have not paid dividends on our common stock since inception, and do not intend to pay any dividends to our stockholders in the foreseeable future. We intend to reinvest earnings, if any, in the development and expansion of our business.

ITEM 2.     PROPERTIES

ITEM 3.     LEGAL PROCEEDINGS

ITEM 4.     MINE SAFETY DISCLOSURES

Table of Contents

·         Explore strategic options to maximize the value of our existing manufacturing assets and business;

·         Aggressively build our patent portfolio to maintain and protect our technology leadership position;

·         Pursue new end markets, including fuel cells, petro-chemicals and thermo-electrics.

Equity Financings             

On July 3, 2013, we completed a public offering in which we sold 1,730,000 shares of common stock and warrants to purchase up to 865,000 shares of common stock, including 130,000 shares and 65,000 warrants upon partial exercise of the underwriter’s over-allotment option, of which 80,000 shares and 40,000 warrants were sold to our new director, Dr. Lon Bell, at the public offering price. The securities were sold in units consisting of one share of common stock and one half of a warrant to purchase one share of common stock. The warrants have an exercise price of $1.25 per share, and are exercisable immediately for a period of five years. We received net proceeds of approximately $1.7 million after deducting discounts and commissions to the underwriter and estimated offering expenses. We used the proceeds for general corporate purposes, including working capital, general and administrative expenses, capital expenditures and implementation of our strategic priorities, and to repay a portion of amounts outstanding under our line of credit.

In addition, concurrent with the offering, on July 3, 2013, we paid $235,000 of premium and interest due June 30, 2013, pursuant to loans made to us by Kanis S.A., with 188,000 shares of common stock and warrants to purchase 94,000 shares of common stock. The warrants have an exercise price of $1.25 per share, and are exercisable immediately for a period of five years. In July 2013, we also sold 54,347 shares of common stock to one of our directors in a private placement pursuant to an agreement dated June 28, 2013. The shares were sold at $1.84 per share, the closing bid price on the day preceding the date of the agreement. We relied on the exemption provided by Regulation S for these private placements.

For more information on these transactions, see Notes 9 and 10 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

In connection with the offering, we considered a variety of alternatives, including the sale of stock under our purchase agreement with LPC, the incurrence of additional debt, and the sale of assets and determined that those alternatives were either unavailable or less attractive at the time. We will require additional capital to execute our strategic plan and continually evaluate alternatives for doing so.

Joint Venture Agreement with Pirelli & C. Ambiente SpA

On February 19, 2013, we entered into a Joint Venture Agreement with Pirelli to form the joint venture entity, Eco Emission Enterprise Srl, under the laws of Italy through which we and Pirelli would jointly sell our emission control products in Europe and the Commonwealth of Independent States (CIS) countries. The joint venture agreement provided that we and Pirelli 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 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. During 2013, these loans were converted into equity contributions as required by local statutory regulations. In the fourth quarter of 2013, we and Pirelli each contributed an additional €262,000 (approximately $361,000) to the joint venture. The joint venture commenced operations in April 2013. On November 8, 2013, as a result of slower than anticipated progress in achieving sales objectives initially established for the joint venture, we and Pirelli agreed to voluntarily dissolve the joint venture. The joint venture ceased operations on November 30, 2013 and commenced liquidation on December 9, 2013. We expect that dissolution will be finalized in the first half of 2014. We have resumed our operations in Europe in a similar manner as conducted prior to the joint venture.

Amendment to 6% Shareholder Note Due 2013   

On January 30, 2013, we and Kanis S.A. entered into an agreement 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 9 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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. had agreed not to accelerate the maturity of these notes during the 2013 calendar year and on March 21, 2014, we and Kanis S.A. entered into another letter agreement whereby Kanis S.A. agreed not to accelerate the maturity of these notes prior to July 1, 2015 . For more information relating to the terms of our 8% subordinated convertible note due 2016, see “— Description of Indebtedness” below and Note 9 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Sources of Revenues and Expenses

Revenues

       We generate revenues primarily from the sale of our emission control systems and products. We generally recognize revenues from the sale of our emission control systems and products upon shipment of these products to our 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. When terms of sale include subjective customer acceptance criteria, we defer revenue until the acceptance criteria are met.

Cost of revenues

Cost of revenues consists primarily of direct costs for the manufacture of emission control systems and products, including cost of raw materials, costs of leasing and operating manufacturing facilities and wages and benefits 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. We include 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.

Selling, general and administrative expenses

Selling, general and administrative expense includes the salary and benefits for sales, marketing and administrative staff as well as samples provided at no-cost to customers, marketing materials, travel, legal, accounting and other professional fees, corporate expenses, regulatory fees and bad debt. Also included is any depreciation related to assets utilized in the selling, marketing and general and administrative functions as well as amortization of acquired intangible assets.

Research and development expenses

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 our heavy duty diesel systems verified and approved for sale by the EPA, the 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.

Other income (expense)

Other income (expense) primarily reflects interest expense, including amortization of debt discounts and premiums and amortization of debt issuance costs, our portion of loss or income from unconsolidated affiliates and changes in the fair value of our liability classified warrants. It also includes loss on foreign exchange and interest income.

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, 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 the following critical accounting policies used in the preparation of our financial statements require significant judgments and estimates. For additional information relating to these and other accounting policies, see Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K .  

Revenue Recognition

We generally recognize 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. When terms of sale include subjective customer acceptance criteria, we defer revenue until the acceptance criteria are met. Concurrent with the shipment of the product, we accrue estimated product return reserves. 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 we recognize.

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. We monitor collections and payments from our customers and maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We also assess current economic trends that might impact the level of credit losses in the future. If the financial condition of our 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 our 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. We write 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 our earnings and working capital.

Product Warranty Reserves

We provide warranties on certain of our Heavy Diesel Division products for varying periods. Generally, the warranty periods range from one to five years and may also contain mileage limitations.  We provide for the estimated cost of product warranties in cost of sales, at the time product revenue is recognized. Warranty costs are estimated primarily using historical warranty information in conjunction with current engineering assessments applied to our expected repair or replacement costs. The adequacy of the provision is assessed at each quarter end. Should actual performance rates or repair costs differ from estimates, revision to the estimated warranty liability would be required, which would have a negative effect on our earnings and working capital.

  Accounting for Income Taxes

Our income tax expense is dependent on the profitability of our various international subsidiaries including Canada, Sweden and the United Kingdom. These subsidiaries are subject to income taxation based on local tax laws in these countries. Our U.S. operations have continually incurred losses since inception.

Our annual tax expense is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions including evaluating uncertainties. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest and penalties related to unrecognized tax benefit in income tax expense. We review our tax positions quarterly and adjust 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 we operate, there could be an increase in tax expense and a resulting decrease in our earnings and working capital.     

Table of Contents

Goodwill

We test goodwill for impairment at the reporting unit level at least annually, as of October 31, using a two-step process, and more frequently upon the occurrence of certain triggering events. Our Engine Control Systems reporting unit, which is within our Heavy Duty Diesel Systems reporting segment, has goodwill subject to impairment testing, which totalled $5.9 million and $6.1 million at December 31, 2013 and 2012, respectively. Goodwill impairment testing requires us to estimate the fair value of the 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. We derived the estimated fair value of the Engine Control Systems reporting unit at October 31, 2013 from a blending of market and income approach models. We utilized a weighting of 25% and 75% between the market and income approaches, respectively. Significant assumptions used in deriving the fair value of the reporting unit under the income approach included: annual revenue growth over the next five years ranging from 5.0% to 28.0%, long-term revenue growth of 3% and a discount rate of 25%. Significant assumptions used in deriving the fair value of the reporting unit under the market approach included: average multiples of 0.6 times on revenue and 5.5 times on EBITDA. The discount rate of 25.0% 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 our Engine Control Systems business reporting unit using data from comparable companies. The revenue growth rates used are higher than our historical growth patterns and consider future growth potential identified by management, however, there is no assurance such growth will be achieved. In addition, we considered the overall fair value of our reporting units as compared to our market capitalization. Because the estimated fair value of the reporting unit substantially exceeded its carrying value, we determined that no goodwill impairment existed as of October 31, 2013. However, it is reasonably possible that future results may differ from the estimates made during 2013 and future impairment tests may result in a different conclusion for the goodwill of our Engine Controls Systems reporting unit. In addition, the use of different estimates or assumptions by management could lead to different results. Our estimate of fair value of the reporting unit is sensitive to certain factors, including but not limited to the following: movements in our share price, changes in discount rates and our 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.

Impairment of Long-Lived Assets Other Than Goodwill

We evaluate 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, we measure the impairment loss and record it based on discounted estimated future cash flows. In estimating future cash flows, we group 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. Our 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 2013, we considered whether any events or changes in circumstance indicated that the carrying amount of our long-lived assets may not be recoverable and concluded that no such triggering event had occurred during 2013 that would lead us to believe that the assets were impaired. Therefore, no further testing was performed. To the extent additional events or changes in circumstances occur, we 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.

We account for stock-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, we recognize 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. We estimate the fair value of stock option awards on the date of grant using the Black-Scholes option-pricing model, which requires that we make certain assumptions regarding: (i) the expected volatility in the market price of our 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 we revise our assumptions and estimates, our stock-based compensation expense could change materially for future grants.

Warrant Derivative Liability

In light of the terms of certain of our outstanding warrants, we have determined that we are required to carry them at fair value until exercised or expired, and record changes in their fair value recorded in our results of operations in each reporting period. At December 31, 2013, we had a liability of $0.9 million related to liability-classified warrants. For the year ended December 31, 2013, we recorded a non-cash loss of $0.2 million to other income in our statement of comprehensive loss to reflect the change in fair value of these liability-classified warrants. The determination of fair value requires the use of judgment and estimates by management. For common stock warrants with market conditions, we use the Monte Carlo pricing model to determine fair value on the grant date. For other common stock warrants, we use the Black-Scholes option-valuation model, which requires that we make certain assumptions regarding: (i) the expected volatility in the market price of our common stock; (ii) dividend yield; (iii) risk-free interest rates; and (iv) the contractual terms of the warrants. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for changes in the valuation of the warrant derivative liability.

Recently Issued Accounting Guidance

In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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." 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.

In June 2013, the FASB ratified Emerging Issues Task Force (“EITF”) Issue 13-C, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” which concludes an unrecognized tax benefit should be presented as a reduction of a deferred tax asset when settlement in this manner is available under the tax law. We will adopt this amendment in the first quarter of 2014 and do not expect adoption of this standard to have a material impact on our consolidated financial statements or financial statement disclosures.

For additional discussion regarding these, and other recent accounting pronouncements, see Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Factors Affecting Future Results

Government Funding and Standards

The nature of our business is heavily influenced by government funding of emissions control projects and increased emission control regulations and mandates. Compliance with these regulatory initiatives drives demand for our products and the timing of the implementation of emission reduction projects. We believe that, due to the constant focus on the environment and clean air standards throughout the world, it can be expected that new and more stringent regulations, both domestically and abroad, will continually be adopted, requiring the ongoing development of new products that meet these standards.

Table of Contents

Table of Contents

In this regard, since the customers of our Catalyst division are primarily OEM auto makers, our Catalyst division is affected by macroeconomic factors impacting the automotive industry generally. During 2013, sales to Honda, our largest OEM auto customer, were positively impacted due to increased vehicle shipments, expansion of our catalysts onto new vehicle platforms and increased purchasing by Honda due to their increased auto sales. 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 Honda. Through June 2012, Honda was reimbursing us for substantially the full amount actually spent by us on these materials. For the balance of the year, Honda reimbursed us partially, pending the agreement on a formula for this reimbursement which is based on formulae established by Honda with other vendors. A formula has been agreed to between Honda and us for all shipments going forward from January 1, 2013. The resolution of the rare earth reimbursement has enabled improved gross margins in this business in 2013. 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.

Technology Strategy

Our strategic focus on developing our ZPGM catalyst technology has resulted in what we believe to be a number of significant patent filings since the first quarter of 2013. It is our intention to invest in developing and commercializing our advanced low-PGM and ZPGM catalyst technologies. As a consequence, we anticipate that we will continue to expand our intellectual property portfolio with additional patents in 2014. In addition, we will invest in other development and marketing activities, including hiring of personnel, and incurring outside testing and consulting expenses in support of our technology strategy that could result in higher operating expenses.

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 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.

Table of Contents

Table of Contents

Cost of revenues decreased $5.9 million, or 13.0% to $39.9 million for the year ended December 31, 2013, compared to $45.8 million for the year ended December 31, 2012. The decrease in cost of revenues was primarily due to a $6.3 million decrease related to lower product sales volume in the Heavy Duty Diesel Systems division, a $1.5 million decrease in rare earth material costs in the Catalyst division and to a decrease of $0.3 million related to the contract with TKK. Additionally, our expense for the write-down of excess inventory during the year ended December 31, 2012 was $0.8 million higher than the same period in 2013 primarily due to higher costs related to the London LEZ program, which was completed in 2012. The impact of these decreases was partially offset by an increase of $3.0 million related to the increase in Catalyst sales volume.

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

Gross profit for the year ended December 31, 2013 increased by $0.7 million, or 4.7%, to $15.4 million from $14.7 million for the year ended December 31, 2012. Gross margin percentage increased to 27.9% for the year ended December 31, 2013 from 24.3% for the year ended December 31, 2012.     

The increase in gross margin percentage for our Heavy Duty Diesel Systems division from 27.0% for the year ended December 31, 2012 to 30.1% for the year ended December 31, 2013 is a result of favorable product mix, with higher margin products sold in California and North America in the year ended December 31, 2013 compared to the lower margin product mix sold in London in the comparable period of 2012 and a shift to higher margin diesel particulate filters from lower margin diesel oxidation catalysts; the favorable impact of a higher content of low PGM catalysts manufactured by our Catalyst division in the year ended December 31, 2013; and a $0.7 million reduction in inventory obsolescence charges, which were higher during the year ended December 31, 2012 primarily due to the London LEZ program, partially offset by the impact of lower sales volume and reduced margins in Europe during the year ended December 31, 2013 due to commissions on sales made through our European joint venture.   

     Gross margin percentage for our Catalyst division increased from 15.3% for the year ended December 31, 2012 to 21.0% for the year ended December 31, 2013. Excluding the impact of the TKK contract, as discussed above, gross margins for our Catalyst division increased to 21.0% for the year ended December 31, 2013 from 12.8% for the year ended December 31, 2012. This increase in gross margin is due to favorable product mix as a result of the introduction of the new model year 2013 vehicles beginning in the third quarter of 2012 and continued improvement in manufacturing efficiencies, partially offset by the impact of an unfavorable product mix due to lower intercompany diesel sales with higher margins in the year ended December 31, 2013 as compared to the comparable period in 2012. In addition, as discussed above, one of our OEM customers provides price adjustments with the intent of isolating us from the impact of rare earth cost increases, which covers cost without any additional profit. Through June 2012, that customer was reimbursing us the full amount actually spent by us on these materials. For the balance of 2012, our customer reimbursed us based on a formula that did not fully reflect our rare earth material cost basis. Further, due to worldwide supply constraints on rare earth materials, we secured supply to insure adequate availability to meet our OEM customer demand. When rare earth material prices declined during the year, our OEM customer’s formula provided for reduced reimbursements while we were still consuming the materials previously secured to protect supply resulting in a negative gross profit on rare earth reimbursements of $1.4 million in 2012. In addition to our customer reimbursements being less than actual cost, the rare earth reimbursements are without profit, hence are dilutive to our margins. 

For the year ended December 31, 2013, operating expenses decreased by $2.8 million, or 12.8%, to $19.7 million from $22.5 million for the year ended December 31, 2012.  

Selling, general and administrative expenses as a percentage of revenues increased to 24.9% in the year ended December 31, 2013 compared to 24.7% in the year ended December 31, 2012.

Research and development expenses

Research and development expenses for the year ended December 31, 2013 decreased by $2.0 million, or 30.0%, to $4.7 million from $6.7 million for the year ended December 31, 2012. This decrease is a result of $1.0 million in cost savings due to headcount reductions made in 2012, a $1.0 million decrease in product verification testing and pre-production scale-up activities in the year ended December 31, 2013 as compared to the prior year period, a decrease of $0.5 million related to the reclassification of an executive to selling, general and administrative expense due to a change in activities, and $0.2 million in other decreases partially offset by $0.7 million in increased legal expense related to patents. 

As a percentage of revenues, research and development expenses were 8.5% in the year ended December 31, 2013, compared to 11.1% i n the year ended December 31, 2012.

Severance and other charges

During 2012, we initiated actions to streamline both our facilities and our workforce at both the Heavy Duty Diesel Systems and Catalyst divisions. These actions were deemed necessary to meet the demands of the markets we serve and our economic environment and to improve our profitability. We recorded $0.6 million in costs related to the termination of 41 employees throughout North America, Europe, the United Kingdom and Asia. We also incurred $0.2 million in lease termination costs related to the exit of a lease in North America and $0.1 million asset impairment expense related to the exit of this facility as well as to the exit of a leased facility in the United Kingdom.

In 2013, we recorded an additional $0.2 million for termination of 11 employees in North America and the United Kingdom related to the continued streamlining of our workforce. Also, on December 4, 2013, our former President and Chief Executive Officer resigned in order to pursue other opportunities. Our Board of Directors determined the departure to be termination without cause, pursuant to his employment agreement. As a result, we recorded $0.4 million in costs related to his separation.

Also included in severance and other charges is $0.6 million related to a legal settlement with our former chief financial officer and legal expenses incurred related to the matter. On March 13 , 2014, we reached a settlement of all claims related to an administrative complaint originally filed against us in 2010 whereby we will pay a lump sum amount of $0.4 million and 75,000 shares of our common stock. See note 17 elsewhere in the Annual Report on Form 10K for more information on this matter.

Other expense, net

34

Table of Contents

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. A s of December 31, 2013, we had an accumulated deficit of approximately $181.7 million compared to $174.6 million at December 31, 2012. We have also had negative cash flows from operations from inception through the year ended December 31, 2013. Our primary sources of liquidity in recent years have been asset sales, credit facilities and other borrowings and equity sales.

At December 31, 2013 and 2012, $1.6 million and $3.3 million, respectively, 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 9 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. At December 31, 2013, we had $2.3 million in borrowings outstanding with $5.2 million available under our FGI credit facility, subject to the availability of eligible accounts receivable and inventory balances for collateral. However, there is no guarantee that we will be able to borrow to the full limit of $7.5 million if FGI chooses not to finance a portion of our receivables or inventory.

Table of Contents

       To address the potential need for capital, in October 2011, we signed a purchase agreement, together with a registration rights agreement, with LPC, whereby LPC has agreed to purchase up to $10.0 million of our common stock over a 30-month period ending April 24, 2014. We have registered 1,823,577 shares related to the transaction, of which 40,247 shares were issued to LPC as a commitment fee; 80,494 shares may be issued to LPC as an additional commitment fee on a pro rata basis as up to $10.0 million of our common stock is purchased by LPC; and 1,702,836 represent shares that we may sell to LPC under the Purchase Agreement. We have the right, in our sole discretion, over a 30-month period to sell shares of our common stock to LPC in amounts limited to from $0.5 million to $1.5 million per sale, depending on the price of our common stock as set forth in the Purchase Agreement, up to the aggregate amount of $10.0 million. We currently have registered 1,702,836 shares for purchase shares under the agreement. The aggregate number of shares issued pursuant to the purchase agreement is limited to 1,434,994 shares of common stock (19.99% of the outstanding shares of our common stock on October 7, 2011, the date of the purchase agreement) (the “Exchange Cap”), unless and until shareholder approval is obtained. The Exchange Cap is not applicable for at-market transactions, defined as when the average price for all shares purchased pursuant to the purchase agreement is greater than or equal the signing price per the agreement of $2.76 plus $0.254, or $3.014 per share. Assuming a purchase price of $2.87 per share (the Arithmetic average of the three lowest closing sale prices for our common stock during the 12 consecutive business days ending on March 17, 2014) and the purchase by LPC of the full 1,702,836 currently registered purchase shares, proceeds to us would be $4.9 million. If the purchase was limited to the Exchange Cap of 1,434,994 shares, proceeds to us would be approximately $4.1 million, assuming a purchase price of $2.87 per share. Moreover, the Purchase Agreement expires on April 24, 2014, which adds additional constraints on our ability to obtain financing from LPC to finance our working capital requirements. We expect to use the proceeds received under the Purchase Agreement for general corporate purposes, which may include working capital, general and administrative expenses, capital expenditures and implementation of our strategic priorities. There have been no sales to date under this arrangement.

In addition, on May 15, 2012, we filed a shelf registration statement on Form S-3 with the SEC (the "Shelf Registration"). The Shelf Registration was declared effective by the SEC on May 21, 2012. The Shelf Registration permits us to sell, from time to time, up to an aggregate of $50.0 million of various securities, including common stock, preferred stock, warrants to purchase common stock or preferred stock and units consisting of one or more shares of common stock, shares of preferred stock, warrants, or any co mbination of such securities. However, we may not sell our securities in a primary offering pursuant the Shelf Registration or any other registration statement on Form S-3 with a value exceeding one-third of our public float in any 12-month period (unless our public float rises to $75.0 million or more). The Shelf Registration is intended to provide us with additional flexibility to access capital markets for general corporate purposes, subject to market conditions and our capital needs. On July 3, 2013, we completed a public offering under the Shelf Registration in which we sold 1,730,000 shares of common stock and warrants to purchase up to 865,000 shares of common stock, including 130,000 shares and 65,000 warrants upon partial exercise of the underwriter’s over-allotment option. The securities were sold in units consisting of one share of common stock and one half of a warrant to purchase one share of common stock. We received net proceeds of approximately $1.7 million after deducting discounts and commissions to the underwriter and estimated offering expenses. Subsequent to December 31, 2013, warrant holders exercised an aggregate of 800,000 of warrants issued in the offering at an exercise price of $1.25 per share for gross proceeds of $1.0 million.

In July 2013, we also sold 54,347 shares of common stock to one of our directors in a private placement pursuant to an agreement dated June 28, 2013. The shares were sold at $1.84 per share, the closing bid price on the day preceding the date of the agreement. We relied on the private placement exemption provided by Regulation S.

On July 27, 2012, we entered into a Loan Commitment Letter with Kanis S.A. pursuant to which we issued a promissory note in the principal amount of $3.0 million. The promissory note bears interest at 8% per annum, which is payable quarterly in arrears and matures on July 27, 2015. See “—Description of Indebtedness” below and Note 9 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

On January 30, 2013, we and Kanis S.A. entered into an amendment to amend certain terms of our outstanding 6% note that was due in 2013. As amended, the maturity date of this note 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. Also 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 and on March 21, 2014, we and Kanis S.A. entered into a letter agreement whereby Kanis S.A. agreed not to accelerate the maturity of these notes prior to July 1, 2015.

Concurrent with our public offering, on July 3, 2013, we paid $235,000 of principal and interest due June 30, 2013, pursuant to loans made to us by Kanis S.A., with 188,000 shares of common stock and warrants to purchase 94,000 shares of common stock.                

36

Table of Contents

  Cash used in operating activities

Our largest source of operating cash flows is cash collections from our customers following the sale of our products and services. Our primary uses of cash for operating activities are for purchasing inventory in support of the products that we sell, personnel related expenditures, facilities costs and payments for general operating matters.

Cash used in operating activities in the year ended December 31, 2013 was $0.4 million compared to cash used of $0.2 million in the year ended December 31, 2012. The year ended December 31, 2012 included the impact of the collection on higher fourth quarter 2011 sales in the Heavy Duty Diesel Systems business, including sales related to the London LEZ project which was partially offset by the favorable impact of a decrease in net loss from operations in our Catalyst division which had a loss from operations of $1.8 million in the year ended December 31, 2012 compared to $1.0 million in income from operations in the year ended December 31, 2013.

Cash used in investing activities

Our cash flows from investing activities primarily relate to asset sales and acquisitions, our European joint venture and Asian investment as well as capital expenditures and other assets to support our growth plans.

Cash used in investing activities was $0.9 million in the year ended December 31, 2013 compared to $0.1 million used in investing activities in the year ended December 31, 2012. Cash used in investing activities in the year ended December 31, 2013 includes $0.7 million in investments in our joint venture with Pirelli and $0.2 million for purchases of property and equipment. Cash used in investing activities in the year ended December 31, 2012 consists of cash used of $0.2 million for purchases of property and equipment partially offset by repayments received of $0.1 million on a loan to our Asian investment.              

Cash provided by financing activities

Since inception, we have financed our 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 our cash flows from financing activities primarily relate to borrowings and payments under debt obligations.

Cash used in financing activities was $1.4 million in the year ended December 31, 2013, compared to cash provided of $3.7 million in the year ended December 31, 2012. Cash used in financing activities in the year ended December 31, 2013 reflects a $3.2 million net decrease in borrowings under our credit facility partially offset by  $1.7 million from our public offering and $0.1 million from our issuance of common stock in a private placement. Cash provided by financing activities in the year ended December 31, 2012 includes proceeds of $3.0 million on the issuance of 8% notes and a $0.9 million increase in borrowings under our line of credit with FGI, partially offset by $0.2 million in debt issuance and shelf registration costs.

Table of Contents

On February 14, 2011, we and certain of our subsidiaries (the “Credit Subsidiaries”) entered into separate Sale and Security Agreements with FGI to provide for a $7.5 million secured demand facility backed by our receivables and inventory (as amended, the “FGI Facility”). We and the Credit Subsidiaries also entered into guarantees to guarantee the performance of their obligations under the Sale and Security Agreements. We also granted FGI a first lien collateral interest in substantially all of our assets. On August 15, 2012, we and FGI agreed to amend the FGI Facility. As amended, the initial term was extended from February 14, 2013 to August 15, 2015 and may be extended at our option for additional one-year terms. However, FGI can cancel the facility at any time.

Under the FGI Facility, FGI can elect to purchase eligible accounts receivables from us and the Credit Subsidiaries at up to 80% of the value of such receivables (retaining a 20% reserve). At FGI’s election, FGI may advance us up to 80% of the value of any purchased accounts receivable, subject to the $7.5 million limit. Reserves retained by FGI on any purchased receivable are expected to be refunded to us net of interest and fees on advances once the receivables are collected from customers. We may also borrow against eligible inventory up to the inventory sublimit as determined by FGI subject to the aggregate $7.5 million limit under the FGI Facility and certain other conditions. At December 31, 2013, the inventory sublimit was the lesser of $1.5 million or 50% of the aggregate purchase price paid for accounts receivable purchased under the FGI Facility. While the overall credit limit and the inventory sublimit was not changed, in the first quarter of 2014 borrowing against Honda inventory has been eliminated by FGI due to their concerns about customer concentration.

The interest rate on advances or borrowings under the FGI Facility, is the greater of (i) 6.50% per annum and (ii) 2.50% per annum above the prime rate, as defined in the FGI Facility. Any advances or borrowings under the FGI Facility are due on demand. We also agreed to pay FGI collateral management fees of 0.30% per month on the face amount of eligible receivables as to which advances have been made and 0.38% per month on borrowings against inventory, if any. At any time outstanding advances or borrowings under the FGI Facility are less than $2.4 million, we have agreed to pay FGI standby fees of (i) the interest rate on the difference between $2.4 million and the average outstanding amounts and (ii) 0.44% per month on 80% of the amount by which advances or borrowings are less than the agreed $2.4 million minimum.     

We account for the sale of accounts receivable under the FGI Facility as a secured borrowing with a pledge of the subject receivables as collateral. At December 31, 2013, we had $0.9 million in borrowings outstanding related to accounts receivable. This consisted of $1.9 million of borrowings on $2.5 million of pledged gross accounts receivable less $1.0 million in cash collections held by FGI related to non-pledged receivables. In accordance with ASC 210-20-45, we have presented this as a reduction in borrowings in our consolidated balance sheet at December 31, 2013 due to the right of offset. At December 31, 2013, we also had $1.4 million in borrowings outstanding against eligible inventory. We were in compliance with the terms of the FGI Facility at December 31, 2013. However, t here is no guarantee that we will be able to borrow the full limit of $7.5 million if FGI chooses not to finance a portion of our receivables or inventory.

If we choose to terminate the FGI facility prior to the last day of the initial term, as extended, or any additional term, we must pay a termination fee of 2% of the facility limit then in effect. No termination fee will be due if we notify FGI of our intent to terminate within 10 days of FGI increasing the reserve percentage for accounts to greater than 40% for more than 30 consecutive days. FGI may terminate the facility at any time. The termination fee is not payable upon a termination by FGI or upon non-renewal. 

$3.0 Million, 8% Subordinated Convertible Notes Due 2016

On May 6, 2011, we issued to Kanis S.A $3.0 million aggregate principal amount of our subordinated convertible notes. The notes bear interest at a rate of 8% per annum, which is payable quarterly in arrears. The notes have a stated maturity of five years from the date of issuance. The original agreement allowed for the acceleration of the maturity of the notes if: (i) we were in breach of the notes or other agreements with Kanis S.A., or (ii) Kanis S.A. provided written notice, not less than 30 days prior to such date, that it elected to accelerate the maturity to a date not earlier than November 11, 2012. On February 16, 2012, the agreement was amended to modify the early redemption date from November 11, 2012 to May 12, 2013. On January 30, 2013, we and Kanis S.A. entered into a letter agreement regarding the notes whereby Kanis S.A. agreed not to accelerate the maturity of these convertible notes during the 2013 calendar year and on March 21, 2014, we and Kanis S.A. entered into a letter agreement whereby Kanis S.A. agreed not to accelerate the maturity of these notes prior to July 1, 2015.

We also have the option to redeem the notes at any time at a price equal to 100% of the face amount plus accrued and unpaid interest through the date of redemption. There is no prepayment penalty. The subordinated convertible notes are unsecured obligations and are subordinated to our existing and future secured indebtedness.

The outstanding principal balance of, plus accrued and unpaid interest on, the notes were convertible into shares of our common stock at an initial conversion price equal to $7.044 per share, which was 120% of the closing bid price per share of our common stock on April 8, 2011, into no more than 369,853 shares. On July 27, 2012, we and Kanis S.A. further amended the terms of the notes to modify the conversion feature. As amended, the outstanding principal balance of, and accrued and unpaid interest on, the notes are convertible, at the option of Kanis S.A. at any time upon written notice given not less than 75 calendar days prior to the date of conversion, into no more than 250,000 shares of our common stock at a conversion price of $4.00 per share.         

$3.0 Million, 8% Shareholder Note Due 2015

On July 27, 2012, we executed a Loan Commitment Letter with Kanis S.A., pursuant to which we issued a promissory note in the principal amount of $3.0 million. The unsecured promissory note bears interest at 8% per annum, payable quarterly in arrears. The promissory note has a stated maturity of three years from the date of issuance. There is no prepayment penalty or premium.

Table of Contents

Capital Expenditures

As of December 31, 2013, we had no material commitments for capital expenditures and no material commitments are anticipated in the near future.

Off-Balance Sheet Arrangements

As of December 31, 2013 and 2012, we had no off-balance sheet arrangements.

Commitments and Contingencies

As of December 31, 2013 and 2012, other than office leases, employment agreements with key executive officers and the obligation to fund our portion (5%) of the losses of our Asian investment, we had no material commitments other than the liabilities reflected in our consolidated financial statement included elsewhere in this Annual Report on Form 10-K.

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

ITEM 9A.  CONTROLS AND PROCEDURES

Table of Contents

ITEM 9B. OTHER INFORMATION

See accompanying notes to the consolidated financial statements.

See accompanying notes to the consolidated financial statements.

See accompanying notes to the consolidated financial statements.