UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549


_______________





FORM
10-Q


_______________





(Mark
One)


x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
      the quarterly period ended June 30,
      2008





or





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
      the transition period from ______ to
______





Commission
file number: 001-33710











CLEAN
DIESEL
TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)








Delaware
            06-1393453(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)300 Atlantic Street -
      Suite 702, Stamford, CT
            06901-3522(Address
      of principal executive offices)
            (Zip
      Code)





(203)
327-7050


(Registrant’s
telephone number, including area code)





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 xNo o





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 o
            
            Accelerated
      Filer xNon-Accelerated
      Filer o
            (Do
      not check if a smaller reporting company.)
            Smaller
      reporting company o





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





As of
August 8, 2008, there were 8,139,302 outstanding shares of common stock, par
value $0.01 per share.













CLEAN DIESEL TECHNOLOGIES, INC.





Quarterly
Report on Form 10-Q


for the
Quarter Ended June 30, 2008





INDEX








PagePART I.
            
            FINANCIAL
      INFORMATIONItem 1.
            
            Financial Statements
            3Condensed Consolidated Balance Sheets as of June 30, 2008
      (Unaudited) and December 31, 2007
            3Condensed Consolidated Statements of Operations for the
      Three and Six Months Ended June 30, 2008 and 2007
      (Unaudited)
            4Condensed Consolidated Statements of Cash Flows for the
      Six Months Ended June 30, 2008 and 2007 (Unaudited)
            5Notes to Condensed Consolidated Financial Statements
      (Unaudited)
            6Item 2.
            
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            16Item 3.
            
            Quantitative and Qualitative Disclosures about Market
      Risk
            22Item 4.
            
            Controls and Procedures
            22PART II.
            
            OTHER
      INFORMATIONItem 4.
            
            Submission of Matters to a Vote of Security
      Holders
            23Item 6.
            
            Exhibits
            23SIGNATURES
            24




- 2
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 Index





PART
      I.
              FINANCIAL
      INFORMATION


Item 1.
              Financial
      Statements





CLEAN DIESEL TECHNOLOGIES, INC.


Condensed
Consolidated Balance Sheets


(in
thousands, except share data)





June
      30,
            
            
            December 31,2008
            
            
            2007(Unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
            
            $
            4,485
            
            
            $
            1,517Accounts
      receivable, net of allowance of $290 and $49, respectively
            
            
            3,330
            
            
            
            1,927Investments
            
            ─
            
            
            
            7,100Inventories,
      net
            
            
            1,038
            
            
            
            1,093Other
      current assets
            
            
            242
            
            
            
            234Total
      current assets
            
            
            9,095
            
            
            
            11,871Investments
            
            
            10,975
            
            
            
            11,725Patents,
      net
            
            
            950
            
            
            
            817Fixed
      assets, net of accumulated depreciation of $461 and $421,
      respectively
            
            
            186
            
            
            
            175Other
      assets
            
            
            71
            
            
            
            75Total
      assets
            
            $
            21,277
            
            
            $
            24,663Liabilities
      and Stockholders’ EquityCurrent
      liabilities:Accounts
      payable
            
            $
            1,006
            
            
            $
            757Accrued
      expenses
            
            
            867
            
            
            
            850Customer
      deposits
            
            
            71
            
            
            
            56Total
      current liabilities
            
            
            1,944
            
            
            
            1,663CommitmentsStockholders’
      equity:Preferred
      stock, par value $0.01 per share:authorized
      100,000 shares; no shares issued and outstanding
            
            ─
            
            
            ─Common
      stock, par value $0.01 per share:authorized
      12,000,000 shares; issued and outstanding 8,139,302 and 8,124,056 shares,
      respectively
            
            
            81
            
            
            
            81Additional
      paid-in capital
            
            
            73,242
            
            
            
            72,447Accumulated
      other comprehensive loss
            
            
            (745
            )
            
            
            (16
            )Accumulated
      deficit
            
            
            (53,245
            )
            
            
            (49,512
            )Total
      stockholders’ equity
            
            
            19,333
            
            
            
            23,000Total
      liabilities and stockholders’ equity
            
            $
            21,277
            
            
            $
            24,663





The
accompanying notes are an integral part of the condensed consolidated financial
statements.





- 3
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 Index





CLEAN DIESEL TECHNOLOGIES, INC.


Condensed
Consolidated Statements of Operations


(in
thousands, except per share amounts) (Unaudited)





Three
      Months Ended
                June
      30,
              
              
              Six
      Months Ended
                June
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007Revenue:Product
      sales
              
              $
              2,490
              
              
              $
              139
              
              
              $
              5,017
              
              
              $
              344Technology
      licensing fees and royalties
              
              
              129
              
              
              
              1,104
              
              
              
              203
              
              
              
              1,115Consulting
      and other
              
              ─
              
              
              ─
              
              
              ─
              
              
              ─Total
      revenue
              
              
              2,619
              
              
              
              1,243
              
              
              
              5,220
              
              
              
              1,459Costs
      and expenses:Cost
      of revenue ─ product sales
              
              
              1,993
              
              
              
              105
              
              
              
              4,058
              
              
              
              221Cost
      of revenue ─ licensing fees and royalties
              
              ─
              
              
              ─
              
              
              ─
              
              
              ─Cost
      of revenue ─ consulting and other
              
              ─
              
              
              ─
              
              
              ─
              
              
              ─Selling,
      general and administrative
              
              
              2,722
              
              
              
              1,495
              
              
              
              5,044
              
              
              
              3,298Research
      and development
              
              
              89
              
              
              
              150
              
              
              
              154
              
              
              
              192Patent
      amortization and other expense
              
              
              42
              
              
              
              79
              
              
              
              78
              
              
              
              176Operating
      costs and expenses
              
              
              4,846
              
              
              
              1,829
              
              
              
              9,334
              
              
              
              3,887Loss
      from operations
              
              
              (2,227
              )
              
              
              ( 586
              )
              
              
              (4,114
              )
              
              
              (2,428
              )Other
      income (expense):Interest
      income
              
              
              113
              
              
              
              67
              
              
              
              356
              
              
              
              94Other
      income (expense), net
              
              
              (29
              )
              
              ─
              
              
              
              25
              
              
              ─Net
      loss
              
              $
              (2,143
              )
              
              $
              ( 519
              )
              
              $
              (3,733
              )
              
              $
              (2,334
              )Basic
      and diluted loss per common share
              
              $
              (0.26
              )
              
              $
              (0.08
              )
              
              $
              (0.46
              )
              
              $
              (0.37
              )Basic
      and diluted weighted-average number of common shares
      outstanding
              
              
              8,138
              
              
              
              6,550
              
              
              
              8,137
              
              
              
              6,333





The
accompanying notes are an integral part of the condensed consolidated financial
statements.





- 4
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 Index





CLEAN DIESEL TECHNOLOGIES, INC.


Condensed
Consolidated Statements of Cash Flows


(in
thousands) (Unaudited)





Six
      Months Ended
              June
      30,2008
            
            
            2007Operating
      activitiesNet
      loss
            
            $
            (3,733
            )
            
            $
            (2,334
            )Adjustments
      to reconcile net loss to cash used in operating
activities:Depreciation
      and amortization
            
            
            68
            
            
            
            68Provision
      for doubtful accounts, net
            
            
            241
            
            
            
            30Compensation
      expense for stock options and warrants
            
            
            771
            
            
            
            642Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (1,644
            )
            
            
            (961
            )Inventories
            
            
            55
            
            
            
            (244
            )Other
      current assets and other assets
            
            
            (4
            )
            
            
            (7
            )Accounts
      payable, accrued expenses and other liabilities
            
            
            281
            
            
            
            (298
            )Net
      cash used for operating activities
            
            
            (3,965
            )
            
            
            (3,104
            )Investing
      activitiesSales
      of investments
            
            
            7,100
            
            
            ─Patent
      costs
            
            
            (161
            )
            
            
            (68
            )Purchases
      of fixed assets
            
            
            (51
            )
            
            
            (18
            )Net
      cash provided by (used for) investing activities
            
            
            6,888
            
            
            
            (86
            )Financing
      activitiesProceeds
      from issuance of common stock, net
            
            ─
            
            
            
            4,313Proceeds
      from issuance of warrants, net
            
            ─
            
            
            
            4,346Stockholder-related
      charges
            
            ─
            
            
            
            (45
            )Proceeds
      from exercise of stock options
            
            
            24
            
            
            
            40Net
      cash provided by financing activities
            
            
            24
            
            
            
            8,654Effect
      of exchange rate changes on cash
            
            
            21
            
            
            ─Net
      increase in cash and cash equivalents
            
            $
            2,968
            
            
            $
            5,464Cash
      and cash equivalents at beginning of the period
            
            
            1,517
            
            
            
            5,314Cash
      and cash equivalents at end of the period
            
            $
            4,485
            
            
            $
            10,778Supplemental
      non-cash activities:Payment
      of accrued directors’ fees in common stock
            
            $
            ─
            
            
            $
            140Unrealized
      loss on available-for-sale securities
            
            $
            750
            
            
            $
            ─





The
accompanying notes are an integral part of the condensed consolidated financial
statements.





- 5
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 Index





CLEAN DIESEL TECHNOLOGIES, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Note
1.  Significant Accounting Policies





Basis
of Presentation:





In this
Quarterly Report on Form 10-Q, the terms “CDT,” “Clean Diesel,” “Company,” “we,”
“us,” or “our” mean Clean Diesel Technologies, Inc. and its wholly-owned
subsidiary, Clean Diesel International, LLC.





The
accompanying unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) and in accordance with accounting principles generally accepted
in the United States of America (GAAP) for interim financial
information.  Certain information and note disclosures normally
included in financial statements prepared in accordance with GAAP have been
omitted or condensed.  These interim consolidated financial statements
should be read in conjunction with Clean Diesel’s consolidated financial
statements and notes thereto included in its Annual Report on Form 10-K for the
year ended December 31, 2007.





The
unaudited consolidated financial statements reflect all adjustments which, in
the opinion of management, are necessary for a fair statement of the results of
operations, financial position and cash flows for the interim periods
presented.  All such adjustments are of a normal recurring
nature.  The results for interim periods are not necessarily
indicative of results which may be expected for any other interim period or for
the full year.





Reverse
Split of Common Stock:





On June
15, 2007, the Company effected a five-for-one reverse split of its common
stock.  All historical share numbers and per share amounts in these
financial statements have been adjusted to give effect to this reverse
split.





Revenue
Recognition:





The
Company generates revenue from product sales comprised of fuel-borne catalysts,
including the Platinum Plus fuel-borne catalyst products and concentrate, and
hardware including the U.S. Environmental Protection Agency (EPA) verified
Purifier System, ARIS advanced reagent injection system injectors and dosing
systems; license and royalty fees from the ARIS system and other technologies;
and consulting fees and other.





Revenue
is recognized when earned.  Revenue from product sales is recognized
when title has passed and our products are shipped to our customer, unless the
purchase order or contract specifically requires us to provide installation for
hardware purchases.  For hardware projects in which we are responsible
for installation (either directly or indirectly by third-party contractors),
revenue is recognized when the hardware is installed and/or accepted, if the
project requires inspection and/or acceptance.  For technology
licensing fees paid by licensees that are fixed and determinable, accepted by
the customer and nonrefundable, revenue is recognized upon execution of the
license agreement, unless it is subject to completion of any performance
criteria specified within the agreement, in which case it is deferred until such
performance criteria are met.  Royalties are frequently required
pursuant to license agreements or may be the subject of separately executed
royalty agreements.  Revenue from royalties is recognized ratably over
the royalty period based upon periodic reports submitted by the royalty obligor
or based on minimum royalty requirements.  Other revenue primarily
consists of engineering and development consulting services.  Revenue
from technical consulting services is generally recognized and billed as the
services are performed.





Generally,
our license agreements are non-exclusive and specify the geographic territories
and classes of diesel engines covered, such as on-road vehicles, off-road
vehicles, construction, stationary engines, marine and railroad
engines.  At the time of the execution of our license agreement, we
convey the right to the licensee to use our patented
technologies.  The up-front fees are not subject to refund or
adjustment.  We recognize the license fee as revenue at the inception
of the license agreement when we have reasonable assurance that the technologies
transferred have been accepted by the licensee and collectability of the license
fee is reasonably assured.  The nonrefundable up-front fee is in
exchange for the culmination of the earnings process as the Company has
accomplished what it must do to be entitled to the benefits represented by the
revenue.  Under our license agreements, there is no significant
obligation for future performance required of the Company.  Each
licensee must determine if the rights to our patented technologies are usable
for their business purposes and must determine the means of use without further
involvement by the Company.  In most cases, licensees must make
additional investments to enable the capabilities of our patents, including
significant engineering, sourcing of and assembly of multiple
components.  Our obligation to defend valid patents does not represent
an additional deliverable to which a portion of an arrangement fee should be
allocated.  Defending the patents is generally consistent with our
representation in the license agreement that such patents are legal and
valid.





- 6
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 Index





Cost
of Revenue:





Our cost
of revenue – product sales includes the costs we incur to formulate our finished
products into saleable form for our customers, including material costs, labor
and processing costs charged to us by our outsourced blenders, installers and
other vendors, packaging costs incurred by our outsourced suppliers, freight
costs to customers and inbound freight charges from our
suppliers.  Our inventory is primarily maintained off-site by our
outsourced suppliers.  To date, our purchasing, receiving, inspection
and internal transfer costs have been insignificant and have been included in
cost of revenue – product sales.  In addition, the costs of our
warehouse of approximately $21,000 per year are included in selling, general and
administrative expenses.  Cost of revenue – licensing fees and
royalties is zero as there are no incremental costs associated with the
revenue.  Cost of revenue – consulting and other includes incremental
out of pocket costs to provide consulting services.





Patent
Expense:





Patents,
which include all direct incremental costs associated with initial patent
filings and costs to acquire rights to patents under licenses, are stated at
cost and amortized using the straight-line method over the remaining useful
lives, ranging from one to twenty years.  During the six months ended
June 30, 2008, we capitalized $161,000 of patent costs.  Indirect and
other patent-related costs are expensed as incurred.  Patent
amortization expense for the three and six months ended June 30, 2008 was
$14,000 and $28,000, respectively, and for the three and six months ended June
30, 2007 was $17,000 and $33,000, respectively.  At June 30, 2008 and
December 31, 2007, the Company’s patents, net of accumulated amortization, were
$950,000 and $817,000, respectively.





Selling,
General and Administrative Expense:





Selling,
general and administrative expense is summarized as the following:





(in
      thousands)
            
            Three
      Months Ended
            
            
            Six
      Months EndedJune
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Non-cash
      stock-based compensation
            
            $
            238
            
            
            $
            91
            
            
            $
            538
            
            
            $
            642Compensation
      and benefits
            
            
            1,193
            
            
            
            653
            
            
            
            2,080
            
            
            
            1,254Total
      compensation and benefits
            
            
            1,431
            
            
            
            744
            
            
            
            2,618
            
            
            
            1,896Professional
            
            
            385
            
            
            
            365
            
            
            
            1,032
            *
            
            
            588Travel
            
            
            251
            
            
            
            158
            
            
            
            365
            
            
            
            296Occupancy
            
            
            265
            
            
            
            123
            
            
            
            510
            
            
            
            235Sales
      and marketing expenses
            
            
            144
            
            
            
            72
            
            
            
            229
            
            
            
            160Bad
      debt provision
            
            
            223
            
            
            
            30
            
            
            
            241
            
            
            
            30Depreciation
      and all other
            
            
            23
            
            
            
            3
            
            
            
            49
            
            
            
            93Total
      selling, general and administrative expenses
            
            $
            2,722
            
            
            $
            1,495
            
            
            $
            5,044
            
            
            $
            3,298





*  Includes
$227,000 of non-cash stock-based compensation charges for fair value of
warrants.





We
account for stock-based compensation in accordance with the provisions of the
Financial Accounting Standards Board (“FASB”) Statement of Financial
Accounting Standard (“SFAS”) No. 123 (Revised 2004), “Accounting for Stock-Based
Compensation” (“SFAS No. 123R”).  Aggregate non-cash stock-based
compensation charges incurred by the Company in the three and six months ended
June 30, 2008 were $241,000 and $771,000, respectively, (including $3,000 and
$6,000, respectively, in research and development expenses) and in the three and
six months ended June 30, 2007 were $91,000 and $642,000, respectively (see Note
4).





- 7
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 Index





Basic
and Diluted Loss per Common Share:





Basic and
diluted loss per share is calculated in accordance with the provisions of SFAS
No. 128, “Earnings Per Share.”  Basic loss per share is computed by
dividing net loss by the weighted-average number of shares outstanding during
the reporting period.  Diluted loss per share is computed in a manner
similar to basic earnings per share except that the weighted-average number of
shares outstanding are increased to include additional shares from the assumed
exercise of stock options and warrants, if dilutive, using the treasury stock
method.  The Company’s computation of diluted net loss per share for
the three and six months ended June 30, 2008 and 2007 does not include common
share equivalents associated with 802,178 and 717,419 options, respectively, and
424,992 and 1,184,405 warrants, respectively, as the result would be
anti-dilutive.





Income
Taxes:





We
adopted FASB Interpretation No. 48 (“FIN 48”) effective January 1,
2007.  There were no unrecognized tax benefits at the date of adoption
of FIN 48, and there were no unrecognized tax benefits at June 30, 2008. It is
the Company’s policy to classify in the financial statements accrued interest
and penalties attributable to a tax position as income taxes.





Utilization
of CDT's U.S. federal tax loss carryforwards for the period prior to December
12, 1995 is limited as a result of the ownership change in excess of 50%
attributable to the 1995 Fuel-Tech N.V. rights offering to a maximum annual
allowance of $734,500.  Utilization of CDT's U.S. federal tax loss
carryforwards for the period after December 12, 1995 and before December 30,
2006 is limited as a result of the ownership change in excess of 50%
attributable to the private placement which was effective December 29, 2006 to a
maximum annual allowance of $2,518,985.  Utilization of CDT's tax
losses subsequent to 2006 may be limited due to cumulative ownership changes in
any future three-year period.  It is not anticipated that CDT's U.S.
taxable income for the full calendar year 2008 will be in excess of the limited
allowable loss carryforwards.





We file
our tax returns as prescribed by the tax laws of the jurisdictions in which we
operate.  Our tax years ranging from 2004 through 2007 remain open to
examination by various taxing jurisdictions as the statute of limitations has
not expired.





Investments:





Investments
represent auction rate securities which are variable-rate debt securities, the
majority of which are AAA/Aaa rated, that are collateralized by student loans
substantially guaranteed by the U.S. Department of Education.  These
investments are classified as "available for sale" under SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity
Securities."  Liquidity for these auction-rate securities is typically
provided by an auction process that resets the applicable interest rate at
pre-determined intervals.  While the underlying securities have a
long-term nominal maturity, the interest rate is reset through dutch auctions
that are held at pre-determined intervals, typically every 28
days.  The securities can be resold in the auction at par and are
callable at par any time at the option of the issuer.  Interest is
paid at the end of each auction period.  The investments are reported
at fair value (see further discussion below under caption “Newly Adopted
Accounting Standards”).  Classification of marketable securities as
current or non-current is dependent upon management’s intended holding period,
the security’s maturity date and liquidity considerations based on market
conditions.  If management intends to hold the securities for longer
than one year as of the balance sheet date, or, if the state of the auction
market effectively prevents their liquidation on resale, they are classified as
non-current.  All income generated from these investments was recorded
as interest income.  The contractual maturities
of the auction rate securities held by us range from 2027 to
2047.Accrued interest receivable at June 30, 2008 and
December 31, 2007 was approximately $9,000 and $49,000,
respectively.





During
the first two months of 2008, the Company sold $7.1 million in auction rate
securities.  However, starting on February 15, 2008 and continuing
through the second quarter of 2008, the Company experienced difficulty in
selling additional securities because of the failure of the auction mechanism as
a result of sell orders exceeding buy orders.  These failed auctions
represent liquidity risk exposure and are not defaults or credit
events.  Holders of the securities continue to receive interest on the
investment, currently at a pre-determined rate, and the securities will be
auctioned at the pre-determined intervals until the auction succeeds, the issuer
calls the securities, or they mature.  Accordingly, because there may
be no effective mechanism for selling these securities, the securities may be
viewed as non-current assets.  The investments associated with failed
auctions will not be accessible until a successful auction occurs or a buyer is
found outside of the auction process.  We classified the fair value of
approximately $11.0 million (par value of $11.7 million) and $11.7 million of
these auction rate securities as non-current investments as of June 30, 2008 and
December 31, 2007, respectively.  At June 30, 2008, the estimated
fair market value of the investments held by the Company declined by $750,000
from par value based upon management’s internal assessment and information
provided by the investment bank through which the Company holds such
securities.  Although these securities have continued to pay interest
according to their stated terms and most of these securities continue to be
AAA/Aaa rated, for six months ended June 30, 2008, the Company recorded an
unrealized temporary loss of $750,000 which is reflected in our consolidated
balance sheet in accumulated other comprehensive loss, resulting in a reduction
in stockholders’ equity.  Factors we considered in determining whether
this loss was temporary included the length of time and extent to which fair
value has been less than the cost basis, the financial condition and near-term
prospects of the issuers, and our intent and ability to retain the investment
for a period of time sufficient to allow for any anticipated recovery in fair
value.  At this time, because the Company has the ability and intent
to hold these securities until recovery of their value, the Company does not
believe such securities are other-than-temporarily impaired or that the failure
of the auction mechanism will have a material impact on the Company’s liquidity
or financial position.





- 8
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 Index





On May 8,
2008, we entered into a $3 million demand loan facility with a lender
collateralized by our auction rate securities.  The loan facility may
be used for our working capital purposes.  We must continue to meet
certain collateral maintenance requirements, such that our outstanding
borrowings may not exceed 50% of the value of our auction rate securities as
established by the lender.  No facility fee is required and borrowings
will be at a floating interest rate per annum equal to the sum of the prevailing
daily 30-day Libor plus 25 basis points.  On July 25, 2008, we
borrowed $3 million under this facility (see Note 10).





Newly
Adopted Accounting Standards:





Effective
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements” for assets and liabilities measured at fair value on a recurring
basis.  SFAS 157 accomplishes the following key
objectives:




·
            Defines
      fair value as the price that would be received to sell an asset or paid to
      transfer a liability in an orderly transaction between market participants
      at the measurement date;


·
            Establishes
      a three-level hierarchy (“valuation hierarchy”) for fair value
      measurements;


·
            Requires
      consideration of the Company’s creditworthiness when valuing liabilities;
      and


·
            Expands
      disclosures about instruments measured at fair
  value.





The
valuation hierarchy is based upon the transparency of inputs to the valuation of
an asset or liability as of the measurement date.  A financial
instrument’s categorization within the valuation hierarchy is based upon the
lowest level of input that is significant to the fair value
measurement.  The three levels of the valuation hierarchy and the
distribution of the Company’s financial assets within it are as
follows:





·
            Level
      1 – inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.


·
            Level
      2 – inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the asset or liability, either directly or indirectly, for
      substantially the full term of the financial
  instrument.


·
            Level
      3 – inputs to the valuation methodology are unobservable and significant
      to the fair value measurement.





The
Company’s assets carried at fair value on a recurring basis are its investments
in auction rate securities as described above under the caption
“Investments.”  The securities have been classified within level 3 as
their valuation requires substantial judgment and estimation of factors that are
not currently observable in the market due to the lack of trading in the
securities.  The valuation may be revised in future periods as market
conditions evolve.





- 9
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 Index





Certain
financial instruments are carried at cost on our condensed consolidated balance
sheets, which approximates fair value due to their short-term, highly liquid
nature.  These instruments include cash and cash equivalents, accounts
receivable, prepaid expenses, accounts payable, customer deposits and accrued
expenses.





The table
below includes a roll forward of the Company’s investments in auction rate
securities from January 1, 2008 to June 30, 2008, and a reclassification of
these investments from level 2 to level 3 in the valuation
hierarchy.  When a determination is made to classify a financial
instrument within level 3, the determination is based upon the significance of
the unobservable parameters to the overall fair value
measurement.  However, the fair value determination for level 3
financial instruments may include observable components.





The
estimated fair value at June 30, 2008 is based upon management’s internal
assessment and information provided by the investment bank through which the
Company holds such securities.





(in
      thousands)Significant Other Observable Inputs
      (Level 2)
            
            
            Significant Unobservable Inputs
      (Level 3)Fair
      value January 1, 2008
            
            $
            18,825
            
            
            $
            —Purchases
            
            
            —
            
            
            
            —Sales
            
            
            (7,100
            )
            
            
            —Transfers
      (out) in
            
            
            (11,725
            )
            
            
            11,725Unrealized
      loss included as reduction in stockholders’ equity and not in
      operations
            
            
            —
            
            
            
            (750
            )Fair
      value June 30, 2008
            
            $
            —
            
            
            $
            10,975





In
February 2008, the FASB issued Staff Position 157-2 (“FSP
157-2”).  FSP 157-2 permits delayed adoption of SFAS 157 for certain
non-financial assets and liabilities, which are not recognized at fair value on
a recurring basis, until fiscal years and interim periods beginning after
November 15, 2008.  As permitted by FSP 157-2, the Company has
elected to delay the adoption of SFAS 157 for qualifying non-financial assets
and liabilities, such as fixed assets and patents.  The Company is in
the process of evaluating the impact, if any, that the application of SFAS 157
to its non-financial assets will have on the Company’s consolidated results of
operations or financial position.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115.”  SFAS No. 159 permits an entity to elect fair
value as the initial and subsequent measurement attribute for many financial
assets and liabilities.  Entities electing the fair value option would
be required to recognize changes in fair value in earnings.  Entities
electing the fair value option are required to distinguish, on the face of the
statement of financial position, the fair value of assets and liabilities for
which the fair value option has been elected and similar assets and liabilities
measured using another measurement attribute.  SFAS No. 159 became
effective beginning January 1, 2008.  The Company elected not to
measure any eligible items using the fair value option in accordance with SFAS
No. 159 and therefore, SFAS No. 159 did not have an impact on the Company’s
consolidated financial position, results of operations or cash
flows.





Recent
Accounting Pronouncements:





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS No. 141R”).  SFAS No. 141R provides revised
guidance on how acquirers recognize and measure the consideration transferred,
identifiable assets acquired, liabilities assumed, noncontrolling interests, and
goodwill acquired in a business combination.  SFAS No. 141R also
expands required disclosures surrounding the nature and financial effects of
business combinations.  SFAS No. 141R is effective, on a prospective
basis, for us in the fiscal year beginning January 1, 2009.  The
Company is currently assessing the impact of SFAS No. 141R on its consolidated
financial position and results of operations.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements.”  SFAS No. 160 establishes
requirements for ownership interests in subsidiaries held by parties other than
the Company (sometimes called “minority interests”) be clearly identified,
presented, and disclosed in the consolidated statement of financial position
within equity, but separate from the parent’s equity.  All changes in
the parent’s ownership interests are required to be accounted for consistently
as equity transactions and any noncontrolling equity investments in
deconsolidated subsidiaries must be measured initially at fair
value.  SFAS No. 160 is effective, on a prospective basis, for us in
the fiscal year beginning January 1, 2009.  However, presentation and
disclosure requirements must be retrospectively applied to comparative financial
statements.  The Company is currently assessing the impact of SFAS No.
160 on its consolidated financial position and results of
operations.





- 10
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 Index





Note
2.  Inventories





Inventories
are stated at the lower of cost or market with cost determined using the average
cost method.  Inventories consist of the following:





(in
      thousands)June
      30,
            
            
            December
      31,2008
            
            
            2007Finished
      goods (Platinum Plus fuel-borne catalyst)
            
            $
            163
            
            
            $
            165Raw
      materials (primarily, Platinum concentrate)
            
            
            527
            
            
            
            656Hardware
            
            
            369
            
            
            
            260Other
            
            
            1
            
            
            
            34$
            1,060
            
            
            $
            1,115Less:
      inventory reserves
            
            
            (22
            )
            
            
            (22
            )Inventories,
      net
            
            $
            1,038
            
            
            $
            1,093





Note
3.  Stockholders’ Equity





In the
first six months of 2008, we issued 15,246 shares of our common stock upon the
exercise of 27,166 stock options.  In connection therewith, we
received approximately $24,000 in cash and the surrender of 11,920 stock
options.





There was
no activity in the Company's 424,992 outstanding warrants during the six months
ended June 30, 2008.





At the
Company’s annual meeting of stockholders held on June 7, 2007, the stockholders
approved a five-for-one reverse split of the Company’s common stock, a reduction
of the par value of the Company’s preferred and common stock from $0.05 per
share to $0.01 per share and an increase in the number of shares of common stock
the Company is authorized to issue from 9 million to 12 million.  Such
actions became effective at the close of business on June 15, 2007 when the
Company filed a Certificate of Amendment to its Restated Certificate of
Incorporation with the Secretary of State of Delaware.  The historical
share numbers and per share amounts in these financial statements have been
adjusted to give effect to the reverse split.  In conjunction with the
reverse split, we incurred costs aggregating approximately $21,000, primarily
from our transfer agents and outside legal counsel which were charged to
additional paid-in capital in the six months ended June 30, 2007.  We
also charged an aggregate of $24,000 to additional paid-in capital for costs
incurred to date in connection with our filing of a Registration Statement on
Form S-1 with the SEC on June 29, 2007 and our submission of an application for
listing on the NASDAQ Capital Market on June 29, 2007.





In the
first six months of 2007, the Company issued 667,993 shares of its common stock
in consideration of approximately $4.5 million ($4.3 million, net of expenses)
cash received from investors to settle stock subscriptions entered into pursuant
to CDT’s December 2006 private placement.  In the December 2006
placement, the Company secured commitments for the purchase of 1,400,000 shares
of its common stock, par value $0.01, and warrants for the purchase of an
additional 1,400,000 shares of common stock for aggregate gross cash proceeds of
$9.5 million (net proceeds of approximately $9.0 million).  The
securities were sold in investment units consisting of one share of common
stock, one Class A Warrant and one Class B Warrant, each warrant entitling the
holder to purchase one additional share of common stock for every two shares of
common stock acquired in the offering at a purchase price of $6.75 per
unit.





In the
six months ended June 30, 2007, the Company received approximately $4.3 million,
net of expenses, upon the exercise of Class A Warrants to acquire 447,134 shares
of our common stock (subsequent to June 30, 2007, we received $2.5 million, net,
for further warrant exercises).  The Class A Warrants entitled the
holder until July 2, 2007 to purchase, at a price of $10.00 per share, one share
of common stock for every two shares of common stock acquired in the December
2006 private placement.





- 11
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 Index





On
January 12, 2007, we issued 17,142 shares of our common stock to three
non-executive members of our board of directors as payment (or partial payment
in the case of one director) of $115,000 in lieu of cash for directors’ fees
earned in 2006.  On June 19, 2007, the Company issued 2,457 shares of
common stock, valued at $25,000, to two non-executive members of the Board of
Directors in lieu of fees for services rendered during the first quarter of
2007.  The number of shares of our common stock issued to the
directors was determined based upon the average of the high and low share prices
during each quarter.  The grant date for such shares of common stock
for purposes of measuring compensation is the last day of the quarter in which
the shares are earned, which is the date that the director begins to benefit
from, or be adversely affected by, subsequent changes in the price of the
stock.  Directors’ compensation charged to operations did not
materially differ from such measurement.





In the
first six months of 2007, CDT issued 16,007 shares of its common stock upon
exercise of stock options for aggregate proceeds to the Company of approximately
$40,000.





Note
4.  Stock-Based Compensation





Share-based
compensation cost recognized under SFAS 123(R) was approximately $241,000 and
$91,000 for the three months ended June 30, 2008 and 2007, respectively, and
$771,000 and $642,000 for the six months ended June 30, 2008 and 2007,
respectively.  Of such 2008 six-month total, $765,000 is classified in
selling, general and administrative expenses ($538,000 as employee compensation
and $227,000 as investor relations compensation for advisory services) and
$6,000 is included in research and development expenses.  Compensation
costs for stock options which vest over time are recognized over the vesting
period.  As of June 30, 2008, there was approximately $1.2 million of
unrecognized compensation cost related to stock options granted under the
Plan.  The cost is expected to be recognized over a weighted-average
period of 0.8 years.





The
Company maintains a stock award plan approved by its stockholders, the 1994
Incentive Plan (the “Plan”).  Under the Plan, awards may be granted to
participants in the form of incentive stock options, non-qualified stock
options, stock appreciation rights, restricted stock, performance awards,
bonuses or other forms of share-based awards or cash, or combinations of these
as determined by the board of directors.  Awards are granted at fair
market value on the date of grant and typically expire ten years after date of
grant.  Participants in the Plan may include the Company’s directors,
officers, employees, consultants and advisors (except consultants or advisors in
capital-raising transactions) as the board of directors may
determine.  The maximum number of awards allowed under the Plan is
17.5% of the Company’s outstanding common stock less the then outstanding
awards, subject to sufficient authorized shares.





- 12
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 Index





The
following table summarizes information concerning options outstanding including
the related transactions under the Plan for the six months ended June 30,
2008:





Number
      of Shares
            
            
            Weighted-Average
      Exercise Price
            
            
            Weighted-Average
      Remaining Contractual Term in Years
            
            
            Aggregate
      Intrinsic ValueOptions
      outstanding as of December 31, 2007
            
            
            812,844
            
            
            $
            11.716Granted
            
            
            18,000
            
            
            $
            16.114Exercised
            
            
            (27,166
            )
            
            $
            10.37Forfeited
            
            
            
            
            
            $
            Expired
            
            
            (1,500
            )
            
            $
            10.00Options
      outstanding as of June 30, 2008
            
            
            802,178
            
            
            $
            11.863
            
            
            6.5
            
            
            $
            1,624,969Options
      exercisable as of June 30, 2008
            
            
            659,844
            
            
            $
            11.104
            
            
            5.9
            
            
            $
            1,477,820Options
      outstanding as of June 30, 2008 and expected to vest
            
            
            756,053
            
            
            $
            11.863
            
            
            6.5
            
            
            $
            1,531,533




The
aggregate intrinsic value (market value of stock less option exercise price) in
the preceding table represents the total pretax intrinsic value, based on the
Company’s closing stock price on June 30, 2008, which would have been received
by the option holders had all holders of options in the money exercised their
options as of that date.




Proceeds
received from the exercise of stock options were approximately $24,000 and
$40,000, respectively, in the six months ended June 30, 2008 and 2007, and were
included in financing activities on the Company’s consolidated statements of
cash flows.  In addition for the six months ended June 30, 2008,
11,890 shares were surrendered upon the exercise of options to fund the
purchase.  The total intrinsic value of stock options exercised for
the three months ended June 30, 2008 and 2007 was $16,738 and $79,795,
respectively, and for the six months ended June 30, 2008 and 2007 was $288,414
and $110,348, respectively.





During
the six months ended June 30, 2008, the board of directors granted 18,000 option
shares to employees at a weighted average exercise price of $16.11 per
share.  During the six months ended June 30, 2007, the board of
directors granted 125,000 option shares to employees, directors and consultants
at an exercise price of $9.10 per share.  The non-executive directors’
options are exercisable immediately.  All other options vest as to
one-third, immediately upon grant and as to one-third, upon each of the first
and second anniversaries of grant.  The weighted-average fair value at
the date of grant for options granted during the six months ended June 30, 2008
was $12.44 per share and was estimated using the Black-Scholes option pricing
model with the following weighted-average assumptions:





Expected
      term in years
            8.64Risk-free
      interest rate
            3.64%Expected
      volatility
            92.6%Dividend
      yield
            0%





The
Company estimates the fair value of stock options using a Black-Scholes option
pricing model.  Key input assumptions used to estimate the fair value
of stock options include the expected term, expected volatility of the Company’s
stock, the risk free interest rate, option forfeiture rates, and dividends, if
any.  The expected term of the options is based upon the historical
term until exercise or expiration of all granted options.  The
expected volatility is derived from the historical volatility of the Company’s
stock on the U.S. NASDAQ Capital Market (the Over-the-Counter market prior to
October 3, 2007) for a period that matches the expected term of the
option.  The risk-free interest rate is the constant maturity rate
published by the U.S. Federal Reserve Board that corresponds to the expected
term of the option.  SFAS No. 123R requires forfeitures to be
estimated at the time of grant in order to estimate the amount of share-based
awards that will ultimately vest.  The estimate is based on the
Company’s historical rates of forfeitures.  SFAS No. 123R also
requires estimated forfeitures to be revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates.  The
dividend yield is assumed as 0% because the Company has not paid dividends and
does not expect to pay dividends in the future.





- 13
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 Index





Note
5.  Commitments





The
Company is obligated under a five-year sublease agreement through March 2009 for
its principal office (3,925 square feet) at an annual cost of approximately
$128,000, including rent, utilities and parking.  The Company is
obligated under a four-year lease which expired in July 2008 for 2,750 square
feet of warehouse space at an annual cost of approximately $21,000, including
utilities.  We have renewed our lease for the warehouse space at the
same annual cost until July 2009.  In addition, the Company is
obligated under a 64-month lease through March 2013 for 1,942 square feet of
administrative space in the U.K. at an annual cost of approximately $65,000,
including utilities and parking.





Effective
October 28, 1994, Fuel Tech, Inc., successor to Fuel-Tech N.V. (“Fuel Tech”),
the company that spun CDT off in a rights offering in December 1995, granted two
licenses to the Company for all patents and rights associated with its platinum
fuel-based catalyst technology.  Effective November 24, 1997, the
licenses were canceled and Fuel Tech assigned to CDT all such patents and rights
on terms substantially similar to the licenses.  In exchange for the
assignment commencing in 1998, the Company is obligated to pay Fuel Tech a
royalty of 2.5% of its annual gross revenue attributable to sales of the
platinum fuel-borne catalysts.  The royalty obligation expires in
December 2008.  CDT may terminate the royalty obligation to Fuel Tech
by payment of $1.1 million.  CDT, as assignee and owner, maintains the
technology at its expense.  Royalty expense incurred under this
obligation for each of the three months ended June 30, 2008 and 2007 was
approximately $3,800 and for the six months ended June 30, 2008 and 2007 was
approximately $8,400 and $6,500, respectively.  Royalties payable to
Fuel Tech at June 30, 2008 and December 31, 2007 were $8,400 and $14,300,
respectively.





Note
6.  Related Party Transactions





The
Company has a Management and Services Agreement with Fuel Tech that requires the
Company to reimburse Fuel Tech for management, services and administrative
expenses incurred on the Company’s behalf at a rate equal to an additional 3% to
10% of the costs paid on the Company’s behalf, dependent upon the nature of the
costs incurred.  Currently, the Company reimburses Fuel Tech for the
expenses associated with one Fuel Tech officer/director who also serves as an
officer/director of CDT.  The Company’s condensed consolidated
statements of operations include charges from Fuel Tech of certain management
and administrative costs of approximately $18,000 in each of the three-month
periods ended June 30, 2008 and 2007 and $35,000 in each of the six-month
periods ended June 30, 2008 and 2007.  The Company believes the
charges under this Management and Services Agreement are reasonable and
fair.  The Management and Services Agreement is for an indefinite term
but may be cancelled by either party by notifying the other in writing of the
cancellation on or before May 15 in any year.





Note
7.  Significant Customers





For the
three and six months ended June 30, 2008 and 2007, revenue derived from certain
customers comprised 10% or more of our consolidated revenue (“significant
customers”) as set forth in the table below:





Three
      Months Ended
              June
      30,
            
            Six
      Months Ended
              June
      30,2008
            
            2007
            
            2008
            
            2007Customer
      A
            
            18.4%
            
            *
            
            15.4%
            
            *Customer
      B
            
            *
            
            80.4%
            
            *
            
            68.5%





*
            Represents less than 10% revenue
      for that customer in the applicable period.  There were no other
      customers that represented 10% or more of revenue for the periods
      indicated.





- 14
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 Index





At June
30, 2008, Clean Diesel had two customers (Customer A in the table above and the
other such customer is not included in the table above) that represented
approximately 24.1% of its gross accounts receivable balance.





Note
8.  Comprehensive Loss





Components
of comprehensive loss follow:





(in
      thousands)Three
      Months Ended
            
            
            Six
      Months EndedJune
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      loss
            
            $
            (2,143
            )
            
            $
            (519
            )
            
            $
            (3,733
            )
            
            $
            (2,334
            )Other
      comprehensive income (loss):Foreign
      currency translation adjustment
            
            
            33
            
            
            
            1
            
            
            
            21
            
            
            
            1Unrealized
      loss on available-for-sale securities
            
            
            (164
            )
            
            
            
            
            
            
            (750
            )
            
            
            Comprehensive
      loss
            
            $
            (2,274
            )
            
            $
            (518
            )
            
            $
            (4,462
            )
            
            $
            (2,333
            )





Note
9.  Geographic Information





CDT sells
its products and licenses its technologies throughout the world.  A
geographic distribution of revenue consists of the following:








(in
      thousands)Three
      Months Ended
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Revenue:U.S.
            
            $
            267
            
            
            $
            710
            
            
            $
            402
            
            
            $
            869U.K./Europe
            
            
            2,304
            
            
            
            533
            
            
            
            4,750
            
            
            
            569Asia
            
            
            48
            
            
            ─
            
            
            
            68
            
            
            
            21Total
            
            $
            2,619
            
            
            $
            1,243
            
            
            $
            5,220
            
            
            $
            1,459





The
Company has patent coverage in North and South America, Europe, Asia, Africa and
Australia.  As of June 30, 2008 and December 31, 2007, the Company’s
assets comprise the following:





(in
      thousands)June
      30,
            
            
            December
      31,2008
            
            
            2007U.S.
            
            $
            16,768
            
            
            $
            22,680Foreign
            
            
            4,509
            
            
            
            1,983Total
      assets
            
            $
            21,277
            
            
            $
            24,663





Note
10.  Subsequent Events





On July
25, 2008, we borrowed $3 million from the demand loan facility with a lender
collateralized by our auction rate securities, a facility we had arranged on May
8, 2008.  Management determined to draw down the entire facility as a
matter of financial prudence to secure available cash.  The loan
facility may be used for our working capital purposes.  We must
continue to meet certain collateral maintenance requirements, such that our
outstanding borrowings may not exceed 50% of the value of our auction rate
securities as determined by the lender.  No facility fee is required
and borrowings will be at a floating interest rate per annum equal to the sum of
the prevailing daily 30-day Libor plus 25 basis points.




On August
8, 2008, the U.S. Securities and Exchange Commission’s Division of Enforcement
announced that it had entered into a preliminary agreement in principle with UBS
Securities LLC and UBS Financial Services, Inc. ( collectively "UBS"), whereby
UBS will use its best efforts to liquidate at par value by the end of 2009 but
not later than June 30, 2010.  Ourinvestment holdings of
$11.7 million par value of auction rate securities were purchased and
held through UBS.  The Company believes that this
agreement in principle will apply to these investments,but has not yet
determined the effect.


- 15
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 Index





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





Forward-Looking
Statements





Statements
in this Quarterly Report on Form 10-Q that are not historical facts, so-called
“forward-looking statements,” are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995.  Investors are
cautioned that all forward-looking statements involve risks and uncertainties,
including those detailed in the Company’s filings with the Securities and
Exchange Commission.  See Item 1A, “Risk Factors,” and Item 7,
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2007.





Results
of Operations





Three
Months ended June 30, 2008 Compared to Three Months ended June 30,
2007





Total
revenue in the three months ended June 30, 2008 was $2,619,000 compared to
$1,243,000 in the three months ended June 30, 2007, an increase of $1,376,000,
or 110.7%, primarily attributable to sales of our Purifier Systems as an
emission reduction solution that meets the standards established for the London
Low Emission Zone.  Of our operating revenue for the three months
ended June 30, 2008, approximately 95.1% was from product sales and 4.9% was
from technology licensing fees and royalties.  Of our operating
revenue for the three months ended June 30, 2007, approximately 11.2% was from
product sales and 88.8% was from technology licensing fees and
royalties.  The mix of our revenue sources during any reporting period
may have a material impact on our operating results.  In particular,
our execution of technology licensing agreements, and the timing of the revenue
recognized from these agreements, has not been predictable.





Product
sales were $2,490,000 in the second quarter of 2008 compared to $139,000 in the
same 2007 quarter, an increase of $2,351,000.  The increase in product
sales is attributable primarily to higher demand for our Platinum Plus Purifier
Systems, a product comprised of a diesel particulate filter along with our
Platinum Plus fuel-borne catalyst to enable regeneration.  We received
approval in October 2007 from Transport for London to supply our Purifier
Systems as an emission reduction solution that meets the standards established
for the London Low Emission Zone.  The deadlines for compliance with
the London Low Emission Zone will be phased in over time for different
classifications of vehicles.  February 2008 was the compliance
deadline for vehicles greater than 12 metric tons.  July 2008 was the
deadline for motor coaches and vehicles greater than 3.5 metric
tons.  In 2008, our Purifier Systems were approved for emissions
reduction in Scotland under a grant-supported retrofit program for Scottish
council fleets.  We believe these sales of our Purifier Systems for
compliance with the requirements of the London Low Emission Zone may provide us
with recurring revenue from use of our Platinum Plus fuel-borne catalyst that
enables the regeneration of the diesel particulate filter.  We believe
we will have the opportunity to expand this business model as additional Low
Emission Zones are established throughout
Europe.





Our
technology licensing fees and royalties were $129,000 in the three months ended
June 30, 2008 compared to $1,104,000 in the same quarter of 2007.  In
each of the three months ended June 30, 2008 and 2007, we executed new
technology licensing agreements and recognized revenue from license fees for the
use of our ARIS® technologies for control of oxides of nitrogen (NOx) using our
selective catalytic reduction (SCR) emission control, the combination of exhaust
gas recirculation (EGR) with SCR technologies, and hydrocarbon injection for
lean NOx traps, NOx catalysts and diesel particulate filter
regeneration.  The second quarter of 2008 reflects license fees from
Hilite International, Inc.  The second quarter of 2007 includes
license fees on license agreements executed with Robert Bosch GmbH and
Combustion Components Associates, Inc.  We are continuing our efforts
to consummate technology license agreements with manufacturers and component
suppliers for the use of our ARIS technologies.





Our total
cost of revenue was $1,993,000 in the three-month period ended June 30, 2008
compared to $105,000 in the three-month period ended June 30,
2007.  The increase in our cost of sales is due to higher product
sales volume.  Our gross profit as a percentage of revenue was 23.9%
and 91.6% for the three-month periods ended June 30, 2008 and 2007,
respectively, with the decrease attributable to the mix of lower margin product
sales.





Our cost
of revenue – product sales includes the costs we incur to formulate our finished
products into saleable form for our customers, including material costs, labor
and processing costs charged to us by our outsourced blenders, installers and
other vendors, packaging costs incurred by our outsourced suppliers, freight
costs to customers and inbound freight charges from our
suppliers.  Our inventory is primarily maintained off-site by our
outsourced suppliers.  To date, our purchasing, receiving, inspection
and internal transfer costs have been insignificant and have been included in
cost of revenue – product sales.  In addition, the costs of our
warehouse of approximately $21,000 per year are included in selling, general and
administrative expenses.  Our gross margins may not be comparable to
those of other entities, because some entities include all of the costs related
to their distribution network in cost of revenue and others like us exclude a
portion of such costs from gross margin, including such costs instead within
operating expenses.  Cost of revenue – licensing fees and royalties is
zero as there are no incremental costs associated with the
revenue.  Cost of revenue – consulting and other includes incremental
out of pocket costs to provide consulting services.





- 16
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 Index





Selling,
general and administrative expenses were $2,722,000 in the three months ended
June 30, 2008 compared to $1,495,000 in the comparable 2007 period, an increase
of $1,227,000, or 82.1%.  The increase in selling, general and
administrative costs is primarily attributable to higher compensation and
benefits, travel and occupancy costs as further discussed
below.  Selling, general and administrative expenses are summarized as
follows:





(in
      thousands)Three
      Months Ended
              June
      30,2008
            
            
            2007Non-cash
      stock-based compensation
            
            $
            238
            
            
            $
            91Compensation
      and benefits
            
            
            1,193
            
            
            
            653Total
      compensation and benefits
            
            
            1,431
            
            
            
            744Professional
            
            
            385
            
            
            
            365Travel
            
            
            251
            
            
            
            158Occupancy
            
            
            265
            
            
            
            123Sales
      and marketing expenses
            
            
            144
            
            
            
            72Bad
      debt provision
            
            
            223
            
            
            
            30Depreciation
      and all other
            
            
            23
            
            
            
            3Total
      selling, general and administrative expenses
            
            $
            2,722
            
            
            $
            1,495





Aggregate
non-cash charges for the fair value of stock options and warrants in the three
months ended June 30, 2008 were $241,000, of which $238,000 has been included in
selling, general and administrative expenses and $3,000 in research and
development expenses.  This compares to $91,000 in non-cash stock
option compensation expense in the three months ended June 30,
2007.





Total
compensation and benefit expense in the three months ended June 30, 2008
included $238,000 of non-cash charges for the fair value of stock options
compared to $91,000 in non-cash stock option compensation expense in the three
months ended June 30, 2007.  Excluding the non-cash stock-based
charges, compensation and benefit expenses were $1,193,000 for the three months
ended June 30, 2008 compared to $653,000 in the comparable prior year period, an
increase of $540,000, or 82.7%, due to new personnel and higher salaries for
existing personnel in 2008 compared to 2007.





Professional
fees include public relations, investor relations and financial advisory fees
along with audit-related costs.   Occupancy costs include office
rents, insurance and related costs.  We moved our U.K. administrative
offices in November 2007 and expect higher occupancy costs in the
future.





Research
and development expenses were $89,000 in the three months ended June 30, 2008
compared to $150,000 in the three months ended June 30, 2007, a decrease of
$61,000, or 40.7%.  The 2008 projects include laboratory testing on
additive formulations, including a new bio-fuel, and field testing of emission
control technologies.  The 2008 research and development expenses
include $3,000 of non-cash charges for the fair value of stock
options.





Patent
amortization and other patent expenses were $42,000 in the three months ended
June 30, 2008 compared to $79,000 in the same period in 2007, a decline of
$37,000 due to additional costs in 2007 associated with the protection of the
CDT patents.





Interest
income was $113,000 in the three months ended June 30, 2008 compared to $67,000
in the three months ended June 30, 2007, an increase of $46,000, or 68.7%, due
to higher invested balances.





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 Index





Other
expense was $29,000 in the three months ended June 30, 2008 and is comprised of
foreign currency transaction losses, net of gains.





Six
Months ended June 30, 2008 Compared to Six Months ended June 30,
2007





Total
revenue for the first half of 2008 increased $3,761,000, or 257.8%, to
$5,220,000 from $1,459,000 in the first half of 2007 due primarily to sales of
our Purifier Systems as an emission reduction solution that meets the standards
established for the London Low Emission Zone.  Operating revenue in
the six months ended June 30, 2008 consisted of approximately 96.1% in product
sales and 3.9% in technology licensing fees and royalties.  Operating
revenue in the six months ended June 30, 2007 consisted of approximately 23.6%
in product sales and 76.4% in technology licensing fees and
royalties.  The mix of our revenue sources during any reporting period
may have a material impact on our operating results.  In particular,
our execution of technology licensing agreements, and the timing of the revenue
recognized from these agreements, has not been predictable.





Product
sales in the six months ended June 30, 2008 were $5,017,000 compared to $344,000
in the same prior year period, an increase of $4,673,000, or
1,358.4%.  The increase in product sales is attributable primarily to
higher demand for our Platinum Plus Purifier Systems, a product comprised of a
diesel particulate filter along with our Platinum Plus fuel-borne catalyst to
enable regeneration.  We received approval in October 2007 from
Transport for London to supply our Purifier Systems as an emission reduction
solution that meets the standards established for the London Low Emission
Zone.  The deadlines for compliance with the London Low Emission Zone
will be phased in over time for different classifications of
vehicles.  February 2008 was the compliance deadline for vehicles
greater than 12 metric tons and July 2008 was the compliance deadline for motor
coaches and vehicles greater than 3.5 metric tons.  During our first
quarter of 2008, our Purifier Systems were approved for emissions reduction in
Scotland under a grant-supported retrofit program for Scottish council
fleets.  We believe these sales of our Purifier Systems for compliance
with the requirements of the London Low Emission Zone may provide us with
recurring revenue from use of our Platinum Plus fuel-borne catalyst that enables
the regeneration of the diesel particulate filter.  We believe we will
have the opportunity to expand this business model as additional Low Emission
Zones are established throughout Europe.





Technology
licensing fees and royalties included fees upon execution of new agreements and
royalties from existing licensees, primarily for use of our ARIS
technologies.  In the first half of each of 2008 and 2007, we executed
new technology licensing agreements and recognized revenue from license fees for
the use of our ARIS® technologies for control of oxides of nitrogen (NOx) using
our selective catalytic reduction (SCR) emission control, the combination of
exhaust gas recirculation (EGR) with SCR technologies, and hydrocarbon injection
for lean NOx traps, NOx catalysts and diesel particulate filter
regeneration.  Our license agreements executed in 2008 include Headway
Machinery Co., Ltd. (Zhucheng City, China) and Hilite International, Inc.
(Cleveland, Ohio).  The new license agreements executed in the first
six months of 2007 include Robert Bosch GmbH and Combustion Components
Associates, Inc.  We are continuing our efforts to consummate
technology license agreements with manufacturers and component suppliers for the
use of our ARIS technologies.





Our total
cost of revenue was $4,058,000 in the six-month period ended June 30, 2008
compared to $221,000 in the six-month period ended June 30, 2007.  The
increase in our cost of sales is due to higher product sales
volume.  Our gross profit as a percentage of revenue was 22.3% and
84.9% for six-month periods ended June 30, 2008 and 2007, respectively, with the
decrease attributable to the mix of lower margin product sales.





Our cost
of revenue – product sales includes the costs we incur to formulate our finished
products into saleable form for our customers, including material costs, labor
and processing costs charged to us by our outsourced blenders, installers and
other vendors, packaging costs incurred by our outsourced suppliers, freight
costs to customers and inbound freight charges from our
suppliers.  Our inventory is primarily maintained off-site by our
outsourced suppliers.  To date, our purchasing, receiving, inspection
and internal transfer costs have been insignificant and have been included in
cost of revenue – product sales.  In addition, the costs of our
warehouse of approximately $21,000 per year are included in selling, general and
administrative expenses.  Our gross margins may not be comparable to
those of other entities, because some entities include all of the costs related
to their distribution network in cost of revenue and others like us exclude a
portion of such costs from gross margin, including such costs instead within
operating expenses.  Cost of revenue – licensing fees and royalties is
zero as there are no incremental costs associated with the
revenue.  Cost of revenue – consulting and other includes incremental
out of pocket costs to provide consulting services.





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 Index





Selling,
general and administrative expenses were $5,044,000 in the six months ended June
30, 2008 compared to $3,298,000 in the comparable 2007 period, an increase of
$1,746,000, or 52.9%.  Selling, general and administrative expenses
are summarized as follows:





(in
      thousands)Six
      Months EndedJune
      30,2008
            
            
            2007Non-cash
      stock-based compensation
            
            $
            538
            
            
            $
            642Compensation
      and benefits
            
            
            2,080
            
            
            
            1,254Total
      compensation and benefits
            
            
            2,618
            
            
            
            1,896Professional
            
            
            1,032
            *
            
            
            588Travel
            
            
            365
            
            
            
            296Occupancy
            
            
            510
            
            
            
            235Sales
      and marketing expenses
            
            
            229
            
            
            
            160Bad
      debt provision
            
            
            241
            
            
            
            30Depreciation
      and all other
            
            
            49
            
            
            
            93Total
      selling, general and administrative expenses
            
            $
            5,044
            
            
            $
            3,298





*  Includes
$227,000 of non-cash stock-based compensation charges for fair value of
warrants.





The
Company’s aggregate non-cash charges for the fair value of stock options and
warrants in the six months ended June 30, 2008 were $771,000, of which $765,000
has been included in selling, general and administrative expenses ($538,000 in
compensation and $227,000 in professional) and $6,000 in research and
development expenses.  This compares to $642,000 in total non-cash
stock-based compensation expense in the six months ended June 30,
2007.





Compensation
and benefit expense in the six months ended June 30, 2008 included $538,000 of
non-cash charges for the fair value of stock options compared to $642,000 in
non-cash stock option compensation expense in the six months ended June 30,
2007.  Excluding the non-cash stock-based charges, compensation and
benefit expenses were $2,080,000 for the six months ended June 30, 2008 compared
to $1,254,000 in the comparable prior year period, an increase of $826,000, or
65.9%, due to new personnel and higher salary rates in 2008 compared to
2007.





Professional
fees include public relations, investor relations and financial advisory fees
along with audit-related costs.  The significant component of the
increase in professional fees is attributable to stock-based compensation
charges for the fair value of warrants issued for investor relations
services.  In addition, the 2008 professional costs include high costs
of complying with the requirements of the Sarbanes-Oxley Act of 2002 associated
with the Company’s transition to accelerated filer status.  Occupancy
costs include office rents, insurance, telephone and communications, office
supplies and related costs.  We moved our U.K. administrative offices
in November 2007 and expect higher occupancy costs in the future.





Research
and development expenses were $154,000 in the six months ended June 30, 2008
compared to $192,000 in the six months ended June 30, 2007, a decrease of
$38,000, or 19.8%, due to the timing of initiation of our 2008
projects.  The 2008 projects include laboratory testing on additive
formulations and field testing of emission control technologies. The 2008
research and development expenses include $6,000 of non-cash charges for the
fair value of stock options.





Patent
amortization and other patent related expense was $78,000 in the six months
ended June 30, 2008 compared to $176,000 in the same prior year period, a
decline of $98,000 due to additional costs in 2007 associated with the
protection of CDT patents.





Interest
income was $356,000 in the six months ended June 30, 2008 compared to $94,000 in
the six months ended June 30, 2007, an increase of $262,000, or 278.7%, due to
higher invested balances and rates of return during the 2008
period.





Other
income was $25,000 in the six months ended June 30, 2008 and is comprised of
foreign currency transaction gains, net of losses.





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 Index





Liquidity
and Sources of Capital





We
require capital resources and liquidity to fund our global development and for
working capital.  Our working capital requirements vary from period to
period depending upon manufacturing volumes, the timing of deliveries and
payment cycles of our customers.  At June 30, 2008 and December 31,
2007, we had cash, cash equivalents and investments classified as current assets
of $4,485,000 and $8,617,000, respectively, to use for our
operations.





Net cash
used for operating activities was $3,965,000 in the six months ended June 30,
2008 and was used primarily to fund the net loss of $3,733,000, adjusted for
non-cash items.  Included in the non-cash items was stock-based
compensation expense of $771,000 accounted for in accordance with SFAS No.
123R.





Our
working capital was $7,151,000 at June 30, 2008 compared to $10,208,000 at
December 31, 2007, a decrease of $3,057,000.  Accounts receivable, net
increased to $3,330,000 at June 30, 2008 from $1,927,000 at December 31, 2007
due to sales of our Purifier Systems to meet the requirements of the London Low
Emission Zone.  Inventories, net decreased to $1,038,000 at June 30,
2008 from $1,093,000 at December 31, 2007.  Our accounts payable and
accrued expenses increased by $266,000 compared to December 31, 2007 reflecting
higher business activity.





Net cash
provided by investing activities was $6,888,000 in the six months ended June 30,
2008, primarily due to sales of investments (see further discussion
below).  We invested $161,000 in patents in 2008 and expect to
continue to invest in our patents.





Cash
provided by financing activities was $24,000 in the six months ended June 30,
2008 and was attributable to exercise of stock options.





At June
30, 2008, our investments are recorded at fair value in accordance with SFAS No.
157.  At June 30, 2008 and December 31, 2007, we held approximately
$11.0 million ($11.7 million par value) and $18.8 million, respectively, in
investments in auction rate securities collateralized by student loans which are
substantially guaranteed by the U.S. Department of Education.  We sold
$7.1 million of these investments in 2008.  However, starting on
February 15, 2008 and continuing to date in 2008, the Company experienced
difficulty in effecting additional sales of such securities because of the
failure of the auction mechanism as a result of sell orders exceeding buy
orders.  Liquidity for these auction rate securities is typically
provided by an auction process that resets the applicable interest rate at
pre-determined intervals.  These failed auctions represent liquidity
risk exposure and are not defaults or credit events.  Holders of the
securities continue to receive interest on the investments (currently at
pre-determined rates), and the securities will be auctioned at the
pre-determined intervals (typically every 28 days) until the auction succeeds,
the issuer calls the securities, or they mature.  Accordingly, because
there may be no effective mechanism for selling these securities, the securities
may be viewed as long-term assets.  The funds associated with failed
auctions will not be accessible until a successful auction occurs or a buyer is
found outside of the auction process.  As of June 30, 2008, the
estimated fair market value of the investments held by the Company declined by
$750,000 from par value based upon management’s internal assessment and
information provided by the investment bank through which the Company holds such
securities.  Although these securities have continued to pay interest
according to their stated terms and the majority of these securities continue to
be AAA/Aaa rated, in the six months ended June 30, 2008, the Company recorded an
unrealized temporary loss of $750,000 which is reflected in our consolidated
balance sheet in accumulated other comprehensive loss, resulting in a reduction
in stockholders’ equity.  Factors we considered in determining whether
this loss was temporary included the length of time and extent to which fair
value has been less than the cost basis, the financial condition and near-term
prospects of the issuers, and our intent and ability to retain the investment
for a period of time sufficient to allow for any anticipated recovery in fair
value.  We classified $11.0 million and $11.7 million of these auction
rate securities as non-current investments as of June 30, 2008 and
December 31, 2007, respectively.  At this time, because the
Company has the ability and intent to hold these securities until recovery of
their value, the Company does not believe such securities areother-than-temporarily
impaired or that the failure of the auction mechanism will have a material
impact on the Company’s liquidity or financial position.  We continue
to monitor the market for auction rate securities and consider its impact, if
any, on the fair value of our investments.  If current market
conditions deteriorate further, we may be required to record additional
unrealized losses as reductions in stockholders’ equity.  If the
anticipated recovery in market values does not occur, we may be required to
adjust the carrying value of these investments through impairment charges as
other-than-temporary change in the fair value.




On August
8, 2008, the U.S. Securities and Exchange Commission’s Division of Enforcement
announced that it had entered into a preliminary agreement in principle with UBS
Securities LLC and UBS Financial Services, Inc. ( collectively "UBS"), whereby
UBS will use its best efforts to liquidate at par value by the end of 2009 but
not later than June 30, 2010. Ourinvestment holdings of
$11.7 million par value of auction rate securities were purchased and
held through UBS.  The Company believes that this
agreement in principle will apply to these investments,but has not yet
determined the effect.


- 20
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 Index





Our
management believes that based upon the Company’s cash and cash equivalents at
June 30, 2008, the current lack of liquidity in the credit and capital markets
will not have a material impact on our liquidity, cash flow, financial
flexibility or our ability to fund our operations for at least the next 12
months.





We have
incurred losses since inception aggregating $53.2 million, which amount includes
$4.8 million of non-cash preferred stock dividends.  We expect to
incur losses through the foreseeable future, until our products and
technological solutions achieve greater awareness.  Although we have
generated revenue from sales of our Platinum Plus fuel-borne catalyst, Purifier
Systems, ARIS advanced reagent injector and dosing systems for selective
catalytic reduction, catalyzed wire mesh filters and from technology licensing
fees and royalties, revenue to date has been insufficient to cover our operating
expenses, and we continue to be dependent upon sources other than operations to
finance our working capital requirements.  Historically, we have been
primarily dependent upon funding from new and existing
stockholders.  The Company can provide no assurance that it will be
successful in any future financing effort to obtain the necessary working
capital to support operations or if such financing is available, that it will be
on acceptable terms.





In the
event that our business does not generate sufficient cash and external financing
is not available or timely, we would be required to substantially reduce our
level of operations and capital expenditures in order to conserve cash and
possibly seek joint ventures or other transactions, including the sale of
assets.  These reductions could have an adverse effect on our
relationships with our customers and suppliers.  Our long-term
continuation is dependent upon the achievement of profitable operations and the
ability to generate sufficient cash from operations, equity financings and other
funding sources to meet our obligations.





No
dividends have been paid on our common stock and we do not anticipate paying
cash dividends in the foreseeable future.





As of
June 30, 2008, we had no indebtedness; however, we have the ability to borrow
funds for working capital purposes pursuant to a margin arrangement we entered
into in May 2008 (see Note 10).  The demand loan facility allows us to
borrow up to $3 million, subject to collateral maintenance requirements, at a
floating interest rate per annum equal to the sum of the prevailing daily 30-day
Libor plus 25 basis points.  Management determined to draw down the
entire $3 million facility as a matter of financial prudence to secure available
cash.





Capital
Expenditures





As of
June 30, 2008, we had no commitments for capital expenditures and no material
commitments are anticipated in the near future.





- 21
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 Index





Item 3.
            Quantitative
      and Qualitative Disclosures about Market
Risk





In the
opinion of management, with the exception of exposure to fluctuations in the
cost of platinum, exchange rates for pounds sterling and Euros, and current
turmoil in the capital markets and auction rate securities, we are not subject
to any significant market risk exposure.  We monitor the price of
platinum and exchange rates and adjust our procurement strategies as
needed.  There have been no material changes in our market risk
exposures at June 30, 2008 as compared to December 31, 2007.





Item 4.
            Controls
      and Procedures





Evaluation
of Disclosure Controls and Procedures





The
Company’s management, including the President and Chief Executive Officer and
Chief Financial Officer, carried out an evaluation of the Company’s disclosure
controls and procedures (as defined in Rule 15d-15(e) under the Securities
Exchange Act of 1934, as amended) as of the end of the period covered by this
Quarterly Report on Form 10-Q.  Based upon that evaluation, the
Company’s President and Chief Executive Officer and Chief Financial Officer
concluded that Clean Diesel had effective disclosure controls and procedures for
(i) recording, processing, summarizing and reporting information that is
required to be disclosed in its reports under the Securities Exchange Act of
1934, as amended, within the time periods specified in the Securities and
Exchange Commission’s rules and forms and (ii) ensuring that information
required to be disclosed in such reports is accumulated and communicated to the
Company’s management, including its President and Chief Executive Officer and
Chief Financial Officer, as appropriate to allow timely decisions regarding
disclosure.





Changes
in Internal Controls




In
connection with the evaluation by the Company’s President and Chief Executive
Officer and Chief Financial Officer of changes in internal control over
financial reporting that occurred during the Company’s last fiscal quarter, no
change in the Company’s internal control over financial reporting was identified
that has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.





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 Index





PART
      II.
            OTHER
      INFORMATION





Item 4.
            Submission
      of Matters to a Vote of Security
Holders





At the
May 13, 2008 Annual Meeting of Stockholders of the Company, the holders of
4,286,219 shares of the Company’s common stock were present in person or by
proxy.  This attendance was 52.7% of the total of 8,137,650 shares of
common stock outstanding as of the record date of March 14, 2008.





The
results of matters submitted to a vote of the stockholders were as
follows:





(i)  the proposal to elect
six nominees as directors was approved by a vote with respect to each
individual, as follows:





Name
            
            Shares
      For
            
            Shares
      WithheldJohn
      A. de Havilland
            
            4,311,767
            
            26,407Derek
      R. Gray
            
            4,315,522
            
            22,652Charles
      W. Grinnell
            
            4,305,022
            
            33,152John
      J. McCloy II
            
            4,313,197
            
            24,925David
      F. Merrion
            
            4,313,197
            
            24,977Bernhard
      Steiner
            
            4,316,952
            
            21,222





(ii)  the proposal to ratify
the appointment of Eisner LLP as the Company’s independent registered public
accounting firm for the year 2008 was approved by a vote of 4,259,220 for and
26,798 shares against.








Item 6.
            Exhibits





(a)
            
            ExhibitsExhibit
      Number
            
            Description31(a)
            
            Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Exchange
      Act31(b)
            
            Certification
      of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Exchange
      Act32
            
            Certifications
      of CEO and CFO Pursuant to 18 U.S.C. Section
  1350




- 23
-
 Index





SIGNATURES








Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.








CLEAN DIESEL
      TECHNOLOGIES, INC.(Registrant)Date:  August
      11, 2008
            By:
            /s/  Bernhard
      SteinerBernhard
      SteinerDirector,
      President andChief
      Executive OfficerDate:  August
      11, 2008
            By:
            /s/  Ann B. RupleAnn
      B. RupleChief
      Financial Officer,Vice
      President and Treasurer







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