Clean Diesel Technology Incorporated's CEO Discusses Q3 2012 Results - Earnings Call Transcript

| About: Clean Diesel (CDTI)

Clean Diesel Technology Incorporated (NASDAQ:CDTI)

Q3 2012 Earnings Call

November 13, 2012 11:00 AM ET


Kristi Cushing - IR

Craig Breese - President and CEO

Nikhil Mehta - CFO


Ian Gilson- Zacks Investment

Philip Shen - Roth Capital

Gary Cooper - Private Investor

Operator: Good day ladies and gentlemen and thank you for standing by and welcome to the Clean Diesel Technology Incorporated’s Third Quarter 2012 Financial Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions). As a reminder today’s conference may be recorded.

It’s now my pleasure to turn the floor over to Kristi Cushing. Please go ahead.

Kristi Cushing

Thank you Harry and good morning everyone. Thank you for joining the Clean Diesel Technology or CDTi conference call and webcast to discuss the Company’s financial results for the third quarter of 2012, which ended on September 30, 2012. By now you should have a copy of our results Press Release which crossed the wire this morning prior to market opened. A copy of the Press Release along with other company information may be found on the Investor Relations page of the Company’s website at

Before I turn the call over to Craig Breese, President and Chief Executive Officer CDTi, I want to emphasize that some of the information discussed in this call are forward looking statements. Particularly statements of our expected growth and business momentum, impact of operational and cost management initiatives, award of additional OEM business, timing and volume of sales under the California Mandated Truck And Bus Regulation or other retrofit initiatives and expected timing, receipt and impact of new product verifications.

These forward looking statements speak only as of today and involve risks and uncertainties that are outside of CDTi’s control. Accordingly undue reliance should not be placed on such forward looking statements as actual results may materially differ. Risks and uncertainties that may affect such forward looking statements include among others, the risk of decreased government spending on Emission Control Projects or decreased regulation of emission and the risks associated with the receipt of regulatory approvals and continued customer acceptance of our products, as well as every risk factors previously detailed in our filings with the SEC.

For a complete discussion and understanding of the risk that the company faces, you should review the risk factors in the Annual Report on Form 10-K which was filed with the SEC on March 29, 2012. All participants are advised that the audio of this conference is being broadcast live over the internet and will be available as an archive replay on our website. The archive may not be re-recorded or otherwise reproduced or distributed without prior written permission from CDTi.

I will now turn the call over to Craig Breese, President and Chief Executive Officer of CDTi.

Craig Breese

Thank you Kristi and good morning to everyone. Thank you for attending our third quarter 2012 conference call. Joining me today will be Nikhil Mehta, our Chief Financial Officer as well. I would like to take this opportunity to share with you my perspective on our business performance and outline the path forward for the remainder of 2012 and beyond. Nikhil will provide greater details on our financial and operating results later in this call.

So let me begin with our total company financial results and then move on to a review of the results for each of our divisions. There were a number of very positive developments in our financial and operating results, as well as in our Catalyst division during this quarter. While our total revenue declined moderately approximately 3.8% compared to a year ago, we were pleased to report strong sales in our Catalyst division, driven by growth in our business with Honda on existing and new programs.

As we've discussed in our second quarter call, we've implemented numerous cost reduction actions and are in the process of deploying additional efficiency initiatives that are expected to provide us with an even greater savings going forward, while continuing to exceed our expectations with regard to quality throughout our business. We have begun to see the benefits of these cost control efforts in the reduction of operating expenses, both sequentially and year-over-year in the third quarter, and we expect to realize additional cost savings in the fourth quarter and for the full year of 2013.

We've undertaken an exhaustive review of all operating costs to enhance our efficiency while ensuring that we have the appropriate resources in place to succeed. We've improved our manufacturing processes, consolidated our sales and marketing team, enhanced supply chain management and improved our management of receivables as well. We believe that there are many opportunities to show additional improvement and profitability going forward. We will continue to work on areas such as lean manufacturing, cycle time reduction and material usage.

And in addition to these cost control initiatives, we're very pleased to report positive cash flow from operations this quarter. Our positive cash flow together with the new loan agreement concluded in the third quarter for $3 million from an existing long term shareholder has strengthened our balance sheet as we ended the quarter with cash and cash equivalence totaling $7.6 million.

Now turning to a review of our actual individual divisions, I will start with our Catalyst division. This division had strong top line performance this quarter and accounted for nearly 40% of our total revenues. We completed our services contract with our Japanese partner TKK, under which we assisted in the installation of a Catalyst manufacturing facility in China. We recorded $1 million in revenue associated with this contract.

Catalyst sales for Honda were up significantly year-over-year. As we recently announced, we began supplying Catalyst for Honda in the new 2013 model of the Accord that incorporates our latest Catalyst offerings. This new model, which is winning industry recognition, and gaining market share in a growing automotive market in North America is utilizing our palladium only catalyst that significantly reduces precious metal content.

In addition to supplying Catalyst for the four cylinder Accord, we are now also shipping Catalyst for six cylinder models that meet one of the most stringent emission regulations in the world. We are also working with Honda on a high performance six cylinder and hybrid vehicle application, which could result in additional volumes in 2013.

This business with Honda represents significant breakthroughs in Catalyst technologies and our Q3 sales were really just a start of a ramp-up of requirements for the new 2013 model. We expect additional momentum to build commensurate with the solid demand and positive industry reviews, that the new Honda Accord is receiving this far in the market.

So in summary, we are very pleased with the improved performance of our Catalyst division and we believe that there is some positive momentum in this business going forward.

The technology that we have developed and enhanced customers like Honda is just one example of the extensive patented and proprietary technology and product portfolio that’s been created at CDTi. Our recently announced patent award for our platinum group metal free catalyzed diesel particulate filter technology is just one example of the innovative technologies we are commercializing today.

We’re in the process of accelerating the number of differentiated patent filings to expand the number of commercial applications our technology is now capable of addressing and we are clearly a technology-rich company, in possession of very disruptive and state-of-the-art technologies and knowhow that we need to better harness to drive greater value for our shareholders going forward.

Our research and development in Catalyst technology has resulted in a broad array of products for the light-duty vehicle and Heavy Duty Diesel market. We have and are seeking to apply a number of our technologies to other applications, to diversify our end markets and grow our revenue opportunities. We’re actively reviewing multiple paths to take advantage of these capabilities, which may include organic or internal development, joint development and marketing, out-licensing and other forms of strategic relationships.

This effort is ongoing and we are intent on unlocking what we believe to be unrecognized and unrealized value for CDTI. We have built a world class team of material scientists and engineers that continue to expand the capability of our technologies and we need to make sure that we're doing the best job possible in moving them from development to commercial success.

Moving on to our Heavy Duty Diesel systems business, our sales in this division were below expectations in the third quarter and represented approximately 60% of our total revenues. Some of the primary contributors to revenue were the previously announced retrofit programs in New Jersey, as well as sales in California. Nearly 38% of this division sales were generated from non-retrofit sources such as sales of products to OEMs and aftermarket customers for off road applications.

Revenues from our Heavy Duty Diesel systems in the third quarter did not meet our expectations, largely as a result of the slower than anticipated ramp up in Heavy Duty Diesel systems revenues associated with the California Air Resources Board, also known as CARB mandating California truck and bus regulations.

Our third quarter sales under the California mandate were $1.7 million. We believe that there were several factors contributing to this reduced performance with the first being the slow adoption by fleet owners obviously. At the end of August we issued a Press Release commenting on the announcement made by the Manufacturers of Emission Controls Association also known as MECA, regarding industry sales of diesel particulate filters under the California program.

The MECA statement highlighted the slow pace of diesel retrofit sales, which was consistent with sales volumes experienced by us, thus far in the year 2012. We continue to experience this slower trend in the fourth quarter to date. We have also been successful in winning lead operator business and continuing to believe that there is a large market opportunity available in California. However, we are cautious about the rate of adoption and the industry projections pertaining to the overall market.

Nonetheless, we believe it can be a positive contributor to our overall growth, and when there is additional market information made available by CARB, we will do our best to communicate that to our shareholders. We believe that there are a number of other reasons as well for the reduced demand including the intensity of state enforcement actions, the level of operator education, the measures taken by operators to gain compliance through other options and the inevitable delay by operators in making decisions regarding the timing of installation. If we take a look at all of these factors and combination, we are pleased by the recent commitment by CARB, to initiate a multi-agency campaign, to ensure that trucks traversing the state’s highways are in compliance with state air pollution loss.

(Inaudible) activity is increasing but it is still too early to gauge its impact on operators and their emission controls decisions and timing of orders. We've also been encouraged by the recent increase on the demand by fleet operators for data loggers. This is the second step in the process after compliance awareness.

Data loggers are used to aid fleet operators in making decisions about their retrofit options. Once this step is completed, we would expect to see a pickup in quotation activity, which is typically followed by purchase orders. A final contributing factor that we believe, negatively affect our Heavy Duty Diesel revenue in California was related to a delay in receiving regulatory approval for one of our most advanced Purifilter emission solutions, whose features our parented mixed, our MPC catalyst technology due to the very unique and preparatory nature of this product, it’s taken longer than expected for CARB to review and verify this product.

We are confident that this product will be approved by CARB in the near future and this product will represent an important addition to our portfolio and will address significant number of Heavy Duty Diesel trucks that are currently subject to the California mandate. In fact, the same Purifilter EGR technology was used in the products which were approved and deployed by our distributors throughout the fleets operating in London low emission zones, which many of you may be familiar with.

We believe the delay has resulted in some lost sales in the third quarter but we continue to see weakness in the California retrofit market in the fourth quarter. We believe that together with our distributors, we have the opportunity to let a number of fleet operators that have been educated and informed about the very positive features of this advanced Purifilter solution and are eager to begin booking orders with these customers.

In summary, while we’re cautious about the rate of adoption and the industry projections pertaining to our overall market opportunity, we continue to believe that the California market will be an important component of our growth strategy over the near and intermediate term. We are prudently managing our cash, operating expenses and investments in line with the operating conditions we currently see with this opportunity to ensure that we have the resources to support our overall growth strategy and operating needs.

In an effort to decrease some of our volatility inherent in the growth of our Heavy Duty Diesel retrofit businesses, we continue to focus our efforts on expanding our Heavy Duty Diesel sales from non-retrofit sources. These sources include OEMs or Original Equipment Manufacturers and aftermarket business for off-road, stationary diesel, gasoline and alternative fuel engines including both propane and natural gas for the reduction of exhaust emissions. We believe these types of applications provide us with greater visibility and predictability to our business and are less prone to a change or delay in regulations.

So in summary, as discussed earlier, our technologies have many applications beyond light-duty vehicle and Heavy Duty Diesel to be explored further. Our growth opportunities include the mandatory California program and building additional relationships for repeatable business with customers such as Honda and other OEMs and aftermarket customers for light-duty vehicle and Heavy Duty Diesel products. Above all, we have a dedicated global team, and I’m confident that we will continue to strive to deliver profitable growth over the long term.

So, now it’s my pleasure to turn this call over to Nikhil Mehta for his comments on our operations. Nikhil?

Nikhil Mehta

Thanks Craig, and good morning everyone. Our third quarter fiscal year 2012 results were as follows. Revenue of $14.4 million, down 3.8% compared to last year; gross margin was 26.9%, compared to 28.5% in the prior year period. Third quarter cash provided by operating activities was $1.6 million, versus $8.4 million of cash used for the same period last year. On a year-to-date basis we have generated approximately $800,000 of cash compared to cash usage of about $13.5 million last year.

Loss from operation was $1.2 million, unchanged from last year and the loss per diluted share was $0.24 versus a loss of $0.29 per share last year. Our Heavy Duty Diesel System business declined 21.6% compared to last year. The decrease was due to decreased retrofit sales of $1.6 million and decreased non retrofit sales of about $800,000. Retrofit sales declined from a strong third quarter in 2011, which was driven by the CARB Early Compliance Program from the second and third quarter last year, compared to below expectation sales in California this year.

Additionally we had $1.6 million of sales in the London low emissions on last year, which were not repeated this year. Partially offsetting these declines were sales in the New Jersey retrofit program this quarter. Non-retrofit sales declined due to a general decline in standard exhaust parts in sales in North America and declines in material handling sales in Europe compared to strong sales last year.

Gross margin in this division was 25.7%, compared to 28.5% for the year ago quarter, as a result of reduced leverage of fixed manufacturing costs resulting from lower sales volume, warranty expense and inventory obsolescence costs. Our Catalyst OEM sales increased 46.7%, compared to last year and largely driven by sales to Honda and the completion of the TKK contract that Craig discussed in his remarks. Excluding the $1 million related to the contract, sales in this division grew by 21%. Gross margins in this division was 23.7%, compared to 18.4% for the year ago quarter, due to the impact of favorable margins under the TKK contract.

Excluding the TKK contract, gross margin was 14.9% for the quarter. The decrease is a result of the escalation of prices of rare earth materials that we use in our catalyst. As discussed in previous quarters, Honda was reimbursing to us the additional amounts actually spent by us due to the severe inflation in rare earth material prices since 2009. Commencing with the third quarter, Honda intends to reimburse the price inflation vis-a-vis 2009, based on a fixed formula. We are still in the process of arriving at an agreed formula with Honda.

As a result we have only been partially reimbursed for this extra cost in the third quarter. We expect to reach an agreement before the end of the year. We continue to control expenses while investing strategically in opportunities for near term and longer term revenue generation. We will continue to aggressively look for opportunities to increase efficiency and reduce costs. Operating expenses for the quarter were $5 million, compared to $5.5 million a year ago.

This decrease was primarily a result of reduction of festivity costs scaling back on London operations, new structuring actions taken in the second quarter and reduced stock compensation and bonus expenses. We recorded an income tax benefit of $123,000 in the third quarter.

Now for the balance sheet; I'm pleased that we had a positive operating cash flow of $1.6 million in the quarter and $825,000 through nine months. This is a result of continued focus on managing working capital including inventory reduction and renegotiation of supplier payment terms. Net working capital was $4.7 million as of September 30, 2012, versus $10.4 million a year ago.

This includes the reclassification of approximately $4.5 million of notes payable from long term debt last year to short term debt this year. Cash and cash equivalents at the end of the quarter was $7.6 million, compared to $3.4 million at the end of the second quarter. On July 31st we announced that we entered into an agreement with an existing investor, pursing to which the investor loaned Clean Diesel $3 million. The loan principle along with unpaid interest which accrues at a rate of 8% per year will be due and payable in full in July 2015. We intend to use proceeds from this loan for working capital and general corporate purposes.

That concludes our formal comments. Operator we're now ready for questions.

Question-and-Answer Session


(Operator instructions) and our first question comes from the line of Ian Gilson with Zacks Investment. Please go ahead, your line is open.

Ian Gilson- Zacks Investment

I have a question basically regarding your market share in California, and primarily it’s due to the fact that you did not have a system that you did not get approval of. Did your competitors have such a system of the sales that you mentioned were lost? Are they deferred or completely lost?

Craig Breese

So Ian, it’s a very good question and I would answer it in two parts. Number one, the market share that we cited in past calls through the traditional California market has been in the range in 20% for CDTI. While we don’t have a current published market database for the current period and we won't really see until 2013, we do believe that we have probably lost some market share due to the fact as you rightly point out that we have not had this EGR solution verified and in the market. So therefore I would say it is less than that traditional market share and even though the market overall appears to be down, our share would be down in Q3, and yet what I would also say is that that particular market mix if you will, which is a significant chunk of the total program has been picked by probably a combination of competitors offerings, some which meet some of the needs, some which meet few of the needs and are being picked regardless. So answer is some declination in market share in Q3, over the traditional levels and some loss of that business because of lack of verification to competitors.

Ian Gilson- Zacks Investment

Okay you had mentioned that some of the operators had other options. What are those options? Can you expand upon that?

Craig Breese

There are a number of players in this market that provide different options. I think we have cited most of the key competitors in previous calls. They would include Donaldson, Johnson Matthey, Cleaire, (inaudible), and ESW. So there is really a number of different players in the field besides ourselves but again we all have different portfolios so we’re not a hundred percent overlapping one over the other.

Nikhil Mehta

Ian, just to build on that I think the other thing is that, of course fleet owners also have the option to go out and buy new vehicles and they also have the option, if they are national fleets to swap out vehicles running in California with newer vehicles that they have from outside the state. So when we give estimates of what the retrofit estimates are, the last two estimate that was published in August that that offer well over 100,000 trucks that are expected to comply, about 60,000, 65,000, 66,000 are expected to go with retrofit ruled out. That was the last industry data that was published.

Ian Gilson- Zacks Investment

Okay so basically due to this lack of compliance, the number of vehicles that’s available for retrofit has in fact declined and could continue to decline until the enforcement is more stringent. Is that correct?

Craig Breese

Yes, let’s be clear. So there’s a couple of factors. Lack of compliance is absolutely one factor that drives down the potential market. A second factor is the one Nikhil just mentioned which is rather than complying, if I own a truck, I’m selling my truck out of California and buying a new truck that complies in California. So that could also shrink the available market, and then in our particular case the third element that’s impacting us is the slower than expected verification and approval of our EGR system.

Ian Gilson- Zacks Investment

Could you expand on that? Why it is slower than you have been expecting because you had been receiving compliance notices in the past three months?

Craig Breese

Yes. What happened was this. As you know, we’re a Catalyst company first and foremost. So when we developed the solution, we actually used what we referred to as base metals which include copper in the coating, which was revolutionary at the time, because up until then everyone was using precious metals in the coating on that substrate, which is a problem obviously from a cost standpoint and so, as early as our London project, we started coating these Catalysts with this copper metal or base metal.

When we went to CARB for the actual verification, it seemed as if we going to get the verification to your point, as it always occurred. There was a review process, there was testing and submittal and then, we received a verification. However in this particular case, since we were coating the substrate with a copper, CARB flagged that as a concern because what they said is look, the byproduct of regenerated copper could be a trace element of dioxin and that in turn, if it reacted with chloride in a sea side environment, could be of concern to us here in California.

Hence they said we'd like you to submit to a further round of testing that's not in the normal protocol in this verification. And we received that request in the early summer. So as a result since then we've gone back and done an exhaustive round of testing both with CARB and as a subset with EPA to ensure that in fact there were no dioxin type issues or concerns which, as a result of the testing that we've now turn through, that test has in fact validated and so the reality is that the tests show no trace whatsoever of dioxin and as a result those documents that have now been submitted to CARB have actually been with CARB for some time and are in the review process and so that's the reason why this verification has taken longer than expected, as it's actually been two different verifications; one on the actual solution and then a specific question that CARB had raised relative to the copper coating and the dioxin testing.

Ian Gilson- Zacks Investment

So the dioxin problem is a political question or good chemistry?

Craig Breese

It’s appropriate I would say that CARB raised the concern. So I don't believe it's political. My view is it's an appropriate concern on the part of CARB but it's certainly one that neither they flagged to us in the early stages nor did we anticipate obviously. I will also tell you that we're filing patents on this and it’s a unique breakthrough in the sense that it gives us now the ability to use this particular solution on off-highway applications and around the other 49 states, as well and to my knowledge nobody in the marketplace has anything like this. So while it's been painful and it's been dragged out from a timing perspective, I believe it actually gives us a competitive advantage now going forward.

Ian Gilson- Zacks Investment

Is this the patents that you announced on November 8th?

Craig Breese

That's correct Ian. That’s exactly the patents I’m referring to.


Thank you sir. Our next question comes from Philip Shen with Roth Capital. Please go ahead, your line is now open.

Philip Shen- Roth Capital

So, one last question on this product approval in process. What’s your expectation as to when the product could actually be approved? Would it be sometime this quarter or could extend out into 2013?

Craig Breese

Good question Philip. What we've actually done at the suggestion of CARB is we've actually filed for a parts exemption, which will give us the ability we believe to get this approval in the next few weeks, so still certainly in Q4. That's are best understanding in talking of the CARB officials. Now withstanding that, and there is parts in it for that in other competitors that have recently gone in that route, some of which very much might be on this call. And so, as a result, but we will continue on that verification, the final verification and that very much depends on CARB’s own schedule but it isn’t finally approved in 2012, it would certainly be forthcoming in early 2013. I don’t give predictions on CARB approvals anymore Philip. I try to stick to the knitting but our parts exemption will give us the ability I believe to get the product and sell it now into the market, still in the remainder of this year.

Philip Shen- Roth Capital

And another question on the California market here. What is the timing and probability of a decision on this case between CARB and the CCTA and when do you think we'll know anything and are there any precedents that might help guide this situation?

Nikhil Mehta

Just very briefly, this is case has being, best as I know dragging on for over a year now. And both the parties, the CCTA I guess is the California Truck Association and CARB are basically digging in that regardless of who wins the first round, this is going to go into appeal. And our best guess is that this is going to drag on for a lot longer and there's no end in sight. In the meantime the program continues to grow and CARB is actually actively enforcing it now. So at this point we are just watching this case. I don’t think the next hearing is for another few months.

Craig Breese

I can just cite on the website, the CCTA website, they issued a short statement dated the October 26th. The headlines stated going on 21 months and still no decision. You can access this right on their website. And it indicates that there's discussion around it from that website, but it doesn’t give any indication at all on a pending decision or even a timing relative to it. The only other piece of information I could maybe proffer here is, in my discussions with CARB officials, they are adamant that the compliance will continue as scheduled and they are not interested nor are they making any statements to the effect that they would consider any delays or altercations to the existing regulations that have been put out there. So we're certainly going on that basis and making those assumptions in our business planning.

Philip Shen - Roth Capital

To what degree do you think the market is using this as a way to -- and when I say the market I refer to truckers or fleets. To what degree do you think they are delaying their purchasing decisions as a result of this? They were some channel checks we've discovered that CARB has been actively enforcing as of the month of August and I think their (inaudible) and correct this if we’re wrong here but tickets were of $1,000 if trucks are not in compliance then they have six to eight weeks to comply and then if they don’t there's another automatic $800 ticket. So I’m wondering can you confirm that the enforcement process that's going on the ground and then two, comment on whether or not you think the CCTA case is actually inhibiting fleets and truckers to make decisions in retrofitting their vehicles?

Craig Breese

Right. So first of all it's absolutely correct to state that the CARB enforcement activities have stepped up as of August. We go on our CARB website and you can actually see the number of citations they're issuing. Last time I looked it was over 187. These will vary by value depending on what has or hasn’t transpired in that particular fleet or fleet owner. Sometimes there will be voluntary declarations and then they will be committing to a schedule of retrofits which could be over a period of as much as three years.

And so in that particular case they would not necessarily be sighted, unless they were falling behind the schedule. There would be other cases which is I believe the majority of the cases you are referring to, where the truck owner or the fleet had simply not voluntarily registered with CARB and committed to any kind of voluntary retrofit program. They're just simply transiting the highway, being stopped by the highway patrol and the CARB enforcement officer and since they have no document in their truck to attest to the fact that they have committed to the voluntary program, they are in turn being cited on the spot. And by the way those violations can go up to as much as $25,000 per incident, depending upon the infraction and the type of situation surrounding it. But $1000 is not an uncommon amount to be cited.

So I think what you're seeing now is definitely a stepping up of enforcement by CARB, but I sense in talking to distributors and trucking fleets that the knowledgeable ones have already declared voluntarily and candidly those tend to be the folks that we spend the most time with because those are the biggest numbers. There's a lot of independent truckers throughout the state and new transit to state who are either uninformed or potentially to your point hold out hope that CCTA might be able to step in and intervene in this process. This is my own view now but I would say that they are probably not the majority of the companies nor the trucks covered under this discussion and as a result I don’t believe that if you were holding back or going and getting retrofit is primarily a function of the CCTA action. It may be an isolated incident. That is certainly not the sense I get when I talk to fleet owners and distributers servicing the retrofit in installer market.

Philip Shen - Roth Capital

And then, to that and in terms of the enforcements, I think we have learned that activity definitely has picked up especially over the past few weeks, three weeks or so. From your perspective, is even that that kind of pick up, less than what you had originally expected? Can you confirm that it will be better than Q3, and if so how much better you think it could be?

Craig Breese

Again this is all perception, right? But I think it’s clear to say two things. One, we had expected enforcement to start a lot earlier than August on this initiative. And when we talked to the CARB officials about that, they cited different reasons for that; budget shortfall, lack of resources, that sort of thing. And so, they told us that we would be or they would be picking up enforcement in August. But again August was the eighth month of the year, and it was very late by that time. So number one, it was late.

Number two, yes, I would say, it’s fair to say that it wasn’t as robust an activity. Initially, my recollection is that they only had six check points in the state, in major freeway entrances into the state which is not very many, if you think about the size of the state and the number of vehicles under the enforcement action. That’s clearly starting to step up to your point now. So I think it was a late enforcement action, under-resourced, and when it did get started probably still not as robust, as what we and perhaps the industry had expected to see it. I think that’s probably still the case today, to some degree.

Philip Shen - Roth Capital

One last question in California and we can move on. You mentioned that you’re optimistic for 2013, given what happened with London last year, meaning, it was mostly a Q4 advance with a spillage into Q1 of this year, and Q4 ramping up this year, given the later than expected CARB enforcement and frankly the end of your deadline. I think there’s another deadline at the end of next year. Would you expect 2013 from a retrofit California standpoint to be mostly a Q4 advantage well, or do you believe we have the ability to pull demand forward?

Craig Breese

Again, here it’s very difficult to answer it in a, I would say scientific way. What we know is that there are many retrofits that are scheduled for 2012. Even now at the end of this year and that's why we're so anxious to get our EGR solution verified, where we believe that there will immediate pickup, not just for us but the industry as a whole.

So my view based on what I'm seeing so far in Q4 is that there should be greater activity this quarter than we've seen in previous quarters for sure, and that's also thanks to the enforcement and people just pushing out till the end of the year, these investments in their retrofit kits if you will.

Now what's going to probably happen though is you're going to see this enforcement continue. It's not going to stop now. Now they're starting the enforcement. The citations are occurring, they're ramping that up. As far as I'm understanding, based on what CARB officials are telling me is, that will continue throughout 2013 and they're really now aggressively trying to go through their database of truck registrations throughout the state and pinpoint the individuals who have not voluntarily declared and run those down.

So as a result I would expect to see a certain level of activity throughout next year. Will that be bunched up towards the end of the year? It just depends on the scheduling of the retrofits, on how intense the enforcement activity is and how many people are getting cited and when. So it’s a little hard to call but I think we've always said that 2013, of the three years of the program should be the most robust of the three years and sitting here today I still believe that will be the case.

Philip Shen - Roth Capital

One last question and this is in the Catalyst business. A couple of quarters ago, you talked about a strategy for driving additional volumes by going after other auto-OEMs, maybe for their overflow business. Can you give us an update on this? It sounds like you did some work with TKK. What's the latest with your overall strategy here?

Craig Breese

So we continue to visit different OEs, both in Asia, North America as well as in Europe actually, and we find different opportunities to quote on our catalytic coatings technology. Clearly the Press Release from Honda helped us a lot, in terms of credibility with these folks and we're getting invitations to meet with them as a result of some of that.

I would also flag another opportunity that we've uncovered in the meantime which is the aftermarket. So aftermarket meaning not the OEs themselves but aftermarket producers that produce if you will exhaust systems with converters inside and we are in discussion with several automotive aftermarket players and trying to determine if we can meet some of all their needs in an aftermarket environment as well. So, we're continuing to work on all those fronts and try to pick off new and profitable business where it makes sense.


Thank you sir. (Operator instructions). Our next question comes from Ian Clarke (ph). Please go ahead your line is open.

Unidentified Analyst

I was curious if you could tell me what the typical time period is between data logging and quotation? Because it seems for the past quarter or two, you’ve talked about increased data logging and then that should be to more quotation and eventually to more retrofits, so I was just curious if you could comment on the average delay you guys see.

Craig Breese

Ian it’s a good question. So earlier in the year, when we referred to this, particularly I believe in my remarks in the Q2 results, we were definitely seeing an uptick in data logging but what we weren't seeing at that time was this enforcement push by CARB, okay? So the gestation period if you will at that point was longer. It could have been several months between the time a trucking fleet was collecting data off the data loggers and then going to the more proactive state of going to an installer and saying, could you please quote me for this system.

So at that point I would say that it varied, but it was probably in the number of months, two maybe three months. I believe now though with the stepped up enforcement activities that we're seeing by CARB that’s why it's so important. What we're now seeing is that period is getting shortened up. So where the fleets owners going and getting data logging, is they are most likely seeking a quotation pretty quickly after that data is in and making their selection depending on quotes from different manufacturers making their selection quicker. So I think that period of time is definitely shortened up in Q4 versus Q3 and I would say instead of two to three months, it's probably one to two months.

Unidentified Analyst

And then on the Catalyst division, if I back out the TKK contract of the past three months, it looks like the Catalyst division is still headed for loss from operations. As you guys expand into other Honda models and potentially into other car companies, what kind of leverage is there in that division, as far as, what cost effects and how are you guys going to be able to get swing to consistent operating profits within the Catalyst division?

Craig Breese

Yes, you are reading it absolutely correctly. Our biggest challenge right now in our Catalyst division is just simply excess capacity. Our utilization of capacity is still well below 50% and as a result every new model or platform or additional volume that we gain from either Honda or anyone else really fills that void and it really isn’t that far away from pushing us into a profitable position in that business. So I would just simply say to you, if all of the projects on the table that we believe, we’re going to see from the Honda organization actually materialize over the next 12 months, and perhaps some other business opportunities that we’re working on, we could be in a very different situation six months, 12 months from now, in terms of is that division truly profitable. You really want to think of that as utilization of your manufacturing. That’s what is going to make us profitable in that business.


Thank you. (Operator instructions). Next question is of Gary Cooper who is a Private Investor, please go ahead.

Gary Cooper - Private Investor

A couple of questions. So what is the cost to the customer for the EGR solution relative to the rest of your portfolio and relative to your competitors’?

Craig Breese

Gary, it’s a good question. But I need to be careful up here, since this is like public forum and very possibly competitors are even listening in or can listen into this recording later. I need to be careful about what I say relative to costs, all right? So I think you can respect that. So it’s really not just cost. It’s price in the market.

What I can tell you is that we are very comparatively priced, to compete with all the solutions that are out in the field today that we would be up against and obviously we believe that we actually have some features and benefits in our particular solution that the other competitors actually can’t reach in terms of duty cycles, service life, and that sort of thing. So if I look at a total cost of ownership model, which most leads tend to do, I believe there is in fact a compelling case to be made, as there was in London, through our ability to succeed with this EGR solution once it’s verified in the market in California

Gary Cooper - Private Investor

Okay. You guys put out a Press Release a few months back, regarding the partnership on the leasing or financing of these retrofit systems and I'm wondering if you did any of those in the quarter, how that relationship's going and what, if any marketing is going to market related leasing up or refinancing opportunity?

Nikhil Mehta

That's another good question. We haven't seen a lot of activity in that area. In fact we've seen almost none. I do talk to our leasing partner pretty often and what we're doing is they work with our salespeople to educate the distributors, the installers and we have this out there in front of everybody and I think what’s happening is that the early compliance has been and this is just my own feeling; the early compliance has been mainly the larger fleets, who don't really need this leasing option and it's the guys who, individual truck owners and the small guys who are actually probably the cause for a slow adoption, are the ones that could use this leasing option. So that option is alive and well it's available to all our customers and in fact I probably have an update call scheduled with these guys tomorrow.

Gary Cooper - Private Investor

You talked about the market declined X amount and you guys apparently declined a bit more. Can you give us some idea of who you think took share on the CARB side?

Craig Breese

Again there for competitive reasons; I don't have any market data per se. It's more anecdotal and I don't want to probably put that out there Gary when it's not really, if you will, pressure tested. I think we should wait for the MECA and the CARB data that will come out in January of next year, which will specify specifically by competitor exactly what happened in the marketplace but I think anything that I would say right now would be pure conjecture and potentially even misleading to people. So I wouldn't want to do that.

Gary Cooper - Private Investor

Okay, last question. So still on the HDD side, if you get away from the CARB business and you think about the non-CARB business, what is going on there? Are you retaining share there? Is the market growing? How do you feel about your business in that part of the world?

Craig Breese

So, that's exciting area for us. You got to remember that our company that we acquired, Engine Control Systems grew up in that business and had significant business in the materials handling, mining, power equipment verticals for many, many years. We sort of got away from that legacy as we moved more into focusing on the retrofit business and that was many years ago by the way; and what we're simply trying to do here, is bring this full circle and make sure that we're touching on those opportunities for either Tier 2 suppliers to equipment manufacturers or the equipment manufacturers themselves to provide state of the art emission control systems.

It's been very encouraging as our sales force has focused in on this, the new opportunities that they are uncovering. Remember for us most of this is new business. We’re growing an area now where we had very low market share for a number of years. So for us frankly there’s only one direction we can go and that’s up and so I’m encouraged by what I think our sales people are seeing in the field, the quotes that we're putting out there, the dialogues we're getting into and some of the early business wins that we're starting to see.

And so that will be a continuing area of both focus and resource as we go forward so we get a good diversification in our portfolio, so that we’re not so reliant and so retrofit-centric in these discussions but they would become more balanced in this area and I really appreciate your question on that because I think as this story unfolds overtime, it's certainly our strategy to make this much more balanced equation in terms of end use applications in markets.


Thank you and presenters I’m showing no additional phone line question at this time. I’d like to turn the program back over to Mr. Breese for any additional or closing remarks.

Craig Breese

Again I appreciate all of the questions and interest in Clean Diesel Technologies as this story continues to develop. It was a tough quarter, there's no question about it. We were disappointed at the delay in the verification which I think we've talked about at some length during the call.

But I’m also optimistic as we move now towards 2013 that a lot of the good things that we've started in 2012 such as cost controls, re-structuring in certain parts of our business, the enormous win with Honda and I think what will develop in to a continuing very good relationship and story in terms of that technology and its adoption.

Also a thing that I touched on in the brief, but I didn’t elaborate on in the questions; our technology portfolio. As I’ve joined this company, I’ve been here a little over six months now, I am just amazed at the amount of technology that sits and resides in this company and yet I don’t believe that we've extracted or monetized the full value of that technology and so what you’re going to be seeing us doing in the coming months and years is making sure that we are protecting all of the innovations that we are creating internally, through patterns and through IP, and ensuring that we extract full and total value for that, either through licensing agreements or other types of cooperation, and I would say that there is a case to be made that we can and will be doing a lot more in this area.

We touched in, had a question relative to our most recent patent filing on the copper based metals for these substrate coatings. I think you're going to be seeing more to come on that front from us in terms of patent filings and this whole discussion around how can we take our base technologies, particularly in the Catalyst low precious metals or even no precious metals and drive those into verticals, not just in the automotive and heavy duty verticals but also in other verticals that could be as far field as fuel cells, petrochemical industries, stationary applications and alike.

So that's an area for additional discussion in the future, but I just wanted to get that out there as we're closing this call out today. So again appreciate everyone's interest in the company. Thank you very much.


Thank you sir. Again ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day.

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